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Initial Decision of an SEC Administrative Law JudgeIn the Matter of
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In the Matter of DEL MAR FINANCIAL SERVICES, INC.,
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INITIAL DECISION
August 14, 2001 |
| APPEARANCES: | William H. Kuehnle and Douglas C. McAllister for the Division of Enforcement, Securities and Exchange Commission.
Scott W. Wellman of Wellman & Warren LLP for Respondents Kevin C. Dills and Del Mar Financial Services, Inc. Stephen G. Topetzes and Elizabeth H. Baird of Kirkpatrick & Lockhart LLP for Respondents Robert A. Roberts and Private Brokers Corporation. Stephen A. Zrenda, Jr., of Stephen A. Zrenda, Jr., P.C., for Respondent Matthew R. Jennings. Daniel A. Kaplan of Coughlan, Semmer & Lipman, LLP, for Respondent Jai Chaudhuri. |
| BEFORE: | Carol Fox Foelak, Administrative Law Judge. |
SUMMARY
This Initial Decision finds that broker-dealer Del Mar Financial Services, its owner Kevin C. Dills, and his associate Jai Chaudhuri engaged in a scheme to promote the stock of Comparator Systems Corporation during 1995 in which Dills received kickbacks that he did not disclose to customers who bought the stock. The stock was obtained by Chaudhuri at discount prices and sold by Dills through Del Mar to targeted customers at market prices. Dills assured customers that he was receiving only a nominal commission on the sales, but was actually receiving substantial kickbacks. Chaudhuri kicked back about $500,000 of the profits to Dills and retained about $100,000 for himself. The Decision concludes that Del Mar, Dills, and Chaudhuri violated the antifraud provisions.
Then, in May 1996, the stock soared during four days of frenzied trading. Dills advised Del Mar customers to sell, and the flood of orders overwhelmed Del Mar's one-man trading operation on Friday, May 3, and Monday, May 6. A mismatch of customer and market maker orders and other trading errors left Del Mar liable to pay out more than $500,000. Dills addressed this problem by lowering prices after the fact on many customer trades and giving customers false explanations when they complained. The Decision concludes that Del Mar and Dills violated antifraud, books and records, and minimum net capital provisions.
The Decision orders Chaudhuri, who holds no securities licenses, to disgorge ill-gotten gains of $103,550 and to cease and desist from further violations. Dills and Del Mar are ordered to pay a total of $1,701,677.50 in fines and disgorgement and to cease and desist from further violations and are barred from the securities industry.
The Decision clears Del Mar's trader, Matthew R. Jennings, and clearing firm and its president, Private Brokers Corporation and Robert A. Roberts, of wrongdoing and dismisses the charges against them.
I. INTRODUCTION
A. Procedural Background
The Securities and Exchange Commission (Commission) initiated this proceeding by an Order Instituting Proceedings (OIP) on August 2, 1999, against Del Mar Financial Services, Inc. (Del Mar), Kevin C. Dills, Private Brokers Corporation (Private Brokers), Robert A. Roberts, and Matthew R. Jennings pursuant to Section 8A of the Securities Act of 1933 (Securities Act) and Sections 15(b)(4), 15(b)(6), and 21C of the Securities Exchange Act of 1934 (Exchange Act); and against Jai Chaudhuri pursuant to Section 8A of the Securities Act and 21C of the Exchange Act.1
The undersigned held five days of hearings in Los Angeles, California, February 14-18, 2000, and three days of hearings in Washington, D.C., March 6-8, 2000. The Division of Enforcement (Division) called nineteen witnesses from whom testimony was taken, including Respondents Chaudhuri, Dills, Jennings, and Roberts. Roberts and Private Brokers called two witnesses, and Jennings called three witnesses. Chaudhuri, Dills, and Del Mar called no witnesses. The record includes 106 exhibits in evidence: 101 from the Division; three from Roberts and Private Brokers; one from Dills; and one from Chaudhuri.2
The findings and conclusions in this Initial Decision are based on the record. Preponderance of the evidence was applied as the standard of proof. See Steadman v. SEC, 450 U.S. 91 (1981). Pursuant to the Administrative Procedure Act,3 the following posthearing pleadings were considered: (1) the Division's Proposed Findings of Fact and Conclusions of Law and Post-Trial Brief, received May 15, 2000; (2) Private Brokers's and Roberts's Post-Hearing Memorandum, received May 15, 2000; (4) Jennings's Post-Hearing Brief and Proposed Findings of Fact and Conclusions of Law, received May 15, 2000; (5) the Division's Post-Trial Reply Brief, received June 23, 2000; and (6) Private Brokers's and Roberts's Reply to Post-Trial Brief Submitted by Division of Enforcement, received June 27, 2000. All arguments and proposed findings and conclusions that are inconsistent with this Initial Decision were considered and rejected.
B. Allegations and Arguments of the Parties
1. Stock Promotion and Kickbacks
The OIP alleged violations of the antifraud and other provisions of the securities laws arising out of two separate fact situations involving the stock of Comparator Systems Corporation (Comparator). First, the OIP alleged a fraudulent scheme from January 1995 to March 1996, in which Chaudhuri obtained stock, at discount prices and as payment for promoting Comparator, that Dills sold through Del Mar to targeted customers at market prices. The OIP alleged that Dills and Del Mar represented to the customers that commissions were their only compensation, but that the trades actually resulted in an immediate $650,000 profit, of which Chaudhuri paid Dills at least $360,000. The OIP charged Dills and Chaudhuri with violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Del Mar, with violating Section 17(a) of the Securities Act and Sections 10(b) and 15(c) of the Exchange Act and Rules 10b-5 and 15c1-2 thereunder. Dills was also charged with aiding and abetting, and causing Del Mar's violations of Exchange Act Section 15(c) and Rule 15c1-2, and Chaudhuri, with causing Dills's and Del Mar's violations. Chaudhuri, Dills, and Del Mar do not affirmatively defend the charges.
2. May 1996 Trading
The second fact situation arose with a sudden spike in Comparator's price during trading on May 3 and 6, 1996. The OIP alleged that Jennings, Del Mar's trader, sold Comparator short so as to cause losses of over $900,000, consisting of a trading loss of over $400,000 and an uncovered short position of 500,000 shares when Comparator closed on May 6 at 1. The OIP alleged that Roberts of Private Brokers, Del Mar's clearing firm, contacted Dills on May 7 and demanded that Del Mar send a $1,000,000 deposit or eliminate its financial exposure. The OIP alleged that Roberts suggested that Del Mar might consider changing customer order tickets to lower prices. The OIP alleged that Dills and Jennings changed many May 3 and 6 order tickets and sent them to Private Brokers. The OIP alleged that Private Brokers had already sent accurate confirmations to customers, and that it processed the changed order tickets and sent new confirmations with lower prices. The OIP alleged that Roberts knew that the changes were part of a scheme to cover Del Mar's trading losses at the expense of its customers.
The OIP charged Dills and Del Mar with antifraud violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Del Mar, with violating Section 15(c) of the Exchange Act and Rule 15c1-2 thereunder. Dills was also charged with aiding and abetting, and causing Del Mar's violations of Exchange Act Section 15(c) and Rule 15c1-2. Jennings was charged with aiding and abetting, and causing Del Mar's violations. Roberts and Private Brokers were charged with violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Private Brokers with violating Section 15(c)(1)(A) of the Exchange Act and Rule 15c1-2 thereunder. Roberts was also charged with aiding and abetting, and causing Private Brokers's violations, and Roberts and Private Brokers, with aiding and abetting, and causing Dills's and Del Mar's violations.
The OIP also charged Del Mar and Private Brokers with books and records violations of Exchange Act Section 17(a) and Rules 10b-10 and 17a-3. Dills, Jennings, Roberts, and Private Brokers were charged with aiding and abetting, and causing Del Mar's violations, and Roberts, with aiding and abetting, and causing Private Brokers's violations. Finally, the OIP charged Del Mar with net capital violations of Exchange Act Section 15(c)(3) and Rules 15c3-1 and 17a-11 by continuing to conduct business as a broker-dealer and failing to notify the Commission when it lacked the required minimum net capital on May 6, 1996. Dills was charged with aiding and abetting, and causing Del Mar's violations.
Dills and Del Mar do not affirmatively defend the charges against them. Roberts and Private Brokers argue that the charges against them are outside the well-established boundaries of a clearing firm's duties; a clearing firm is not the compliance officer for the introducing firm and is not responsible for the introducing firm's fraud against its customers. They argue that they acted reasonably and in good faith throughout the time at issue. They argue that Roberts acted appropriately when he informed Dills of price and share discrepancies, deleted Del Mar's ability to execute its trades, and covered the oversell, and that he did not instruct Dills to change prices. Roberts and Private Brokers argue that they had no knowledge of Del Mar's communications with customers about the changes, and that it was reasonable to process the changes. Jennings argues that he participated in changing the order tickets only under duress, consisting of credible threats of violence by Dills.
3. Sanctions Sought
As to Chaudhuri, the Division seeks disgorgement of ill-gotten gains from the stock promotion scheme of $662,451.51 and prejudgment interest, jointly and severally with Dills; and a cease and desist order. As to Dills and Del Mar, the Division additionally seeks disgorgement of $860,159.38 of losses avoided by changing order tickets and prejudgment interest, jointly and severally, from Dills, Del Mar, Roberts, and Private Brokers; third-tier civil money penalties; a bar and revocation; and cease and desist orders. As to Roberts and Private Brokers, the Division additionally seeks third-tier civil money penalties; a bar and revocation; and cease and desist orders. As to Jennings, the Division seeks a one-year suspension; and a cease and desist order. Chaudhuri, Dills, and Del Mar do not affirmatively defend the charges but offer evidence concerning their ability to pay penalties and disgorgement. Roberts, Private Brokers, and Jennings contend that the proceedings against them should be dismissed.
C. Procedural Issues
1. Adverse Inference from Refusal to Testify
Chaudhuri and Dills each invoked his Fifth Amendment right against self-incrimination when called by the Division to testify at the hearing. Tr. 35-43, 353-57, 358-60. An adverse inference may be drawn from a respondent's refusal to testify in a Commission administrative proceeding. See Pagel, Inc. v. SEC, 803 F.2d 942, 946-47 (8th Cir. 1986); N. Sims Organ & Co., Inc. v. SEC, 293 F.2d 78, 80-81 (2d Cir. 1961); see also Baxter v. Palmigiano, 425 U.S. 308, 319 (1976) (Fifth Amendment privilege against self-incrimination does not forbid drawing adverse inferences from an inmate's failure to testify at his own disciplinary proceedings). Therefore Chaudhuri's and Dills's silence may be considered along with other relevant evidence in assessing the evidence against them. See Pagel, Inc., 803 F.2d at 947.
2. Investigative Testimony of Chaudhuri and Dills
The Division took investigative testimony concerning the events at issue and other matters from Chaudhuri on November 15, 1996, and from Dills on October 28 and 29, 1996, and April 22, 1997. Because of their refusal to testify at the hearing concerning the events at issue, the undersigned admitted the transcript of Chaudhuri's investigative testimony as Div. Ex. 149 for use against him, and of Dills's investigative testimony as Div. Ex. 150 for use against him. Tr. 1462-63.
The Division urges that the investigative testimony of Dills should be admitted for use against Roberts, Private Brokers, and Jennings, as well. These Respondents oppose this use. The Division cites the hearsay exceptions of statement against interest by an unavailable declarant and coconspirator statements found in the Federal Rules of Evidence (FRE).4 The Division notes that the standard of admissibility in administrative proceedings is extremely broad.
The Commission's Rules, tracking the Administrative Procedure Act, provide, "the [administrative law judge] may receive relevant evidence and shall exclude all evidence that is irrelevant, immaterial, or unduly repetitious." 17 C.F.R. § 201.320; see also 5 U.S.C. § 556(c)(3) and (d). The Commission has ruled that administrative law judges should be inclusive in making evidentiary determinations in its proceedings: "if in doubt, let it in." See City of Anaheim, Order Vacating Grant of Motion to Exclude Evidence, 71 SEC Docket 191, 193-94 & nn. 4-8 (Nov. 16, 1999).
There is no doubt that the investigative testimony of Dills should not be admitted against Roberts, Private Brokers, and Jennings because it would be fundamentally unfair to do so.5 It would cast doubt on whether they were accorded due process in this proceeding. These Respondents did not have the opportunity, and were forbidden by the Commission's Rules, to confront Dills and to cross-examine him. 17 C.F.R. § 203.7(b).
3. Investigative Testimony of Roberts and Jennings
The Division called Jennings and Roberts as witnesses in its direct case. Jennings testified in Los Angeles, California, on February 14, 15, and 16, and Roberts, on February 16 and 17. Roberts testified again in his own case in Washington, D.C., on March 7. Thereafter, on March 7, the Division offered Jennings's October 8, 1996, investigative testimony as Div. Ex. 151 and Roberts's January 9, 1997, investigative testimony as Div. Ex. 152. Counsel for Roberts objected. Jennings was not present during the hearing sessions in Washington, D.C., but the undersigned invited the Division to recall Roberts to the witness stand to elicit live testimony and enable the Division to use Div. Ex. 152 to impeach him. The Division declined, stressing that the purpose of offering Roberts's investigative testimony was not to impeach his hearing testimony. Tr. 1449-50, 1456-61. The exhibits were not admitted into evidence. Tr. 1193, 1461. The Division argues that they should be admitted, citing the evidentiary concepts of prior statements of a party opponent and prior inconsistent statements. The arguments concerning this matter are found in the Division's and Roberts's posthearing pleadings and at Tr. 1189-95 and 1443-66. As the undersigned ruled at the hearing, Div. Exs. 151 and 152 should not be admitted because to do so is fundamentally unfair.6 Also, the timing of the offer of the exhibits reduced the Respondents' ability to rebut them.7
II. FINDINGS OF FACT
A. Respondents
1. Dills and Del Mar
a. Dills
Dills was the sole owner and president of Del Mar. Tr. 351-52. Prior to founding Del Mar in 1993, Dills worked for several broker-dealers, including Stuart-James.8 Tr. 348, 351. He has Series 7, 24, and 63 securities licenses. Tr. 347. Born in 1956, Dills did not graduate from high school. Tr. 347; Div. Ex. 155 at ENF 05590. His criminal history includes: a 1989 cocaine arrest, later dismissed; a juvenile drug prosecution resulting in a drug diversion program; two drunk driving arrests resulting in probation; a hit and run misdemeanor resulting in ninety days confinement; an arrest for a stolen auto, released the next day; and falsely impersonating another person. Tr. 348-49; Div. Ex. 155 at ENF 05619-20, 05631, 05637, 05646, 05648. Dills has been the subject of regulatory actions that include: a 1988 Cease and Desist Order from the state of Montana; a 1997 censure by the National Association of Securities Dealers (NASD); and a number of arbitrations. Div. Ex. 155 at ENF 05609-10, 05598-99, 05603-04, Div. Ex. 156. On August 16, 2000, NASD Regulation, Inc., permanently barred Dills from association with any NASD member firm in any capacity. Div. Ex. 175. Dills invoked his Fifth Amendment right against self-incrimination in declining to answer most questions concerning the events at issue. Tr. 353-57, 358-60.
Dills's overall demeanor includes a volatile temper, physical threats, and tantrums. Tr. 262-64, 284, 293-94, 361-63, 379, 405-06, 603, 818, 823, 842; Div. Ex. 170 at 213-14, 250, 262, 354-55. The undersigned observed a display of this type of demeanor while Dills was testifying at Tr. 361-63. Jennings has raised Dills's temperament as a defense to the charges against him. The evidence concerning it comes from him as well as from others with no interest in the charges against Jennings: Comparator employee Robert W. Marple and customers Albert Thorne, Dr. Evelyn Maddela, and Lawrence Johnson. Dills's response concerning his temper and threats actually made their testimony more convincing.
Thorne testified that Dills was amiable in their initial contacts, but when Thorne attempted to register a complaint in a phone call, Dills screamed that he had a black belt and would "get [in] his face" and called him a loser. Thorne determined to pursue his complaint in writing instead but obtained a tape recorder lest Dills phone him again. Tr. 284-85, 292-94. In response, Dills testified that Thorne was drunk during the phone call and threatened to assault him. Tr. 361. Thorne's testimony was completely believable while Dills's was incredible. The undersigned observed Dills to be a physically fit younger individual, and Thorne to be in his late sixties. Dills became agitated when he testified about the phone call, while Thorne displayed a calm demeanor when he testified.
When Maddela called to complain about a $125,000 discrepancy in the proceeds from the sale of her stock, Dills became angry and shouted; as a result she determined not to pursue her complaint and to accept the lower amount, reasoning that she might receive no money at all if he was provoked further. Tr. 839-42. When Johnson resisted Dills's advice to sell, Dills became angry and called him "stupid" and threatened to annotate his account to that effect; as a result Johnson agreed to sell. Tr. 379.
Concerning an alleged fight that Dills had with his brother in the parking lot at Del Mar, Dills testified that there was no "fighting"; he was just "pushing" his "little brother" in the course of an argument. He then segued into a rant against Jennings, which stopped only when his attorney reminded him that he had invoked his Fifth Amendment right to decline to answer questions concerning events at Del Mar. Tr. 361-64.
Dills's testimony at the hearing was brief. Tr. 347-65. His investigative testimony, however, went on for about 500 pages and casts further light on his temperament. Div. Ex. 150. He vilified and blamed others to a degree that was beyond mere self-interest and not believable. Dills claimed that Jennings, from the beginning of his employment at Del Mar, ordered Dills not to interfere with his trading and Dills obeyed. Div. Ex. 150 at 41-42, 149-51. In connection with the oversell of May 3 and 6, 1996, Dills stated that the trading room was chaotic, there were too many tickets for Jennings to handle by himself, and the volume caused Jennings to execute some tickets at the wrong price. Div. Ex. 150 at 76, 124, 134, 153-54, 325-28. Dills also blamed market makers and Del Mar registered representatives for the situation. Div. Ex. 150 at 92-94. Yet Dills also claimed that Jennings deliberately caused the oversell in a bungled attempt to earn profits from trading and then lied to him about it. Div. Ex. 150 at 85-87. Dills claimed, however, that when the oversell came to light, he did not fire Jennings because he trusted Jennings to clear up the mess and because he needed a trader (which was untrue because Private Brokers had resumed executing Del Mar's trades). Div. Ex. 150 at 174-75, 180, 332. Dills further claimed that he was a passive onlooker while Jennings and/or, variously, Roberts hatched and carried out a scheme to cover up the effects of the oversell. Div. Ex. 150 at 99-110, 117-18, 195-96, 298-99, 325-31. Dills went beyond alleging that Roberts ordered Del Mar to change order tickets; he also claimed that Roberts had consistently performed the clearing function in a slipshod manner, sending reports late so that Dills did not have timely information on Del Mar's trading and positions.9 Div. Ex. 150 at 53-54, 90, 260-61, 297. Dills claimed that he had attempted to discharge Private Brokers and hire another clearing firm but was thwarted when the second firm refused to accept Del Mar because of Brandon's criminal record.10 Div. Ex. 150 at 60-63.
b. Del Mar
Del Mar was a broker-dealer owned by Dills and located in Del Mar, California. Tr. 352; Div. Ex. 154 at ENF 05555. Del Mar had a high turnover of registered representatives, who numbered five to ten at any point in time. Tr. 684-85. The record shows that Dills maintained firm control of the small, one-office firm, and ran it with a heavy hand. Private Brokers was Del Mar's clearing firm.11 Tr. 689; Div. Ex. 87. In the beginning Private Brokers executed and cleared Del Mar's trades; in March 1996, Del Mar began executing its own trades. Tr. 661, 691-92, 703-04, 1249. Private Brokers's Roberts spent a day at Del Mar reviewing with Dills, Jennings, and Brandon the procedures to follow in executing orders, what the limitations were, and reports Del Mar would receive. Tr. 692-95. Thereafter, Del Mar began executing trades and did so correctly until the events at issue. Tr. 704-05. Del Mar made markets in a few low-priced stocks and made very few trades. Tr. 685, 703-04. As a result of the events at issue, Private Brokers resumed executing Del Mar's trades itself; Private Brokers discontinued clearing for Del Mar altogether a few months later. Tr. 882. Del Mar was the subject of various regulatory proceedings including: suspension by the NASD for twenty-seven days for failure to submit financial information in October 1997; censure and fine by the NASD relating to violations of Automated Confirmation Transaction (ACT) reporting rules in 1997; suspension from the NASD for failure to pay an arbitration award in October 1998; censure and fine by the NASD for failure to make timely filing of form BD-Y2K in June 1999; and, finally, expulsion from the NASD for failure to pay fines and an arbitration award. Div. Exs. 154, 175.
During May 1996 Del Mar's required minimum net capital, pursuant to Exchange Act Rule 15c3-1(a)(2)(iii), was $100,000. Div. Ex. 84 at ENF 02328, Div. Ex. 85 at ENF 02339. Dills was Del Mar's financial and operations principal and responsible for its compliance with its net capital requirement. Div. Ex. 150 at 258-60. During the second quarter of 1996 Del Mar usually maintained net capital of approximately $200,000. Div. Exs. 84, 85.
2. Chaudhuri
Dills and Chaudhuri had been friends for a few years before the events in question; they first met in Newport Beach, California, through a mutual interest in body surfing and were roommates for a while. Div. Ex. 149 at 25, Div. Ex. 150 at 218-21. Chaudhuri has never held any securities licenses. Tr. 31. He studied business administration for three years, 1982-84, at the University of Southern California but did not graduate. Tr. 30-31. Criminal offenses include: a 1999 drunk driving arrest, fined; 1991 drunk driving arrest, fined; and a 1984 cocaine offense, six months in county jail. Tr. 31-32; Div. Ex. 149 at 20-24. From 1983 to 1993, Chaudhuri was a salesman in food distribution businesses in southern California and a microbrewery business. Tr. 32-33, 351. From 1994 onward, Chaudhuri, with an associate, has bought foreclosed properties for resale in the San Diego area. Tr. 33-35. His annual income from these activities from 1983 to 1996 was $60,000 to $75,000. Tr. 32-33, 35. Like Dills, Chaudhuri invoked his Fifth Amendment right against self-incrimination in declining to answer most questions concerning the events at issue. Tr. 35-43.
3. Roberts and Private Brokers
a. Roberts
Roberts was president and part owner of Private Brokers during the time at issue. Tr. 644, 658; Div. Ex. 160 at ENF 05739. Roberts graduated from the University of Texas with a B.A. in 1963 and an M.B.A. in 1965. Tr. 643. Roberts's employment prior to Private Brokers included: Salomon Brothers in New York; Rauscher Pierce in Dallas, Texas (registered representative); Weber Hall (registered representative); Clark and Clark Securities (registered representative, president of operations); Richardson Savings and Loan (chief financial officer, established broker-dealer subsidiary); and Frontier Federal Savings and Loan in Oklahoma (chief financial officer). Tr. 651-56; Div. Ex. 160 at ENF 05739. Roberts and others started Private Brokers as a clearing broker-dealer in 1986; he first obtained an ownership interest in the firm in the early 1990s. Tr. 657-58; Div. Ex. 159 at ENF 05699.
Roberts's licenses include: registered representative, registered options principal, senior registered options principal, municipal securities, general securities principal, and financial and operation principal. Tr. 643-44; Div. Ex. 160 at ENF 05740. Currently, he is registered with Midland Securities, Waterford Capital, and is a financial principal at another firm, Netherland Securities, that is in the registration process. Tr. 644, 888. Roberts has been sanctioned by the NASD three times: (1) in 1974, concerning a 1967 violation of Regulation T, arranging credit at a rate better than what was available publicly ($2,000 fine, censure and two day suspension); (2) in 1989, for an interpretation violation of Exchange Act Rule 15c3-3 for not treating bank accounts separately ($2,000 fine and censure); and (3) in 1991, for a Rule 15c3-3 interpretation violation concerning withdrawing and computing excess credit balances ($7,500 fine and censure). Tr. 644-47; Div. Ex. 160 at ENF 05757-73.12
b. Private Brokers
Private Brokers was a clearing broker in Dallas, Texas, established in 1986. Div. Ex. 159 at ENF 05699. Private Brokers stopped clearing and arranged for its correspondents to transfer to a larger firm in 1997; it withdrew its broker-dealer registration in 1999. Tr. 885-87; Div. Ex. 159 at ENF 05700-02. During the time at issue, Private Brokers cleared approximately 150 to 200 trades each day from twenty corresponding brokers and one registered representative and had net capital of $2,000,000. Tr. 659-60.
Private Brokers employed seven individuals: two in the trading room (trading assistant Cherri Childers and head trader Wanda Davis), two in the back office, a secretary, a receptionist, and Roberts. Tr. 660, 664, 1201. There were two NASDAQ Level 3 machines in the trading room for executing trades. Tr. 662, 664. The machines could also display trades that Private Brokers's correspondent brokers executed with other brokers through the ACT system.13 Tr. 662-63. The machines did not display transactions between a correspondent broker and its customers. Tr. 664.
Private Brokers cleared for about ten correspondent brokers, such as Del Mar, who executed their own trades and sent their executed order tickets to Private Brokers by fax. Tr. 661, 1210. Correspondents were asked to send the information when available during the day, so that the data could be input promptly and Private Brokers would not be swamped at the end of the day. Tr. 662, 681. Del Mar, however, typically faxed its few order tickets to Private Brokers at the end of the day. Tr. 704. The faxes were brought to Childers, who entered the orders into the computer trading system among other duties. Tr. 1203, 1205-06. The computer system updated the customers' accounts and produced confirmations. Tr. 680. Copies of the confirmations were mailed to the customers and the introducing brokers and retained by Private Brokers. Tr. 680-82. The firm made its best effort to input the data before 4:30 p.m. Central time so as to mail the confirmations the same day the trades were executed, and failing that, by the end of the day. Tr. 717-18. The Private Brokers's computer system shut down at 7:00 p.m., engaged in batch processing between 10:00 p.m. and 1:00 a.m., and produced reports of the day's activity for the next business morning. Tr. 729, 790. The trade data was also transmitted to the National Securities Clearing Corporation (NSCC) for processing overnight. Tr. 665. The following business morning, Private Brokers downloaded NSCC contract sheets itemizing compared and any uncompared trades.14 Tr. 664-66.
After inputting a trade, Childers wrote a transaction number generated by the computer on the order ticket. Tr. 1207. The transaction number reflected the order that the tickets were inputted into the computer and was used to track the trade. The number did not reflect the order in which trades were executed or show when a trade was executed. Tr. 1207. Childers wrote the transaction numbers in blue or black ink; she did not write anything else on the tickets.15 Tr. 1208, 1234.
The Fully Disclosed Correspondent Agreement dated September 30, 1993, between Private Brokers and Del Mar was in effect at the time at issue. Tr. 697-701; Div. Ex. 87. Under its terms, Private Brokers was responsible for maintaining customer accounts, preparing daily and monthly reports, and generating and distributing confirmations and account statements. Div. Ex. 87 at 1-2. Del Mar was responsible for establishing and maintaining a system of compliance and supervision consistent with the securities laws and NASD rules. Div. Ex. 87 at 4. Del Mar was responsible for the conduct of each customer's account and the authenticity of all orders. Div. Ex. 87 at 3. Del Mar warranted all information it provided regarding customers and orders to be complete, accurate, and correct in all respects. Div. Ex. 87 at 5. Private Brokers sent a "plain English" disclosure statement delineating the responsibilities of Private Brokers and of Del Mar to Del Mar customers at least annually. Tr. 1306-07; PB Ex. 5. Roberts believed that when a broker-dealer that clears through a clearing broker is given authority to execute its own trades, the clearing firm has no right to refuse to process the executed trades and issue confirmations; if the clearing firm is dissatisfied with the correspondent's trades, its remedy is to resume executing trades or terminate the clearing agreement. Tr. 699-701.
4. Jennings
Jennings, born in 1970, received a B.A. in finance from California State University at Fullerton. Tr. 130-31; Div. Ex. 158 at ENF 05680. Jennings's securities licenses include Series 4, 7, 24, 27, 63, and 65. Tr. 132-35; Div. Ex. 158 at ENF 05682. Jennings was fined $2,500 and censured by the NASD in 1997 for reporting trades of Comparator stock that he should not have reported because he was not a market maker in the stock. Tr. 136, 509; Div. Ex. 158 at ENF 05689-93. He is now a principal at, and has a fifteen percent interest in, Mission Capital Investment Group, Inc. Tr. 159, 433. The firm's principal financial backer is Richard Crawford, in whose home Jennings lived during his teenage years. Tr. 637. Jennings is a registered representative with management and compliance responsibilities. Tr. 434. He intends never to be a trader or market maker again. Tr. 432-34.
Jennings entered the securities industry in 1993, while in college, as a registered representative at Montano Securities. Tr. 138. After a year under the training of Alex Montano, Jennings moved to trading and eventually made markets in five stocks. Tr. 146. After Montano Securities went out of business in December 1994, Jennings was employed as a registered representative at other broker-dealers. Tr. 155-56; Div. Ex. 158 at ENF 05683. Then he responded to an advertisement for an opening at Del Mar, was hired, and began work as Del Mar's trader and market maker in March 1996. Tr. 156, 158-61. He did not have any supervisory authority or compliance responsibilities; he did not prepare Financial and Operational Combined Uniform Single (FOCUS) reports and was not in charge of Del Mar's books and records. Tr. 439-40. Dills agreed to pay him $5,000 a month and a percentage of principal trading profits, but actually paid him approximately $2,300 a month, stating that the firm was not making enough money to pay more. Tr. 440-42. At all times, Jennings was under the supervision of Dills. Div. Ex. 150 at 31.
Soon after Jennings began at Del Mar and was briefed by Roberts, he began executing Del Mar's trades. Tr. 525-28. The brokers filled out the order tickets except for the executed price and time stamp, which Jennings added. Tr. 176. Jennings also had the discretion to buy and sell stock, up to $100,000, for Del Mar through a Del Mar inventory account. Tr. 168-69, 525. Any activity exceeding this limitation or that would sell a stock short required advance authorization from Private Brokers. Tr. 526-27. Jennings determined Del Mar's positions each morning through Activity and Position Reports provided by Private Brokers. Tr. 186. He made markets in two or three stocks. Tr. 171. The trading-one to ten trades per day-was at a level Jennings could handle and was much less than what he had experienced at Montano Securities. Tr. 171, 445.
The events of May 3 and 6, 1996, were unlike anything Jennings had experienced previously and beyond his capabilities. Tr. 203, 462. Over the weekend of May 4-5 Jennings conferred with Richard Crawford and with a religious advisor; they told him that he had a commitment to his job and should not quit. Tr. 246-47, 256-57, 640-41. Their advice changed because of Dills's threats of physical violence during the following week, and Jennings left Del Mar about two weeks later. Tr. 429-31, 640-42.
B. Stock Promotion Scheme: Chaudhuri, Dills, and Del Mar
Dills orchestrated a stock promotion scheme during 1995 and early 1996. Using Chaudhuri as an intermediary, Dills obtained Comparator stock at discount prices and sold it at market prices to Del Mar customers. Chaudhuri retained some of the premium and funneled the remainder to Dills through intermediary organizations. The payments were not disclosed when Dills and others associated with Del Mar recommended the purchase of Comparator to customers.
1. Acquisition of Comparator Stock
Dills believed that Comparator's stock had potential to rise greatly.16 Div. Ex. 150 at 207-14. He contacted Comparator and suggested that Del Mar promote Comparator, for example, by a mailing of postcards. Div. Ex. 170 at 214-16. Dills recommended Comparator to Chaudhuri and, in late 1994 or early 1995, introduced him to Wayne Marple, a Comparator employee whose responsibilities included identifying possible sources of funding.17 Div. Ex. 149 at 30-32, Div. Ex. 170 at 195-96, 214-15, 220-22. With Chaudhuri and his entities, Calloway Consulting and Chaudhuri Family Trust, as intermediaries, Del Mar provided promotional services for Comparator and received free-trading Comparator stock to sell to investors.18 Additional stock was purchased directly from Comparator stockholders. The transactions by which Chaudhuri acquired Comparator stock, as well as Dills's involvement, are clearly shown through Div. Exs. 1-2, 5-25, 174.
There is a conflict between the evidence of Dills and Marple concerning Dills's role. Dills essentially claims that he was a passive onlooker, at most, to Chaudhuri's acquisition of Comparator stock that was ultimately sold to Del Mar customers and that he met with Chaudhuri and Marple together only once, at lunch, and he left them together. Div. Ex. 150 at 217-22, 228-29, 237-45, 518-21. According to Marple, however, he never met or talked with Chaudhuri without Dills, who had introduced him as someone who would buy Comparator stock. Div. Ex. 170 at 228-29, 243, 263, 274-75. According to Marple, Dills reprimanded him sharply when he once telephoned Chaudhuri directly, even though he was only trying to locate Dills. Div. Ex. 170 at 275.
Marple's version of Dills's paramount role in the acquisition of Comparator stock is supported by other evidence in the record and is accepted. For example, Div. Ex. 22 is a November 1995 fax to Dills from Marple about a Chaudhuri transaction with Comparator stockholder Ed Evanson. Div. Ex. 11 is a two-page fax dated February 14, 1995, to Dills from Equitrade Securities Corporation (Equitrade), a broker-dealer where Chaudhuri opened an account in the name of Chaudhuri Family Trust on December 30, 1994, a few days after creating the trust. Tr. 1097-98; Div. Ex. 26. The cover page contains a note to Dills: "Attached is the information we discussed." The second page is a record of activity in the Chaudhuri account, consisting of deposits of Comparator stock. An August 29, 1995, two-page fax from Marple to Celeste at Comparator refers to "the Dills transaction" on the cover page; the second page is a worksheet depicting a convoluted transaction involving Rocky Mountain Securities, Comparator stockholders Arthur Taylor and George Levering, and Dills; $31,750 was payable to Rocky Mountain Securities. Div. Ex. 20 at ENF 00047-48. The $31,750 was paid by Chaudhuri from the Scripps Bank account by check No. 1045 dated September 1, 1995. Div. Ex. 174. Further, Marple, who recalled their contacts in detail, had no interest in whether or not Dills was behind Chaudhuri's acquisition of stock. Dills, however, has a motive to conceal his involvement in the acquisition of stock that eventually was sold to Del Mar customers.
Chaudhuri, in a series of three six-month contracts between Calloway Consulting and Comparator, agreed to provide promotional/consulting services for compensation to be paid in Comparator stock; Calloway Consulting hired Del Mar to carry out the promotion. Div. Exs. 6, 17, 19, Div. Ex. 170 at 259-61. Dills and Chaudhuri misunderstood the arrangement, believing that Calloway Consulting was to receive free-trading stock that they could resell immediately. Div. Ex. 170 at 213, 250, 254. After Comparator made its first payment in restricted stock, Dills became enraged in a manner that Marple found surprising in a businessman. Div. Ex. 170 at 213-14. Dills also threatened to have his clients dump Comparator stock if Calloway Consulting did not receive free-trading stock. Div. Ex. 170 at 250-53, 264-65. If this threat were carried out, the price of Comparator stock would sink calamitously. Div. Ex. 170 at 252. To avoid this, Marple sought out long-standing investors who would exchange their free-trading stock for Calloway Consulting's restricted stock. Div. Ex. 170 at 250. Accordingly, for each of the three contracts, exchanges were made so that Calloway Consulting ultimately received free-trading stock. Div. Ex. 6, 15, 17, 19-25. Chaudhuri had the certificates for the stock issued in the name of Chaudhuri Family Trust. Div. Ex. 149 at 111. Calloway Consulting received a total of 1,300,000 shares of restricted Comparator stock that were exchanged for an equal amount of free-trading stock from long-term investors and placed in the Chaudhuri Family Trust account at Equitrade.
With Marple as an intermediary, Chaudhuri purchased millions of additional free-trading shares at discount rates of .0265, .0270, and .0285 per share from Comparator stockholders.19 Div. Exs. 8, 10, 14, Div. Ex. 149 at 33-37, Div. Ex. 170 at 226, 228-29. The market price was about .03 bid and .06 ask, and Chaudhuri noted the potential profit from buying near the bid and reselling the stock at or near the ask.20 Div. Ex. 149 at 33-36.
The Chaudhuri Family Trust account at Equitrade received over 25,000,000 shares of Comparator stock between January 1995 and February 1996. Div. Ex. 27. It was the only Equitrade account with a position in Comparator, and its activity was limited to receiving Comparator stock, selling it, and having the proceeds wired out. Tr. 1096, 1100-02. Dills called Equitrade regularly seeking to buy Comparator. Tr. 1103. All sales of Comparator went to Del Mar. Tr. 1106-08. The price was near the ask or between the bid and ask. Tr. 1104. The account's fax number, to which customer activity reports were faxed, was Del Mar's.21 Div. Exs. 11, 30-33, Div. Ex. 149 at 60-63.
2. Sale of Comparator Stock to Del Mar Customers
Del Mar began the promotional campaign in 1995 by mailing postcards touting an unnamed company with a fingerprint identification product to doctors and higher income individuals. Tr. 316, 368, 828, 912; Div. Ex. 43, Div. Ex. 44 at ENF 00832-33, 00844. The recipients were invited to respond to Del Mar if they were interested and could invest at least $5,000. Div. Ex. 43 at 00830-31. Dills or someone else from Del Mar telephoned those who responded and cold-called others. Tr. 103, 274, 297, 316, 479.
Nine Del Mar customers testified about their transactions in Comparator: Dr. Richard Fischel,22 Dr. Evelyn Maddela,23 Dr. Sergio Ilic,24 Craig Rogers,25 Lawrence Johnson,26 Albert Thorne,27 Martin Goetz,28 William Reichard,29 and Laurence Cuneo.30 The investors were told that Comparator had an existing product and/or a new fingerprint machine that was going into production, that Comparator was in negotiations or already had contracts with the federal government and other security agencies, and that the price of the stock would likely increase soon. Tr. 104, 274-76, 299, 316-17, 479, 736, 738-39, 830-32, 912-13. They also were told that there would be no commission or, at most, a minimal commission when the customer sold the stock. Tr. 104-05, 275, 318, 372. They were never told that Dills was receiving substantial sums from the proceeds of their purchases. Tr. 105, 275, 319, 481, 741, 914. They would have wanted to know this in making their decision to invest. Tr. 105, 319, 741, 914.
3. Proceeds Funneled to Dills and Chaudhuri
By purchasing Comparator at discount prices from stockholders and receiving stock as compensation for services, Chaudhuri realized an immediate profit when the Chaudhuri Family Trust sold the shares to Del Mar customers at approximately .06 a share. The proceeds from the sale of the Comparator stock to Del Mar customers were approximately $1,233,045. Div. Exs. 27, 163, 174.31 Chaudhuri paid $570,094 to buy free-trading stock from long-standing investors.32 Tr. 58-59; Div. Exs. 163, 174. He paid $47,650 toward the costs of the promotion.33 Div. Exs. 43-44, 174. After these expenses the profits were $615,301. Chaudhuri also paid other expenses of Del Mar that were not related to the Comparator promotion, such as $925 for a sign and $2,293 for a computer program. Div. Exs. 45-46, 163, 174. Chaudhuri also delivered $496,175 of the profits to Dills and his wife Julie Riddle and $103,550 to himself.34 Div. Exs. 163, 174. Chaudhuri made additional payments, such as to Mr. Cheaps Travel and Townsend Jaguar, but the record does not show the beneficiary of these payments.
All the deposits into the Chaudhuri Family Trust account at the Scripps Bank came from the Equitrade account through wire transfer.35 Tr. 49-50; Div. Exs. 42, 163, 174. From that account money was paid directly to Dills and his wife by check or cashiers check or paid into an account at the Bank of America in the name of Callaway Consulting from which payments were made to Dills and his wife. Tr. 51-54; Div. Exs. 163, 174.
The following are examples of the flow of funds from Chaudhuri's Equitrade account through the Chaudhuri Family Trust account at the Scripps Bank (CFTS) to Dills:
| 07/07/1995 | $20,000 from Equitrade to CFTS |
| 07/10/1995 | $20,000 cashiers check from CFTS to Dills |
| 09/13/1995 | $100,000 from Equitrade to CFTS |
| 09/15/1995 | $100,000 cashiers check from CFTS to Dills |
| 07/21/1995 | $16,000 from CFTS to Callaway Consulting |
| 07/26/1995 | $15,000 from Callaway Consulting to Riddle |
| 08/07/1995 | $10,000 from CFTS to Callaway Consulting |
| 08/09/1995 | $9,700 from Callaway Consulting to Riddle |
| 08/10/1995 | $5,000 from CFTS to Callaway Consulting |
| 08/11/1995 | $5,000 from Callaway Consulting to Dills |
| 09/05/1995 | $18,000 from CFTS to Callaway Consulting |
| 09/05/1995 | $17,000 from Callaway Consulting to Riddle |
| 02/09/1996 | $15,000 from CFTS to Callaway Consulting |
| 02/13/1996 | $15,000 from Callaway Consulting to Riddle |
Tr. 51-54; Div. Exs. 42, 163, 174.
C. Del Mar Copes With Heavy Trading as Comparator Soars
These events involved Dills, Del Mar, Jennings, Roberts, and Private Brokers. The stock that Del Mar customers bought in the stock promotion scheme was sold when the price of Comparator began to rise dramatically on Friday, May 3, 1996.36 Dills and others from Del Mar contacted customers and recommended selling, and Del Mar processed an enormous volume of sell orders. The following week it became apparent that the transactions with customers were out of balance with sales to the street, potentially exposing Del Mar and even Private Brokers to losses, since the stock was still rising. Dills remedied this situation by changing the prices on some order tickets downward and telling the customers that the clearing firm or other causes outside Del Mar were to blame for the price changes.
1. Friday, May 3, 1996
On Friday, May 3, 1996, Comparator began to rise, and Dills and others from Del Mar contacted their customers and recommended selling. Tr. 108, 277-78, 303, 322-23, 377-78, 482, 744-45, 915-16. There were about 238 customer trades, which Jennings batched into 100 dealer-side trades. Tr. 444, 1030-32, 1054, 1056-57; Div. Exs. 74, 81, 92, 94. This compared with ten or fewer trades in a normal day. Tr. 201, 445, 704, 713, 1249; Div. Ex. 73. Chaos reigned as Dills and Del Mar registered representatives gave written and oral orders to Jennings, at times grabbing tickets back from him, market makers phoned, and Dills yelled.37 Tr. 201-25, 452, 456, 494-99, 598, 603-04, 851; Div. Ex. 98 at ENF 04095-96, 04102. Jennings jotted the orders on scratch paper and batched them for trades to market makers. Tr. 204, 207, 211-12, 218, 595-96. Others, including Dills, his wife, Brandon, and Sean Crawford, helped out in the trading room. Tr. 448; Div. Ex. 98 at ENF 04095. At the end of the day Jennings believed that he had traded correctly so that sell orders from customers balanced with sales to market makers. Tr. 225-26.
After the market closed on May 3, Childers called at 3:42 p.m. (CDT) to ask whether Del Mar had any orders to send, as Private Brokers had not received any that day. Tr. 229, 1211; Div. Ex. 98 at ENF 04095-102. Jennings told her that it had been a hectic day with a high volume of sales of Comparator and that they were processing the orders to send to Private Brokers; Jennings also spoke to Roberts about the situation. Tr. 716, 1212-13; Div. Ex. 98 at ENF 04095-102, PB Ex. 7. Jennings explained that he had batched a large number of customer orders for sale to market makers, and that it would take further time to associate the contra broker with each customer order ticket. So that Childers could start inputting the orders, Roberts decided on a makeshift system of using Del Mar's inventory account, used for principal trades, as a suspense account until the contra side of the trades could be entered. Tr. 719-23, 725-26, 1214-17. The May 3 trades, however, were agency trades. Tr. 539, 726, 988-89, 1033, 1054, 1215, 1251, 1271, 1334-37; Div. Exs. 94-95, Div. Ex. 98 at ENF 04098; PB Ex. 8. The account in which the trades were processed did not change the capacity in which they were made. Tr. 952, 1336. The confirmations that resulted from processing the trades in the inventory account were annotated to show that they were agency trades. Tr. 1217; PB Ex. 2.
Del Mar then started faxing customer order tickets, and Childers entered as many as she could until she left for the weekend around 7:00 p.m. CDT, four hours after the market had closed and three hours later then usual. Tr. 1218-19. All the order tickets had not been processed. Tr. 1221.
2. Monday, May 6, 1996
On Monday morning, May 6, 1996, Roberts compared the NSCC contract sheets and Private Brokers's internal Activity and Position Report. He determined that Del Mar had sold 14,272,670 shares of Comparator stock, but that Private Brokers had received orders for only 11,366,409 shares from Del Mar. Tr. 776, 779; Div. Exs. 92, 102. Roberts believed that additional order tickets that had not been transmitted before Childers left on Friday accounted for the discrepancy. Tr. 779-80, 1253-54.
Roberts called Del Mar and verified that Del Mar would be sending more orders from Friday's trading; he also checked an online stock record position report and ascertained that Del Mar customers had far more than enough Comparator stock to cover the apparent discrepancy. Tr. 1253-54, 1272, 1304-05. When Childers arrived, she began entering the tickets that had come in after she had left on Friday. Tr. 1220. The orders were entered as they accumulated; since Private Brokers was not executing them and the mechanics of entering them into the system had no impact on the actual times of execution, Private Brokers did not try to enter the trades in the order in which they were executed. Tr. 804, 1225-26.
As of 12:05 p.m. CDT, Childers still did not have all of Friday's order tickets. Tr. 1223-24, 1241-42; Div. Ex. 98. She had not completed entering all the Friday and Monday tickets as of 4:19 p.m. CDT (2:19 PDT, 5:19 EDT). Tr. 1224-26; Div. Ex. 98 at ENF 04110-11. Private Brokers transaction numbers show that sixty-three Del Mar Comparator trades, representing nearly six million shares, were entered after the 500,000 share May 6 Fischel order which Del Mar faxed to Private Brokers at 1:44 p.m. PDT (3:44 CDT), after the market had closed.38 The sixty-three trades included all forty-five dealer-side trades of Monday and four dealer-side trades of Friday. PB Ex. 8. By the end of the day on Monday, Childers had entered all of Friday's and Monday's orders. Tr. 787-88, 1242-43. Because she was entering orders throughout the day, there was no way to verify whether the Friday imbalances had been rectified during the day. Tr. 788-89, 1224-26, 1276. Thus, Roberts did not know on Monday during the trading day that Del Mar had actually oversold to market makers. Tr. 1254-56. Nor did he know Monday evening; he did not try to check the trades that Childers had entered during the day; there was no action he could have taken to deal with the trading then, and it was easier to view the situation by using the reports that were produced overnight and available Tuesday morning. Tr. 790, 1256, 1276-77.
At Del Mar, Jennings continued to believe that his Friday trading had balanced out. Tr. 249-53, 257, 459. Monday's volume of trading, although less than Friday's, was enormous, Jennings was still overwhelmed, and the trades were executed in manner similar to Friday's. Tr. 253-56, 457, 553.
3. Tuesday, May 7, 1996
On Tuesday morning, May 7, 1996, Roberts again reviewed the NSCC contract sheets and the Activity and Position Reports for the previous day. Tr. 791, 846; Div. Exs. 92, 103. He found that there was an oversell from Friday's trading, and, additionally, customer prices did not match market maker prices.
Roberts determined that Del Mar oversold more than 500,000 shares. Tr. 846-47, 1257-58. He was not in a position to identify where the oversell occurred. Tr. 998-1005, 1361, 1418-19. For working purposes he concluded that the oversell resulted from the last trades. Tr. 807, 848-50. With the benefit of hindsight and time for extended review of information that was not available to Roberts, it is possible to estimate, but not establish, when the oversell occurred.39 Tr. 63-101, 1050-52, 1354-62; Div. Exs. 92, 94, 96, 162.
Further, as to shares sold by customers to the market, the Activity and Position Report showed the customers' prices exceeded the market makers' prices by about $494,479. This number, reported as Profit/Loss, is the sum of all the prices added (selling) and subtracted (buying) of every trade made during the day. Tr. 795-808; Div. Ex. 103. Roberts did not expect this discrepancy because the trades were agency trades; total customer sale prices should have equaled total market maker purchase prices, a zero Profit/Loss. Tr. 799-800, 806-07, 989, 1256.
The oversell concerned Roberts. Tr. 806, 850-51. The stock had closed Monday at around a dollar.40 Tr. 1259. If the stock continued to rise, covering the oversell would create a loss. Tr. 1258-59. Concerning the Profit/Loss discrepancy, Roberts believed that the only possible explanation was that Del Mar had transmitted incorrect prices to Private Brokers since the trades were agency trades. Tr. 807.
An oversell is usually covered by the net capital of the introducing firm that made the trading error. Tr. 985. Additionally, Private Brokers had over $300,000 of Del Mar's net capital, including its $75,000 deposit and about $230,000 in commissions Del Mar had generated; if that were insufficient, Private Brokers would have sought all of Del Mar's additional assets; Private Brokers also had a personal guarantee against loss from Dills. Tr. 1259-60; Div. Ex. 87 at 10-11. If Roberts's analysis proved unduly optimistic, Private Brokers theoretically could have been liable for part of the $494,479 discrepancy and of losses from covering the oversell. Tr. 950-51, 962-66, 1259, 1274. Such a theoretical liability would not have affected Private Brokers's compliance with net capital requirements; however, Private Brokers had net capital of about $2,000,000, far in excess of its required net capital of about $320,000. Tr. 1261-62; Div. Ex. 105 at ENF 04583, 04586.
The trading errors affected Del Mar's compliance with its net capital requirement of $100,000. It had net capital of approximately $200,000 before the Comparator trading, so the oversell of 500,000 shares marked to market at 1, resulted in a negative net capital value. Other pricing errors depressed the net capital further. At no time did Dills notify the Commission that Del Mar was not in compliance with its net capital requirement. Div. Ex. 150 at 319.
a. Roberts Calls Del Mar
Roberts called Jennings Tuesday morning to find out if all Friday's and Monday's customer orders had been sent. Tr. 257-58, 851, 1257-58. When Jennings replied that all the orders had been sent, Roberts said that Del Mar had made significant errors in overselling shares to market makers and had wrong prices on the shares that it had sold. Tr. 851. Jennings realized for the first time that there was a problem. Tr. 460, 554-55. He told Roberts that brokers had been yelling oral orders and not following up with tickets during the frenzied trading. Tr. 851. Roberts demanded to speak to Dills. Tr. 851, 1258. Dills was not there yet, so Roberts called him at home, explained the problems, and demanded a $1,000,000 clearing deposit if Dills wanted to continue the oversold shares.41 Tr. 852, 1267. Dills refused to comply and said that Roberts should not worry about Comparator continuing to rise, because the company was worthless. Tr. 852, 1293. That is, Dills suggested that Del Mar fail to deliver the shares and gamble that the market makers would fail to buy in before the Comparator bubble burst.
Roberts declined to rely on Dills's fraudulent suggestion and informed Dills that he was going to delete Del Mar from access to NASDAQ and make trades to cover the oversold shares. Tr. 855-56, 1263, 1294. Concerning the second problem, Roberts told Dills that he needed to correct the prices of the customer trades that were executed so that the total equaled the total of prices of sales to market makers. Tr. 853. Numbers were not discussed. Tr. 854. As soon as he hung up, Roberts deleted Del Mar's access to NASDAQ, thus ensuring that Private Brokers would execute Del Mar's trades. Tr. 855-56. Roberts then covered the oversell, using various trading strategies; the trading problem was essentially resolved by Wednesday, May 8, at a total net loss of $94,000 for Del Mar. Tr. 858, 1263-67, 1298-99; Div. Ex. 150 at 291, 295, 324, 334, 337, 386-87, 420.
The Division urges that Roberts's first phone call to alert Del Mar to the problems occurred on Monday, not Tuesday. The evidence, however, shows that the call occurred on Tuesday morning. Roberts's testimony that the call was on Tuesday is unrebutted. It is corroborated by the fact that Childers, who entered the trades, first learned of the oversell on Tuesday. Tr. 1233, 1243-44. It is corroborated by the facts that Roberts deleted Del Mar's access to NASDAQ on Tuesday immediately after the call to Dills and commenced to cover the oversell. Had Roberts known enough to be concerned and to call Dills on Monday, he would have deleted Del Mar's access to NASDAQ on Monday.42
The Division argues, based on the opinion of its trading expert Scott Ryan, that Del Mar's trading pattern changed on Monday afternoon in a way that indicates Del Mar was aware of the oversell. There is, however, no evidence to link this purported change in trading to Roberts. Nonetheless, the Division theorizes he could have known of the oversell through continuous checking during Monday. This theory is contrary to the evidence that Roberts did not engage in continuous checking and that, had he done so, he would not have obtained meaningful information during the trading day. Finally, the Division tried to refresh Jennings's recollection of the time of the call with a few lines of his investigative testimony in an attempt to elicit testimony that the call was on Monday. Jennings's hearing testimony was consistent with his investigative testimony that it could have been Tuesday morning or it could have been Monday night. Tr. 257-58. Even if the call had been Monday night, that was too late to have any impact on Monday's trading, which ended at 1:00 p.m. Pacific time.
b. Dills is Enraged
When Dills arrived at Del Mar on Tuesday, he was enraged; red-faced, he yelled at Jennings and gestured in a threatening manner. Tr. 263-64. As the outbursts continued during the day, Dills threatened to kill Jennings and referred to criminal associates who would carry out a contract murder. Dills threatened to shoot Jennings in the head. Dills boasted that he was not afraid to die for the crime and displayed gunshot wounds in his torso and leg. Tr. 405-06, 466-68.
Dills also threatened to kill Sean Crawford, a long-time friend and current business associate of Jennings, who was at Del Mar during the time at issue, helping out and studying for his Series 7 examination.43 Tr. 468, 638, 640, 814, 817-18, 821; Div. Ex. 98 at ENF 04095. Sean Crawford and his father, Richard Crawford, took Dills's threats seriously. Sean Crawford started bringing a handgun with him to Del Mar for protection. Tr. 819. Richard Crawford told his son and Jennings to quit Del Mar. Tr. 642. He also installed a security system at his home and kept the doors and windows locked at all times for the next few months. Tr. 638-40.
Dills forbade Jennings to speak with Roberts again. Tr. 264, 631, 1300, 1309. Dills called Roberts to ask how to fix the pricing problem. Tr. 854. Roberts explained to Dills that Del Mar had executed the orders and that it needed to match up the orders it had executed with the sell orders on the market side. Tr. 854. Roberts could be of no help to Del Mar in matching up and correcting the trades between the customer side and the market makers; only the brokers and trader at Del Mar would know which customer ordered what sale and who the contra dealer was. Tr. 854, 863. Roberts suggested that one possibility was to give every customer an average price of about 18 cents, or 3/16, for Friday trades. Tr. 855, 1286, 1289. Roberts left it to Del Mar to compare the customer trades by price and volume to the NSCC sheets. Tr. 1296. Roberts had no further communication with Del Mar on Tuesday until the end of the day when he advised Dills of the amount of his realized loss.44 Tr. 863, 1310.
c. Dills Changes Order Tickets
Roberts's suggestion of giving every May 3 customer an average price of 3/16 was not followed. Under Dills's direction and with Jennings's participation, tickets for a number of May 3 trades were changed downward to 3/16; none were changed upward. Tr. 266-67, 270, 391, 405, 409, 412, 466, 470, 522-24; Div. Ex. 81. Dills also directed changing May 6 tickets above .31 downward, to various prices. Tr. 266-67, 270, 391, 470, 522-24; Div. Ex. 81. Dills telephoned at least some customers about the price changes, blaming the reductions on causes outside Del Mar, such as the clearing firm or market conditions. Tr. 281, 381-86, 837.
Jennings had no discretion over the price changes and participated unwillingly; he was given no explanation of the rationale for the changes and was afraid to ask; Dills's threats continued. Tr. 405-06, 412-13, 416, 464-66, 520-24, 631. Dills also claimed Jennings to have consulted legal counsel about changing the tickets and to be in frequent contact with Roberts. Tr. 266, 464-65, 520. Jennings, however, did not observe any conversations between Roberts and Dills during Tuesday. Tr. 464, 574. Roberts denied any contact during the day on Tuesday, when he was occupied with trading to cover the oversell. Tr. 863, 1263-66, 1310. Apart from his suggestion to give all May 3 customers an average price of 3/16, he denied discussing prices of trades at all. Tr. 862-63, 1288-89. The Division theorizes that Roberts likely communicated the changes to the May 6 tickets to Del Mar. There is, however, no evidence in the record that ties Roberts to those changes. Further, Roberts's testimony that he did not communicate with Del Mar during Tuesday is corroborated by Jennings's testimony that he observed no calls between Dills and Roberts.
d. Dills's Claim that Roberts or Jennings Ordered the Price Changes is False
Dills stood to lose hundreds of thousands of dollars, both as owner of Del Mar and because he had given his personal guarantee to Private Brokers should Del Mar's assets be insufficient to cover losses. Yet, incredibly, he claimed to be a passive onlooker while Jennings and/or, variously, Roberts hatched and carried out a scheme to cover up the effects of the oversell. Div. Ex. 150 at 99-110, 117-18, 195-96, 298-99, 325-31. Roberts testified that he did not suggest price changes, other than to give all May 3 customers the 3/16 average price, and had no contact with Del Mar during Tuesday. Jennings testified that he was following Dills's orders, not vice versa. Thus Roberts's and Jennings's live testimony contradict Dills's claim, which he refused to subject to cross examination. Additionally, if a party in an administrative proceeding elects not to testify as to facts within his knowledge, a negative inference can be drawn from that party's silence. Dills's refusal to testify creates an adverse inference that to do so would have damaged his position. See Pagel, Inc., 803 F.2d at 946-47; N. Sims Organ, 293 F.2d at 80-81. His silence, therefore, corroborates the evidence that he was acting on his own and not taking orders from Jennings or Roberts. Additionally, Dills's claim is inherently not believable in view of his personality and controlling position at the firm.
In brief, the record establishes that Dills, not Roberts or Jennings, conceived and carried out the program of changing prices on May 3 and May 6 trades to avoid losses to Del Mar. The record establishes that Roberts informed Dills of the oversell problem on Tuesday morning and informed him that the prices on his agency trades of May 3 could not be correct. There is no evidence in the record that ties Roberts in the slightest degree to the price changes to the May 6 trades. Jennings's participation in the price changes was ministerial, carrying out Dills's orders.
e. Additional Errors
Apart from the price reductions, there were errors in Del Mar's trading records. For example, Ilic had 320,000 shares which he sold, 100,000 on May 3, 150,000 on May 6, and 70,000 on May 7. However, he received additional confirmations, for the sale of 100,000 shares at 11/32 on May 6 (corrected to 9/16 on May 7, and canceled on May 8) and 80,000 shares on May 6 (corrected to 13/32 on May 8 and canceled on May 9). Div. Ex. 115 at ENF 04725, 04730-32, 04734. Cuneo had 100,000 shares, which he sold on May 6. He received an additional confirmation of a May 6 sale of 9,500 shares at 1 (canceled on May 8). Tr. 311-12; Div. Ex. 96A at ENF 03228, 03952. Johnson authorized the sale of his shares on May 4, but order tickets and confirmations date the sale on May 3. Tr. 377-80, 385-86; Div. Ex. 81 at ENF 01534, 01536, Div. Ex. 96A at ENF 03841, 03864. Goetz sold 40,000 shares at .12 on May 15; he received a confirmation dated May 3. Tr. 756-57; Div. Ex. 114 at ENF 04700. Roberts also discovered errors when covering the oversell; Del Mar had executed sale orders for customers who, in fact, did not own the shares. Tr. 1265-66, 1298.
f. Private Brokers Processes the Changed Tickets
The changed tickets were faxed to Private Brokers. Tr. 865; Div. Ex. 95. Roberts informed Childers that corrected tickets, changing incorrect prices, would be coming in from Del Mar for Private Brokers to process.45 Tr. 868, 874, 1230. Childers processed the changes routinely; she did not call any Del Mar customers at this or any other time, or otherwise check for anything out of line; Del Mar's customers talk with Del Mar, and Del Mar had executed the trades. Tr. 1231-33. She did not view the balances that resulted from the trades she entered. Tr. 1242.
4. Customer Losses
As a result of Dills's price reductions, the nine customers who testified in this proceeding lost, and Del Mar gained, a total of $505,502.50 when the proceeds of their sales were reduced. Fischel lost $239,125.46 Maddela lost $125,000.47 Ilic lost $74,375.48 Rogers lost $18,350.49 Johnson lost $17,165.50 Thorne lost $13,300.51 Goetz lost $8,437.50.52 Reichard lost $3,500.53 Cuneo lost $6,250.54 The Division calculates that the changes to the tickets resulted in an $860,159.38 loss to all Del Mar customers who sold Comparator on May 3 and 6. Div. Ex. 162.
5. Expert Testimony
Scott Ryan testified on behalf of the Division and was accepted as an expert in trading. Tr. 1026. He has about thirty years of experience in trading, and, since 1988, has had his own trading firm, S.W. Ryan & Company, which makes markets in approximately 160 stocks. Tr. 1022-23. John Cirrito testified on behalf of the Division and was accepted as an expert on clearing. Tr. 946. He has forty years of experience in the securities industry, including extensive experience in clearing. Tr. 942-46. Benjamin Lubin testified on behalf of Roberts and Private Brokers and was accepted as an expert on clearing. Tr. 1327. He has over forty years of experience in the securities industry, including extensive experience in clearing. Tr. 1314-27. To the extent that the experts' evidence does not lead to findings of fact, it will be summarized here and referred to as appropriate in the Conclusions of Law section of this Decision.
a. Trading
The oversell resulted from errors. Ryan focused on the May 3 trading where most of the oversell occurred.55 Tr. 1029. He opined that Jennings did as well as possible in coping with 238 trades on Friday; his own firm has three traders who do a total of 100 trades a day and make five to ten mistakes a day. Tr. 1054. As Ryan and Lubin opined, three categories of errors occurred, and it is impossible to quantify the extent of error in any individual category. Tr. 1028, 1347. First, Jennings executed oral orders that were not backed up by tickets. Tr. 1030. Second, he made arithmetic errors in batching the customers' orders for sale to the market and also double sold some of the batches. Tr. 1030. Third, he accepted information entered by contra dealers into ACT rather than entering the trading information independently from his side. If a contra dealer entered incorrect information, and Jennings did not enter the trade independently, he accepted the error. Tr. 1031. Jennings accepted eighty-nine of Friday's 100 trades with market makers as they were reported by the other side. Tr. 1031; Div. Exs. 164A, 164B. He accepted only four trades by entering the information from his side. The other seven trades were SelectNet trades.56 Tr. 1031; Div. Ex. 164A at ENF 05790. Thus, Jennings's failure to affirmatively match trades increased the possibility for error in the eighty-nine trades. Tr. 1031. Finally, Cirrito opined that it is not uncommon for traders to absorb the loss when they make errors in executing agency orders. Tr. 984.
Ryan opined that Private Brokers knew of the oversell on Monday during the trading day and directed Del Mar to cover it. Tr. 1063-64, 1077-78. This opinion is rejected. It is based on assumptions that are contrary to fact-that all Friday tickets had been sent to Private Brokers by the middle of the trading day on Monday, that Roberts was continuously checking throughout the day and in frequent contact with Del Mar, and that he could have learned of the amount of the oversell during the trading day. Tr. 1080-86. Ryan finds support for this opinion in his opinion that Del Mar was trading into its inventory on Monday afternoon. Tr. 1037-49. As far as Private Brokers knew, however, the Monday afternoon trades were agency trades since they were marked as such. Div. Ex. 81.
b. Clearing57
During Monday, Roberts did not know about the 500,000 share oversell and the results of the errors in executing orders. The experts disagree as to whether his actions on Monday were sufficient or whether he should have done more that day to investigate Del Mar's Friday trading. The experts agree that Roberts acted appropriately on Tuesday when he informed Del Mar of the price and share discrepancies, deleted Del Mar's ability to execute its own trades, and engaged in trading to cover the oversell. Roberts did not dictate price changes, which would have been inappropriate. The experts disagree as to whether Roberts should have proactively helped Del Mar reconcile the discrepancies and as to whether he should have reviewed the changed order tickets for correctness before allowing the changes to go forward as rebills.
As the experts agree, a clearing firm has no duty or role with respect to ensuring that an introducing firm executes a trade consistent with its customer's instructions. Tr. 997-98, 1329. The introducing firm has all the information about the orders. Tr. 959. The clearing firm does not know which customers are identified with which executions. Tr. 994, 1359. The clearing firm does not talk to the customers of the introducing firm; Private Brokers had no obligation to contact Del Mar's customers and learn the details of their orders. Tr. 1005, 1329. The clearing firm does not review order tickets, or verify their authenticity, prices, or whether they were properly reported through the ACT system; industry practice is to assume that changes have been properly approved by the introducing firm. Tr. 973, 1334, 1418. It is appropriate for a clearing firm to contact an introducing firm and advise it that price discrepancies exist, but not to dictate individual price changes. Tr. 969, 972, 1351-52, 1411. A clearing firm does not know how the problem occurred and what the correct prices or shares should be. Tr. 959, 969, 1352-53. If there is an error, the introducing firm must call the customer and explain. Tr. 1431.
i. Monday
Lubin opined that Roberts acted reasonably on Monday after he reviewed reports that showed a discrepancy between customer orders and sales to the street; Roberts never had a problem with Del Mar before, and he ascertained that Del Mar was sending more trades and that Del Mar customers had more than enough shares to sell to make up the discrepancy. Tr. 1382-86. As Lubin noted, it is necessary to rely on the honesty of oral representations in the securities industry. Tr. 1384. It is not unusual for a clearing firm to have a great many added trades "as-of" a previous trading day; for example, when a research report is issued, there may be many late-day transactions. Tr. 1338-39. Cirrito opined that it was clear that Del Mar had lost control of its business so that, on Monday, Roberts should have started matching the orders he had against the NSCC sheets to identify the missing transactions. Tr. 959-62.
ii. Tuesday
Cirrito opined that Private Brokers should have departed from normal industry practice and reviewed Del Mar's corrections. Because Del Mar had lost control over its processing and because of the possible financial exposure of Private Brokers, it would want to make sure the corrections were reducing the exposure, not increasing it, and resolving discrepancies, not increasing them. Tr. 973. In this case, lowering all trades above .18 to .18 caused price breaks that previously balanced to become unbalanced. Tr. 974-76. Changes to large trades such as the Maddela and Fischel trades would attract attention. Tr. 977-78. However, as pointed out by Lubin, the clearing firm would know nothing about conversations between the introducing firm and customers. Tr. 1416. Lubin also opined that under the circumstances of this case, a dollar for dollar or share for share reconciliation would not have been possible. Tr. 1419
Lubin opined that it was proper for Private Brokers to process the changes. Tr. 1363-66. He opined that a clearing broker has no obligation, nor is it industry practice, to examine transaction changes for consistency with the price breaks on the NSCC sheet. Tr. 1404. As he described the division of responsibilities between Private Brokers as clearing broker and Del Mar as introducing broker, Del Mar was responsible for order taking and trade execution and for ensuring that its practices and personnel complied with laws that apply to those functions. Private Brokers was not Del Mar's supervisor. Its role was limited to clearance and settlement. Tr. 1229-31, 1233-34, 1329. As a clearing firm, Private Brokers was entitled to assume that the information provided by Del Mar was accurate and that corrections were done properly. Tr. 1363, 1418. Private Brokers had no authority or responsibility to redo the work of Del Mar. Tr. 1363, 1394. Cirrito, however, opined that a clearing firm could refuse to process a change that appears improper. Tr. 978.
Cirrito also opined that the method Dills used to correct the discrepancy was inappropriate. Instead, he opined, Dills should have carried out a tedious process of balancing at break points. Tr. 960. The process is tedious because changing one ticket affects other already balanced break points, and demands reconstructing the day's trades in the hope that the errors will become obvious.58 Tr. 975, 1352, 1393. In the instant case, the process would be complicated by Del Mar's execution of oral orders, so that the reconciliation could not be accomplished solely by comparing reports. For example, the May 6 Fischel trade of 500,000 shares, was initially indicated to be at 31/32. The May 6 Goetz trade for 40,000 shares was also indicated at 31/32, and trade tickets in the record for customers who did not testify indicate further sales at 31/32. Tr. 998-1003; Div. Ex. 94. Yet only 200,000 shares were sold to the street at that price according to the NSSC contract sheet. Div. Ex. 92. It goes without saying that the clearing firm would not know the answer to the question of what price the shares really sold at, which could have been lower, and would have to ask the correspondent firm. Tr. 1002-05.
III. CONCLUSIONS OF LAW
In this section it is concluded that Dills, Chaudhuri, and Del Mar violated the antifraud provisions in connection with the 1995 Comparator stock promotion. Also, Dills aided and abetted, and caused Del Mar's violations, and Chaudhuri was a cause of Dills's and Del Mar's violations. Dills and Del Mar committed additional antifraud, books and records, and net capital violations in connection with the sale of the Comparator stock of Del Mar customers in May 1996. Finally, it is concluded that Jennings, Roberts, and Private Brokers did not violate the antifraud or books and records provisions or aid and abet or cause such violations.
A. Antifraud Provisions
Section 17(a) of the Securities Act makes it unlawful "in the offer or sale of" securities, by jurisdictional means, to:
1) employ any device, scheme, or artifice to defraud,
2) obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary to make the statement made not misleading, or
3) engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder proscribe similar practices "in connection with" the purchase or sale of securities. Section 15(c) of the Exchange Act and Rule 15c1-2 thereunder proscribe similar practices by brokers and dealers in connection with transactions in securities.
Scienter is required to establish violations of Section 17(a)(1) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; it is "a mental state embracing intent to deceive, manipulate, or defraud." Aaron v. SEC, 446 U.S. 680, 686 n.5, 695-97 (1980); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976); SEC v. Steadman, 967 F.2d 636, 641-42 (D.C. Cir. 1992). Scienter is not required to establish a Section 17(a)(2) or (3) violation; a finding of negligence is adequate. Richard H. Morrow, 53 S.E.C. 772, 781 (1998) (citing Aaron, 446 U.S. at 696-97); Jay Houston Meadows, 52 S.E.C. 778, 785 n.16 (1996), aff'd, 119 F.3d 1219 (5th Cir. 1997); see also Steadman, 967 F.2d at 643 & n.5 (citing Aaron, 446 U.S. at 701-02); Newcome v. Esrey, 862 F.2d 1099, 1102 n.7 (4th Cir. 1988).
Material misrepresentations and omissions violate Securities Act Section 17(a), Exchange Act Section 10(b) and Rule 10b-5 thereunder, and Exchange Act Section 15(c) and Rule 15c1-2 thereunder. The standard of materiality is whether or not a reasonable investor or prospective investor would have considered the information important in deciding whether or not to invest. See Steadman, 967 F.2d at 643; see also Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 240 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).
Del Mar and Private Brokers are accountable for the actions of their responsible officers, including, respectively, Dills and Roberts. See C.E. Carlson, Inc. v. SEC, 859 F.2d 1429, 1435 (10th Cir. 1988); A.J. White & Co. v. SEC, 556 F.2d 619, 624 (1st Cir. 1977). A corporation's scienter may be imputed from that of individuals controlling it. See SEC v. Blinder, Robinson & Co. Inc., 542 F. Supp. 468, 476 n.3 (D. Colo. 1982) (citing SEC v. Manor Nursing Ctrs., Inc., 458 F.2d 1082, 1096-97 nn.16-18 (2d Cir. 1972)). Further, as associated persons, Dills's and Jennings's conduct and scienter are attributed to Del Mar, and Roberts's, to Private Brokers. See Section 15(b)(4) of the Exchange Act.
1. Aiding and Abetting; Causing
For aiding and abetting liability under the federal securities laws, three elements must be established: (1) a primary or independent securities law violation committed by another party; (2) awareness or knowledge by the aider and abettor that his or her role was part of an overall activity that was improper; also conceptualized as scienter in aiding and abetting antifraud violations; and (3) that the aider and abettor knowingly and substantially assisted the conduct that constitutes the violation. See Graham v. SEC, 222 F.3d 994, 1000 (D.C. Cir. 2000); Woods v. Barnett Bank, 765 F.2d 1004, 1009 (11th Cir. 1985); Investors Research Corp. v. SEC, 628 F.2d 168, 178 (D.C. Cir. 1980); IIT v. Cornfield, 619 F.2d 909, 922 (2d Cir. 1980); Woodward v. Metro Bank, 522 F.2d 84, 94-97 (5th Cir. 1975); SEC v. Coffey, 493 F.2d 1304, 1316-17 (6th Cir. 1974); Russo Sec. Inc., 65 SEC Docket 1990, 1998 & n.16 (Oct. 1, 1997); Donald T. Sheldon, 51 S.E.C. 59, 66 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995); William R. Carter, 47 S.E.C. 471, 502-03 (1981). A person cannot escape aiding and abetting liability by claiming he was ignorant of the securities laws. See Sharon M. Graham, 53 S.E.C. 1072, 1084 n.33 (1998), aff'd, 222 F.3d 994 (D.C. Cir. 2000). The knowledge or awareness requirement can be satisfied by recklessness when the alleged aider and abettor is a fiduciary or active participant. See Ross v. Bolton, 904 F.2d 819, 824 (2d Cir. 1990); Cornfield, 619 F.2d at 923, 925; Rolf v. Blythe, Eastman Dillon & Co. Inc., 570 F.2d 38, 47-48 (2d Cir. 1978); Woodward, 522 F.2d at 97.
A respondent who aids and abets a violation also is a cause of the violation, within the meaning of Sections 8A of the Securities Act and 21C of the Exchange Act. See Sharon M. Graham, 53 S.E.C. at 1085 n.35. Negligence is sufficient to establish liability for causing a primary violation that does not require scienter. KPMG Peat Marwick LLP, 74 SEC Docket 384, 421 (Jan. 19, 2001), recon. denied, 74 SEC Docket 1351 (Mar. 8, 2001), appeal pending, No. 01-1131 (D.C. Cir.).
2. Willfulness
The Division requests sanctions pursuant to Sections 8A of the Securities Act and 15(b)(4) and (6), 19(h), 21B, and 21C of the Exchange Act. The Commission must find willful violations to impose sanctions under Sections 15(b), 19(h), and 21B of the Exchange Act. A finding of willfulness does not require an intent to violate, but merely an intent to do the act which constitutes a violation. See Wonsover v. SEC, 205 F.3d 408, 413-15 (D.C. Cir. 2000); see also Steadman v. SEC, 603 F.2d 1126, 1135 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981); Arthur Lipper Corp. v. SEC, 547 F.2d 171, 180 (2d Cir. 1976); Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965).
B. Antifraud Violations - Stock Promotion Scheme
The OIP charged Dills and Chaudhuri with violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Del Mar, with violating Section 17(a) of the Securities Act and Sections 10(b) and 15(c) of the Exchange Act and Rules 10b-5 and 15c1-2 thereunder during 1995 through early 1996 based on their acquiring Comparator stock from long-time stockholders and obtaining undisclosed kickback payments from the proceeds of selling the stock to unwitting investors. Dills was also charged with aiding and abetting, and causing Del Mar's violations of Exchange Act Section 15(c) and Rule 15c1-2, and Chaudhuri, with causing Dills's and Del Mar's violations.
During 1995, as found above, Dills and Chaudhuri negotiated with Comparator to obtain free-trading stock from Comparator stockholders at discount prices or in return for services. The stock was then registered in the name of an entity Chaudhuri controlled, placed in a brokerage account, and sold at market prices to investors whom Dills and other Del Mar representatives solicited. The only activity in the brokerage account was receiving Comparator stock, selling it, and wiring the proceeds to bank accounts under Chaudhuri's control. Chaudhuri remitted $496,175 of the profits to Dills and $103,550 to himself. No one told the investors about the kickbacks.
1. Scienter
The record shows Dill's scienter, which is attributed to Del Mar, and Chaudhuri's scienter. The intent of each individual was to deceive and defraud. The payments of $103,550 for Chaudhuri and $496,175 for Dills, hidden from the purchasers of the stock they were promoting, were the purpose of their scheme. Their intent is shown by the devious way they obtained free-trading stock, the convoluted steps through which the stock passed on its way from Comparator stockholders to Del Mar customers, and the equally convoluted steps that the undisclosed payments took on their way to Chaudhuri's and Dills's pockets.
2. Material Misrepresentations
In selling the stock to Del Mar customers, Dills and other Del Mar representatives did not disclose the payments flowing to Dills from the proceeds of these sales. Dills also affirmatively misrepresented to some customers that a nominal or no commission was all that he was receiving from their transactions. The omissions and misrepresentations are also attributed to Del Mar. See C.E. Carlson, 859 F.2d at 1435; A.J. White, 556 F.2d at 624 (a firm is accountable for the actions of its responsible officers). The omissions and misrepresentations are attributed to Chaudhuri as well. See SEC v. First Jersey Secs., Inc., 101 F.3d 1450, 1471 (2d Cir. 1996) (primary liability may be imposed not only on persons who made fraudulent misrepresentations but also on those who had knowledge of the fraud and assisted in its perpetration); SEC v. U.S. Envtl., Inc., 155 F.3d 107, 111 (2d Cir. 1998) cert. denied, 526 U.S. 1111 (1999) (a primary violator is one who participated in the fraudulent scheme).
The standard of materiality is whether or not a reasonable investor would have considered the information important. See Steadman, 967 F.2d at 643; see also Basic Inc., 485 U.S. at 231-32, 240; TSC Indus., Inc., 426 U.S. at 449. In this case, the omitted and misrepresented information was clearly material. Misrepresenting or omitting to disclose a broker's financial incentive in connection with a stock recommendation violates the antifraud provisions. The customer is prevented from knowing that the stock recommendation might be based upon the salesman's financial interest rather than the investment value of the security. See SEC v. Hasho, 784 F. Supp. 1059, 1109-10 (S.D.N.Y. 1992) (citing Chasins v. Smith, Barney & Co., 438 F.2d 1167, 1172 (2d Cir. 1970)).
It is concluded that the primary violations charged against Dills, Chaudhuri, and Del Mar in connection with the stock promotion scheme are proven. Dills, Chaudhuri, and Del Mar violated Sections 17(a) of the Securities Act and 10(b) of the Exchange Act and Rule 10b-5 thereunder. Del Mar violated Section 15(c) of the Exchange Act and Rule 15c1-2.
Dills also aided and abetted, and caused Del Mar's violations of Exchange Act Section 15(c) and Rule 15c1-2. Del Mar's violations were largely committed through Dills's actions, and all three elements of aiding and abetting are present: Del Mar's primary violation and Dills's scienter and substantial assistance. Since he aided and abetted Del Mar's violation, he also caused it. Similarly, Chaudhuri's actions were an essential part of the scheme and were thus a cause of Dills's and Del Mar's violations.
3. Willfulness
The acts that constituted the Respondents' violations were, as described above, clearly intentional. Their violations of the antifraud provisions were thus willful.
C. Antifraud Violations-May 1996 Sale of Comparator Stock
The OIP charged Dills and Del Mar with violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Del Mar, with violating Section 15(c) of the Exchange Act and Rule 15c1-2 thereunder based on the price changes to May 3 and 6, 1996, order tickets. Dills was also charged with aiding and abetting, and causing Del Mar's violations of Exchange Act Section 15(c) and Rule 15c1-2. Jennings was charged with aiding and abetting, and causing Del Mar's violations.
Roberts and Private Brokers were charged with violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Private Brokers with violating Section 15(c)(1)(A) of the Exchange Act and Rule 15c1-2. Roberts was also charged with aiding and abetting, and causing Private Brokers's violations, and Roberts and Private Brokers were charged with aiding and abetting, and causing Dills's and Del Mar's violations.
1. Dills and Del Mar
As found above, Dills conceived and carried out a scheme of lowering sale prices on customer order tickets for trades executed on May 3 and May 6 to avoid losses to Del Mar. The record establishes that Del Mar avoided losses of, and customers lost, at least $505,502.50 by this means. The price changes were not associated with any specific errors in those customers' trades and Dills knew this.
a. Scienter
The record shows Dill's scienter, which is attributed to Del Mar. His intent was to deceive and defraud. The purpose of his scheme was to avoid hundreds of thousands of dollars of losses and to avoid paying a $1 million clearing deposit. The fact that he lowered prices on tickets with prices above the average but did not raise prices on tickets with prices below the average shows that he was not merely using a macroscopic method to correct pricing mismatches between trades with customers and with market makers. The scheme, which Dills conceived and carried out, to lower sale prices on customer order tickets was a scheme to defraud within the meaning of Section 17(a)(1) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and a fraudulent device or contrivance within the meaning of Sections 10(b) and 15(c)(1)(A) of the Exchange Act.
b. Material Misrepresentations
Additionally, the lowered prices, sent to customers in confirmations, were material misrepresentations of the prices of their trades. The excuses offered to customers-that the changes were due to the clearing firm, high volume, chaos, or an employee who had been fired-were material misrepresentations. The misrepresentations are also attributed to Del Mar. The misrepresentations were material since they were excuses for depriving individual customers of thousands of dollars each. A reasonable investor would consider the information important. Del Mar customers considered the information important, and some even initiated proceedings to recover the sums about which Dills and Del Mar made the misrepresentations.
It is concluded that the primary antifraud violations charged against Dills and Del Mar in connection with changing the May 3 and 6, 1996, order tickets are proven. Dills and Del Mar violated Sections 17(a) of the Securities Act and 10(b) of the Exchange Act and Rule 10b-5 thereunder. Del Mar violated Section 15(c)(1)(A) of the Exchange Act and Rule 15c1-2.
Dills also aided and abetted, and caused Del Mar's violations of Exchange Act Section 15(c)(1)(A) and Rule 15c1-2. Del Mar's violations were largely committed through Dills's actions, and all three elements of aiding and abetting are present: Del Mar's primary violation and Dills's scienter and substantial assistance. Since he aided and abetted Del Mar's violation, he also caused it.
c. Willfulness
The acts that constituted Dills's and Del Mar's violations were, as described above, clearly intentional. Their violations of the antifraud provisions were thus willful.
2. Jennings
Jennings was charged with aiding and abetting, and causing Del Mar's antifraud violations. As found above, Dills, Jennings's supervisor, ordered him to participate in changing prices on customer tickets, and Jennings complied. Dills told Jennings he had consulted counsel and also reinforced his orders by threats of violence. Dills's threats were credible at the time to Jennings and to Sean and Richard Crawford.
The threats affect both the second element of the aiding and abetting charge-scienter, and the third-substantial assistance. The first element-a primary violation was committed by Del Mar-is clearly present. The second element has not been proven. Jennings had no compliance or supervisory responsibility at Del Mar and his participation in changing the tickets was at the orders of the firm's owner, who gave him assurances as to the propriety of the actions.59 Further, he threatened Jennings physically if he did not comply. Thus, any scienter was reduced by Dills's orders and threats. As to the third element, Jennings assisted the conduct that constitutes the violation because he participated in changing the tickets. His assistance was unwilling, however, and would not have been provided absent Dills's orders and threats.
Since scienter is a required state of mind for violation of Securities Act Section 17(a)(1) and Exchange Act Section 10(b) and Rule 10b-5, Jennings was not a cause of Del Mar's violation of those sections. Negligence is sufficient to establish a violation of Section 17(a)(2) and (3) of the Securities Act. However, irrespective of the applicable standard of care, Jennings cannot be said to have been negligent in view of Dills's threats. Accordingly, it is concluded that Jennings did not aid and abet or cause Del Mar's violations of Securities Act Section 17(a) or Exchange Act Section 10(b) and Rule 10b-5 or Exchange Act Section 15(c) and Rule 15c1-2.
3. Roberts and Private Brokers
As found above, Del Mar's trading was uneventful until May 3 and 6, and on May 7, when Roberts became aware of Del Mar's trading errors, he acted immediately to stop it from causing future problems. On Friday, May 3, Roberts learned, at about 4:00 p.m. CDT, that Del Mar had a high volume of Comparator sales and had not faxed the order tickets to Private Brokers. Roberts instructed Del Mar to fax incomplete order tickets so Private Brokers could start at once to enter the customer side of the trades into a makeshift suspense account for batch processing over the weekend. On Monday, Roberts reviewed reports that showed an imbalance consistent with the fact that some Friday trades had not been entered. He ascertained that more tickets remained to be sent and entered and that Del Mar customers had sufficient stock to cover the imbalance. On Tuesday, he became aware of trading errors and the oversell, and informed Dills. He asked Dills to increase his security deposit. Dills refused and suggested failing to deliver and gambling on a drastic price drop before market makers bought in. Roberts rejected Dills's fraudulent suggestion, deleted Del Mar's access to ACT, and commenced trading to cover the oversell. Roberts also suggested to Dills that one way to remedy what he saw as errors in prices on agency trades was to give every May 3 customer an average price. Whether or not that was a valid suggestion, it was not followed. Later that day Private Brokers received corrected order tickets for May 3 and 6 trades from Del Mar. Roberts and Private Brokers had no knowledge of Del Mar's communications with customers about the changes. Private Brokers processed the changed tickets and sent new confirmations to the customers.
As concluded above, Del Mar and Dills violated the antifraud provisions. Roberts and Private Brokers did not violate the antifraud provisions, nor did they aid and abet or cause Del Mar's and Dills's violations. The charges against Roberts and Private Brokers go far beyond any precedent holding clearing brokers liable for introducing brokers's wrongdoing.60 Specifically, Roberts and Private Brokers did not violate Securities Act Section 17(a)(1) or Exchange Act Section 10(b) and Rule 10b-5 and did not aid and abet or cause Del Mar's and Dills's violations of the antifraud provisions because they did not have scienter. Additionally, their conduct was not negligent and thus did not violate Securities Act Section 17(a)(2) or (3). Roberts's state of mind is attributed to Private Brokers because of his position at the firm and because of his role in the events at issue.
a. Scienter
Roberts did not have intent to deceive and defraud. There is no evidence to show such intent beyond the fact that Private Brokers theoretically could have been liable for part of Del Mar's losses. Nor was Roberts reckless. Del Mar's previous trading was uneventful, and Del Mar had not shown any indications of fraud such as customer complaints, unauthorized trades, parking, or trades that were not paid for.
b. Material Misrepresentations
There were no material misrepresentations by Private Brokers to Del Mar customers. Del Mar made material misrepresentations, misrepresenting the prices of trades in the second set of confirmations to customers and offering false excuses about the changed prices in telephone calls with the customers. The fact that Private Brokers processed and mailed the confirmations does not make these misrepresentations Private Brokers's and Roberts's.
c. Substantial Assistance
Roberts and Private Brokers did not provide substantial assistance to Dills's and Del Mar's violations. The proven facts are that on May 7 Roberts informed Dills of the price discrepancy on May 3 trades; Roberts made a suggestion, which Dills did not follow, that one way to resolve it was to give all May 3 customers an average price; and Private Brokers processed Del Mar's changed order tickets for May 3 and 6 trades.
d. Precedent
There are essentially no cases in which clearing brokers have been held liable for antifraud violations or secondarily liable for an introducing firm's fraud, even when they knew of it. See Blech Sec. Litig., 961 F. Supp. 569, 584 (S.D.N.Y. 1997) (clearing firm not primarily liable for antifraud violations when its conduct is no more than the performance of routine clearing functions); see also Bolton, 904 F.2d at 824 (clearing firm has no fiduciary duty to introducing firm's customer; aiding and abetting charge fails absent actual intent to defraud by clearing firm); Edwards & Hanly v. Wells Fargo Sec. Clearance Corp., 602 F.2d 478, 484-85 (2d Cir. 1979) (clearing firm is generally under no fiduciary duty to owners of securities that pass through its hands; aiding and abetting liability for an antifraud violation requires close to an actual intent to aid in a fraud in the absence of a fiduciary duty); Blech Sec. Litig., 928 F. Supp. 1279, 1295-96 (S.D.N.Y. 1996) (no material omission even if clearing firm knew and failed to disclose a material fact because a clearing broker owes no duty of disclosure to introducing firm's customer); Dillon v. Militano, 731 F. Supp. 634, 636-39 (S.D.N.Y. 1990) (clearing broker performs clerical functions; not liable for introducing broker's fraud; no aiding and abetting liability as clearing firm owed no duty to customers of introducing firm).
The limited precedent for holding a clearing broker liable for fraud is found in cases in which courts denied motions to dismiss complaints against clearing brokers that alleged long-running, egregious situations in which the clearing broker was a full partner in the introducing broker's wrongdoing. Roberts and Private Brokers's conduct on May 7 was far from a long-running partnership in wrongdoing. See Blech Sec. Litig., 961 F. Supp. at 582-85 (allegation that clearing broker Bear Stearns, knowing the history of sham trading of Blech & Co., demanded that it reduce its debit balance and then cleared its fraudulent parking transactions); Atlantic Fin. Mgmt., Inc., Sec. Litig., 658 F. Supp. 380, 381 (D. Mass. 1986) (allegation that clearing broker had close working relationship with individual defendants and knew of their conflict of interest in plaintiffs' transactions); Margaret Hall Found., Inc. v. Atlantic Fin. Mgmt., Inc. 572 F. Supp. 1475, 1480-81 (D. Mass. 1983) (allegation that clearing broker had close relationship with introducing firm, rented offices to it, and promoted the same fraudulent investment). Similarly, recent Commission settlements61 with Bear, Stearns Securities Corp. (Bear Stearns) and its president Richard Harriton involved an egregious, long-running situation.62
e. Negligence
Roberts and Private Brokers's actions on Monday, May 6, and Tuesday, May 7, were not negligent, and they did not violate Securities Act Sections 17(a)(2) or (3). There is an absence of precedent for charging a clearing broker with negligent antifraud violations. However, the expert testimony is useful in illuminating the standard of care.
Roberts acted with due care on Monday. He had never had any trouble with Del Mar previously, and it was reasonable to assume that the orders Jennings would be sending on Monday would clear up the discrepancy since Del Mar customers had more than enough stock to cover it. Division expert Cirrito's opinion that Roberts had a duty to start proactively reconciling trades on the theory that Del Mar had lost control of its business is rejected in light of the facts that Roberts knew-that Del Mar was sending more order tickets and that Del Mar customers owned more than enough stock to make up the shortfall of customer orders. Additionally, it is not unusual to have added as-of transactions when, for instance, there are many late day transactions related to breaking news.
Roberts acted with due care on Tuesday as well. As the experts agree, Roberts acted appropriately when he informed Del Mar of the price and share discrepancies, deleted its ability to execute its trades, and covered the oversell. It is inappropriate to dictate price changes, and he did not.
Further, as the experts agree, industry practice is to assume that changes have been properly approved by the introducing firm. A clearing firm has no duty to ensure that an introducing firm executes a trade consistent with the customer's instructions. The clearing firm has no contact with the introducing firm's customers, and does not review order tickets, or verify their authenticity, prices or whether they were properly reported through ACT. Cirrito opined that Private Brokers should have departed from normal industry practice and reviewed Del Mar's changes closely because Del Mar had lost control of its processing. The opinion that Private Brokers had a duty to depart from normal industry practice is rejected. Roberts and Private Brokers will not be faulted for adhering to industry practice and held to be negligent for conforming to the usual standard of due care.
D. Books and Records Violations-May 1996
The OIP charged Del Mar and Private Brokers with violations of Exchange Act Section 17(a) and Rules 10b-10 and 17a-3, based on creating false order tickets and issuing false confirmations by changing prices on May 3 and 6, 1996, trades. Dills, Jennings, Roberts, and Private Brokers were charged with aiding and abetting, and causing Del Mar's violations, and Roberts, with aiding and abetting, and causing Private Brokers's violations.
1. Books and Records Provisions
Section 17(a)(1) provides that brokers and dealers "shall make and keep for prescribed periods such records, furnish such copies thereof, and make and disseminate such reports as the Commission, by rule, prescribes as necessary or appropriate in the public interest." The requirement that records be kept embodies the requirement that they be accurate. James F. Novak, 47 S.E.C. 892, 897 (1983).
The Commission has emphasized the importance of the records required by the record keeping rules as "the basic source documents and transaction records of a broker-dealer." Statement Regarding the Maintenance of Current Books and Records by Brokers and Dealers, 4 SEC Docket 195, 195 (Apr. 26, 1974). The record keeping rules are "a keystone of the surveillance of brokers and dealers by our staff and by the securities industry's self-regulatory bodies." Edward J. Mawod & Co., 46 S.E.C. 865, 873 n.39 (1977) (citation omitted), aff'd, 591 F.2d 588 (10th Cir. 1979). Scienter is not required to prove a violation of Section 17(a)(1) of the Exchange Act and the rules thereunder. Stead v. SEC, 444 F.2d 713, 716-17 (10th Cir. 1971); SEC v. Drexel Burnham Lambert Inc., 837 F. Supp. 587, 610 (S.D.N.Y. 1993), aff'd sub nom. SEC v. Posner, 16 F.3d 520 (2d Cir. 1994).
Rule 17a-3 requires brokers and dealers to make and keep current certain books and records, including:
1) memoranda (order tickets) of each brokerage order and of each purchase and sale of securities for the account of the member, broker, or dealer showing the price and, to the extent feasible, the time of execution (Rules 17a-3(a)(6) and (7)); and
2) copies of confirmations of all purchases and sales of securities (Rule 17a-3(a)(8)).63
Rule 10b-10 requires brokers and dealers to send customers written confirmations of each transaction, disclosing, inter alia, the date and time of the transaction, and the identity, price, and number of shares of the security purchased or sold, and whether the broker or dealer is acting as agent, principal, or market maker. Rule 10b-10 is violated by inaccurate confirmations. Bison Sec., Inc., 51 S.E.C. 327, 333 (1993).
Pursuant to Rule 17a-3(b)(1), a broker such as Del Mar that transacts business through a clearing broker such as Private Brokers, is not required to maintain the records required by Rule 17a-3 if they are customarily made and kept by the clearing firm.
2. Dills and Del Mar
As found and concluded above, Dills conceived and carried out the fraudulent scheme of lowering sale prices on Del Mar's customer order tickets for trades executed on May 3 and May 6 to avoid losses to Del Mar. Del Mar violated Exchange Act Section 17(a)(1) and Rules 10b-10 and 17a-3 by creating false order tickets, resulting in false confirmations, by changing the prices at which Del Mar had executed customer trades.
Dills also aided and abetted, and caused Del Mar's violations of Exchange Act Section 17(a)(1) and Rules 10b-10 and 17a-3. Del Mar's violations were largely committed through Dills's actions, and all three elements of aiding and abetting are present: Del Mar's primary violation and Dills's scienter and substantial assistance. Since he aided and abetted Del Mar's violation, he also caused it.
The acts and omissions that constituted Dills's and Del Mar's violations were, as described above, clearly intentional. Their violations were thus willful.
3. Jennings
Jennings was charged with aiding and abetting, and causing Del Mar's violations of Exchange Act Section 17(a) and Rules 10b-10 and 17a-3 by assisting in making false changes to customer order tickets. It is concluded that Jennings did not aid and abet or cause Del Mar's violations of these books and records provisions for the same reasons that he did not aid and abet or cause Del Mar's antifraud violations.
4. Roberts and Private Brokers
Roberts and Private Brokers were also charged with violating and aiding and abetting violations of Exchange Act Section 17(a) and Rules 10b-10 and 17a-3. It is concluded that Roberts and Private Brokers did not violate or aid and abet or cause violations of these books and records provisions for the same reasons that they did not violate or aid and abet or cause violations of the antifraud provisions. That is, they did not have scienter, render substantial assistance, or act negligently.
E. Minimum Net Capital Violations-May 1996
The OIP charged Del Mar with violating Exchange Act Section 15(c)(3) and Rules 15c3-1 and 17a-11 by continuing to conduct business as a broker-dealer and failing to notify the Commission when it lacked the required minimum net capital on May 6, 1996. Dills was charged with aiding and abetting, and causing Del Mar's violations.
Pursuant to Exchange Act Section 15(c)(3) and Rule 15c3-1 Del Mar was required at all times to have and maintain minimum net capital of $100,000. Rule 15c3-1 is designed to ensure that broker-dealers have sufficient liquid capital to protect the assets of customers and to meet their responsibilities to other broker-dealers. See Lowell H. Listrom, 50 S.E.C. 883, 886 (1992), aff'd, 975 F.2d 866 (8th Cir. 1992) (unpublished table decision); Joseph S. Barbera, 73 SEC Docket 2271, 2273 (Nov. 7, 2000). Exchange Act Rule 17a-11 provides, "every broker or dealer whose net capital declines below the minimum amount required . . . shall give notice of such deficiency that same day" to the Commission.
During May 1996 Del Mar had net capital of approximately $200,000, except on May 3 and 6. The record establishes an oversell of over 500,000 shares on May 6. The value of that oversell for the purposes of calculating Del Mar's net capital position is determined by the market value, pursuant to Exchange Act Rule 15c3-1(c)(2)(i)(B)(1). Comparator had a market value of approximately $1.00 per share at the close on May 6. The oversell alone reduced Del Mar's net capital to a negative value, below its $100,000 minimum requirement. Del Mar continued to conduct business as a broker-dealer on May 7. At no time did it notify the Commission of its net capital deficiency.
Accordingly, Del Mar violated Section 15(c)(3) of the Exchange Act and Rules 15c3-1 and Rule 17a-11, and Dills aided and abetted, and caused Del Mar's violations. Del Mar's violations were committed through Dills's actions and inaction, and all three elements of aiding and abetting are present: Del Mar's primary violation, Dills's knowledge that his role was part of an overall activity that was improper, and his knowing and substantial assistance. The record shows that Dills was aware of his responsibility to calculate Del Mar's net capital daily, that it was his responsibility to ascertain and notify the Commission of any deficiency, and that he did not do so. Since he aided and abetted Del Mar's violation, he also caused it.
The acts and omissions that constituted Dills's and Del Mar's violations were, as described above, clearly intentional. Their violations of the antifraud provisions were thus willful.
IV. ULTIMATE CONCLUSIONS
No violation alleged in the OIP against Jennings, Roberts, or Private Brokers was proved. Accordingly, the proceeding will be dismissed as to each of them.
In connection with the 1995 stock promotion scheme, Dills, Chaudhuri, and Del Mar violated the antifraud provisions. Each willfully violated Sections 17(a) of the Securities Act and 10(b) of the Exchange Act and Rule 10b-5 thereunder. Del Mar willfully violated Section 15(c) of the Exchange Act and Rule 15c1-2. Dills also willfully aided and abetted, and caused Del Mar's violations of Exchange Act Section 15(c) and Rule 15c1-2, and Chaudhuri caused Dills's and Del Mar's violations.
In connection with the May 3 and 6, 1996, trading, Dills and Del Mar again violated the antifraud provisions. Each willfully violated Sections 17(a) of the Securities Act and 10(b) of the Exchange Act and Rule 10b-5 thereunder. Del Mar willfully violated Section 15(c)(1)(A) of the Exchange Act and Rule 15c1-2. Dills also willfully aided and abetted, and caused Del Mar's violations of Exchange Act Section 15(c)(1)(A) and Rule 15c1-2.
Also in connection with the May 1996 trading, Dills and Del Mar violated books and records provisions. Del Mar willfully violated Exchange Act Section 17(a)(1) and Rules 10b-10 and 17a-3 by creating false order tickets and confirmations following its execution of May 3 and 6 customer trades. Dills willfully aided and abetted, and caused Del Mar's violations of Exchange Act Section 17(a)(1) and Rules 10b-10 and 17a-3.
Finally, in connection with the May 1996 trading, Dills and Del Mar violated the minimum net capital provisions. Del Mar willfully violated Exchange Act Section 15(c)(3) and Rules 15c3-1 and 17a-11. Dills willfully aided and abetted, and caused Del Mar's violations of Exchange Act Section 15(c)(1)(A) and Rules 15c1-2 and 17a-11.
V. SANCTIONS
The Division requests a cease and desist order against each Respondent. As to Dills, the Division also requests disgorgement, jointly and severally with Chaudhuri, of $662,451.51 of ill-gotten gains from the stock promotion scheme; disgorgement, jointly and severally with Del Mar, of $860,159.38 of ill-gotten gains from losses avoided by changing order tickets for the May 3 and 6, 1996, trades; third-tier civil money penalties in an unspecified amount; and a bar. As to Del Mar, in addition to disgorgement, the Division requests revocation of registration, and third-tier civil money penalties in an unspecified amount.
For the reasons discussed below, these sanctions will be ordered: a cease and desist order against Dills, Del Mar, and Chaudhuri; disgorgement of $103,550 from Chaudhuri, $496,175 from Dills, and $505,502.50 from Dills and Del Mar jointly and severally; civil money penalties of $200,000 against Dills and $500,000 against Del Mar; and bar of Dills and revocation of registration of Del Mar.
A. Sanction Considerations
When the Commission determines administrative sanctions, it considers:
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, 603 F.2d at 1140 (quoting SEC v. Blatt, 583 F.2d 1325, 1334 n.29 (5th Cir. 1978)), aff'd on other grounds, 450 U.S. 91 (1981).
The Commission determines sanctions pursuant to a public interest standard.64 Thus, in addition to issues related to the violator, it "weigh[s] the effect of [its] action or inaction on the welfare of investors as a class and on standards of conduct in the securities business generally." Arthur Lipper Corp., 46 S.E.C. 78, 100 (1975); Richard C. Spangler, Inc., 46 S.E.C. 238, 254 n.67 (1976). The amount of a sanction depends on the facts of each case and the value of the sanction in preventing a recurrence. See Berko v. SEC, 316 F.2d 137, 141 (2d Cir. 1963); Leo Glassman, 46 S.E.C. 209, 211-12 (1975).
B. Sanctions
1. Cease and Desist
Sections 8A of the Securities Act and 21C of the Exchange Act authorize the Commission to issue a cease and desist order against a person who "is violating, has violated, or is about to violate" any provision of the Acts or rules thereunder. Whether there is a reasonable likelihood of such violations in the future must be considered. See KPMG, 74 SEC Docket at 429. In determining whether a cease and desist order is appropriate, the Commission considers the Steadman factors quoted above, as well as the recency of the violation, the degree of harm to investors, and the combination of sanctions against the respondent. KPMG, 74 SEC Docket at 436. As concluded above, Chaudhuri violated the antifraud provisions in a scheme that continued for a year, and Dills and Del Mar violated the antifraud provisions in two separate schemes over a year and a half, as well as books and records and minimum net capital provisions. Further, the record shows a reasonable likelihood of such violations in the future.
All three Respondents' violations were part of a pattern and were also flagrant and deliberate, involving a high degree of scienter. Del Mar is wholly owned by Dills. There were no assurances against future violations and no recognition of the wrongful nature of Respondents' conduct. The record shows a continuing association between Dills and Chaudhuri. Thus, Respondents' business will present opportunities to violate the law in the future. The degree of harm to investors is quantified in over $1,000,000 of ill-gotten gains in which each shared. A cease and desist order against all three is appropriate. Accordingly, Dills, Chaudhuri, and Del Mar will be ordered to cease and desist from committing or causing any violations or future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(c) and Rules 10b-5 and 15c1-2. Dills and Del Mar will also be ordered to cease and desist from committing or causing any violations or future violations of Exchange Act Section 17(a) and Rules 10b-10, 15c3-1, 17a-3, and 17a-11.
2. Disgorgement
Exchange Act Section 21C(e) authorizes disgorgement of ill-gotten gains from Chaudhuri, Dills, and Del Mar. Disgorgement is an equitable remedy that requires a violator to give up wrongfully obtained profits causally related to the proven wrongdoing. See SEC v. First City Fin. Corp., 890 F.2d 1215, 1230-32 (D.C. Cir. 1989); see also Hateley v. SEC, 8 F.3d 653, 655-56 (9th Cir. 1993). It returns the violator to where he would have been absent the violative activity.
The Division requests disgorgement from Dills and Chaudhuri, jointly and severally, of ill-gotten gains from the stock promotion scheme in the amount of $662,451.51. As found, Dills obtained ill-gotten gains from the stock promotion scheme in the amount of $496,175, and Chaudhuri, in the amount of $103,550. These are the profits each obtained that are causally related to the proven wrongdoing and will be ordered against each, with prejudgment interest.
Gains from changing the May 3 and 6, 1996, order tickets of the customers who testified were proven to total $505,502.50. Disgorgement in this amount will be ordered jointly and severally against Dills and Del Mar as causally related to the proven wrongdoing. It is not possible to determine with certainty any amount of ill-gotten gains obtained from changing order tickets beyond that sum. The Division calculated that gains totaled $860,159.38 and requests disgorgement in this amount. The records on which this calculation was based contain errors, however, and could also contain some legitimate changes. See Laurie Jones Canady, 69 SEC Docket 1468, 1479, 1486-87 (April 5, 1999), recon. denied, 70 SEC Docket 905 (Aug. 6, 1999), pet. for review denied, 230 F.3d 362 (D.C. Cir. 2000) (disgorgement amount reduced to reflect only clearly proven ill-gotten gains from churning accounts of several customers who testified about their dealings with Respondent; no disgorgement of commissions from unsolicited trades and from accounts of similar customers who did not testify; Commission declined to "engage in speculation" and hold she controlled those accounts).
Chaudhuri and Dills filed statements containing evidence concerning ability to pay, pursuant to 17 C.F.R. § 201.630. Chaudhuri Ex. 1 is a sworn statement of his financial condition as of March 2000. Dills Ex. 1 is a statement of the financial condition of himself and Del Mar as of January 2000, in which he indicates minimal assets and about $1,000,000 in judgments against them. The disgorgement amounts will be fixed as described above and ordered, nonetheless.
The disgorgement amount ordered against Chaudhuri is not inconsistent with Chaudhuri Ex. 1. Additionally, the exhibit, which was offered and accepted after the hearing closed, was not subjected to cross-examination. Also, at the hearing he declined to answer questions about receipt and payment of funds obtained in the stock promotion scheme.
Likewise, Dills Ex. 1 was not subjected to cross-examination, and Dills declined to answer questions about his and Del Mar's receipt of funds and avoidance of losses arising from the events at issue. This lowers the evidentiary weight of the exhibit.
3. Civil Money Penalty
Section 21B of the Exchange Act authorizes the Commission to impose civil money penalties for willful violations of the Securities and Exchange Acts or rules thereunder. In considering whether a penalty is in the public interest, the Commission may consider six factors: (1) fraud; (2) harm to others; (3) unjust enrichment; (4) previous violations; (5) deterrence; and (6) such other matters as justice may require. See Section 21B(c) of the Exchange Act; New Allied Dev. Corp., 52 S.E.C. 1119, 1130 n.33 (1996); First Sec. Transfer Sys., Inc., 52 S.E.C. 392, 395-96 (1995); see also Jay Houston Meadows, 52 S.E.C. at 787-88; Consolidated Inv. Servs., Inc., 52 S.E.C. 582, 590-91 (1996).
There are no mitigating factors, and there are several aggravating factors. Dills and Del Mar violated the antifraud provisions, so their violative actions "involved fraud [and] reckless disregard of a regulatory requirement" within the meaning of Section 21B(c)(1) of the Exchange Act. Harm to others and unjust enrichment of Dills and Del Mar occurred by virtue of their ill-gotten gains exceeding $1,000,000 that were obtained at the expense of investors. Deterrence requires substantial penalties against Del Mar and its owner because of the flagrant and deliberate nature of the violations.
Penalties are in the public interest in this case. Penalties in addition to cease and desist orders, bar, and revocation are necessary for the purpose of deterrence. See Section 21B(c)(5) of the Exchange Act; see also H.R. Rep. No. 101-616 (1990). Third-tier penalties, as the Division requests, are appropriate because the violative acts involved fraud, reckless disregard of a regulatory requirement and resulted in substantial losses to other persons and resulted in substantial pecuniary gain to the violators. See Section 21B(b)(3) of the Exchange Act.
The maximum third-tier penalty for each act or omission is $100,000 for a natural person and $500,000 for any other person.65 Section 21B of the Exchange Act, like most civil penalty statutes, leaves the precise unit of violation undefined. See Colin S. Diver, The Assessment and Mitigation of Civil Money Penalties by Federal Administrative Agencies, 79 Colum. L. Rev. 1435, 1440-41 (1979). The Division requests that Dills and Del Mar each be ordered to pay third tier penalties without specifying dollar amounts or units of violation. Dills and Del Mar did not respond. Dills Ex. 1, however, is intended to indicate that Dills and Del Mar are unable to pay penalties.
The events at issue will be considered as two courses of action resulting in two units of violation-the violations arising from the stock promotion scheme and the violations arising from the May 3 and 6, 1996, trading. Penalty amounts of $200,000 against Dills and $1,000,000 against Del Mar are consistent with Commission precedent.66 There will be no reduction in the penalty against Dills for the reasons set forth above. However, the amount imposed against Del Mar will be reduced to $500,000. This value takes into account the need for deterrence as well as record evidence bearing on Del Mar's ability to pay.67 See Sections 21B(c)(5) and (d) of the Exchange Act.
4. Bar and Revocation
As the Division requests, and based on the factors enunciated in Steadman v. SEC, 603 F.2d at 1140, Dills will be barred from association with a broker or dealer, and the broker-dealer registration of Del Mar will be revoked. These remedies are authorized by Sections 15(b) and 19(h) of the Exchange Act. Combined with other sanctions ordered, bar and revocation are in the public interest and an appropriate deterrents. The violations involved scienter. Dills and Del Mar's business presents them with the opportunity to commit violations of the securities laws in the future. The record shows a lack of recognition of the wrongful nature of their conduct. In short, it is necessary for the public interest and the protection of investors that Dills and Del Mar not be in the securities industry.
VI. RECORD CERTIFICATION
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.351(b), it is certified that the record includes the items set forth in the record index issued by the Secretary of the Commission on August 1, 2001.
VII. PROCEDURAL ORDER
IT IS ORDERED that the Division's request to admit Div. Ex. 150 into evidence against Respondents Roberts, Private Brokers, and Jennings IS DENIED. Div. Ex. 150 is in evidence for use against Respondent Dills.
IT IS FURTHER ORDERED that the Division's request to admit Div. Exs. 151 and 152 into evidence IS DENIED.
VIII. ORDER
Based on the findings and conclusions set forth above,
IT IS ORDERED that this administrative proceeding IS DISMISSED as to Private Brokers Corporation.
IT IS FURTHER ORDERED that this administrative proceeding IS DISMISSED as to Robert A. Roberts.
IT IS FURTHER ORDERED that this administrative proceeding IS DISMISSED as to Matthew R. Jennings.
IT IS FURTHER ORDERED that, pursuant to Sections 8A of the Securities Act and 21C of the Exchange Act,
Jai Chaudhuri CEASE AND DESIST from committing or causing any violations or future violations of Section 17(a) of the Securities Act and Sections 10(b) and 15(c) of the Exchange Act and Rules 10b-5 and 15c1-2 thereunder;
Kevin C. Dills CEASE AND DESIST from committing or causing any violations or future violations of Section 17(a) of the Securities Act and Sections 10(b), 15(c), and 17(a) of the Exchange Act and Rules 10b-5, 10b-10, 15c1-2, and 17a-3 thereunder; and
Del Mar Financial Services, Inc. CEASE AND DESIST from committing or causing any violations or future violations of Section 17(a) of the Securities Act and Sections 10(b), 15(c), and 17(a) of the Exchange Act and Rules 10b-5, 10b-10, 15c1-2, and 17a-3 thereunder.
IT IS FUTHER ORDERED that, pursuant to Sections 8A of the Securities Act and 21C of the Exchange Act,
Jai Chaudhuri DISGORGE $103,550 plus prejudgment interest at the rate established under Section 6621(a)(2) of the Internal Revenue Code, 26 U.S.C. § 6621(a)(2), compounded quarterly, pursuant to Rule 600 of the Commission's Rules of Practice, 17 C.F.R. § 201.600. Pursuant to Rule 600(a), prejudgment interest is due from January 1, 1996, through the last day of the month preceding which payment is made;
Kevin C. Dills DISGORGE $496,175 plus prejudgment interest at the rate established under Section 6621(a)(2) of the Internal Revenue Code, 26 U.S.C. § 6621(a)(2), compounded quarterly, pursuant to Rule 600 of the Commission's Rules of Practice, 17 C.F.R. § 201.600. Pursuant to Rule 600(a), prejudgment interest is due from January 1, 1996, through the last day of the month preceding which payment is made;
Del Mar Financial Services, Inc., and Kevin C. Dills JOINTLY AND SEVERALLY DISGORGE $505,502.50 plus prejudgment interest at the rate established under Section 6621(a)(2) of the Internal Revenue Code, 26 U.S.C. § 6621(a)(2), compounded quarterly, pursuant to Rule 600 of the Commission's Rules of Practice, 17 C.F.R. § 201.600. Pursuant to Rule 600(a), prejudgment interest is due from June 1, 1996, through the last day of the month preceding which payment is made.
IT IS FURTHER ORDERED that, pursuant to Section 21B of the Exchange Act,
Del Mar Financial Services, Inc. PAY A CIVIL MONEY PENALTY of $500,000; and
Kevin C. Dills PAY A CIVIL MONEY PENALTY of $200,000.
IT IS FURTHER ORDERED that, pursuant to Sections 15(b) and 19(h) of the Exchange Act,
The REGISTRATION of Del Mar Financial Services, Inc., as a broker or dealer IS REVOKED; and
Kevin C. Dills IS BARRED from association with any broker or dealer.
Payment of disgorgement and penalties shall be made on the first day following the day this initial decision becomes final by certified check, U.S. Postal money order, bank cashier's check or bank money order payable to the Securities and Exchange Commission. The check[s] and a cover letter identifying the Respondent[s] and Administrative Proceeding No. 3-9959, 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 at the same address.
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. 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 him, 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.
____________________________
Carol Fox Foelak
Administrative Law Judge
| 1 | The proceeding has ended as to Respondent Brandon. See Del Mar Financial Services, Inc., Order Making Findings, Ordering Respondent to Cease and Desist, and Imposing Remedial Sanctions as to Philip S. Brandon, 71 SEC Docket 1909 (Feb. 14, 2000). |
| 2 | Citations to exhibits offered by the Division, Private Brokers/Roberts, Dills, Chaudhuri, and to the transcript of the hearing will be noted as "Div. Ex. __," "PB Ex. __," "Dills Ex. __," "Chaudhuri Ex. __," and "Tr. __," respectively. |
| 3 | See 5 U.S.C. § 557(c). |
| 4 | FRE Rule 801(d)(2)(E) provides, "A statement is not hearsay if . . . offered against a party and is . . . a statement by a coconspirator of a party during the course and in furtherance of the conspiracy." By analogy to a conspiracy, Roberts and Jennings were charged with aiding and abetting Dills's or Del Mar's alleged scheme to defraud customers in May 1996 by lowering prices on order tickets. Dills's investigative testimony months later was not "during the course and in furtherance of the conspiracy." See Wong Sun v. United States, 371 U.S. 471, 488 (1963) (out-of-court declaration made after arrest may not be used at trial against declarant's partner in crime); United States v. Clark, 18 F.3d 1337, 1342 (6th Cir. 1994) (statement is "in furtherance of" a conspiracy if intended to promote objectives of the conspiracy); United States v. Carper, 942 F.2d 1298, 1301 (8th Cir. 1991) (statement made after arrest could not have been in furtherance of the conspiracy). |
| 5 | To the extent that Dills's investigative testimony inculpates them, it is also unreliable. As the subject of a formal investigation testifying pursuant to subpoena, Dills had every motive to deflect blame for any wrongdoing away from himself and toward Roberts, Private Brokers, and Jennings. See Lee v. Illinois, 476 U.S. 530, 541-44 (1986) (testimony that inculpates another conspirator is suspect); see also Vincent v. Seabold, 226 F.3d 681, 686-88 (6th Cir. Sept. 2000); United States v. Gomez-Lemos, 939 F.2d 326, 329-32 (6th Cir. 1991) (coconspirators' statements made after conspiracy has terminated presumed untrustworthy; when the wrongdoing is revealed, they lose identity of interest and become antagonists). A statement is more reliable when made voluntarily and without a motive to implicate others. Compare Gomez-Lemos, supra, with United States v. Accetturo, 966 F.2d 631, 635 (11th Cir. 1992). |
| 6 | Additionally, live testimony is preferable to written testimony, especially where credibility is at issue. Cf. 17 C.F.R. § 201.235(a)(5). |
| 7 | The Division noted that Div. Exs. 151 and 152 were on its prehearing exhibit list. As the undersigned observed, it is not unusual to list investigative transcripts on prehearing exhibit lists in the Commission's administrative proceedings. However, the usual use of a party's or other witness's transcript at the hearing is to attempt to impeach him with portions of it. |
| 8 | The registration of Stuart-James was revoked and its principals and other associated persons were sanctioned for multiple serious violations connected with its business of underwriting and retail trading of low-priced speculative securities. See C. James Padgett, 52 S.E.C. 1257 (1997) for a description of the firm's practices. |
| 9 | Dills even tried to claim that he could not calculate Del Mar's net capital on May 7 because Private Brokers had not returned order tickets to him, until reminded by his attorney that, having facsimiled (faxed) the tickets to Private Brokers, Del Mar had the originals. Div. Ex. 150 at 297. |
| 10 | Philip Brandon, who was associated with Del Mar and settled the charges against him in this proceeding, had been incarcerated, at least twice; one conviction was for commercial burglary. Tr. 352-53; Div. Ex. 150 at 31-33, 61-62. |
| 11 | An "introducing" (also called "correspondent") firm, such as Del Mar, sends its order tickets to its clearing (also called "carrying") firm, which clears and settles the transactions, provides computer support, and sends confirmations and account statements to the customers of the introducing firm. Tr. 1329. The arrangement enables introducing brokers to engage in the securities business without large amounts of capital. |
| 12 | To the extent that there is any inconsistency between Roberts's testimony and Div. Ex. 160, an NASD print-out purporting to summarize regulatory actions against Roberts, his testimony is accepted as more accurate. Div. Ex. 160, for example, refers to violation of non-existent Rule 15c3-(E). Div. Ex. 160 at ENF 05763. Also, Roberts's testimony is based on his personal knowledge, while the record does not show the source of the information in Div. Ex. 160. Thus his testimony that the first regulatory action occurred in 1974 is more reliable than the 1976 or 1977 date indicated in Div. Ex. 160. The Division did not challenge Roberts's account of the three NASD regulatory actions against him. |
| 13 | NASD members use ACT for trade reporting and clearance; after negotiating a trade on the phone, they enter it into ACT to be matched and compared and then sent for clearing to the National Securities Clearing Corporation. Tr. 1151-52. The trades are also displayed to the rest of the market on the consolidated tape. Tr. 1151. Usually both buyer and seller independently enter the trade into ACT, each entering the security, the quantity, the price, and the contra side. Tr. 1151. ACT finds both entries and compares them to make sure that the information entered is an exact match. Tr. 1152. Also, the reporting firm can enter the trade into ACT, and the contra party can accept it using a browse function. Tr. 1152. Once a trade has been entered by both parties or accepted by the non-reporting party, each has the responsibility to deliver what is promised, money by the buyer and stock by the seller. Tr. 1153. |
| 14 | NSCC contract sheets are used by clearing firms. A firm's NSCC contract sheet arranges trades in three categories. First, compared trades, which have been agreed between the counter-parties, are listed. Any discrepancies are categorized as uncompared (data was submitted by the clearing firm to NSCC that has not compared with any contra party submission) or advisory (transactions were submitted by contra parties to NSCC but data from the clearing firm is lacking). Tr. 665-66, 949. The discrepancies should be reconciled before the settlement date to ensure that firms receive proper payments and securities. Tr. 949. |
| 15 | The block to designate whether a trade is principal, agency, or market maker is filled out by the broker-dealer executing the trade, in this case Del Mar. Tr. 1206. |
| 16 | Comparator, based in Newport Beach, California, was purportedly engaged in research and development of software-based digital fingerprint comparison systems. Investors were told that it was, or soon would, produce devices for verifying identifications by fingerprints and that these systems would be used by business and government agencies. Comparator had gone public in 1979 in an offering underwritten by Blinder, Robinson & Co., Inc., and had limited sales, few products, and no profits. |
| 17 | Marple's April 8, 1997, investigative testimony, Div. Ex. 170, was admitted into evidence, pursuant to 17 C.F.R. § 201.235(a)(1), because he died before the hearing. |
| 18 | Calloway (variously, "Callaway") Consulting was incorporated in 1994; it is 100% owned by, and has no employees other than, Chaudhuri. Div. Ex. 149 at 15-16. The Chaudhuri Family Trust was created by Chaudhuri on December 21, 1994. Div. Ex. 26 at ENF 00067, Div. Ex. 149 at 43. Comparator was the only security that the trust bought and sold. Div. Ex. 149 at 42. |
| 19 | The stockholders used at least some of the proceeds to buy more (restricted) stock directly from Comparator. Div. Ex. 170 at 230, 239, 246-49. |
| 20 | The bid is the highest price a prospective buyer is prepared to pay at a particular time, and the ask is the lowest price acceptable to a prospective seller of the same security. John Downes & Jordon Elliot Goodman, Barron's Dictionary of Finance and Investment Terms 47-48 (4th ed. 1995). |
| 21 | Chaudhuri claims that he had account information faxed to himself via Del Mar merely as a convenience since he did not have a fax machine. Div. Ex. 149 at 59-63. This claim is belied by the February 14, 1995, fax of account information from Equitrade to Dills. The cover page contains a note to Dills: "Attached is the information we discussed. If there are any discrepancies or questions, please call." Div. Ex. 11. |
| 22 | Dr. Fischel began the practice of thoracic surgery in July 1995, after eleven years of residency. Tr. 103. Del Mar cold-called him, and he purchased 1,000,000 shares of Comparator for $59,000 in December 1995. Tr. 103-07. |
| 23 | Dr. Maddela, a pediatrician, bought a total of 500,000 shares at .0575. Tr. 827-30. |
| 24 | Dr. Ilic, an orthopedic surgeon, purchased 320,000 shares at .0625 in December 1995 through Del Mar registered representative Hanny Hassieb for $20,000. Tr. 911, 913. |
| 25 | Rogers, a contractor, received Del Mar's promotional postcard and then a phone call from Dills, who sold him a total of 200,000 shares at about .06 in December 1995. The purchase was an agency transaction, but Dills waived the commission, only charging a minimal fee for processing. Tr. 316-20, 339; Div. Ex. 172, PB Ex. 2. |
| 26 | Retired, Johnson had been a building mechanic for American Airlines at Los Angeles Airport. Tr. 367. After receiving the promotional postcard, a phone call from Dills, and additional material from Dills, Johnson purchased a total of 210,000 shares at .0525 and .055. Tr. 367-75; Div. Exs. 119, 120, 124. Johnson bought the stock with the understanding that there would be no commission because the stock was Dills's personal stock. Tr. 372-74. The confirmations indicate agency transactions. Div. Ex. 120, PB Ex. 2. Johnson was not informed of the actual source of the stock and the proceeds Dills would receive. Tr. 372. |
| 27 | Thorne, a structural designer for forty years, has worked at the Metropolitan Water District of Southern California for the past ten years. Tr. 273. Thorne was cold-called by Dills and purchased 200,000 shares at about .05875. Tr. 274-77. Dills waived payment of any commission, saying he would take a commission when Thorne sold the stock at a profit. Tr. 275. Dills did not disclose that he would make money in any other way from Thorne's purchase and even told him that the purchase was at a discount to the .06 market price. Tr. 274-75, 277. |
| 28 | Goetz is an engineering director of semiconductor chip integration for an electronics company. Tr. 734. He purchased 100,000 shares at .06 in August 1995. Tr. 735-40. He paid a commission of $250. Tr. 740; Div. Ex. 114 at ENF 04697. He was not told that Dills would receive a kickback; that would have been important to him in deciding whether to invest. Tr. 741. |
| 29 | Reichard is a printer by occupation who sold his business and now helps a university recruit students. Tr. 478. After being cold-called by Dills and receiving follow-up information, Reichard purchased 32,000 shares. Tr. 479-82. Dills did not tell him that he would receive payments from third parties for the sale. Tr. 481. |
| 30 | Cuneo has been a commercial photographer, producing advertisements for department stores, for over thirty years. He first heard of Comparator when Del Mar cold-called him. Tr. 297. After studying materials Del Mar sent him describing Comparator and an identification device purportedly developed by Comparator, Cuneo purchased 100,000 shares. Tr. 299-301. If he had known that some of the proceeds would be kicked back to the owner of Del Mar, he would not have made the purchase. Tr. 306. |
| 31 | Div. Ex. 163 is a summary of evidence in Div. Ex. 174, which contains account statements, cancelled checks, and similar financial records of the Chaudhuri Family Trust and Callaway Consulting accounts at Equitrade, the Scripps Bank, and the Bank of America. It was prepared by Charles Scates, a certified public accountant who is employed in the Division and works with Division attorneys investigating allegations of fraud. Tr. 44-60. |
| 32 | The checks were payable to Rocky Mountain Securities and investors Evanson, Gerber, Hanscome, and Hudson. Div. Ex. 174. |
| 33 | The payments were for services such as printing, renting mailing lists, and postage. The vendors included Specialist Computer Services, Inc., West Coast Mailing and Distribution, and the U.S. Postal Service. Chaudhuri paid by checks drawn on accounts at the Bank of America and the Scripps Bank in the names of Callaway Consulting, Chaudhuri Family Trust, and Sorriso Group, Ltd. All checks were signed by Chaudhuri. Div. Exs. 42-44. |
| 34 | Chaudhuri's $103,550 includes $4,725 paid to the Sorriso Group, Ltd. The payments to Dills and Riddle include payments made to Gateway Consulting, which paid funds out to Dills and Riddle. Div. Ex. 174. |
| 35 | Some of Equitrade's requests in Div. Ex. 42 for Chaudhuri funds to be wired appear to indicate that the funds are directed to the Bank of America. However, the account number provided is that of the Chaudhuri Family Trust account at the Scripps Bank. |
| 36 | According to news reports, Comparator began its sudden rise on May 3, 1996, due to hundreds of Internet message board postings that mentioned the release of a new product. Comparator's market value surged from $36 million to more than $1 billion during the four days of frenzied trading that followed; 449 million shares changed hands. Thereafter, trading was halted, and investigation revealed that Comparator did not have a new product ready for sale or manufacture. |
| 37 | Jennings time-stamped the tickets, but his priority was to execute the trades at the best prices for the customers, so the times may not be precise. Tr. 178, 214, 224, 611, 616. |
| 38 | The sender information required by law to be printed at the top (or bottom) of a fax includes the date and time it was sent as well as the sender's name and telephone number. 47 C.F.R. § 68.318(c)(3). Thus, the times printed on the faxes sent by Del Mar are Pacific time. |
| 39 | Division employee Craig Miller compiled Div. Ex. 162 based on NSCC contract sheets, order tickets, confirmations, and blue sheet information obtained from the NASD. Tr. 62-68; Div. Exs. 92, 94, 96, 97. Based on Div. Ex. 162, Division trading expert Scott Ryan opined that there were oversells on Friday of 420,591 shares at 3/32 (about .09), 462,400 at .255, 83,000 at 7/32, 14,000 at 3/16, and 254,667 at .25, and that the average price of the oversells was .1937. Tr. 1050-52. |
| 40 | The National Quotation Bureau National Daily Quotation Service reflects Comparator's price at the close on May 6, 1996, as Bid - 1, Ask - 1 1/32. |
| 41 | Roberts did some on-the-spot arithmetic to arrive at the $1,000,000 demand. Tr. 1267-68. |
| 42 | The Division theorizes that on Tuesday Roberts found the problem to be even worse than he had assumed on Monday, but this does not explain why he did not act on Monday. |
| 43 | The record does not show whether this outburst occurred on Tuesday or late on Monday, but the precise timing is immaterial. In any event it added to the ominous ambiance surrounding Jennings on Tuesday. The Division argues that it occurred Monday and shows that Roberts had already advised Del Mar of the trading problems, theorizing that there appears to be nothing else that would have caused the eruption. The record, however, clearly shows the contrary, that Dills might erupt at any time for any reason. |
| 44 | Roberts believed that he had addressed the oversell fully at the close of business on May 7. The next day he found that some customer orders were for stock the customer did not own, and he had to buy more stock. Tr. 1265-66. |
| 45 | To make a correction, Childers displayed the trade and canceled and reentered information. Tr. 874, 1231; Div. Ex. 96A. The computer produced a new confirmation. Tr. 874. Corrections occurred every day, although not on Tuesday's scale. Tr. 875, 1231, 1233. |
| 46 | Fischel spoke with Brandon around 10:00 a.m. (PDT) on May 3, authorized the sale of 500,000 shares, and received oral confirmation of a sale at .255. Tr. 108, 110-11. He authorized the sale of his remaining 500,000 shares on May 6 at a .75 limit. Tr. 112. The next morning, Brandon confirmed a sale at 31/32. Tr. 112. Later, Brandon said that the trades had not gone through at the original prices because the office was in chaos on May 3 and 6. Tr. 113-14, 116, 126. Fischel initiated arbitration. Tr. 118, 120-21. His original loss of $269,125 was reduced by $30,000, a part payment by Dills of the settlement of the arbitration. Tr. 118, 120-21. |
| 47 | On Saturday, May 4, Dills called Maddela, who authorized selling her stock on May 6. Tr. 833-34; Div Ex. 173. On Monday, Dills called to report the sale at 5/8, a net of about $297,000. Tr. 836-37. Dills called again on Tuesday and said that there was a mistake, the shares sold at 3/8, a net of about $172,000. Tr. 837. She received a confirmation reflecting the 5/8 price and two more confirmations reflecting the 3/8 price, each with a different net amount. Div. Ex. 96A at ENF 03754-55, 03601-02, 03762. She called Del Mar several times and finally reached Dills. Tr. 841-42. When she questioned him, Dills became angry and shouted that he had not cheated her. Tr. 842. She decided to drop the matter, reasoning that she might not receive even the reduced amount if Dills was provoked further. Tr. 842. |
| 48 | Ilic, in Chile on May 3, was contacted by Hassieb and decided to sell 100,000 of his 320,000 shares. Tr. 915-16. Hassieb orally confirmed the sale at .255. Tr. 917, 920-21. On May 6, Ilic sold another 150,000 shares; Hassieb orally confirmed the sale at 13/32. Tr. 921-23; Div Ex. 115 at ENF 04718. On May 7, Ilic sold his remaining 70,000 shares; Hassieb confirmed the sale at 1 9/32. Tr. 923-24. Ilic received three confirmations consistent with Hassieb's oral confirmations, followed by cancellations and confirmations reducing the sale prices of 100,000 shares from .255 to 3/16, 150,000 shares from 13/32 to 11/32, and 70,000 shares from 1 9/32 to 13/32. Div. Ex. 115. Ilic called Hassieb, who said that he had been fired, and then Brandon, who accused Hassieb of changing the order tickets. Tr. 925-26, 933-34. Ilic was awarded the difference between the original and reduced confirmations in an arbitration proceeding, but neither Del Mar nor Dills paid the award. Tr. 929-30. |
| 49 | On May 3 Dills recommended selling the stock, then trading at .28; Rogers authorized the sale, which Dills orally confirmed at .28. Tr. 322-23; Div. Ex. 132 at ENF 04859. Rogers received a confirmation at .28 (9/32) and a reduced confirmation at .18. Div. Ex. 132 at ENF 04863-65. After several attempts, Rogers reached Dills to complain. Dills claimed that market makers or the clearing firm had not honored the original sale price. Tr. 327-33. Rogers closed his Del Mar account and contacted the government and the NASD; he decided that it would not be worth his time and money to take legal action against Dills. Tr. 328-30; Div. Ex. 132 at ENF 04856. |
| 50 | Dills called on May 3; Johnson declined to sell. Tr. 377-78. Dills called again on Saturday and persuaded Johnson to sell at .28. Tr. 379-80. On Monday morning, Johnson attempted to contact Dills and left a message that he did not want to sell. Tr. 380-81. Dills called back to say that the stock had sold at .18; Johnson told him that was not what they agreed to and Dills said he would look into it. Tr. 381-85. Johnson then received confirmations for a May 3 sale of 10,000 shares at .25 and 200,000 shares at 9/32 (.28). Div. Ex. 96A at ENF 03841, 03864. Order tickets also show a May 3 trade date, before Johnson authorized the sale. Tr. 377-80, 385-86; Div. Ex. 81 at ENF 01534, 01536. A second set of confirmations reduced the sale of all 210,000 shares to 3/16 (.18). Tr. 383; Div. Ex. 96A at ENF 03480-81. Dills blamed the problem on the clearing firm, saying it had fallen behind due to high volume, a nonsensical explanation for executing a trade before the investor agreed to sell. Tr. 386. Johnson's wife put their complaint in writing; they received an unsatisfactory response from Dills's attorney but decided it was not worth the expense to pursue legal action. Tr. 387-88. |
| 51 | Dills called on May 3 and recommended selling at .25; Thorne authorized the sale. Tr. 278-79. Thorne received a confirmation at .255; Dills phoned him the same day and said that the price was reduced to 3/16, blaming the change on the clearing firm. Tr. 280-81; Div Ex. 96A at ENF 03396, 03655. After consulting the NASD and others, he called Dills to complain; Dills became abusive and made physical threats. Tr. 283-84. Thorne eventually decided that it was not worth the cost to attempt to recover the $13,000 difference between the two confirmations. Tr. 285. |
| 52 | Goetz decided to sell 20,000 shares on May 6; Brandon confirmed the sale at 7/16. Tr. 744-48; Div. Ex. 114 at ENF 04697. Goetz sold another 40,000 shares later that day; the sale was confirmed at 31/32. Tr. 749; Div. Ex. 114 ENF 04699. Goetz received confirmations at the original prices, followed by cancellations and confirmations reducing the prices of 20,000 shares from 7/16 to 21/64, and of 40,000 shares from 31/32 to 13/16. Tr. 750-51; Div. Ex. 114 at ENF 04698-700. Goetz called Del Mar, which blamed the reduction on high volume and the clearing firm. Tr. 753. Goetz requested Del Mar to credit the original prices to his account. Div. Ex. 114 at ENF 04696. In response Del Mar's attorney blamed the situation on the high volume of trades and Private Brokers and suggested that Goetz was greedy for "a windfall" and "phantom profits," noting that at the reduced prices he had made a profit of over 500%. Div. Ex. 114 at ENF 04701-03. |
| 53 | Del Mar contacted Reichard when the stock began to rise, and he decided to sell his 32,000 shares. Tr. 482. He received confirmation of the May 6 sale at 7/16, followed by a reduced confirmation at 21/64. Tr. 482; Div. Ex. 96A at ENF 03515, 03929. He was satisfied with his profit but disturbed by what he believed to be Del Mar's tardy execution of his order; he tried, unsuccessfully, to obtain an explanation from Del Mar. Tr. 482-85, 487. |
| 54 | Regan Dills contacted Cuneo, who decided to sell on May 6 when the stock was at 1/2. Tr. 303, 306-08. Cuneo received a confirmation at 1/2, followed by a reduced confirmation at 7/16. Tr. 309; Div. Ex. 96A at ENF 03294, 03937. Regan Dills said that Cuneo's trade was recorded incorrectly, and the first confirmation was incorrect. Tr. 309-10. |
| 55 | He based his opinion on investigative testimony of Dills, Roberts, and Jennings; Div. Ex. 98; hearing testimony of February 14-18; customer tickets; Private Brokers inventory and activity reports; NSCC contract sheets; and Division summaries derived from these exhibits. Tr. 1027. |
| 56 | SelectNet is an electronic order delivery system, operated by NASDAQ, for entering and executing orders. A member enters an order; when another member places a matching trade or accepts the previously entered order, the trade is executed and automatically sent for clearance. Tr. 1152-53. The members using this service do not have to communicate verbally to negotiate the trade. Tr. 1152. Thus, there is less opportunity for error. Of seven SelectNet trades, three were reduced, one, for customer Goetz. Tr. 621-624; Div. Ex. 92 at ENF 02725, Div. Ex. 94 at ENF 02747. |
| 57 | Cirrito based his opinion on Roberts's hearing testimony, Respondents' investigative testimony, schedules prepared by the Division comparing NSCC contract sheets with Private Brokers' records, and at least some trade tickets. Tr. 947, 982. He did not match up all the original trade tickets with the dealer side. Tr. 982. Lubin based his opinion on interviewing Roberts, NSCC contract sheets, Roberts's and Jennings's investigative testimony, schedules Roberts provided, pleadings, order tickets, expert reports, and statements of other witnesses. Tr. 1332-33, 1387-88. |
| 58 | Various reports are provided in the normal process of clearing trades along with the NSCC contract sheets. Going by price, the reports show the number of transactions for each price. The total of those shares is then compared to the total of the shares submitted by the brokerage. If these totals match, then the shares at that price balance. Tr. 960. |
| 59 | Compare James L. Owsley, 51 S.E.C. 524, 528 (1993) (branch manager charged with antifraud violation lacked scienter because a firm official told him he did not have to tell customers he was selling his shares of a stock that customers were being asked to purchase; situation involved a single inquiry and limited transactions) with James J. Pasztor, 70 SEC Docket 2611 (Oct. 14, 1999) (branch manager of small firm held liable for failure to supervise so as to prevent aiding and abetting antifraud violations; firm's owner had countermanded manager's attempts to stop the violations; Commission rejected this as a defense to the charges because of his position as branch manager and incomplete understanding of applicable law but considered it as a mitigating factor in determining the sanction.). Although following the orders of the firm's owner, Jennings, unlike Pasztor, was not the branch manager and had no supervisory or compliance responsibilities. |
| 60 | Generally, clearing brokers are not liable for introducing brokers' wrongdoing. See John M. Bellwoar, Note: Bar Baron at the Gate: An Argument for Expanding the Liability of Securities Clearing Brokers for the Fraud of Introducing Brokers, 74 N.Y.U. Law Rev. 1014, 1014-29 (Oct. 1999) and sources cited therein. |
| 61 | It goes without saying, and the Commission has stressed many times, that settlements are not precedent. See Richard J. Puccio, 63 SEC Docket 158, 163 (Oct. 22, 1996) (citing David A. Gingras, 50 S.E.C. 1286, 1294 (1992), and cases cited therein); Robert F. Lynch, 46 S.E.C. 5, 10 n.17 (1975) (citing Samuel H. Sloan, 45 S.E.C. 734, 739 n.24 (1975); Haight & Co. Inc., 44 S.E.C. 481, 512-13 (1971), aff'd without opinion, (D.C. Cir. 1971); Security Planners Assocs., Inc., 44 S.E.C. 738, 743-44 (1971)); see also Michigan Dep't of Natural Res. v. FERC, 96 F.3d 1482, 1490 (D.C. Cir. 1996) and cases cited therein (settlements are not precedent). Commission settlement orders contain disclaimers to this effect. See Bear, Stearns Sec. Corp., 70 SEC Docket 710, 711 n.1 (Aug. 5, 1999). |
| 62 | See Bear, Stearns, 70 SEC Docket at 710; Richard Harriton, 72 SEC Docket 626 (Apr. 20, 2000). Bear Stearns cleared for a year for A.R. Baron & Co., which sold penny stocks through fraudulent, high-pressure sales methods and used such tactics as no net selling, unauthorized trading, and parking to keep its business afloat. Bear Stearns knew Baron's reputation when it started clearing, and soon became aware of signs of unauthorized trading and parking, failures to pay for trades, trade cancellations, corrections, credit extensions, customer complaints, and a pattern of stock sold to customers from inventory and then repurchased close to settlement at a loss. In addition to routine clearing functions Bear Stearns approved and disapproved trades, provided working capital, and at times prevented Baron from rescinding unauthorized trades. It also discarded records relating to Baron, such as customer complaints, order tickets, and internal reports on Baron's trading activity. The settlement orders concluded that Bear Stearns and Harriton were causes of Baron's antifraud violations and aided and abetted other violations.
The fall-out from the Bear Stearns situation included amendments to NASD and New York Stock Exchange Rules (NYSE). Clearing Agreements, 69 SEC Docket 2695, 64 Fed. Reg. 31,024 (June 9, 1999) (NASD); Carrying Agreements, 69 SEC Docket 2700, 64 Fed. Reg. 31,338 (June 10, 1999) (NYSE). The rule changes require clearing firms to inform introducing firms of complaints about the introducing firms and to inform them of exception reports that would help introducing brokers to monitor customer accounts. |
| 63 | This rule is not violated by inaccurate confirmations. Hattier, Sanford & Reynoir, 53 S.E.C. 426, 430 n.11, aff'd, 163 F.3d 1356 (5th Cir. 1998) (unpublished table decision). |
| 64 | See Exchange Act Sections 15(b)(6)(A) and 21B(a), (c), and (d). |
| 65 | The Commission increased the amounts for violations occurring after December 9, 1996, and, again, for violations occurring after February 2, 2001. See 17 C.F.R. §§ 201.1001 (1996 adjustment) and .1002 (2001 adjustment). |
| 66 | See, e.g., J. Stephen Stout, 73 SEC Docket 1441 (Oct. 4, 2000) ($300,000 penalty, bar, and cease and desist order. Individual violated antifraud provisions in trading with retail customers and caused substantial losses.); Al Rizek, 70 SEC Docket 927 (Aug. 11, 1999) ($100,000 penalty, disgorgement, bar, and cease and desist order. Individual violated antifraud provisions by churning.), aff'd, 215 F.3d 157 (1st Cir. 2000); L.C. Wegard & Co., Inc., 67 SEC Docket 814 (May 29, 1998) (unpublished table decision) (Broker-dealer - $1,000,000 penalty, registration revoked, disgorgement, cease and desist order; sole owner - $175,000 penalty, one year broker-dealer suspension, penny stock bar, cease and desist order. Individuals violated antifraud provision by market manipulation.), aff'd, 189 F.3d 461 (2d Cir. 1999); New Allied Dev. Corp., 52 S.E.C. 1119 (1996) ($1,000,000 penalty for individual with history of securities violations and deceit, $150,000 for individual with less knowledge and involvement, also penny stock bars, disgorgement and cease and desist orders. Respondents violated antifraud provisions.) |
| 67 | Although little weight is placed on Dills Ex. 1, Div. Exs. 84 and 85 show that Del Mar had net assets well under $1,000,000 during the time at issue. |
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