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Securities and Exchange Commission
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In the Matter of
JAVED ANVER LATEF, and
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OPINION OF THE COMMISSION
INVESTMENT COMPANY PROCEEDING
CEASE AND DESIST PROCEEDING
Failure to Comply with Reporting Requirements
President of registered investment adviser and registered investment company failed to disclose material facts concerning financing arrangement in Form ADV, Form ADV-S, and in the mutual fund prospectus. Financing provider was alleged to have aided and abetted the disclosure and reporting violations. Held, it is in the public interest to bar president of registered investment adviser and of registered investment company from association with any investment adviser or investment company for three months and to order him to cease and desist from committing or causing any violations or any future violations of the applicable securities laws. The aiding and abetting allegations have not been established and, accordingly, theproceeding with respect to the financing provider is dismissed.
Larry Alan Stockett, pro se.
Thomas M. Melton and Brent R. Baker, for the Division of Enforcement.
Appeal filed: April 20, 1999
Last brief received: July 20, 1999
Javed Anver Latef, president and director of Hudson Investors Fund, Inc. ("Hudson Fund" or the "Fund") and president and sole shareholder of Hudson Advisers, Inc. ("Hudson Advisers") and Hudson Investment Management, Inc. ("Hudson Management"), and Larry Alan Stockett appeal from the decision of an administrative law judge. The law judge found that Latef, the Hudson Fund, and Hudson Advisers (collectively the "Hudson Respondents") willfully violated Section 17(a) of the Securities Act of 1933,1 Section 10(b) of the Securities Exchange Act of 1934,2 Exchange Act Rule 10b-5,3 and Section 34(b) of the Investment Company Act of 1940.4 These findings were based on the Hudson Respondents' failure to disclose to shareholders: (1) the nature of Stockett's business relationships with the Hudson Respondents; (2) Stockett's payment of the expenses of Hudson Management; and (3) the Fund's investment in securities of companies from which it received payments and in which Stockett held an interest. The law judge concluded that Stockett aided and abetted these violations because he: (1) knew that the Hudson Respondents wereviolating the securities laws by not disclosing certain material information, and (2) knowingly and substantially assisted in the commission of these violations by concealing information from Latef and by contributing to misinformation disclosed to investors.
The law judge also found that Hudson Advisers violated Section 204 of the Investment Advisers Act of 19405 and Advisers Act Rule 204-1(b),6 and that Latef and Hudson Advisers violated Section 207 of the Advisers Act7 by failing to include the material information in Form ADV-S, the annual report for investment advisers registered under the Advisers Act, or in the Fund's prospectus.8 The law judge found that Stockett aided and abetted these violations of Section 204 and 207 of the Advisers Act and Advisers Act Rule 204-1(b) because he knew that Hudson Advisers and Latef were violating the reporting provisions and he assisted in those violations.
The law judge concluded that it was in the public interest to suspend Latef from association with any investment adviser or investment company for three months. The law judge found that Stockett's activities "flowed across" the securities professions and posed a significant risk of harm to investors and he therefore imposed an industry-wide, or collateral bar against Stockett. The law judge also imposed a $50,000 civil money penalty on Stockett and ordered that all of the respondents cease and desist from further violations of the applicable securities laws. Latef and Stockett appealed the law judge's decision to the Commission. The Hudson Fund and Hudson Advisers have not appealed. We base our findings on an independent review of the record except with respect to those findings not challenged on appeal.
The Hudson Respondents
In 1994, Latef, along with Akram Choudhry and a few other individuals, created the Hudson Fund. The Hudson Fund invests in companies it deems to meet strict ethical standards, for example, companies not involved with tobacco, alcohol, or gambling. Latef is the president of the Fund and is responsible for its day-to-day operation. Choudhry made the initial $100,000 investment in the Fund and during the relevant times held a majority of the shares of the Fund. The Fund has been registered with the Commission since August 1994.
Hudson Advisers has been registered with the Commission as an investment adviser since March 1993 and acts as the Fund's investment adviser. Hudson Advisers' compensation is set at a percentage of the Fund's average daily net asset value, paid monthly. Hudson Management provides management services to the Fund. Its monthly fee also is calculated as a percentage of the Fund's average daily net asset value. In fact, Hudson Management and Hudson Advisers never collected fees due to them from the Hudson Fund because of the high expenses of the Fund relative to its value.9 Latef owns Hudson Advisers and Hudson Management and is president of both entities.
Larry Alan Stockett
Latef and Choudhry were anxious to attract new investors to the Fund in order to increase assets under management, improve investment selection opportunities, and make the Fund more successful. During their effort to attract new investors, Latef and Choudhry were introduced to Larry Alan Stockett. Stockett was owner, president, and manager of the OTC Emerging Growth Fund, Inc. ("OTC Fund") and the IPO Network, Inc. ("IPO Network"), a subsidiary of the OTC Fund. Through these entities, Stockett published information and statistical analyses on initial public offerings. Specifically, Stockett published research relating to after-market performance of initial public offerings through a newsletter, a book, and training tapes. Healso created an Internet database containing information about initial public offerings and other stocks.
Latef and Choudhry had their initial meeting with Stockett during the first week of August 1996. Stockett represented that he had connections with investors with considerable resources who might be interested in investing in the Hudson Fund. Stockett also suggested that the Fund employ a computerized stock selection program with which he was familiar. Stockett told Latef he was looking for a company to utilize this program, for an example in recruiting potential investors.
The stock selection program was called the Neuropro System. It was developed by The New Industrialist, Inc. ("The New Industrialist"), publisher of The New Industrialist magazine. The magazine provided information about investment opportunities gleaned primarily from the Neuropro System. In early August, Stockett, on behalf of the IPO Network, entered into an agreement with The New Industrialist, which gave the IPO Network licensing rights to the Neuropro System.
Stockett has an extensive disciplinary history which he did not disclose to Latef or Choudhry. In 1985, the United States District Court for the Eastern District of Virginia permanently enjoined Stockett from violations of the antifraud provisions of the federal securities laws. In 1988, the State of California permanently enjoined Stockett from offering to sell or selling certain securities in California. California also assessed civil penalties against Stockett. In 1996, the State of Oregon ordered Stockett to cease and desist from offering securities in Oregon and required him to pay a civil penalty.
Stockett's Relationship With the Hudson Entities
Latef and Choudhry decided to enter into a business arrangement with Stockett, which was formalized in four separate written documents, all signed on August 7, 1996.10 Stockett signed the four documents on behalf of an entity named Neuropro Nevada, which Latef believed to be a Nevada corporation owned by Stockett. Neuropro Nevada, however, did not exist at the time that the contract with the Hudson entities was signed byStockett, and it was never formed as a corporation in Nevada, or in any state.11
Two of the documents gave Neuropro Nevada irrevocable options, expiring on July 31, 2001, to acquire all of the common stock of Hudson Management and Hudson Advisers for a total of $100 for each company. The next two documents detailed the consideration that Stockett was to provide in exchange for receiving the options. One of these documents, signed by Neuropro Nevada, Hudson Management, Hudson Advisers, and the Hudson Group, provided that, "in connection with the Option Agreements," Neuropro Nevada would pay the costs and expenses of operating the Hudson Fund to the extent that fees available from the Fund were not sufficient to cover those costs and expenses. As additional consideration, Neuropro Nevada agreed to pay $50,000 upon execution of the expense agreement. The final document signed by Neuropro Nevada, Hudson Management, and Hudson Advisers stated that Neuropro Nevada was to provide Hudson Management with stock information and analysis, but specifically provided that Neuropro Nevada would not participate in, or in any way influence, the management of the Fund.
Shortly after he signed the agreements on August 7, 1996, Latef discovered that Neuropro Nevada had never been incorporated. Notwithstanding this discovery, Latef and Stockett acted as though the agreements were valid. For example, on August 16, 1996, Stockett made a $50,000 payment to the Hudson Group as he would have done had the written expense agreement been valid. Stockett also made monthly expense payments to Hudson Management, and Latef accepted these payments.12 Stockett maintained that he made the payments to Hudson Management in order to preserve his options to acquire Hudson Management and Hudson Advisers. Latef admitted that the payments made by Stockett were used for Hudson Fund expenses. He claimed that the payments were not made pursuant to the written expense agreement because he believed that agreement to be invalid, but he testified that Stockett personally could exercise the options to purchase Hudson Advisers and Hudson Management at any time, as long as Stockett provided expense payments for the months since he stopped making payments in April 1997.
Form ADV, the investment adviser registration form, requires that an applicant financed by a person not named in other parts of the Form furnish the name of the person providing the financing and describe the arrangement through which the financing was made available, including the amount of the financing.13 Neither Latef nor Hudson Advisers amended Hudson Advisers' Form ADV to reflect that Stockett provided financing, the amount of that financing, or the arrangement through which the financing was made available, namely that the financing was consideration for Stockett's options to purchase Hudson Advisers and Hudson Management. In addition, on March 27, 1997, when Latef signed Form ADV-S, the annual report for investment advisers registered under the Advisers Act, he checked the box indicating that he did not need to amend Hudson Advisers' Form ADV to correct information contained in that Form.
Latef Purchases Hightec and Sinclare Stock for the Hudson Fund
After entering into the agreements with Hudson Management, Hudson Advisers, and the Hudson Group, Stockett continued to expand his business holdings. In November 1996, Stockett acquired a controlling interest in Hightec, Inc. ("Hightec"), a publicly traded corporation, to use as a holding company. On November 21, 1996, the new board of directors, which included Stockett, voted to make Stockett president and chief financial officer of Hightec. On February 19, 1997, Stockett, through Hightec, purchased S.I.N.C.L.A.R.E. Group, Inc. ("Sinclare"), a Canadian company that held a license from The New Industrialist to use the Neuropro System and to publish a Canadian version ofThe New Industrialist magazine.14 Stockett became president of Sinclare on February 24, 1997.
While Stockett was acquiring Hightec and Sinclare, Latef was purchasing securities in these companies for the Hudson Fund. On December 6, 1996, the Hudson Fund purchased 20,000 shares of Hightec stock. On December 11, it purchased another 500 shares. On January 13, 1997, the Hudson Fund purchased 5,000 shares of Sinclare stock; on January 14 the Fund made four separate purchases totaling another 35,000 shares of Sinclare; and on February 11 the Fund purchased 10,000 shares of Sinclare. As of February 28, 1997, the Fund's holdings in Hightec and Sinclare comprised over twenty percent of the Fund's assets.
Latef stated that, as a general rule, he used several sources of information in deciding which stocks to purchase for the Hudson Fund, including publications and technical analysis computer programs. Latef used the Neuropro System report printed in The New Industrialist magazine as one resource in selecting securities for the Hudson Fund. Stockett, through the IPO Network, had begun publishing the results of his research in The New Industrialist magazine in May 1996. According to Latef, Stockett never attempted to force Latef to buy a particular security and Latef did not inform Stockett about which securities Latef planned to purchase for the Fund.
Latef admitted that his decision to purchase Hightec and Sinclare was not based on an analysis as extensive as he normally used. Latef first became aware of Hightec when he saw a notice in a special edition of The New Industrialist in early December. This edition was called the Winners United States Edition ("Winners Edition"). Latef subsequently discussed Hightec extensively with Stockett, asking Stockett whether he thought it was a good stock that would do well in the future. Latef also discussed Hightec with some other brokers, but did not speak to anyone at Hightec. Latef claims that he did not know of Stockett's affiliation with Hightec until approximately one week after he purchased the Hightec stock; Stockett's testimony agreed with Latef on this point.15 Stockett also testified that hedid not become aware that Latef had purchased Hightec stock for the Hudson Fund until January 1997.
Latef also spoke with Stockett to obtain his opinion regarding Sinclare prior to Latef's purchase of that company's stock for the Hudson Fund. Latef testified that he did not know whether Stockett was affiliated with Sinclare at the time he purchased Sinclare stock and that he never asked Stockett about, nor had Stockett informed him of, any affiliation or potential affiliation with Sinclare.16
Latef maintains that the decision to purchase stock in Hightec and Sinclare was his alone. Latef testified that he spoke extensively with Stockett about Hightec and Sinclare and whether those were solid companies whose stock price was likely to increase. Despite these extensive conversations, Stockett never informed Latef that he owned Hightec or was in the process of acquiring Sinclare. Latef and Stockett both testified that Latef did not ask Stockett explicitly if he should purchase these securities for the Hudson Fund, and Stockett never advised Latef explicitly to purchase the securities for the Fund.17
Stockett Markets the Hudson Fund
The Winners Edition of The New Industrialist magazine not only contained information about Hightec, but also information on the Hudson Fund, including material that attempted to solicit investors for the Fund.18 The magazine contained an advertisement for the Fund, a copy of the Fund's prospectus, and an application to invest in the Fund. It also contained a front page article touting the Hudson Fund as "the best stock for WIN members." According to Latef, the article contained several inaccuracies. For example, statements to the effect that the Fund employed the Neuropro System on a test basis for a portion of its portfolio were not true.
Latef claims that he did not authorize the magazine to print, did not pay for, and did not provide materials or information for any of the Hudson Fund items that appeared in the Winners Edition. In fact, Latef wrote a letter to Chris Lazarus, the owner of The New Industrialist, stating that The New Industrialist did not have permission to print the Hudson Fund's prospectus in any of its magazines. However, Latef took no steps to correct the inaccuracies concerning the Hudson Fund that appeared in the Winners Edition. He accepted investment applications that were copied or removed from the Winners Edition.
Stockett admitted providing a copy of the Hudson Fund prospectus to Lazarus, but denied providing any of the performance information discussed in the article. Circumstantial evidence suggests, however, that Stockett likely was responsible for much of the information about the Hudson Fund that appeared in the Winner's Edition. For example, a number of WIN members who invested in the Hudson Fund believed that Stockett had some sort of affiliation with the Fund. One investor went so far as to ask the Hudson Fund for confirmation that Stockett was the Fund's investment manager.
Stockett also touted the performance of the Hudson Fund in seeking prospective investors for his other ventures. In the course of doing so, he held himself out both as having an ownership interest in the Hudson Fund and its related entities and as having responsibility for selecting the Fund's investments and therefore for its success.
Stockett even attempted to sell part of the Hudson Fund to an entity called Select Capital Advisors.19 In a June 11, 1997 letter, Stockett proposed to Select Capital Advisors that (1) its president become an equal partner with Stockett in all of Stockett's ventures, including the Hudson Fund and the Hudson Group; (2) the Hudson Fund and the Hudson Group would change their names to the Select Capital Fund and the Select Capital Partners, respectively; and (3) Stockett would instruct Latef, to whom he referred as the Fund's "registered investment advisor," to purchase securities of Select Capital Advisors' publicly-traded clients. According to Stockett, his purpose in proposing this transaction was to sell his ownership interest in Hudson Advisers and Hudson Management, as represented by the option agreements, to Select Capital.20 This transaction was never completed and Stockett ceased making expense payments to Hudson Management in or about April 1997.
A. Latef's Fraudulent Failure to Disclose Material Information
The antifraud provisions of the Securities Act and the Exchange Act prohibit fraudulent and deceptive acts and practices in connection with the offer, purchase or sale of a security.21 It is undisputed that all of the relevant conduct was in connection with the offer, purchase or sale of a security -- shares of the Hudson Fund. The issues before us are whether Latef omitted to disclose aspects of his relationship with Stockett, and if so, whether the omissions were material and made with scienter.
1. Omissions
The Division alleges that Latef failed to disclose that (1) Stockett had an option to purchase Hudson Advisers and HudsonManagement for $100 each; (2) Stockett agreed to pay the Fund's expenses and then paid the Fund's expenses from August 1996 until April 1997; and (3) the Fund invested in the securities of companies in which Stockett had, or was in the process of acquiring, an interest. The Division argues that Latef should have disclosed this information by amending Form ADV22 and by including it in the Form ADV-S that he filed on April 2, 1997 and in the Fund's prospectus.
Latef and Stockett both maintain that the documents that provided for the options and the expense payments were not valid contracts because one of the contracting parties, Neuropro Nevada, had never been formed. They argue that, because the contracts were not valid, there was nothing to disclose.23 Their argument is unpersuasive. At the hearing, both Latef and Stockett testified that Stockett had the continuing right to exercise the options as long as he kept current on his payment of the Fund's expenses and regardless of the validity of the contract executed by Stockett. Latef and Stockett also agree that Stockett paid the Fund's expenses from August 1996 until April 1997. The only apparent consideration for making these payments was the right to exercise the options.
Latef also failed to disclose to shareholders or potential investors in the Hudson Fund the nature of Stockett's involvement with Hightec and Sinclare. At the time Latef purchased Hightec stock for the Fund, Stockett already had become Hightec's president and chief financial officer. Latef also purchased stock in Sinclare shortly before Hightec acquired it and Stockett became its president. It is undisputed that Latef never disclosed to shareholders or potential investors in the Fund the nature of Stockett's affiliation with Hightec, even after he discovered that Stockett owned the company, nor did Latef disclose Stockett's affiliation with Sinclare.24
2. Materiality
A fundamental purpose of the federal securities laws is to "substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry."25 In order to achieve this high standard, investors must be provided with all material facts relating to their investment decisions. A fact 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."26
A reasonable investor would have considered it important that the Hudson Fund was being financed by Stockett in exchange for options to purchase Hudson Advisers and Hudson Management. An investor would think carefully about investing in a fund where a third party had an option to purchase the Fund's investment adviser and manager because it creates uncertainty as to who would direct the Fund's investment decisions in the near future. The fact that the third party who had the options also had an extensive disciplinary history and had been enjoined from committing or causing violations of the federal securities laws would be especially significant to Hudson Fund investors, because the Fund holds itself out as investing according to strict ethical standards. Reasonable investors likely would question whether the Fund's ability to act consistently with its investment philosophy would be compromised by the sale of options to an individual with a disciplinary record involving fraud.
It would also have been material to a reasonable investor that an undisclosed third party was paying the Fund's expenses, because that party could be expected to influence Latef in selecting securities for the Hudson Fund. Stockett's expense payments created an incentive for Latef to select securities that Stockett favored so as not to jeopardize future expense payments. Thus, information about Stockett's payments of the Fund's expenses was material to shareholders and potential investors inthe Hudson Fund in evaluating the independence of Latef's investment selections.27
The fact that the Hudson Fund invested in companies controlled by Stockett would have been material to a reasonable investor in evaluating the total mix of information prior to investing in the Fund. Stockett held options to purchase Hudson Advisers and Hudson Management and paid the Fund's expenses from August 1996 until April 1997. Given these facts, Latef's purchase for the Hudson Fund of securities in companies with which Stockett was, or was in the process of becoming, affiliated would have raised a serious question in the mind of a reasonable investor about Latef's objectivity in making investments for the Hudson Fund. A reasonable investor could have concluded that Latef purchased these stocks to secure Stockett's continued financial support. Latef's acceptance of $20,000 in expense payments made by Hightec, on behalf of Stockett, is further evidence of the apparent conflict of interest. This information could have caused a potential investor to question the independence of Latef's investment decisions not only with respect to Hightec and Sinclare, but also more generally.28 Stockett's involvement with companies whose stock Latef purchased for the Hudson Fund was material information because it would have significantly altered the total mix of information available to investors in assessing the quality of the Fund's portfolio.
3. Scienter
Scienter is a necessary element of a violation of Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act, and Exchange Act Rule 10b-5.29 Scienter has been defined by the Supreme Court as a "mental state embracing intent to deceive, manipulate or defraud."30 Reckless behavior satisfies the scienter requirement.31
There is no merit to Latef's argument that he acted without scienter. Latef argues that he did not believe he needed to disclose the option agreements or Stockett's expense payments because the failure of Neuropro Nevada to become incorporated made the written agreements invalid. Our analysis does not depend on the validity of the written contracts, however. Form ADV unambiguously requires that an applicant disclose the identity of a person providing financing and the arrangement through which the financing is made available. Nothing in Form ADV limits this requirement to written financing agreements. Latef's testimony establishes the existence of an agreement allowing Stockett to purchase Hudson Advisers and Hudson Management for $100 each, contingent only on Stockett's making up the expense payments he had missed. Even at the time of thehearing, Latef intended to honor the agreement and believed that he was obligated to do so. Stockett made expense payments to Hudson Management from August 1996 until April 1997 to preserve his right to exercise his options pursuant to the agreement and Latef accepted those payments. Latef's relationship with Stockett created a material conflict of interest. Latef acted recklessly when he failed to disclose that conflict, not only by failing to amend Form ADV, but also by failing to include information about the conflict in the Fund's prospectus. Latef also acted reckless by checking the box on Form ADV-S indicating that he did not need to amend Form ADV.
Latef also knew, or was reckless in not knowing, that a reasonable investor would have viewed as material the fact that the Fund was investing in companies controlled by Stockett, given that Stockett had an option to purchase Hudson Advisers and Hudson Management and that he had been paying the Fund's expenses.32 Latef was reckless in not appreciating that a reasonable investor would have viewed this relationship as material in evaluating the independence of the investment decisions that Latef made on behalf of the Fund's investors. Furthermore, the conflict of interest must have been obvious to Latef when he accepted two expense payments made to Hudson Management by Hightec on behalf of Stockett, when the Fund held Hightec stock.33
The conflicts created by the options and expense payments, as well as the Fund's purchases of stock of companies Stockett owned or was in the process of acquiring, were so apparent that Latef must have been aware of their materiality and of the need to disclose them. Latef's failure to disclose this material information represents an extreme departure from the standards of ordinary care. We conclude, therefore, that Latef, along with the Hudson Fund and Hudson Advisers, willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Exchange Act Rule 10b-5.
The Hudson Respondents also violated Section 34(b) of the Company Act, which prohibits any person from making a false or misleading statement of material fact with respect to documents filed or transmitted pursuant to the provisions of the Company Act.34 We find that Latef, along with the Hudson Fund and Hudson Advisers, violated Section 34(b) of the Company Act when Latef failed to make the appropriate disclosures in the Fund's prospectus.
B. Violation of Reporting Requirements
Hudson Advisers' failure to disclose material facts concerning its relationship with Stockett also violated Section 204 of the Advisers Act and Advisers Act Rule 204-1(b).35 Rule 204-1(b) requires prompt amendment of the investment adviser registration form, Form ADV, if specific information on that Form becomes inaccurate, including information concerning the identity of persons providing financing and the arrangement through which that financing was made available. It is undisputed that Hudson Advisers, through Latef, failed to amend Form ADV to reflect the material facts that Stockett paid the Fund's expenses from August 1996 until April 1997 and that he held options to purchase Hudson Advisers and Hudson Management. Hudson Advisers, through Latef, also failed to amend Form ADV to reflect that Stockett owned or controlled Hightec after Latef purchased shares of Hightec forthe Fund. Moreover, Latef affirmatively misrepresented that there was no need to amend Form ADV when he filed Form ADV-S on April 2, 1997. In so doing, Latef and Hudson Advisers willfully violated Section 207 of the Advisers Act.36
C. Stockett's Aiding and Abetting
The Division argues that Stockett aided and abetted the Hudson Respondents' securities law violations. The three elements necessary to find aiding and abetting are: (1) securities law violations by another party; (2) substantial assistance by the aider and abettor in the conduct constituting those violations; and (3) general awareness or knowledge by the aider and abettor that his actions are part of an overall course of conduct that is illegal or improper.37 Stockett argues that he did not provide substantial assistance to the Hudson Respondents, and that he lacked the requisite knowledge of their misconduct, because he had no control over their investment or reporting decisions and acted only as a publisher of investment advice.
The Division has established the primary disclosure violations committed by Latef and the other Hudson Respondents. We conclude, however, that the Division has not established that Stockett possessed a general awareness or knowledge that his actions were part of an overall course of conduct by the Hudson Respondents in violation of the federal securities laws.38 Specifically, with respect to the options to purchase Hudson Management and Hudson Advisers and the expense payments made by Stockett, the Division has not established that Stockett was aware of the Hudson Respondents' disclosure obligations or whether they had met those disclosure obligations. The fact that Stockett signed the documents concerning the options and the expense payments on behalf of a corporation that did not exist and paid the expenses through companies he owned or that owed him money may indicate that Stockett was trying to hide his relationship with the Hudson Respondents. Stockett, however, did not hide his identity from Latef. As discussed earlier, Latef knew Stockett was making the expense payments, Latef accepted those payments, and he believed, as late as the date of the hearing, that Stockett still could exercise the options to purchase Hudson Management and Hudson Advisers. Thus, while the Hudson Respondents were obligated to disclose this information, nothing in the record establishes that Stockett knew that theywere obligated to do so or that he was aware that they would fail to do so.39
Nor has the Division established that Stockett was aware of the Hudson Respondents' disclosure obligations with respect to the Fund's purchase of stock in Hightec and Sinclare. Stockett omitted to disclose his ownership of Hightec and Sinclare to Latef. Nothing in the record indicates, however, that Stockett was aware that Latef was required to disclose this information or that Latef would fail to discover it during the course of his research on the companies.
We conclude, therefore, that the Division has failed to establish that Stockett willfully aided and abetted the Hudson Respondents' violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, Exchange Act Rule 10b-5, and Section 34(b) of the Company Act.40
We also find that the Division has not established that Stockett was aware of the Hudson Respondents' reporting obligations with respect to the options, the expense payments, and the Hudson Fund's purchase of stock in Hightec and Sinclare, or whether the Hudson Respondents had fulfilled those obligations and, therefore, we cannot conclude that Stockett aided and abetted the violations of Advisers Act Sections 204 and 207 and Advisers Act Rule 204-1(b).
When Congress grants an agency the responsibility to impose sanctions to achieve the purposes of a statute, "the relation of remedy to policy is peculiarly a matter for administrative competence."41 We have indicated that, in determining what sanction is in the public interest, we consider the following factors:
the egregiousness of the [respondent's] actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the [respondent's] assurances against future violations, the [respondent's] recognition of the wrongful nature of his conduct, and the likelihood that the [respondent's] occupation will present opportunities for future violations.42
Applying these factors, the law judge ordered Latef and Stockett to cease and desist from further violations of the applicable securities laws, imposed a three-month suspension on Latef, and imposed a collateral bar and a $50,000 civil money penalty on Stockett.43
Latef argues that there was no basis for the law judge's determination that he violated the federal securities laws and, therefore, the sanctions imposed by the law judge are not warranted.44 Specifically, Latef maintains that the law judge's decision to suspend him from association with any investment adviser or investment company for three months is too harsh.
Latef's disclosure failures were egregious. Latef failed to disclose to the Fund's shareholders that Stockett paid the Fund's expenses, that Stockett held options to purchase Hudson Advisers and Hudson Management, and that the Fund had invested in companies with which Stockett either was affiliated or with which he was seeking to become affiliated. These material facts indicated serious conflicts of interest. Latef's failure to disclose them to shareholders and potential investors in the Fund represented an extreme departure from ordinary care.
Latef acted with a high degree of recklessness. Even though he claims that disclosure was not required because the agreements signed by Stockett were not valid, Latef believed nonetheless that Stockett could purchase the Hudson Fund and Hudson Advisers for the agreed-upon price, and he accepted numerous expense payments from Stockett. Latef bought stock in Hightec for the Fund and, even after he discovered that Stockett was Hightec's president, Latef failed to disclose this fact to the Fund's shareholders and potential investors. Moreover, Latef acceptedexpense payments from Hightec on Stockett's behalf after he had purchased Hightec stock for the Hudson Fund.
Latef has no disciplinary history, and the record indicates that his violations were limited to those arising out of his involvement with Stockett. However, Latef, despite claiming that he wants to comply with the securities laws, testified that, as of the time of the hearing, he had not yet made any public disclosure of the agreement with Stockett, which he testified that he still considered to be valid. We also find that Latef's serious and repeated violations raise a sufficient risk of future violation to warrant imposition of a cease-and-desist order against him.45 We conclude, therefore, that it is in the public interest to suspend Latef from association with any investment adviser or investment company for three months and to order that he cease and desist from committing or causing any violations or future violations of the applicable securities laws.
We have determined that the aiding and abetting allegations against Stockett have not been established and, accordingly, we conclude that it is necessary to dismiss the proceeding with respect to him.
An appropriate order will issue.46
By the Commission (Chairman DONALDSON and Commissioners GLASSMAN, GOLDSCHMID and ATKINS); Commissioner CAMPOS not participating.
Jonathan G. Katz
Secretary
INVESTMENT ADVISERS ACT OF 1940
Rel. No. 2116/ March 20, 2003
INVESTMENT COMPANY ACT OF 1940
Rel. No. 25965 / March 20, 2003
Admin. Proc. File No. 3-9374
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In the Matter of
JAVED ANVER LATEF, and
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ORDER IMPOSING REMEDIAL SANCTIONS
On the basis of the Commission's opinion issued this day, it is
ORDERED that Javed Anver Latef be, and hereby is, suspended from association with any investment adviser or investment company for a period of three months, to be served beginning the second Monday after the date of this order; and it is further
ORDERED that Latef cease and desist from committing or causing any violations or any future violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, Exchange Act Rule 10b-5, Section 34(b) of the Investment Company Act of 1940, and Section 207 of the Investment Advisers Act of 1940; and it is further
ORDERED that the proceeding with respect to Larry Alan Stockett be, and it hereby is, dismissed.
By the Commission.
Jonathan G. Katz
Secretary
1 15 U.S.C. §77q.
2 15 U.S.C. §78j.
3 17 C.F.R. §240.10b-5.
4 15 U.S.C. §80a-33.
5 15 U.S.C. §80b-4.
6 17 C.F.R. §275.204-1.
7 15 U.S.C. §80b-7.
8 The law judge determined that he could not conclude that Latef aided and abetted Hudson Advisers' violations of Section 204 of the Advisers Act and Advisers Act Rule 204-1(b) because the Order Instituting Proceedings charged Latef with having caused "violations of Section 204 of the Investment Company Act and Rule 204-1(b) thereunder." The Division has not appealed this finding.
9 An entity called Hudson Investment Group ("Hudson Group") initially paid the costs and expenses associated with operating the Hudson Fund. Latef is president of the Hudson Group. In August 1996, Stockett began paying these costs and expenses. See infra note 12 and accompanying text.
10 Although Latef and Stockett executed four separate documents, their testimony and the terms of the documents make clear that the four documents were meant to be part of one agreement.
11 Neuropro Nevada was not connected with the Neuropro System licensed by The New Industrialist.
12 Stockett did not make these payments directly, but rather through companies that he owned or that owed him money. On September 12, 1996, Stockett, through the OTC Fund, wired $10,000 into Hudson Management's account. On October 10, 1996, Stockett withdrew $10,006.73 invested by the OTC Fund in the Hudson Fund and transferred the proceeds to Hudson Management "to pay the ongoing expenses of the management company." On November 8, and again on December 4, The New Industrialist wired $5,000 into Hudson Management's account. Latef testified that he believed Stockett arranged for The New Industrialist to make this payment because it owed Stockett money. On February 25, 1997 and again on March 21,1997, Hightec, Inc. (a company acquired by Stockett in November 1996) deposited $10,000 into the Hudson Management account. Stockett stopped making payments in or about April 1997, and Latef and Choudhry resumed paying expenses whenever there was a shortfall.
13 Form ADV, Question 10B provides:
Is the applicant financed by a person not named in Items 1A or Schedule A, B, or C other than by: (1) a public offering under the Securities Act of 1933; (2) credit given in the ordinary course of business by banks, suppliers or others; or (3) a satisfactory subordination agreement under Securities Exchange Act of 1934 Rule 15c3-1 (17 C.F.R. 240.15c3-1)?
If the answer to Question 10B is affirmative, the applicant is instructed to "state on Schedule E the exact name of each person and describe the arrangement thought which the financing is made available, including the amount." With respect to Question 10, Form ADV also requires the applicant to amend the form promptly for material changes and within 90 days of the end of the fiscal year for any other changes.
14 Stockett testified that he acquired Sinclare because The New Industrialist recently had been shut down, and he could obtain access to the Neuropro System through Sinclare.
15 Latef testified that, had he known of Stockett's affiliation with Hightec, he would have considered Stockett's opinionbiased and probably would not have bought Hightec stock.
16 Hightec bought Sinclare, and Stockett became Sinclare's president, on February 24, 1997. While this was almost two weeks after Latef made his last purchase of Sinclare stock for the Hudson Fund, Latef testified that he might not have purchased Sinclare stock had he known that Stockett was going to become its president in the near future.
17 Stockett testified that, while he did not specifically recommend that Latef purchase Sinclare stock for the Hudson Fund, Stockett's web site contained a recommendation to purchase Sinclare stock that was available to anyone who accessed the site.
18 The Winners Edition was distributed by Hightec, pursuant to an agreement between The New Industrialist and an entity called the Wealth International Network, LLC ("WIN"). WIN's stated purpose was "to inform its members to become more aware investors."
19 Stockett also solicited investments in Hightec through a Private Placement Memorandum which included a "relationship chart" indicating that the Hudson Fund had been managed by the IPO Network, a Hightec subsidiary, since August 7, 1996, the date of the agreements between the Hudson entities and Neuropro Nevada.
20 Stockett testified that he wanted Select Capital to purchase his Hudson options and to assume the payment of the Fund's expenses. Latef testified that he did not authorize Stockett to take any steps to alter the control or the management of any of the Hudson entities. Latef believed that Stockett made contact with Select Capital because Select Capital wanted to invest large amounts with the Fund. Stockett claims that he informed Latef of his intent to assign the options and that Latef consented to the assignment.
Choudhry stated that Stockett told Choudhry that Select Capital was interested in investing with the Hudson Fund and that, as part of this transaction, Select Capital might want the Fund to change its name. Choudhry could not recall whether Stockett informed him that the transaction also would involve a change in the ownership of the Fund.
21 Section 17(a) of the Securities Act, 15 U.S.C. §77q; Section 10(b) of the Exchange Act, 15 U.S.C. §78j; and Exchange Act Rule 10b-5, 17 C.F.R. §240.10b-5.
22 See supra note 13 (detailing the requirement in Form ADV that an applicant furnish the name of any person providing financing to the applicant and describe the arrangement through which the financing is being made available, including the amount of the financing).
23 In the alternative, Latef alleges that, by informing Choudhry of the facts concerning Stockett's options and expense payments, he informed the majority of the Fund's investors. Latef concedes, however, that he failed to disclose these facts to all of the Fund's shareholders and potential shareholders, as he was required to do in Form ADV, Form ADV-S, and the Fund's prospectus.
24 It is undisputed that Latef never disclosed Stockett's ownership of Sinclare; however, the record does not indicatewhether Latef ever knew of that ownership. Whether Latef was reckless in failing to discover this fact is addressed infra at notes 31-33 and accompanying text.
25 SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186 (1963).
26 Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988) (quoting TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)).
27 Latef, as an investment adviser, is a fiduciary who owes the Fund's investors a duty of utmost good faith to avoid misleading clients, including disclosing all material facts and conflicts of interest. Cf. SEC v. Capital Gains Research Bureau, Inc., 375 U.S. at 194, 201; L.W. Laird v. Integrated Resources, Inc., 897 F.2d 826, 833 (5th Cir. 1990). Indeed, an investment adviser is required to "expose all conflicts of interest which might incline an investment adviser, consciously or unconsciously, to render advice which is not disinterested." SEC v. Capital Gains Research Bureau, Inc., 375 U.S. at 191-92 (discussing congressional intent in enacting the Advisers Act).
28 For example, had this information been disclosed, a reasonable investor would have been more likely to question Latef's December 31, 1996 decision to purchase securities in ten companies listed in a chart prepared by Stockett entitled "Biggest Gainers From Offering to December 16, 1999." This chart appeared in an investment publication entitled New Issues Outlook.
29 See Aaron v. S.E.C., 446 U.S. 680, 695, 697 (1980); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976); Steadman v. S.E.C., 603 F.2d 1126, 1134 (5th Cir. 1979), aff'd, 450 U.S. 91 (1981). Scienter need not be found to support a violation of Sections 17(a)(2) and (a)(3) of the Securities Act or Section 34(b) of the Company Act. See, e.g., Aaron v. S.E.C., 446 U.S. at 696; S.E.C. v. Capital Gains Research Bureau, Inc., 375 U.S. at 196; Steadman, 603 F.2d at 1133.
30 Ernst & Ernst v. Hochfelder, 425 U.S. at 193.
31 See, e.g., Hackbart v. Holmes, 675 F.2d 1114, 1117 (10th Cir. 1982). The Tenth Circuit defined recklessness as:
"an extreme departure from the standards of ordinary care, [] which presents a danger of misleading buyers or sellers that is either known or is so obvious that the actor must have been aware of it."
Id. at 1118 (quoting Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1045 (7th Cir.), cert. denied, 434 U.S. 875 (1977)). See also Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 135 F.3d 266, 272-73 (3d Cir. 1998) ("recovery on a federal securities fraud claim requires a showing of scienter: a deliberate or reckless misrepresentation of a material fact").
32 Even if Latef was unaware of Stockett's relationship with Hightec and Sinclare at the time he purchased stock in those companies for the Hudson Fund, Latef was under an obligation to disclose to investors the material information concerning Stockett's affiliation with the companies once he learned of it. Latef testified that he learned of Stockett's affiliation with Hightec about one week after he bought Hightec stock for the Fund, but never disclosed this fact to the Fund's investors. Although it is unclear from the record when Latef learned of Stockett's involvement with Sinclare, Latef also failed to disclose this fact to the Fund investors.
33 In addition, one Hudson Fund investor inquired as to whether Stockett was making investment decisions for the Fund. While the Hudson Respondents informed the inquiring investor that Stockett had no role in the Fund's investment decisions, the fact that Latef received such an inquiry is further evidence that he was aware that Stockett's relationship to the Fund was a material piece of informationthat the Hudson Respondents were obligated to disclose.
34 15 U.S.C. §80a-33.
35 The law judge determined that he was unable to conclude that Latef aided and abetted Hudson Advisers' violation of Section 204 of the Advisers Act and Rule 204-1(b) thereunder. See supra note 8. The Division has not appealed this finding.
36 Section 207 prohibits the making of an untrue statement of material fact in any registration application or report filed with the Commission under Section 203 or 204, or willfully omitting to state in any such application or report any material fact required to be stated therein.
37 See Donald T. Sheldon, 51 S.E.C. 59, 66 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995).
38 In light of this conclusion, we do not discuss whether Stockett provided substantial assistance to the fraud.
39 These facts also lead us to conclude that the record before us does not establish that Stockett knew or should have known that he was contributing to the Hudson Respondents' violations and, therefore, we find that he was not a cause of the Hudson Respondents' violations. See 15 U.S.C. §78u-3(a) (authorizing the Commission to enter a cease-and-desist order against any person that "is, was, or would be a cause of the violation due to an act or omission the person knew or should have known would contribute to such a violation.")
40 We are troubled, however, by a number of Stockett's actions that indicate he may have exercised control over Hudson Advisers. It seems likely that Latef would have been strongly influenced by the opinions of the person who was providing the financing that was keeping the Hudson Fund afloat. In addition, circumstantial evidence indicates that Stockett provided the Winner's Edition magazine with the erroneous information that the Hudson Fund employed the Neuropro System on a test basis for a portion of its portfolio and provided WIN members with erroneous information as to his role managing the fund. Moreover, Stockett represented to numerous potential investors that he had an ownership interest in the Hudson Fund and had responsibility for directing the Fund's investment decisions. The law judge determined, however, that Stockett did not control the Hudson Fund. The Division has not appealed this finding and, therefore, we are unable to make a determination as to whether Stockett controlled the HudsonFund and whether this may have led to Stockett's primary liability for the disclosure violations committed in this case.
41 Butz v. Glover Livestock Comm'n Co., Inc., 411 U.S. 182, 185 (1973) (quoting American Power Co. v. SEC, 329 U.S. 90, 112 (1946)).
42Donald T. Sheldon, 51 S.E.C. at 86.
43 By imposing a collateral bar on Stockett, the law judge barred him from associating with any broker, dealer,municipal securities dealer, investment adviser, and investment company. The law judge imposed a collateral bar because he found it contrary to the public interest to allow Stockett to serve in any capacity in the securities industry. The decision by the U.S. Court of Appeals for the District of Columbia Circuit in Teicher v. SEC, 177 F.3d 1016 (D.C. Cir. 1999), held that the Commission lacks the authority to impose a collateral bar. Accordingly, the Division has withdrawn its request for a collateral bar and requests instead a bar from association with an investment adviser or investment company.
44 The Division maintains that Latef has not challenged the law judge's imposition of a cease-and-desist order. While Latef's brief does not address the cease-and-desist order directly, we consider his request that "the sanctions imposed on [him] be vacated" to include a challenge to the cease-and-desist order.
45 See KPMG Peat Marwick, LLP, Exchange Act Rel. No. 43862 (Jan. 19, 2001), 74 SEC Docket 384, 421, motion for reconsideration denied, Exchange Act Rel. No. 44050 (Mar. 8, 2001), 74 SEC Docket 1351, petition denied, 289 F.3d 109 (D.C. Cir. 2002).
46 We have considered all of the parties' contentions. We have rejected or sustained these contentions to the extent that they are inconsistent or in accord with the views expressed herein.
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Modified: 03/21/2003