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Initial Decision of an SEC Administrative Law JudgeIn the Matter of
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In the Matter of G. BRADLEY TAYLOR |
: |
INITIAL DECISION September 24, 2002 |
| APPEARANCES: | Mary Scherschel Brady and Polly A. Atkinson for the Division of Enforcement, Securities and Exchange Commission.
Howard J. Stein for Respondent. |
| BEFORE: | Lillian A. McEwen, Administrative Law Judge |
SUMMARY
The Respondent, G. Bradley Taylor (Taylor), violated Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, by willfully making material omissions in the sale of securities to his customers. This Initial Decision imposes sanctions on Taylor, including a bar and a cease-and-desist order.
PROCEDURAL HISTORY
The United States Securities and Exchange Commission (Commission) issued an order instituting these public administrative and cease-and-desist proceedings against Taylor, pursuant to Section 8A of the Securities Act of 1933 (Securities Act) and Sections 15(b) and 21C of the Securities Exchange Act of 1934 (Exchange Act). The Order Instituting Proceedings (OIP) was filed on August 2, 1999.
THE HEARING
On November 30 and December 1-3, 1999, I held a public hearing in Chicago, Illinois. During the hearing, eight witnesses testified for the Division of Enforcement (Division). Three witnesses testified on Taylor's behalf, including Taylor. I admitted twenty-two exhibits from the Division and thirteen from Taylor.1
ISSUES PRESENTED
The OIP alleged that Taylor willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5, by failing to disclose to his customers that he was receiving compensation for recommending the purchase of First Entertainment, Inc. stock to his customers.
If I conclude that the allegations in the OIP are true, I must then determine whether remedial action is necessary or appropriate pursuant to Section 15(b) of the Exchange Act; whether Taylor should be ordered to pay disgorgement and prejudgment interest pursuant to Section 8A of the Securities Act and Sections 21B(e) and 21C of the Exchange Act; whether civil penalties against Taylor are appropriate pursuant to Section 21B of the Exchange Act; and whether Taylor should be ordered to cease and desist from committing or causing violations of, and any future violations pursuant to, Section 8A of the Securities Act and Section 21C of the Exchange Act.
FINDINGS OF FACT
The findings and conclusions herein are based on the entire record. I applied preponderance of the evidence as the applicable standard of proof of the Division's case. See Steadman v. SEC, 450 U.S. 91, 102 (1981). I considered all post-hearing findings, conclusions, and arguments raised by the parties, and I accept those that are consistent with this decision. I find the following facts to be true.
Taylor and Investors Associates, Inc.
Taylor, a resident of Carol Stream, Illinois, attended Manatee Community College in Bradenton, Florida, during 1986 and part of 1987. (Tr. 20-21.) After receiving his Series 7 license in 1988, Taylor worked for several brokerage firms. (Tr. 21-22, 29-36, 61-63.) Taylor also received his Series 24 and 63 licenses. (Tr. 25-26.) In late 1993, Taylor began working in the Chicago branch office of Investors Associates, Inc. (Investors Associates), based in Hackensack, New Jersey. (Tr. 38; Div. Exs. 1-8.) In January or February 1994, Taylor was promoted to branch manager of the Chicago branch. (Tr. 39-40.) By fall 1994, Taylor and a partner, Luis Loza, had purchased the Chicago branch. (Tr. 43-44.) Investors Associates was a broker-dealer registered with the Commission from March through August 1995. (Tr. 13-15; Div. Exs. 1-8.) During Taylor's tenure with Investors Associates, there was no compliance officer in the Chicago office. (Tr. 38.) Instead, Herman Epstein, based in the New Jersey branch office, was responsible for compliance. (Tr. 38, 44.) Taylor thought his managerial responsibility for compliance consisted of overseeing the brokers and monitoring the accounts; he also was responsible for training the brokers. (Tr. 44.)
Taylor's compensation was based on commissions. He received sixty percent of the commissions that he generated on his own trades and a percentage of the total commissions generated by the Chicago branch. (Tr. 45-46.) Prudential Securities cleared transactions for Investors Associates, which also did some investment banking. (Tr. 53-54.) The New Jersey office sometimes made markets in securities, including stocks that the Chicago branch traded. (Tr. 54-55.) After leaving Investors Associates, Taylor filed for bankruptcy. (Tr. 596.) He owns two homes that are presently in foreclosure. (Tr. 595, 600-01.) His only other assets are $6,000 in an individual retirement account and some furniture. (Tr. 598-99.) He owes approximately $75,000 to the Internal Revenue Service and $20,000 in legal fees. (Tr. 595.) Taylor pays $2,000 monthly to his ex-wife for child support, and has a judgment against him for $17,000 from a bankrupt former employer, Rodman and Renshaw, Inc. (Tr. 595, 598.) A second former employer, Stifel, Nicolaus & Company, Inc., claims that he owes it $144,000. (Tr. 594.) Taylor's only source of income is his present employer, Gunn Allen Financial, Inc. (Tr. 599.) In 1998, Taylor's salary after taxes was less than $100,000. (Tr. 601.)
Taylor and First Entertainment, Inc.
In 1995, First Entertainment, Inc. (FTET) was a diversified multi-media entertainment company traded on the National Association of Securities Dealers Automatic Quotation System (NASDAQ) (NASDAQ symbol FTET). (Resp. Ex. 4.) In February 1995, FTET expanded into the licensing arena by signing a series of agreements that formed a business relationship with the Indian Motor Company, the owner of the Indian Motorcycle trademarks. (Resp. Ex. 4.) The Indian Motorcycle Company and Harley-Davidson were the two dominant brands of American motorcycles for the first half of the twentieth century. (Resp. Ex. 4.) Pursuant to the agreements, the Indian Motor Company granted FTET the rights to be its exclusive licensing agent worldwide in connection with the manufacture, distribution, advertising, promotion, or exploitation of Indian Motorcycle goods and services. FTET also received a license to create and operate Indian Motorcycle Diners, which would be similar to Hard Rock Café or Planet Hollywood. In addition, FTET became the consultant to the Indian Motor Company in exchange for an option to acquire a ten percent interest in the company. (Resp. Ex. 4.)
FTET needed a way to disseminate information to the brokerage community. (Tr. 347.) Some principals of FTET met with Morton B. Lempel (Lempel) in the end of February 1995, in Denver, Colorado, for a "dog and pony show." (Tr. 348.) Lempel, a resident of Spring Valley, New York, is presently a national sales manager for a distributing company. (Tr. 346.) In 1995, Lempel left the fur business to form MBL Investments, a consulting business that would provide financial public relation services and assist companies in raising money. (Tr. 346-47, 442.) Lempel was employed by his own company as a consultant, but he has never been a registered representative with a broker-dealer and has had no professional licenses. (Tr. 347.)
A mutual acquaintance introduced Lempel to Taylor in 1994. (Tr. 353.) Thereafter, Taylor became Lempel's broker while Taylor still worked for Chatfield Dean. (Tr. 353.) When Taylor left Chatfield Dean for Investors Associates, Lempel moved his brokerage accounts from Chatfield Dean to Investors Associates. (Tr. 354.) In early to middle March 1995, Lempel told Taylor about FTET and promised to keep him posted. (Tr. 354.) By the end of March, Lempel and his associate, Miron Leshem (Leshem), had met Taylor in Chicago, Illinois. (Tr. 355.) During the meeting, the three men discussed Taylor's relationship with FTET and entered into an oral agreement whereby Taylor would sell shares of FTET to his clients in exchange for FTET stock. (Tr. 355-57.) As Lempel explained, the oral agreement was that, "[t]here were certain milestones to be reached and at certain milestones, [Taylor] would be compensated with some free-trading stock from the stock that [Lempel] received from [FTET]." (Tr. 357-58.) The milestones were based on the volume of buying by Investors Associates in Chicago and by Taylor's clients. (Tr. 359.) When a certain milestone was met, Taylor would be compensated. (Tr. 357-59.)
In exchange for FTET stock, Taylor was:
to be like the cheerleader, so to speak, for First Entertainment, for the Indian Motorcycle, helping them, you know, find investors to invest in the private placements, introducing them to the firm. It was just not going to be I just buy the stock and that's the end of it. He wanted me to be actively involved in assisting him at bringing the Indian Motorcycle deal together, helping him bring the deal together.
(Tr. 464.) I find that Taylor entered into an agreement during the March meeting with Lempel and that the agreement continued through August 1995. On March 16, 1995, Lempel and FTET signed a consulting agreement. (Tr. 349-50; Div. Ex. 21 at 4111-15). Lempel would receive three hundred thousand (300,000) shares of FTET free-trading common stock and options to purchase an additional two hundred thousand (200,000) of free-trading common stock. (Div. Ex. 21 at 4112.) The consulting agreement was amended on July 26, 1995, to provide that all options to purchase free-trading common stock would expire on August 3, 1995, with an exercise price of $.50 per share. (Div. Ex. 21 at 4116.) In addition, another option for fifty thousand shares was granted at $.50 per share and a second option for fifty thousand shares was granted at $.75 per share; both were to expire on August 3, 1995. (Div. Ex. 21 at 4116.) Effectively, this brought the total options to two hundred fifty thousand shares to be exercised at $.50 and fifty thousand shares to be exercised at $.75. (Div. Ex. 21 at 4116.)
After their initial meeting, Taylor told Lempel and Leshem when he reached a certain milestone. (Tr. 359-60.) Taylor instructed them to transfer the stock to a brokerage account in the name of Charlene K. Nelson (Nelson), Taylor's mother. (Tr. 59, 365.) Taylor then called his mother and had her open a brokerage account in her name. (Tr. 467.) Account number 11-729372, at Burke Christensen & Lewis Securities, Inc., was opened in Nelson's name on April 5, 1995. (Div. Ex. 11 at 5.) On April 19, 1995, Nelson and Clair E. Salter (Salter), Taylor's grandmother, opened a joint bank account number 601151148 at Mid America Federal Savings Bank. (Tr. 59-60; Div. Ex. 14 at 32022.)
Pursuant to the arrangement, in three separate transactions, from April 12 to June 5, 1995, a total of 40,000 FTET shares were transferred from Lempel's brokerage account to Taylor's mother's account, the Nelson brokerage account. (Tr. 153-57; Div. Exs. 9; 10 at 32176-77, 79; 11 at 11-13.) On five separate dates, from April 26 to August 10, 1995, the 40,000 FTET shares were sold out of the Nelson brokerage account for a total of $59,436.25, less applicable wire transfer fees of $75.00; the net proceeds were $59,361.25. (Div. Exs. 11 at 11-20; 12; 13 at 1-2; 14 at 32024, 32050, 32082.) Net proceeds of $25,523.71 were washed through the Nelson and Salter bank account before being distributed to Taylor, his creditors, or his employee, Sherwood Tucker. (Tr. 108-11, 118-19; Div. Exs. 13 at 1-2; 14 at 32035-36, 32039-42, 32044-45, 32048-50, 32054-57, 32064-65, 32078-79; 15 at 32956-58, 32971-72.)
The last transfer of securities into the Nelson brokerage account was on June 5, 1995. (Tr. 473.) On June 14, 1995, Investment Associates and FTET entered into an investment banking agreement. (Resp. Ex. 9.) I credit the testimony of Charles H. Chaney, a Commission accountant who was qualified as an expert in the area of financial analysis. He opined that the trail of shares and proceeds as I have described it is accurate. (Tr. 76-77, 99-100, 105-06.)
TESTIFYING CUSTOMERS
From March through August 1995, Taylor recommended to his customers that they purchase FTET stock, even though he was selling his own shares during much of the same period. (Tr. 57-58.) A total of 556,700 shares of FTET were purchased by customers under Taylor's registered representative code. (Div. Ex. 17 at 32.) Commissions generated under Taylor's registered representative number totaled $32,546.75. (Tr. 143; Div. Ex. 20 at 4.) Of these total commissions, Taylor received sixty percent, or $19,528.05. However, not only were Taylor's sales to his customers included within the total commissions generated, but also commissions generated by other brokers, such as Paul Buchanan, whose commissions were included under Taylor's registered representative code. (Tr. 487.)
John Tabb.
John Tabb (Tabb), an avid motorcycle rider in his youth, had a brokerage account with Taylor at Investors Associates in 1995. (Tr. 241-43.) In earlier conversations, Tabb had told Taylor about his interest in motorcycles. (Tr. 243.) Taylor told Tabb, over the telephone, that he had done business with FTET and he recommended the stock because of Tabb's interest in motorcycles. (Tr. 243.) Pursuant to his discussions with Taylor, on March 30, 1995, Tabb purchased 6,000 shares of FTET (at $1.9375 per share) for $11,625. (Tr. 135-36, 245; Div. Ex. 17 at 3.)
Taylor did not tell Tabb that he would be compensated for Tabb's purchase of FTET stock by FTET or by its agent, nor did he disclose his own sale of FTET shares. (Tr. 245-47.) Tabb thought that Taylor would be compensated "just like any other stock purchase that . . . when the client makes money the broker makes money upon the sale after there's a gain, other than the standard fees for purchasing a stock." (Tr. 245.) Tabb would have wanted to know that Taylor was receiving compensation from an FTET agent, since it "would give the broker more incentive to sell the stock and not consider the client's benefits." (Tr. 247.) After purchasing the shares, Tabb watched the stock "sadly go down" and never sold the shares. (Tr. 247.)
David Oberg.
In 1995, Taylor was David Oberg's (Oberg) broker at Investors Associates. (Tr. 277; Resp. Ex. 2 at 46-58.) Oberg became familiar with FTET because Taylor told him about the company over the telephone. (Tr. 278.) During their conversation, Taylor told Oberg that FTET was going to revive the Indian Motorcycle and remarket its trademark in other ways, and Taylor recommended that Oberg purchase stock of FTET. (Tr. 279.) Pursuant to Taylor's recommendation, Oberg bought 2,000 shares (at $2.0312 per share) on April 3, 1995, for $4,062.40. (Tr. 137, Div. Ex. 17 at 2, 30.) Taylor did not tell Oberg that he was being paid by FTET's agent in exchange for selling him FTET. (Tr. 282-83.) If Taylor had told him the truth, Oberg would have questioned Taylor's motive for recommending the stock. (Tr. 283.) Oberg thought that Taylor would be compensated in the way that any other salesman would be for a stock deal, that is, "[s]tock broker gets a commission, a normal commission and that shows on a statement that comes . . . [which is] a percentage of the purchase or in some cases . . . a flat fee." (Tr. 281.) Oberg eventually sold his FTET shares at a loss of about $2,000. (Tr. 283.)
Thomas Shafer.
From 1992 until late 1995, Taylor bought and sold securities for Thomas Shafer (Shafer). (Tr. 300-301.) In April 1995, Taylor told Shafer that there would be a big announcement regarding FTET doing something with the Indian Motorcycle, and he recommended that Shafer invest in FTET. (Tr. 301-02.) Based on Taylor's recommendations to buy FTET stock, Shafer did so. (Tr. 302.) Shafer bought 3,500 shares (at $2.0312 per share) on April 3, 1995, for $7,109.20. (Tr. 137, 302; Div. Ex. 17 at 30.) Shafer knew nothing about how Taylor would be compensated, other than by being a broker in the transaction and getting some fees as a result. (Tr. 302.) Taylor did not tell Shafer that he was receiving compensation by an agent for FTET in exchange for selling him FTET. (Tr. 303.) If Taylor had told Shafer the truth, it would have raised concerns for Shafer. (Tr. 303-04.) Shafer eventually sold the stock for a forty or fifty percent loss. (Tr. 304.)
Frederick Oswald.
Taylor was Frederick Oswald's (Oswald) stockbroker at Investor Associates. (Tr. 321-322.) After discussing FTET over the telephone, Taylor recommended to Oswald that he purchase FTET. (Tr. 323.) Oswald purchased 3,000 shares of FTET on June 7, 1995, at $1.5468 per share, for a total of $4,640.40. (Tr. 136-37, Div. Ex. 17 at 31.) Oswald believed that the only compensation Taylor would receive on the stock sale was a commission, since Taylor did not tell him about any other compensation. (Tr. 324.) Taylor did not tell him about being paid by someone working for FTET for selling him FTET. (Tr. 324.) If Taylor had told Oswald the truth, Oswald would not have purchased the stock, which he eventually sold at a loss. (Tr. 324-25.)
Other Customers.
Taylor was the branch office manager when Paul Buchanan (Buchanan) went to work for Investors Associates, and he became Buchanan's mentor. (Tr. 202, 205.) Buchanan received his Bachelor of Arts in Economics from Western Illinois University in December 1994. (Tr. 203.) After receiving his Series 7 license in December 1994, Buchanan spent approximately the first nine months of 1995 with Investors Associates and obtained a Series 63 license. (Tr. 203-04.) In May 1995, Buchanan, as a new broker, was struggling to make enough commissions. (Tr. 207.) Taylor and Buchanan entered into an arrangement whereby Taylor would pay Buchanan a minimum salary if Buchanan's commissions were very low. If Buchanan's commissions exceeded his minimum salary, Buchanan would receive those monies. Buchanan never earned more than his minimum salary. (Tr. 208.)
Taylor brought FTET to Buchanan's attention, telling him that FTET was bringing back the concept of the Indian Motorcycle in terms of remarketing the trademark in restaurants and cafes. (Tr. 209.) Buchanan recommended to his customers that they purchase FTET stock, and the commissions generated by Buchanan on the sales of FTET went directly to Taylor. (Tr. 211.) Other than commissions on Buchanan's sales of FTET; Buchanan was not aware of any other compensation that Taylor was receiving. (Tr. 212.) Buchanan had three clients who purchased FTET, Kevin Brown (Brown), Robert Homsey (Homsey) and Tony Beyer (Beyer). (Tr. 214, 217.) Brown purchased 700 shares at $1.5625 per share for a commission of $109 on June 7, 1995. (Div. Exs. 17 at 4; 19 at 49.) Homsey purchased 500 shares at $1.5750 per share for a commission of $75 on June 9, 1995. (Div. Exs. 17 at 4; 19 at 49.) Beyer purchased 1,000 shares at a price of $1.5312 per share for a commission of $100 on June 2, 1995. (Div. Exs. 17 at 4; 19 at 50.)
Buchanan told Brown and Homsey that it was a stock that he liked and that they might want to participate in investing in the company. (Tr. 215.) Buchanan did not tell them about extra compensation that Taylor would be receiving on the sale. (Tr. 215.) While Buchanan was at Investors Associates, Taylor did not speak with any of these customers about FTET. (Tr. 219-22.) Taylor spoke to Beyer, however, after Buchanan resigned from Investors Associates to work at Rodman and Renshaw, Inc. (Tr. 219.) Buchanan had sold Beyer's FTET and Beyer wanted to acquire more shares in the company, so Buchanan had him contact Taylor. (Tr. 219). Sherwood Tucker (Tucker) was also an employee of Investors Associates who sold FTET under a similar arrangement. (Tr. 434.) While Tucker's accounts were under Taylor's registered representative number, Taylor advanced money to Tucker in exchange for commissions that he might generate on FTET sales. (Tr. 432-34.)
CONCLUSIONS OF LAW
Contentions of the Parties.
The OIP charges that Taylor violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder, by making material omissions concerning the compensation that he was receiving for recommending the sale of FTET stock to his customers. The Division also contends that Taylor violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5, by having registered representatives, who worked for him, sell FTET stock without disclosing the compensation he was receiving to either his employees or to the customers. This contention is stated for the first time in the Division's Post-Hearing Brief.
The Division recommends that Taylor be barred from associating with any broker or dealer and ordered to cease and desist from committing or causing future violations. The Division seeks disgorgement from Taylor of the $59,361 generated from the sale of FTET paid to him as compensation, plus $19,350 Taylor received in commissions, for a total of $78,711. Finally, the Division seeks pre-judgment interest of $33,407 and third-tier penalties of $110,000 against Taylor pursuant to Section 21B of the Exchange Act. (Division's Post-Hearing Brief.)
Taylor contends that the Division has failed to prove that he violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5. He claims that the Division failed to prove that at the time he recommended FTET stock to his customers that he had received or expected to receive compensation. In support, Taylor argues that an agreement between Taylor and Lempel was never finalized during the March meeting in Chicago. He claims it was not until the first week of April, or within a "day or two" of April 5, that an agreement was entered into between Taylor and Lempel and that the agreement ended on June 5, 1995, the last day Taylor received FTET stock from Lempel. Taylor claims that the sale of FTET to the four testifying witnesses occurred either before he had reached an agreement with Lempel or after his agreement with Lempel ended.
Taylor also contends that he received FTET stock only for his services in connection with establishing an investment banking relationship between Investors Associates and FTET; and that the Division failed to prove that he made a material omission with regard to the non-testifying customers who purchased FTET through Taylor. Further, he claims that the Division failed to prove that the alleged omission was "in connection with the purchase or sale of a security" and denies that he acted with scienter. Taylor requests a dismissal of the charges against him or no more than sixty days of suspension; disgorgement of $22,000; and repayment of commissions earned on the stock purchased by the four testifying witnesses. He contends that his financial condition precludes imposition of third-tier penalties. (Taylor's Post-Hearing Brief.)
Taylor Willfully Violated the Antifraud Provisions of the Securities Laws.
For the reasons stated herein, I conclude that Taylor violated the antifraud provisions of the securities laws.
Section 17(a) of the Exchange Act provides:
It shall be unlawful for any person in the offer or sale of any securities . . .
(1) to employ any device, scheme, or artifice to defraud, or (2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact . . . , or (3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.
15 U.S.C.S. § 77q(a).
Section 10(b) of the Exchange Act provides that:
It shall be unlawful for any person . . . (b) [t]o use or employ, in connection with the purchase or sale of any security . . . , any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
15 U.S.C.S. § 78j(b).
Pursuant to Section 10(b) of the Exchange Act, the Commission has promulgated
Rule 10b-5, which makes it unlawful for any person:
(a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.
17 C.F.R. § 240.10b-5.
In order to establish liability under these provisions, the Commission has the burden of proving, by a preponderance of the evidence, that there were: (1) a misrepresentation, or omission, or other fraudulent device; (2) materiality; (3) in the offer or sale, or in connection with the purchase or sale, of a security; (4) scienter; and (5) the use of any means or instruments of transportation or communication in interstate commerce, or of the mails, or any facility of any national securities exchange. See SEC v. Hasho, 784 F. Supp. 1059, 1106 (S.D.N.Y. 1992).
Material Omission
"[M]ateriality depends on the significance the reasonable investor would place on the withheld or misrepresented information." Basic, Inc. v. Levinson, 485 U.S. 224, 240 (1988). An omission is material if there is a "substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available." Basic, 485 U.S. at 231-32 (quoting TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)). Materiality is a mixed question of law and fact and must be determined in light of facts existing at the time of nondisclosure. See TSC Industries, Inc., 426 U.S. at 450.
Misrepresentations and omissions regarding a registered representative's own economic self-interest are material facts. See Affiliate Ute Citizens of Utah v. United States, 406 U.S. 128, 153 (1972) (market maker status); see also Ettinger v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 835 F.2d 1031, 1033 (3d Cir. 1987) (excessive commissions); Hasho, 784 F. Supp. at 1110 (failure to disclose commissions is a material fact when defendants failed to disclose amount of commissions); SEC v. Morrow, 67 SEC Docket 2706, 2718 (1998) (salesman recommending a limited partnership while compensated by that partnership's general partner might not be wholly disinterested); SEC v. Shaughnessy, 67 SEC Docket 1798, 1801 (1998) (kickbacks to sell particular securities material to the investor's decision whether to purchase those securities based on the broker's recommendations). The failure to disclose such economic self-interest "deprives the customer of the knowledge that his registered representative might be recommending a security based upon the registered representative's own financial interest rather than the investment value of the recommended security." Hasho, 784 F. Supp. at 1110.
Liability for failing to disclose material information is "premised upon a duty to disclose arising from a relationship of trust and confidence between parties to a transaction." Chiarella v. United States, 445 U.S. 222, 230 (1980). A fiduciary relationship exists between a stockbroker and his client. See Arleen W. Hughes, 27 S.E.C. 629, 634-35 (1948), aff'd, 174 F.2d 969 (D.C. Cir. 1949); see also, Marc N. Geman, 74 SEC Docket 999, 1011-13 (2001), appeal pending, No. 01-9512 (10th Cir.). As the Commission stated:
The very function of furnishing investment counsel on a fee basis - learning the personal and intimate details of the financial affairs of clients and making recommendations as to purchases and sales of securities - cultivates a confidential and intimate relationship and imposes a duty upon the registrant to act in the best interests of her clients and to make only such recommendations as will best serve such interests.
Hughes, 27 S.E.C. at 635. As a fiduciary, a broker owes his or her client a duty of loyalty to disclose all material information fully and completely. See Id. at 636. A broker violates his or her duty to a client when his or her interest conflicts with those of the client absent disclosure. See Id. at 635.
A fiduciary relationship existed between Taylor and his clients. Taylor's clients placed their trust and confidence in Taylor in following his recommendations. At the time Taylor sold FTET securities to clients of Investors Associates, he was a party to an agreement with Lempel that would place his own economic interest in conflict with theirs. He was receiving, or would receive, FTET stock in exchange for selling FTET directly to his own customers and indirectly to customers of the registered representatives whom he supervised. Taylor's failure to disclose the agreement deprived the customers of the knowledge that he might be recommending FTET for his own financial interest rather than the clients'. This conflict is clearly demonstrated by his sale of his own "free" FTET stock while he was advising his clients to buy. Surely, each of the four witnesses would have wanted to know that Taylor was receiving and then selling the stock when they were deciding whether to purchase FTET themselves. I conclude that Taylor's failure to disclose that he was receiving, or expecting to receive, FTET shares while selling the stock to his customers was a material omission.
Taylor argues that there was no material omission. He claims that there was no agreement in place when he sold FTET to the four testifying witnesses and that there was no evidence as to the other non-testifying customers. I have found that Taylor entered into an agreement with Lempel, which began at the end of March and continued to August of 1995, and the fact that the Commission did not produce every person who dealt with Taylor does not impair the testimony of those investors who did testify about the omission made to them. See Richard C. Spangler, Inc., 46 S.E.C. 238, 243 (1976).
In Connection With
Taylor's failure to disclose that he was receiving, or expecting to receive, FTET stock for selling it to his clients was made "in connection with the purchase or sale of a security." The "in connection with" requirement has been broadly construed by the Supreme Court. Hasho, 784 F. Supp. at 1106 (citing Superintendent of Insurance v. Bankers Life and Casualty Co., 404 U.S. 6, 12 (1971)). "[A]ny statement that is reasonably calculated to influence the average investor satisfies the `in connection with' requirement of Rule 10b-5." Hasho, 784 F.Supp. at 1106. Taylor's argument that the material misrepresentation or omission must affect the value of the particular security is without merit. See SEC v. Zandford, 122 S.Ct. 1899, 1902 (2002). The Supreme Court has held that it is enough that the fraudulent scheme and sale of securities coincide. See id. at 1904. In the instant case, the fact that there is an omission and not a misrepresentation does not change the result. As the Supreme Court stated, "[a]ny distinction between omissions and misrepresentations is illusory in the context of a broker who has a fiduciary duty to his or her clients." See id. at 1905 (citing Chiarella, 445 U.S. at 230 (noting that "silence in connection with the purchase or sale of securities may operate as a fraud actionable under § 10(b)" when there is "a duty to disclose arising from a relationship of trust and confidence between parties to a transaction")); see also Affiliated Ute Citizens of Utah, 406 U.S. at 153; Zweig v. Hearst Corporation, 594 F.2d 1261, 1266-1267 (9th Cir. 1979) (financial columnist violated Section 10(b) of the Exchange Act and Rule 10b-5 by failing to disclose in his column that he was purchasing stock in a company at a discount, publishing a favorable column about the company, waiting for a resulting rise in the market, and then selling the stock at a profit); SEC v. Blavin, 557 F. Supp. 1304, 1310-1312 (D.C. Mich. 1983), aff'd, 760 F.2d 706 (6th Cir. 1985) (defendant violated Section 10(b) of the Exchange Act and Rule 10b-5 by purchasing large amounts of securities and writing and disseminating a newsletter touting these same securities without disclosing his interest).
Taylor received FTET stock from Lempel for selling FTET to his customers. The amount of stock Taylor received from Lempel was based on the total volume of FTET stock that he could convince Lempel that he sold to his customers. I find that Taylor's failure to disclose to his customers the compensation that he was receiving, or expecting to receive, was "in connection with the purchase or sale of a security."
Scienter
In order to make a claim of a violation of Section 17(a)(1) of the Securities Act and Section 10(b) of the Exchange Act, and Rule 10b-5, Taylor must be shown to have acted with scienter. See Aaron v. SEC, 446 U.S. 680, 701-02 (1980). Scienter has been interpreted to mean "a mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12 (1976). Intentional or reckless conduct has been deemed sufficient to satisfy the scienter requirement. See SEC v. Jakubowski, 150 F.3d 675, 681 (7th Cir. 1998), cert. denied, 525 U.S. 1103 (1999); see also Sundstrand Corp v. Sun Chemical Corp., 553 F.2d 1033, 1039 (7th Cir. 1977), cert. denied, 434 U.S. 875 (1977). Reckless conduct is defined as "a highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it." Sundstrand, 553 F.2d at 1045. Sections 17(a)(2) and 17(a)(3) of the Securities Act do not require a showing of scienter. See Aaron, 446 U.S. at 702. A showing of negligence is sufficient under Section 17(a)(2) and 17(a)(3) of the Securities Act. See SEC v. Dain Rauscher, Inc., 254 F.3d 852, 856 (9th Cir. 2001). Scienter is a question of fact and may be proved by circumstantial evidence. See Hasho, 784 F. Supp. at 1107.
In the context of a material omission, any requirement of scienter is satisfied where the defendant has actual knowledge of material information and fails to disclose the material information. See Fenstermacher v. Philadelphia National Bank, 493 F.2d 333, 340 (3d Cir. 1974) ("in a non-disclosure situation, any required element of scienter is satisfied where . . . the defendant had actual knowledge of material information"); see also Thomas v. Duralite Co., 524 F.2d 577, 584 (3d Cir. 1975), aff'd, 559 F.2d 1209 (3d Cir. 1977) (finding that knowledge of material facts and failure of disclosure provide adequate bases for culpability sufficient to establish liability for violation of § 10(b) of the Exchange Act and Rule 10b-5). The Supreme Court has held that in the context of a material omission, it is not enough that there was actual knowledge of the material information; there must be a duty to disclose arising from a relationship of trust and confidence between the parties to the transaction. See Chiarella, 445 U.S. at 230. I have already found that Taylor had a relationship of trust and confidence with his clients and that his failure to disclose the compensation he was receiving was a material fact. Thus, I conclude that Taylor acted with the requisite scienter.
Jurisdiction
The jurisdictional clauses under the antifraud provisions are given broad interpretation and are satisfied by intrastate telephone calls and by incidental use of the mails. See McDaniel v. United States, 343 F.2d 785, 787-88 (5th Cir. 1965), cert. denied, 382 U.S. 826 (1965); see also Ruebe v. Pharmacodynamics, Inc., 348 F. Supp. 900, 912 (D.C. Pa. 1972); Ingraffia v. Belle Meade Hospital, Inc., 319 F. Supp. 537, 538 (D.C. La. 1970). Over the telephone, Taylor recommended to three of the four testifying witnesses that they purchase FTET stock. Shafer received account statements from Investors Associates in the mail. (Resp. Ex. 3 at 8-13.) I conclude that Taylor's actions are sufficient to trigger the jurisdictional clauses under the antifraud provisions.
SANCTIONS
I have concluded that the Division has established that Taylor committed the illegal acts described in the OIP. The remaining issue is the sanction that is appropriate in the public interest. Section 15(b)(6) of the Exchange Act authorizes me to impose sanctions on any person associated with a broker-dealer if it is in the public interest and the person has willfully violated any provision of the federal securities laws. The following factors are relevant for determining the public interest:
[T]he egregiousness of the defendant's actions; the isolated or recurrent nature of the infraction; the degree of scienter involved; the sincerity of the defendant's assurances against future violations; the defendant's recognition of the wrongful nature of his conduct; and the likelihood that the defendant's occupation will present opportunities for future violations.
Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981). The severity of a sanction depends on the facts of each case and the value of the sanction in preventing a recurrence. See Berko v. SEC, 316 F.2d 137, 141 (2d Cir. 1963); see also Richard C. Spangler, Inc., 46 S.E.C. 238, 254, n. 67 (1976); Leo Glassman, 46 S.E.C. 209, 211-12 (1975). Willfulness does not require intent to violate, but merely intent to do act which constitutes violations. See Arthur Lipper Corp. v. SEC, 547 F.2d 171 (2d Cir. 1976), cert. denied, 434 U.S. 1009 (1978).
Bar.
Taylor's actions were egregious. As the branch manager of Investors Associates, he knew or should have known that accepting compensation without disclosure was improper, whether to promote the sale of FTET to his customers or to help facilitate an investment banking relationship between FTET and Investors Associates. Taylor's clients placed their trust and confidence in him to recommend stocks, and he violated their trust. His actions were not isolated, and occurred over a substantial number of weeks, March through August, 1995.
Taylor acted with a high level of scienter, "knowingly" and "willfully." He recommended to his customers that they purchase FTET while he had an agreement with Lempel to promote the stock. Taylor recommended to registered representatives that worked for him that they sell FTET to their customers without disclosing to them that he was being compensated with shares. The commissions generated by these brokers were included under his registered representative number. Taylor furnished the salesmen with a financial incentive to sell FTET shares. This arrangement allowed him, in turn, to obtain more "free" shares from Lempel that he could liquidate. Thus, the evidence in the record establishes a scheme whereby Taylor was able to exploit the entire branch office for his own economic benefit.
In addition, Taylor failed to disclose to his own customers that he was selling FTET stock that he received through his mother's brokerage account while recommending that his customers purchase FTET. His liquidation of FTET shares while recommending FTET to his clients demonstrates a desire to profit at their expense. Furthermore, the manner in which he transferred the FTET shares to his mother's brokerage account in an effort to hide the transactions demonstrates consciousness of guilt. See SEC v. Netelkos, 592 F. Supp. 906, 920 (S.D.N.Y. 1984) (finding that concealment of recipients' identities, their respective backgrounds, and nature of transactions are strongly indicative of an intent to deceive, manipulate, or defraud). I conclude that Taylor hoped that the insertion of his family into the accounts would protect his identity and conceal his wrongdoing.
Taylor stated that he did not intend to hurt his clients. However, the possibility that Taylor did not intend to harm his customers or that he actually thought that FTET was a good investment is not dispositive. See Andrews v. Blue, 489 F.2d 367, 375 (10th Cir. 1973) (intent in the odious or malicious sense not required); see also Transconian Tender Offer Securities Litigation, 455 F. Supp. 999, 1011 (D.C. Ill. (1978) (mere fact that a defendant does not have a specific intent to deceive or harm investors as a result of his deception is not important). Nor does a defendant have to know his or her actions are illegal; knowledge of what one is doing and of the consequences of those actions suffices. See SEC v. Falstaff, 629 F.2d 62, 77 (D.C. Cir. 1980), cert. denied, 449 U.S. 1012 (1980).
Taylor has made no assurances that he will not conduct future violations of the securities laws and he denies that any harm was done to his customers by his conduct. Finally, Taylor continues to be employed as a registered representative associated with a broker-dealer. Thus, there is a strong likelihood that Taylor will violate the federal securities laws again. It is therefore in the public interest that Taylor be barred permanently from associating with any broker or dealer.
Cease and Desist.
Section 8A of the Securities Act and Section 21C of the Exchange Act provide that the Commission can enter an order against a person, who is violating, has violated, or is about to violate any provision of the Securities Act and the Exchange Act, to cease and desist from committing or causing violations and future violations of the provisions of the Securities Act and the Exchange Act. In issuing a cease-and-desist order, there must be a "reasonable likelihood of future violations." KPMG Peat Marwick, LLP, 74 SEC Docket 384, 429 (2001), petition denied, No. 01-1131 (D.C. Cir. 2002). As the Commission has stated, "[a]bsent evidence to the contrary, a finding of violation raises a sufficient risk of future violation." Id. at 430. Taylor willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5. Based on Taylor's disregard for the securities laws, there exists a strong likelihood that Taylor will violate the antifraud provisions of the securities laws in the future; a cease-and-desist order would be appropriate against Taylor.
Disgorgement.
Section 8A of the Securities Act and Section 21C of the Exchange Act provide that "the Commission may enter an order requiring accounting and disgorgement, including reasonable interest." The purpose of disgorgement is to prevent the wrongdoer from profiting from his or her illicit conduct. See Robert A. Magnan, 59 SEC Docket 2276, 2313 (1995). When calculating disgorgement, separating legal from illegal profits exactly may, at times, be a near-impossible task; therefore, disgorgement need only be reasonable approximation of profits causally connected to violation. See Joseph J. Barbato, 63 SEC Docket 626, 649 (1996). The evidence presented at the hearing establishes that Taylor or his family members derived $59,361.25 in net proceeds from the sale of FTET stock that he received from Lempel. In addition, Taylor received $19,528.05 in commissions on sales of FTET underneath his registered representative number.
Pursuant to Rule 630 of the Commission's Rules of Practice, 17 C.F.R. § 201.630, a Respondent may present evidence of an inability to pay disgorgement, interest, or a penalty and the hearing officer may, in his or her discretion, consider evidence concerning ability to pay in determining whether disgorgement, interest, or a penalty is in the public interest. See also Terry T. Steen, 67 SEC Docket 837 (1998); First Securities Transfer System, Inc. and Steven Telsey, 60 SEC Docket 441 (1995). Taylor is in a tenuous financial position, and the permanent bar will not contribute to his financial stability. His debts, child-support payments, and lack of assets show an inability to pay disgorgement. Thus, an order of disgorgement is likely to prove a futile act and would not be in the public interest. I am not persuaded by First Securities or by Steen that Taylor is able to pay disgorgement. No disgorgement will be ordered.
Civil Penalty.
Pursuant to Section 21B(b) of the Exchange Act, the Division also seeks third-tier penalties against Taylor in the amount of $110,000. The assessment of a penalty pursuant to Section 21B of the Exchange Act depends on the finding that such assessment is in the public interest.
In determining the public interest, the Commission may consider: (1) whether the act or omission for which such penalty is assessed involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement; (2) the harm to other persons resulting either directly or indirectly from such act or omission; (3) the extent to which any person was unjustly enriched, taking into account any restitution made to persons injured by such behavior; (4) whether such person previously has been found by the Commission, another appropriate regulatory agency, or a self-regulatory organization to have violated the Federal securities laws, State securities laws, or the rules of a self-regulatory organization, has been enjoined by a court of competent jurisdiction from violations of such laws or rules, or has been convicted by a court of competent jurisdiction of violations of such laws or of any felony or misdemeanor described in section 15(b)(4)(B); (5) the need to deter such person and other persons from committing such acts or omissions; and (6) such other matters as justice may require. See 15 U.S.C.S. §78u-2(c).
Taylor's omission to state that he was receiving compensation was done knowingly and deliberately. The harm to the four testifying witnesses was that their shares of FTET became worthless or they sold their shares for a loss. However, the amount of money that the four witnesses lost was relatively small. Taylor received $19,528.05 in commissions under his registered representative number. He or his family members received $59,361.25 from the sale of FTET stock that he received pursuant to his scheme.
On the other hand, he does not have a history of violations of the securities laws. In addition, the evidence in the record establishes that Taylor is not able to pay a civil penalty. Section 21B(d) of the Exchange Act and Rule 630 of the Commission's Rules of Practice, 17 C.F.R. § 201.630, authorize me to consider such evidence in determining whether to impose penalties on Taylor. The same reasoning for not imposing disgorgement also applies for not imposing a civil penalty. I conclude for all these reasons that Taylor should not be assessed a civil penalty.
RECORD CERTIFICATION
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.351(b), I certify that the record includes the items set forth in the record index issued by the Secretary of the Commission on May 16, 2000.
ORDER
Based on the findings and conclusions set forth above:
IT IS ORDERED, pursuant to Section 15(b) of the Securities Exchange Act of 1934, that G. Bradley Taylor be, and he hereby is, BARRED from associating with a broker or dealer.
IT IS FURTHER ORDERED, pursuant to Section 8A of the Securities Act of 1933 and Section 21C of the Securities Exchange Act of 1934, that G. Bradley Taylor CEASE AND DESIST from committing or causing violations or future violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder.
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.
Lillian A. McEwen
Administrative Law Judge
1 "(Tr. __.)" refers to the transcript of the hearing. I will refer to the Division's exhibits and Respondent's exhibits as "(Div. Ex. __.)" and "(Resp. Ex. __.)," respectively.
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