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Municipal Bond Participants: Sales Practices Injunctive Proceedings Securities and Exchange Commission v. First California Capital Markets Group, Inc., H. Michael Richardson and Derrick Dumont , Civ. No. 97-2761-SI (N.D. Cal.), Litigation Release No. 15423 (July 28, 1997) (complaint); Litigation Release No. 16107 (April 7, 1999) (settled final orders). See "The Underwriter" section. To Contents    SEC v. J.B. Hanauer & Co., Civ. Action No. 82-407 (D. N.J.), Litigation Release No. 9582 (February 11, 1982) (settled final order). The Commission announced today that the United State District Court for the District of New Jersey permanently enjoined J. B. Hanauer & Co. ("Hanauer") from violating the antifraud, recordkeeping and certain other provisions of the Securities Exchange Act of 1934, the anti-fraud provisions of the Securities Act of 1933, Rules of the Municipal Securities Rulemaking Board concerning customer account information, delivery of confirmations, and supervision of employees and the filing and recordkeeping requirements of the Currency and Foreign Transactions Reporting Act and regulations thereunder. J.B. Hanauer & Co. is a municipal bond dealer with headquarters in Livingston, New Jersey. Hanauer consented to the entry of the Final Judgment of Permanent Injunction without admitting or denying the allegations in the Commission's Complaint, which was also filed today. n1 The Commission's Complaint alleges that Hanauer engaged in a course of conduct in which it encouraged its salesmen to solicit business of persons who, for income tax avoidance or other reasons, sought anonymity and paid for bond purchases with currency. As a part of this course of conduct and to accommodate these persons by concealing their identity, according to the Complaint, Hanauer opened and maintained accounts in fictitious names and addresses, made false entries in its books and records, failed to deliver customer confirmations of securities transactions and failed to file Currency Transaction Reports with the Internal Revenue Service which it was required to file upon the receipt of currency in excess of $10,000. The Complaint further alleges that Hanauer, through certain of its officers and employees, overcharged or permitted customers to be overcharged and made or caused false statements to be made to such customers concerning the prices charged for such purchases. In connection therewith, such persons overstated the offering prices for municipal securities and failed to deliver customer confirmations indicating the purchase price or delivered confirmations which they prepared indicating a higher purchase price, received the greater amount in currency from the customer and remitted the actual amount owed to the firm, diverting the excess to their own use. The Complaint also alleges that one Hanauer employee made or caused false statements to be made to a customer concerning the prices of certain municipal securities in order to conceal a market loss from this customer. Footnotes -[n1]-The Commission today also issued an order instituting proceedings, making findings and imposing remedial sanctions in administrative proceedings against Hanauer and eighteen past and present associated persons. See Securities Exchange Act of 1934 Release No. / February 11, 1982. To Contents    SEC v. Shelby Bond Service Corporation, et al. Civ. Action No. C-77-2236 (W.D. Tenn.), Litigation Release No. 7888 (April 27, 1977) (complaint); Litigation Release No. 7965 (June 9, 1977) (settled final orders); Litigation Release No. 8578 (October 27, 1978) (settled final order). See "The Underwriter" section. To Contents    SEC v. Bertsil L. Smith and Robert W. Bradford and Jon R. Walls , Civ. Action No. C-76-497 (W.D. Tenn.), Litigation Release No. 7652 (November 16, 1976) (complaint). Jule B. Greene, Administrator of the Atlanta Regional Office of the Securities and Exchange Commission, today announced that on November 5, 1976 the Honorable Bailey Brown, Chief Judge of the United States District Court for the Western District of Tennessee at Memphis, after a hearing on motions filed by the Commission, entered an Order of Preliminary Injunction and an Order Barring Disposal of Assets against Bertsil L. Smith ("Smith"), individually and d/b/a Smith-Walls, Inc. ("Smith-Walls") and Jon R. Walls ("Walls"), all of Memphis. The defendants were preliminarily enjoined from further violations of the antifraud provisions of the federal securities laws. The complaint on which the Commission's motions were based alleged that Smith and Robert W. Bradford ("Bradford"), a co-defendant, aided and abetted by Walls, defrauded a Georgia investor by inducing him to sell municipal bonds and then converting the proceeds to their personal use. Smith induced the investor to sell his bonds on the misrepresentations that they were in imminent danger of default and that the investor would be paid within one week of delivery of the bonds. Bradford picked up the investor's bonds and returned to Memphis. Smith contracted Walls, who was then employed as a salesman with a Memphis municipal securities firm, and offered them to Walls at a price substantially less than Walls knew the bonds could be sold for. Walls told Smith that his employer had forbidden any employees from effecting securities transactions with Smith. Walls then arranged for Smith to sell the bonds to one of Walls' customers and for Walls to purchase them from the customer, thereby hiding Smith's identity as the true seller of the bonds. In addition to receiving a commission on the transaction, Walls was paid additional monies by Smith. The investor never received any proceeds from the sale of his bonds. To Contents    SEC v. Bertsil L. Smith and Robert W. Bradford and Jon R. Walls, Litigation Release No. 7764 (January 31, 1977) (defaults entered). Jule B. Greene, Administrator of the Atlanta Regional Office of the Securities and Exchange Commission, announced that on January 21, 1977, Honorable Bailey Brown, Chief Judge of the United States District Court for the Western District of Tennessee, at Memphis, entered default judgments permanently enjoining Bertsil L. Smith and Robert W. Bradford, both of Memphis, individually and doing business as Smith-Walls, Inc., from violations of the anti-fraud provisions of the Securities Exchange Act of 1934 in the purchase or sale of any security, including but not limited to municipal securities. Smith and Bradford were further ordered to disgorge proceeds from the sale of securities fraudulently obtained from customers to the registry of the Court. (For further information see Litigation Release Nos. 7615 and 7652). To Contents    SEC v. C. Norman Driscoll, et al., Civ. Action No. 76-1520 (D. N.J.), Litigation Release No. 7515 (August 6, 1976) (settled final orders). William D. Moran, Administrator of the New York Regional Office of the Securities and Exchange Commission, announced that on August 3, 1976, a Complaint was filed in the U.S. District Court for the District of New Jersey seeking to enjoin C. Norman Driscoll ("Driscoll'), Lyle Hatch ("Hatch"), Stephen Skubina ("Skubina"), and Richard L. Tecott ("Tecott") from engaging in further violations of the reporting and anti-fraud provisions of the federal securities laws. The Commission's Complaint alleges that between August 1973 and September 1974, Driscoll, Hatch, and Skubina, while employed by Fidelity Union Trust Co. ("Fidelity Bank"), a wholly-owned subsidiary of Fidelity Union Bancorporation ("Holding Company"), along with Tecott, a partner in a now defunct municipal securities dealer, engaged in a series of pre-arranged purchases and sales of municipal securities, at prices unrelated to their fair market value, which were designed to cover up losses sustained in Fidelity Bank's municipal securities portfolio. Following the discovery of these prearranged transactions, an analysis was conducted to determine the impact of this wrongful conduct on the financial condition of Fidelity Bank. This analysis disclosed that Fidelity Bank had sustained a realized loss of $2,003,921.85 and an unrealized loss of $1,305,795.81. The Complaint further alleges that Driscoll, Hatch, Skubina, and Tecott hid the true nature of their transactions, and the actual losses sustained as a result thereof, from the senior management of Fidelity Bank and the Holding Company. Accordingly, the books and records of Fidelity Bank failed to accurately state Fidelity Bank's financial condition, and accordingly, caused the Holding Company to file a false and misleading Form 10-Q for the six month period ending June 30, 1974. Skubina and Tecott consented, without admitting or denying the allegations contained in the Commission's Complaint, to the entry of Final Judgments of Permanent Injunction, prohibiting further violations of Sections 10(b) and 13(a) of the Exchange Act and Rules 10b-5 and 13a-13 thereunder. To Contents    SEC v. C. Norman Driscoll, et al., Litigation Release No. 7588 (September 28, 1976) (settled final order). William D. Moran, Administrator of the New York Regional Office, announced that on August 27, 1976, the Honorable Vincent P. Biunno, United States District Judge for the District of New Jersey, signed a Final Judgement of Permanent Injunction by Consent of Lyle Hatch enjoining Lyle Hatch ("Hatch") of Emerson, New Jersey, from engaging in further violations of the reporting and anti-fraud provisions of the federal securities laws. The Commission, in its complaint filed on August 3, 1976, alleged that between August 1973 and September 1974, Hatch, while employed by Fidelity Union Trust Co. ("Fidelity Bank"), a wholly-owned subsidiary of Fidelity Union Bancorporation ("Holding Company"), along with two other employees of Fidelity Bank and a partner in a now defunct municipal securities dealer, who were also named in the complaint, engaged in a series of prearranged purchases and sales of municipal securities, at prices unrelated to their fair market value, which were designed to cover up losses sustained in Fidelity Bank's municipal securities portfolio. Following the discovery of these prearranged transactions, an analysis was conducted to determine the impact of this wrongful conduct on the financial condition of Fidelity Bank. This analysis disclosed that Fidelity Bank had sustained a realized loss of $2,003,921.85 and an unrealized loss of $1,305,795.81. The Complaint further alleged that Hatch, and the other three defendants, concealed the true nature of their transactions, and the actual losses suffered as a result thereof, from the senior management of Fidelity Bank and the Holding Company. As a result, the books and records of Fidelity Bank failed to accurately state Fidelity Bank's financial condition, and, accordingly, caused the Holding Company to file a false and misleading Form 10-Q for the six month period ending June 30, 1974. Hatch consented to the entry of the injunction without admitting or denying the allegations contained in the Commission's complaint. For further information, see Litigation Release No. 7515. To Contents    SEC v. C. Norman Driscoll, et al., Litigation Release No. 7612 (October 20, 1976) (settled final order). William D. Moran, Administrator of the New York Regional Office, announced that on September 23, 1976, the Honorable Vincent P. Biunno, United States District Judge for the District of New Jersey, signed a Final Judgment of Permanent Injunction by Consent of C. Norman Driscoll enjoining C. Norman Driscoll ("Driscoll") of Chatham, New Jersey, from engaging in further violations of the reporting and antifraud provisions of the federal securities laws. The Commission, in its complaint filed on August 3, 1976, alleged that between August 1973 and September 1974, Driscoll, while employed by Fidelity Union Trust Co. ("Fidelity Bank"), a wholly-owned subsidiary of Fidelity Union Bancorporation ("Holding Company"), along with two other employees of Fidelity Bank and a partner in a now defunct municipal securities dealer, who were also named in the complaint, engaged in a series of prearranged purchases and sales of municipal securities, at prices unrelated to their fair market value, which were designed to cover up losses sustained in Fidelity Bank's municipal securities portfolio. Following the discovery of these prearranged transactions, an analysis was conducted to determine the impact of this wrongful conduct on the financial condition of Fidelity Bank. This analysis disclosed that Fidelity Bank had sustained a realized loss of $2,003,921.85 and an unrealized loss of $1,305,795.81. The complaint further alleged that Driscoll, and the other three defendants, concealed the true nature of their transactions, and the actual losses suffered as a result thereof, from the senior management of Fidelity Bank and the Holding Company. As a result, the books and records of Fidelity Bank failed to accurately state Fidelity Bank's financial condition, and, accordingly, caused the Holding Company to file a false and misleading Form 10-Q for the six month period ending June 30, 1974. Driscoll consented to the entry of the injunction without admitting or denying the allegations contained in the Commission's complaint. For further information, see Litigation Release No. 7515. To Contents    SEC v. Irvin D. Kaplan Civ. Action No. ___ (S.D. Tex.), Litigation Release No. 7051 (August 22, 1975) (settled final order). Richard M. Hewitt, Administrator of the Fort Worth Regional Office of the Securities and Exchange Commission, announced that on August 19, 1975 Federal District Judge Allen B. Hannay at Houston, Texas entered an order of permanent injunction enjoining Irvin. D. Kaplan, Houston, from further violations of the antifraud provisions of the Securities Exchange Act of 1934 in the purchase and sale of various bonds. Kaplan consented to the entry of the order without admitting or denying the allegations in the Commission's complaint. The Commission's complaint was filed contemporaneously with the entry of the order of permanent injunction. The Commission's complaint alleges that during the period from November 1974 to April 10, 1975 Kaplan engaged in a securities trading and check manipulation scheme wherein he sold corporate, government and municipal bonds valued at $93,000,000 and purchased bonds worth approximately $111,000,000, through ten brokerage firms and one bank bond department. The complaint further alleges Kaplan made payment for the purchases with checks drawn on accounts at five banks when the accounts had insufficient funds to cover the checks. During the second week of April 1975 Kaplan, according to the complaint, issued checks in payment for the purchase of securities which were dishonored and returned by the banks. The losses from the sales of securities and from the returned checks given in payment for the securities were more than $2.7 million. In connection with the securities purchases, the complaint charges that Kaplan made misrepresentation of material facts concerning his true financial condition and the sources and availability of funds used to purchase securities. To Contents    SEC v. R.J. Allen & Associates, Inc., et al., Civ. Action No. 74-1273-Civ-CF (S.D. Fla.), 386 F. Supp. 866 (S.D. Fla. 1974). See Federal Reporter. To Contents    SEC v. R.J. Allen & Associates, Inc., et al., Litigation Release No. 6653 (December 7, 1974) (settled final orders). Jule B. Greene, Administrator, and Michael J. Stewart, Associate Administrator of the Atlanta Regional Office of the Securities and Exchange Commission, announced today that on November 27, 1974, the Honorable Charles B. Fulton, Chief Judge for the Southern District of Florida, issued a Memorandum Opinion permanently enjoining R.J. Allen & Associates, Inc., Robert J. Allen, Howard W. Alexander, Charles J. Diaz, and Thomas A. Preston, all of Ft. Lauderdale, Florida, from further violations of the anti-fraud provisions of the Securities Act of 1933 [Section 17(a)] and the Securities Exchange Act of 1934 [Section 10(b) and Rule 10b-5 thereunder]. Chief Judge Fulton's Opinion, which was entered following an extensive hearing on the merits of the Commission's Complaint, was twenty-five pages in length. Labeling the defendants' operation "a horrible fraud," "vicious and brutal," and "a diabolical scheme," Chief Judge Fulton, equating the Commission's request for disgorgement with restitution, ordered the defendants to disgorge to the Court-appointed Receiver the full amount received from all investors who purchased Industrial Development Revenue Bonds ("IDR's") from the firm of R.J. Allen & Associates, Inc. ("R. J. Allen"). The total to be disgorged, which is not definitely known at this time, is to be restored in the following fashion: R. J. Allen plus the individual defendants Robert J. Allen and Howard W. Alexander must jointly and severally restore to the Receiver "the full amount received from all of those investors who purchased IDR's," while Charles J. Diaz ("Diaz"), Executive Vice President of the firm, and Thomas A. Preston ("Preston"), a salesman, must return the aggregate sum received by each as a result of such sales. In order to determine exactly how much money must be disgorged, the Court's Opinion continues the appointment of David Hughes as Receiver for the corporation and directs him to prepare an accounting showing the sums received by the defendants as a result of the bond sales; it also directs Diaz and Preston to account to the Receiver for all monies or property received by them directly or indirectly from such sales. The Court also directed Receiver Hughes to ascertain the names and addresses of all IDR purchasers from R. J. Allen and to then circularize those purchasers and allow them to file verified claims with him. Any correspondence in this matter should be directed to Mr. Hughes at P.O. Box 397, Airport Branch, Miami, Florida 33148. Concluding that it would be appropriate and necessary to prevent waste and dissipation of any assets available for restitution and disgorgement, the Court responded affirmatively to the Commission's motion for a temporary trust over the assets of all the defendants. The Order prohibits each and every defendant from directly or indirectly "dissipating, concealing, or disposing of in any manner, any assets, choses in action, or other property . . ." until further Order of the Court. On the same day that the Memorandum Opinion was entered, the Court issued an Order denying various motions by the defendants for modification and/or to vacate previous orders of the Court. (For further information see Litigation Release 6575). To Contents    SEC v. Investors Associates of America, et al., Civ. Action No. (W.D. Tenn.), Litigation Release No. 6164 (December 4, 1973) (settled final orders). The Securities and Exchange Commission today announced the entry of orders of permanent injunction in the United States District Court for the Western District of Tennessee against Investors Associates of America, Inc., (Investors), a Memphis, Tennessee municipal bond dealer (formerly known as Hamilton Securities, Inc., Liberty National Securities, Inc. and Harper Investment Company); Investors Associates of America, an Arizona partnership; Investors Associates of Mississippi, Inc.; Clarence H. Hamilton, Jerry R. Hamilton and Bill H. Harper, officers, directors and partners of Investors and its Affiliates; and Edward J. Blumenfeld, a former sales and branch office manager for Investors, from engaging in further violations of certain anti-fraud provisions of the federal securities laws, Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder, in connection with transactions in municipal bonds by, among other things, the employment of "boiler room" sales techniques, fraudulent interpositioning in securities transactions, and excessive mark-ups. The defendant Blumenfeld, in his consent to a permanent injunction, agreed to disgorge the sum of $2,500 representing the gross profit realized by Investors' Arizona Office on specific transactions alleged in the Commission's complaint to be improper and illegal. Investors Associates of America, Inc., an Arizona partnership, Investors Associates of Mississippi, Inc., Clarence H. Hamilton, Jerry R. Hamilton, and Bill H. Harper, in their consents to permanent injunctions, agreed to disgorge under certain conditions the sum of $196,715.58 representing the gross profit realized by these defendants on specific transactions alleged in the Commission's complaint to be improper and illegal, and further agreed (1) that the judgment of permanent injunction providing for disgorgment of profits would survive any decree of bankruptcy against the defendants and (2) that the judgment of permanent injunction would not preclude any individual investors from filing or prosecuting any claim against the defendants. To Contents    SEC v. Jackson Municipals Inc., et al., Civ. Action No. ___ (W.D. Tenn.), Litigation Release No. 5763 (February 28, 1973) (settled final orders). The Securities and Exchange Commission today announced the entry of an order of permanent injunction in the United States District Court for the Western District of Tennessee against Jackson Municipals, Inc. (Jackson) a municipal bond dealer located in Jackson, Mississippi, and Cecil Lamberson, an officer and director of Jackson from engaging in further violations of certain anti-fraud provisions of the federal securities laws, Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, in connection with transactions in municipal bonds. Also announced was the entry of orders of preliminary injunction by the same court against Investors Associates of America, Inc. (Investors), a Memphis, Tennessee municipal bond dealer (formerly known as Hamilton Securities, Inc., Liberty National Securities, Inc. and Harper Investment Company); Investors Associates of America, an Arizona partnership; Investors Associates of Mississippi, Inc.; Clarence H. Hamilton, Jerry R. Hamilton and Bill H. Harper, officers, directors and partners of Investors and its affiliates; and Edward J. Blumenfeld, a former sales and branch office manager for Investors from engaging in further violations of certain anti-fraud provisions of the federal securities laws, Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, in connection with transactions in municipal bonds. By their consents to permanent (Jackson and Lamberson) and preliminary (all others) injunctions, each defendant, without admitting or denying the allegations of the Commission's complaint, agreed to injunctions against, among other things, the employment of "boiler room" sales techniques, fraudulent interpositioning of persons in securities transactions, and excessive mark-ups by: (a) employing any device, scheme or artifice to defraud, or (b) engaging in any transactions, practices or course of business which operates or would operate as fraud or deceit upon any person, by, among other things: paying and charging such persons prices not reasonably related to the current prevailing market price for such securities; sending confirmations of sale to customers who have not agreed to purchase securities; causing customers to "trade in," purchase, and sell securities without regard to the character of the security sold and the investment objectives of the customer; employing high pressure sales tactics which require hasty investment decisions by investors; interpositioning any other securities dealer or person between itself and the best market in the security, therefore increasing the price of the security as sold to the ultimate purchaser; receiving as a kickback from any person, monies previously paid to that person as part of an interpositioning arrangement employed to defraud others; maintaining and keeping inaccurate and incomplete books and records which, among other things, reflect transactions in securities involving fictitious prices and secret rebates in a manner aimed at concealing the true nature of such transactions; or other acts and practices of similar purport and object; or (c) obtaining money or property by means of untrue statements of material facts or omitting to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, concerning among other things: the current market price of the securities offered; the purchase or sale price of the securities offered; the financial condition of the issuer of the securities offered; the available supply of the securities offered for sale at bargain prices; the source from which the securities were obtained which are being offered for sale at bargain prices; the investment rating and quality of the securities being offered; the amount of securities required to be purchased in order to obtain a bargain or discount price; the prospects of an increase of decrease in the market price or value of the securities offered; the speculative nature of the securities offered; the likelihood of default on payment of interest or principal of bonds offered; the "call" features of the bonds being offered; the cost of acquisition by the dealer of such securities; the repurchase by a dealer of such securities from the customer and the price to the customer to which such repurchase would occur; prospective aid or assistance to be received by the issuer of the securities being offered; the potential income or gain realizable from such securities; the tax treatment to owners of such securities; the date of maturity of bonds; the rate of interest of bonds; the capacity in which the dealer is acting toward the investor; the current market price of securities being purchased from customers; the suitability of a security to the investor's needs in light of his financial condition and investment objectives; the interpositioning any other securities dealer or person between itself and the best market in the securities therefore increasing the price of the security as sold to the ultimate purchaser; the receiving as a kickback from any firm, monies previously paid to that firm as reflected by false confirmations which were employed as a device to defraud others; the maintaining and keeping inaccurate and incomplete books and records which, among other things, reflect transactions in securities involving fictitious prices and secret rebates in a manner aimed at concealing the true nature of such transactions; or other statements of similar object and purport. (Section 17(a) of the Securities Act, 15 U.S.C. 77a(a); and Section 10(B) of the Exchange Act, 15 U.S.C. 78j(b), and Rule 10b-5 thereunder, 17 CFR 240.10b-5.) In addition, the defendant Jackson, in its consent to a permanent injunction, agreed to pay to the court the sum of $6,275 with interest thereon, representing the gross profit realized by the firm on the specific transactions alleged in the Commission's complaint to be improper and illegal. To Contents    SEC v. Charles A. Morris & Associates, Inc., et al. , Civ. Action No. ___ (W.D. Tenn.), Litigation Release No. 5584 (October 26, 1972) (complaint). The Securities and Exchange Commission today announced the filing of a complaint in the United States District Court for the Western District of TennesSee king a preliminary and a permanent injunction against Charles A. Morris & Associates, Inc. formerly known as Morris-Darley and Associates, Inc. and Tax Free Bonds, Inc. ("Tax Free"), Charles A. Morris ("Charles Morris"), Michael Patrick McTighe ("McTighe"), Claude Dean Dillard ("Dillard"), Edward Disbrow Morris ("E. Morris"), Ray Thomas Bauman, Charles T. Chicorelli, Jim Walker Cunningham, Jr., Ted L. Cutshaw, Ronald Lee Epperson, John William Ferrell, Gary Crizer Hottum, Steven Adams Lancaster, Roy G. Lovelace, Robert J. Phillips, Malcolm E. Ratliff, Roger Charles Russell, Donald Bryan Smith, and Roy Langston White from engaging in further violations of certain of the anti-fraud provisions of the federal securities laws (Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder) in connection with transactions in certain securities commonly referred to as municipal bonds. In its complaint the Commission alleges that Tax Free is a securities dealer in Memphis, Tennessee, specializing in municipal bonds and is not registered with the Commission as a broker-dealer; that defendants Charles Morris, McTighe, E. Morris, and Dillard, were all officers of Tax Free; and the remaining fourteen defendants were all employed as securities salesmen for Tax Free. It is further alleged that the defendants employed "boiler room" sales techniques and, among other things, conducted high pressure sales campaigns through the concentrated use of long distance telephone calls to individuals whose names were obtained from various sources such as telephone books; employed salesmen with little or no experience or training; mailed confirmations of sales to customers who had not agreed to purchase securities; and pressed potential customers to make quick investment decisions based on misrepresentations and omissions of material facts concerning, among other things: (a) the current market price of the securities offered, (b) the financial condition of the issuer of the securities offered, (c) the source and available supply of such securities, (d) the speculative nature of such securities, (e) the likelihood of default on payment of interest and principal of bonds offered, and (f) the availability of securities at "bargain" prices. It is also alleged that Tax Free as part of the violative conduct failed to keep accurate and timely records of its transactions and transactions for its customers. The complaint further alleges that the defendants have been buying from and selling to customers, bonds at prices not reasonably related to the current market price for such securities and in connection with transactions in three specific issues of securities, the mark-ups charged by Tax Free averaged approximately 35%, 45% and 75%, respectively, over the current prevailing market prices for such securities. To Contents    SEC v. Charles A. Morris & Associates, Inc., et al. , Litigation Release No. 5728 (February 7, 1973) (orders of preliminary injunction). The Securities and Exchange Commission today announced the entry of an order of preliminary injunction in the United States District Court for the Western District of Tennessee against Charles A. Morris & Associates, Inc. formerly known as Morris-Darley and Associates, Inc. and Tax Free Bonds, Inc. ("Tax Free"), Charles A. Morris ("Charles Morris"), Michael Patrick McTighe ("McTighe"), Claude Dean Dillard ("Dillard"), Edward Disbrow Morris ("E. Morris"), Ray Thomas Bauman, Charles T. Chicorelli, Jim Walker Cunningham, Jr., Ronald Lee Epperson, John William Ferrell, Steven Adams Lancaster, Roy G. Lovelace, Malcolm E. Ratliff, Donald Bryan Smith, and Roy Langston White enjoining them from engaging in further violations of certain of the anti-fraud provisions of the federal securities laws (Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder) in connection with transactions in certain securities commonly referred to as municipal bonds. Earlier, the defendants Ted L. Cutshaw, Roger Charles Russell and Gary Crizer Hottum had consented to similar injunctions. After a five day hearing on the Commission's motion for preliminary injunction, the Court in its opinion found that Tax Free was a securities dealer in Memphis, Tennessee, specializing in municipal bonds; that defendants Charles Morris, McTighe, E. Morris, and Dillard, were all officers of Tax Free; and the remaining fourteen defendants were all employed as securities salesmen for Tax Free. The Court further found that the defendants employed "boiler room" sales techniques and, among other things, conducted high pressure sales campaigns through the concentrated use of long distance telephone calls to individuals; employed salesmen with little or no experience or training; and pressed potential customers to make quick investment decisions based on misrepresentations and omissions of material facts concerning, among other things, the following: that certain bonds were being offered by persons needing to sell the bonds to establish a tax loss or raise money to pay taxes when, in fact, such was not the case; that there was available only a limited supply of bonds sought to be sold when, in fact, the supply was abundant; that certain bonds were general obligation bonds when, in fact, they were revenue bonds; that the payment of interest and principal of certain bonds was guaranteed by the state and federal governments when, in fact, payment was not so guaranteed, that certain securities were presently rated "BBB" by Standard and Poor's Corporation when, in fact, the rating had been withdrawn; that the financial condition of certain issuers was good when, in fact, the issuers were experiencing severe financial difficulties; that a purchase of bonds offered would be a safe investment when, in fact, the investment was highly speculative; that certain bonds were revenue bonds; that certain bonds had been given a very low "B" rating by Standard and Poor's; that a purchase of certain bonds was a speculative investment; that Tax Free was selling to the customer securities for its own account rather than acting as an agent for the customer; that the bonds matured at a date in the distant future; and that the issuers of certain bonds were experiencing severe financial difficulties adversely affecting the likelihood of their continued payment of interest and principal. The Court found that Tax Free maintained few of the records traditionally maintained by securities broker-dealers and that certain of the records that it did maintain were grossly inaccurate. Finally, the Court found that the defendants have been selling to customers bonds at prices not reasonably related to the current market price for such securities and in connection with transactions in three specific issues of securities, the majority of markups charged ranged between 25% and 100% over Tax Free's contemporaneous cost. To Contents    SEC v. Charles A. Morris & Associates, Inc., et al. , Litigation Release No. 6264 (February 28, 1974) (settled final orders and defaults entered). The Securities and Exchange Commission announced the entry of orders of permanent injunction in the United States District Court for the Western District of Tennessee against Charles A. Morris & Associates, Inc., formerly known as Morris-Darley and Associates, Inc. and Tax Free Bonds, Inc., Charles A. Morris, Michael Patrick McTighe, Claude Dean Dillard, Edward Disbrow Morris, Ray Thomas Bauman, Charles T. Chicorelli, Jim Walker Cunningham, Jr., Ted L. Cutshaw, Ronald Lee Epperson, John William Ferrell, Steven Adams Lancaster, Roy G. Lovelace, Malcolm E. Ratliff, Donald Bryan Smith, and Roy Langston White from engaging in further violations of certain of the anti-fraud provisions of the federal securities laws (Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder) in connection with transactions in certain securities commonly referred to as municipal bonds. Each of the above defendants, with the exception of Smith and Ferrell, without admitting or denying the allegations of the Commission's complaint consented to the entry of an injunctive decree which enjoined them from, among other things, employing "boiler room" sales techniques and selling bonds at prices not reasonably related to the current market price for such securities. The Court issued similar decrees with respect to defendants Smith and Ferrell by default. In addition, pursuant to the Commission's prayer for disgorgement in its complaint, the Court ordered certain defendants to pay into the Court funds which they had received as a result of their alleged unlawful conduct. A trustee has been appointed to administer the disgorged funds. To Contents    Administrative Proceedings - Commission Decisions In re Donald T. Sheldon, et al., Exchange Act Release No. 31475, A.P. File No. 3-6626 (November 18, 1992). TEXT: OPINION OF THE COMMISSION Initial Decision. Donald T. Sheldon, Bruce W. Reid, and Gregory L. Pattison appeal from the decision of an administrative law judge. The law judge found that Sheldon aided and abetted violations of the Commission's net capital, hypothecation, and customer protection rules and violated, or aided and abetted violations of, the Municipal Securities Rulemaking Board's ("MSRB") advertising rule. The law judge further found that Sheldon and Reid violated, or aided and abetted violations of, the antifraud provisions of the securities laws and failed reasonably to supervise, as well as violated, or aided and abetted violations of, the MSRB fair dealing, markup, and supervisory rules and, in the case of Reid, the MSRB suitability rule. He further found that Pattison violated the antifraud provisions of the securities laws and the MSRB fair dealing rule. The law judge barred both Sheldon and Reid from association with any broker, dealer, or municipal securities dealer, although he permitted Reid to apply after two years to become associated in a non-supervisory and non-proprietary capacity upon a satisfactory showing of adequate supervision. Pattison was suspended from association with any broker, dealer, or municipal securities dealer for 45 days. The Division of Enforcement appeals the sanction imposed on Reid, asking that an unqualified bar be imposed against him. Our findings are based on an independent review of the record, except to the extent that respondents do not challenge particular findings of fact on review. n1 Where such reconstruction was not possible, we have in certain instances assumed the fact or facts that the exhibits were intended to establish, as discussed more specifically below. In other instances, we have declined to rely on Division exhibits because corresponding respondents' exhibits are missing. For example, the Division introduced redacted versions of certain investigatory transcripts, including Exhibits 237, 239, 240, 242, and 248. In lieu of making cross-designations of these transcripts, Sheldon successfully moved that the transcripts be admitted in their entirety. These transcripts, including Sheldon Exhibits J, K, W, O, V and Q, were transmitted by the Division to the law judge (the letter, dated March 29, 1988, from the Division to the law judge transmitting these exhibits, is hereby admitted as an addition to the record), and the law judge retained them until he rendered his decision. They are now missing. Sheldon did not rely below, and does not rely on appeal, on particular portions of these transcripts. However, we have also excluded the Division's redacted transcripts from our consideration of this matter. II. Introduction Donald Sheldon was president of Donald Sheldon & Co., Inc. ("DSC"), formerly a registered broker-dealer engaged in the sale of municipal securities and a member of the Securities Investor Protection Corporation ("SIPC"), and Donald Sheldon Government Securities, Inc. ("GSI" and, collectively with DSC, the "Firms"), formerly an unregistered dealer in United States government-backed securities. Reid, a registered principal of DSC, was branch manager of the Firms' Houston office, and Pattison was a registered representative in that office. n2 The Firms were wholly-owned subsidiaries of Donald Sheldon Group Inc. ("Group"), of which Sheldon was also president. In addition to DSC and GSI, Group owned other ventures, including an investment advisern3 and Data Station Systems, Inc. ("Systems"), which was organized in the early 1980s and developed and marketed computer applications. Increasingly during the last year of their existence, Sheldon ignored the operations of the Firms and the numerous indications that violations were occurring under his supervision. He was largely concerned with the pursuit of new business ventures (particularly with respect to Systems) which proved to be a significant drain on the financial and management resources of the Firms. Faced with a shortage of cash, the Firms misused customers' securities. Ultimately, the financial drain on Sheldon's enterprises produced a net capital deficiency at DSC. Sheldon aided and abetted these violations. n4 The Firms maintained joint offices in Houston, New York, Los Angeles, and Pompano Beach and Miami Beach, Florida.n5 Sheldon staffed his far-flung operations with inexperienced salesmen, and, because the Firms did not pay well, the turnover among those salesmen was high. Sheldon designated branch managers to supervise his sales force who nonetheless did not play a strong supervisory role.n6 Many of these managers were unqualified, n7 and there were no internal controls to determine whether the branch managers were fulfilling their responsibilities. The Firms conducted little formal research with respect to the securities they offered and sold, but instead relied on their salesmen to ferret out and provide any material facts about the issuers and the securities. Sheldon and Reid failed to ensure that the salesmen were obtaining these facts or that such facts were being conveyed to customers. The Firms' salesmen, including Pattison, misrepresented and failed to disclose material information. Moreover, DSC undertook a series of misleading advertisements and engaged in excessive and fraudulent markups. Sheldon and Reid's failures to supervise resulted in widespread violations of the antifraud and markup provisions, as well as, in the case of Sheldon, misappropriation of customer securities. III. Financial Mismanagement. The customers of GSI and DSC depended on the Firms' sound operation for the safety of their cash and securities. For a time preceding their demise, the Firms grossly abused this trust. In addition to operating DSC with inadequate net capital, the Firms' back office n8 repeatedly defrauded customers, especially those whose securities were pledged to secure financing for the Firms.n9 As is well recognized, once a customer makes full payment for a security, the security must be removed from pledge and treated as the customer's sole property.n10 The Firms, however, used customers' fully-paid securities as collateral to obtain financing without disclosing that fact and the further fact that DSC's business depended on that practice. Trade custom requires a dealer to consummate transactions with customers promptly . . . [and a dealer may not] divert the proceeds of payments to his other business activities. . . Additionally, for the same basic reasons, it is a fraudulent and deceptive act, practice, and course of business, which operates as a fraud and deceit on a customer, for a broker-dealer to hypothecate or otherwise convert to his own use customers' funds or fully-paid for securities of customers held by the broker-dealer for safe-keeping. E. Weiss Registration and Regulation of Brokers and Dealers 181 (1965) (citations omitted). See also SEC v. Scott, Gorman Municipal, Inc., 407 F. Supp. 1383, 1387 (S.D.N.Y. 1975); Edward C. Jaegerman, 46 S.E.C. 706 (1976). The above practices violated the general antifraud provisionsn11 as well as securities law requirements regarding customer protectionn12 and net capital.n13 Sheldon was given early and repeated notice of the Firms' deteriorating condition and the need for decisive action. The pertinent facts are as follows. As mentioned, Sheldon launched a new computer business, Systems, in the early 1980's. To provide cash for Systems, Sheldon had GSI lend Group about $2 million, which Group in turn transferred to Systems. Beyond its substantial demand on GSI's financial resources,n14 Systems drew Sheldon's attention away from the Firms. His lack of involvement with the Firms repeatedly evoked criticism from his bankers. By summer 1984, officials at Chase Manhattan Bank, which was then providing financing to DSC, warned Sheldon that he was "spread too thin"; that Chase had no confidence in the firm's backup management; and that the credit relationship would end in six months unless changes were made. These pleas went unheeded by Sheldon and, in early 1985, Chase terminated the relationship. n15 Sheldon also received warnings from the National Association of Securities Dealers, Inc. (the "NASD"). The NASD, which in 1978 had disciplined Sheldon, DSC, and the Firms' financial officer, Mary Schad, for certain back office violations, conducted an examination of DSC in late 1983 and early 1984. Among the numerous back office problems discovered was a failure by DSC in four instances to reduce customer fully-paid securities to its possession or control.n16 In an October 31, 1984 letter to Sheldon, the NASD described these problems and directed Sheldon to set up a meeting to discuss them. Sheldon failed to respond either to this letter or a follow-up letter in February 1985.n17 Finally, in late July 1985, DSC's compliance officer responded to the NASD's October letter. As the financial pressure increased, the Firms repeatedly failed to redeem the pledge of customers' securities. Increasingly, during the fall of 1984 and the spring of 1985, GSI, with a large debt outstanding to its clearing agent, Security Pacific Clearing & Services Corp. ("SEPAC"), kept securities under pledge even after customer payment had been made.n18 As of October 31, 1984, GSI was using roughly $1.7 million of fully-paid customer securities to collateralize its SEPAC loan. It also pledged customer securities to another brokerage firm after they had been fully paid.n19 By May 1985, DSC's financial position had deteriorated to the point that it, too, was unable to redeem customer securities that it had pledged to SEPAC.n20 The value of customer securities pledged by DSC during this period ranged as high as $2 million. These practices came to the attention of James Neill, one of the Firms' auditors, while he was auditing the Firms.n21 In a May 9, 1985 letter, Neill told Sheldon of GSI's poor financial condition and improper practices. Neill noted that GSI's loss for the 1984 fiscal year would approximate $500,000 and that its $2 million receivable from Group was uncollectible. Moreover, Neill expressed concern over his discovery of GSI's pledging of customer securities: Fully paid customer government securities, on deposit at Security Pacific Clearing, are not being delivered to the customers or placed in safekeeping on a timely basis. To the extent that this problem exists, the Company is borrowing money against customer fully paid securities. A review of the April 30, 1985 stock record indicates that this condition is worse than at October 31, 1984. We urge you to review this condition immediately. Sheldon's only response to the accountants' letter was to have a brief conversation with Schad, the Firms' financial officer.n22 On July 9, 1985, Neill and his colleagues resigned upon learning that GSI had not merely failed to redeem fully-paid customer securities, but had deliberately pledged customer securities, pursuant to repurchase agreements, after customer payment had been received by the firm.n23 Sheldon feared the repercussions of the accountants' resignation on a planned public offering of Systems stock and tried to dissuade them. At a meeting on July 10, the accountants confronted Sheldon with their discovery of GSI's collateralizing of repurchase agreements with fully-paid securities. Sheldon admitted that he had not responded to their earlier instruction to redeem fully paid securities on a timely basis. He assured them, however, that he would do so in the future. In addition, and notwithstanding the accountants' advice to Sheldon that, given GSI's financial condition, repayment was impossible, Sheldon announced to the accountants that all the repurchase agreements had been paid off or would be within the next day or so. n24 At the time, the Firms' collapse was all but complete. n25 Sometime in June or July 1985, SEPAC notified Sheldon it was terminating its line of credit with GSI. n26 As a result, between July 9 and 12, 1985, DSC advanced $4.25 million to GSI's SEPAC account to pay GSI's debt. That measure placed DSC in a net capital deficiency which, by July 15, totaled $1 million. DSC remained in business for two additional weeks despite this deficiency. It appears that, immediately prior to the Firms' collapse, NASD staff members were on the premises, reviewing DSC's books and records. The prospective purchaser testified that he discussed his interest in the Firms with the NASD and, by phone, with the staff of this Commission. While these regulators may have overstated the Firms' liabilities, they also told the prospective purchaser that their estimate was qualified because, given the large volume of business involved, it was impossible to make an accurate assessment at that time. Indeed, it was the prospective purchaser's impression that no one, not even the Firms' personnel, "really had any confidence in any particular number" concerning the size of the liabilities. In any event, by the time that these conversations occurred, "a day or two before" the Firms closed, the violations at issue had already occurred. On July 26, 1985, NASD examiners discovered the fund transfers from DSC to GSI and asked DSC for a net capital computation. On July 29, Sheldon reported DSC's net capital deficiency to the NASD and did not reopen the Firms for business. At that point, roughly $1 million in fully-paid customer securities were still collateralizing an outstanding repurchase agreement. Those securities ultimately were liquidated by the lender under the repurchase agreement. Shortly after they closed, the Firms were placed in liquidation.n27 Sheldon claims that a Division staff member working on this proceeding vindictively persuaded the Commission to deny IPM's exemption. As noted, however, the necessity for the exemption proceeding concerning IPM arose automatically pursuant to provisions of the Investment Company Act by virtue of the temporary restraining order. In any event, no member of the trial staff participated in consideration of IPM's exemption request. See n. 4, supra. We agree with the law judge that Sheldon willfully aided and abetted an array of back office misconduct. The record establishes the three elements courts have associated with aiding and abetting: (1) violations by the Firms; (2) Sheldon's knowing and substantial assistance of those violations; and (3) Sheldon's general awareness that his actions were part of an overall course of conduct that was illegal or improper.n28 The Firms' violations are clear. The facts show not only DSC's violations of customer protection requirementsn29 and our net capital rule, but also a scheme by both Firms to deceive customers as to the use the Firms were making of fully-paid securities. Customers were not told that the Firms were using customers' securities to secure the Firms' financing, and that DSC's cash was so scarce that it could not conduct business any other way.n30 Fraudulent intent with respect to the schemes by the Firms is demonstrated by the repeated and prolonged retention of customers' securities under pledge, and by GSI's willingness to pledge fully-paid securities. Sheldon's assertion that government securities firms were not subject to any requirements is simply wrong.n31 Nor is the result affected by Sheldon's assertion that repurchase agreements were widely used within the industry.n32 Sheldon notes that owners of securities that had been redeemed received no better settlement in bankruptcy than those whose securities had remained under pledge, and further claims that all repurchase agreements had been paid off by the time of the Firms' bankruptcy. However, in determining whether the Firms violated antifraud provisions the issue is not what ultimately happened to their customers, but rather whether their failure to disclose their hypothecation of customer fully-paid securities was material. It is clear that, at the time the Firms were dealing with customers, their pledge of fully-paid securities was a fact that would have assumed actual significance in the deliberations of the reasonable investor, and as such was material. TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1979) See also, SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir. 1968) (en banc), cert. denied, 394 U.S. 976 (1969). It also is clear that Sheldon substantially assisted these violations and acted with the requisite knowledge. Sheldon's focus, as well as the Firms' financial resources, was diverted to other projects, setting the stage for the problems to follow. n33 Sheldon was, at a minimum, recklessly indifferent to serious problems in the Firms' back office. Not only did he thoroughly dominate the Firms and insist on knowing their most important affairs, but, at critical points, his bank and the NASD warned him of an ever worsening situation. Sheldon, however, did nothing. Even when, in May 1985, he was directly confronted with Neill's revelations of serious irregularities, Sheldon merely held a perfunctory consultation with his financial officer. At the hearing, Sheldon claimed he could not recall what the financial officer told him, except that she somehow allayed his concerns. n34 In our view, even allowing for the possibility that that official misled Sheldon, it is not credible that Sheldon saw no need to take strong independent action or even to confer with Neill. Only in July, to impress his auditors and to meet SEPAC's demands, did Sheldon attempt to respond. Juggling funds from one troubled firm to another, Sheldon plunged DSC into a severe net capital deficiency, and, thereafter, kept dealing with customers for two additional weeks. Moreover, during that time, despite the disclosure from Neill that back office misconduct included the pledge of already paid-for securities, Sheldon still did not eliminate the serious deficiencies in his back office operations. The picture that emerges is that of an entrepreneur bent on staying in business regardless of the effect on public investors. We conclude that Sheldon was culpably aware with respect to the violations that were occurring. He either fully knew about, or, in bad faith, intentionally ignored indications of, the Firms' fraudulent and improper practices regarding customer securities and, later, DSC's deception regarding its financial condition, and that firm's net capital deficiency. Such conduct, which was at the very least reckless, amply supports a finding that Sheldon willfully aided and abetted those violations. n35 IV. Antifraud Violations and Related Misconduct. All three respondents, in connection with transactions in municipal securities, willfully violated, or willfully aided and abetted violations of, Section 17(a) of the Securities Act, Sections 10(b) and 15(c)(1) of the Exchange Act and Rules 10b-5 and 15c1-2 thereunder and MSRB Rule G-17. Sheldon and Reid also failed reasonably to supervise to prevent violations of the securities laws and violated MSRB Rules as set forth below. A. Misconduct in the Offer and Sale of WPPSS 4 and 5 Bonds. 1. Events of 1982 through 1983. Between 1982 and 1983, a series of adverse events culminated in the default of certain bonds ("WPPSS 4 and 5 Bonds") issued by the Washington Public Power Supply System ("WPPSS"). In the face of these rapidly deteriorating conditions, Sheldon and DSC salesmen, including Pattison, offered and sold WPPSS 4 and 5 Bonds to the public without adequate disclosure. In the early 1970s, WPPSS began construction of several nuclear power plants to generate electricity for the Pacific Northwest, and, over the next several years, issued bonds to fund their construction. WPPSS 4 and 5 Bonds were issued to fund construction of two of those plants, projects 4 and 5. However, those projects were delayed by labor problems, environmental requirements, and mismanagement which, coupled with rising inflation, resulted in a tripling of their projected costs. In January 1982, construction on projects 4 and 5 was terminated because of cost overruns and a decline in the projected need for power in the region. However, 88 municipal and cooperative utilities (the "Participants") had executed agreements (the "Participants' Agreements") to pay the debt service on the WPPSS 4 and 5 Bonds even if projects 4 and 5 were never completed. Notwithstanding the requirements of the Participants' Agreements, Standard & Poor's ("S&P") lowered its rating on WPPSS 4 and 5 Bonds to its lowest investment grade, BBB+, following the projects' termination.n36 In early October 1982, an Oregon trial court gave a preliminary indication of concern regarding the enforceability of the Participants' Agreements against Oregon Participants. This action caused S&P to place the WPPSS 4 and 5 Bonds on its "Credit Watch" list (an indication of a potential rating change). Later in October, Pattison discussed generally WPPSS 4 and 5 Bonds with a customer, Joseph MacInerney, and sent him a prospectus. He then sold MacInerney WPPSS 4 and 5 Bonds without disclosing that construction on projects 4 and 5 had been terminated, that there was ongoing litigation regarding the bonds' backing, that Moody's had suspended its ratings on the bonds, or that S&P had just placed the bonds on Credit Watch. In November, S&P lowered its rating on the bonds from "BBB+" to "B" (a speculative grade) -- and retained them on Credit Watch. S&P noted that judicial decisions in both Oregon and Idaho raised "serious questions" concerning whether WPPSS could meet its debt payments. Moreover, Washington state Participants were unwilling to make their contributions to pay the debt service until an appeal was heard from a Washington state court decision holding that Washington state Participants were bound by the terms of the Participants' Agreements. Nonetheless, beginning in November 1982, Sheldon authorized DSC radio advertisements in Houston and Los Angeles, and television advertisements in Florida. In those advertisements, Sheldon reassured an investor who was concerned about a possible WPPSS default, explaining that Sheldon owned WPPSS 4 and 5 Bonds, which, he stated, were his most recent purchase in the tax exempt market. The advertisement minimized the possibility of default and omitted any adverse information which would suggest caution, including any reference to the adverse judicial decisions. At the end of January 1983, 86 of the 88 Participants failed to make their contributions to the bond fund, based on litigation in all three states questioning the enforceability of the Participants' Agreements. Nonetheless, in February, DSC distributed to its customers an "Editorial by Donald Sheldon, President, Donald Sheldon & Co., Inc.," in which Sheldon claimed that unspecified news "this week" about WPPSS 4 and 5 Bonds continued "to remain encouraging." Sheldon also asserted his "strongly" felt view that "the cases currently before the court . . . will protect the investor and that the utility companies in Washington will pay their just debts." The editorial did not describe the status of the litigation, and, before the law judge, Sheldon was unable to recall which news he found encouraging. At the end of February, S&P lowered its rating on WPPSS 4 and 5 Bonds to "CC," the lowest rating above default, because it found that there was a "significant likelihood of actual payment default by January 1984." S&P attributed this possible default to the legal challenges to the Participants' Agreements, as well as "the absence of cooperation required for any resolution of this problem. . . ." When, in April 1983, a tentative agreement was reached between government and power industry leaders to avoid default, Sheldon issued an advertisement hailing this "substantial agreement in principle," and asserting that, "[t]he capacity of these utilities to repay the people that had loaned them this money was never in doubt." n37 The tentative agreement quickly collapsed. Nonetheless, in late May, Sheldon authorized, on DSC's behalf, the issuance of an "Economic Commentary: By Dr. Lance Brofman," an economist affiliated with DSC. In it, Brofman opined that "even WPPSS bonds have a significant probability of full payment." The commentary concluded that "[t]he mathematics of the situation suggests that those who do not presently include WPPSS bonds in their portfolio should do so now, and those who hold them should add to those positions." A DSC press release was issued, stating: Rejecting dire warnings of possible default and bankruptcy for . . . WPPSS, Dr. Lance Brofman . . . sees the current steep price declines and yield run-ups as a not-to-be-missed opportunity for even the most prudent investor. (Emphasis added.) In May 1983, Pattison sold WPPSS 4 and 5 Bonds to Charles Reass. Pattison reassured Reass that, notwithstanding the pending litigation and termination of construction, WPPSS would not default on the bonds. Pattison further told Reass that the WPPSS 4 and 5 Bonds were backed by the Bonneville Power Administration, which was not true, and that the State of Washington would not permit them to default. In June 1983, the Washington Supreme Court ruled that the Participants' Agreements were unenforceable. Later that summer, when WPPSS failed to meet an accelerated demand for payment of principal and accrued interest, S&P lowered the rating for the bonds to "D" -- default. We find that Sheldon and Pattison willfully violated or willfully aided and abetted violations of Section 17(a) of the Securities Act and Section 10(b) and 15(c)(1) of the Exchange Act and Rules 10b-5 and 15c1-2 thereunder.n38 We further find that Reid, as branch manager, failed reasonably to supervise the Houston office with respect to violations of the antifraud provisions in the sale of WPPSS 4 and 5 Bonds. 2. Sheldon. Sheldon authorized and, in certain instances, prepared and participated in, DSC advertisements that presented the WPPSS situation in a wholly misleading manner and minimized the increasingly significant risks of WPPSS 4 and 5 Bonds.n39 He distributed these advertisements to the Firms' sales representatives for use in their solicitations. Sheldon knew of many of the adverse developments relating to WPPSS and was, at best, reckless, in causing DSC to use these advertisements.n40 Sheldon claims that it is improper to hold him liable for these violations, which he claims are based on his inability to predict the adverse decision of the Washington Supreme Court. In this he is mistaken. As is clear from the discussion above, his liability is predicated on his repeated misleading descriptions in DSC advertisements of material adverse facts related to WPPSS 4 and 5 Bonds. Sheldon's personal belief that the bonds would not default did not diminish his obligation to disclose to DSC customers contrary material facts, including the termination of the projects, adverse legal decisions, and declining ratings. n41 3. Pattison. Pattison conceded before the law judge not only that he omitted to disclose information to MacInerney but that the information was material.n42 Pattison also made misrepresentations to Reass regarding the safety and creditworthiness of WPPSS 4 and 5 Bonds.n43 Pattison claims that DSC provided him and other salesmen "only the most positive" information on WPPSS, and he was pressured to sell WPPSS 4 and 5 Bonds because they comprised the bulk of DSC's inventory at the time. However, Pattison, as a registered representative, had a duty to his customers to have a reasonable basis for his recommendations and to avoid "recklessly stat[ing] facts about matters of which he is ignorant." n44 Pattison asserts that the law judge gave insufficient weight to the fact that the bonds were rated BBB+ at the time of the sale to MacInerney, which indicated their safety. Pattison misunderstands the objective of the federal securities laws, which is not to ensure that investors make only "safe" investments but, rather, to ensure that they invest based upon full disclosure. Once Pattison began offering WPPSS 4 and 5 Bonds to MacInerney, he could not present a partial picture of the WPPSS situation and thereby mislead MacInerney as to the attendant risks. Pattison also asserts that he must have made proper disclosure to Reass, whom he characterizes as "yield aggressive," because another of his customers testified that he, the customer, had received full disclosure. Pattison's disclosures to other customers and Reass' interest in speculation are irrelevant to the issue of whether Reass received appropriate disclosure. William L. Kicklighter, Jr., Securities Exchange Act Rel. No. 30096, 50 SEC Docket 826 at 831, 833; James F. Novak, 47 S.E.C. at 895. 4. Reid's Failure to Supervise. Several Houston office salesmen violated the antifraud provisions of the securities laws in connection with the sale of WPPSS 4 and 5 Bonds.n45 Reid concedes that this misconduct occurred. He contends, however, that DSC's staff in New York -- not Reid -- was responsible for supervising the Houston salesmen. n46 However, the record, including both Sheldon's testimony and DSC's procedures manual, demonstrates that Reid, as Houston branch manager, was responsible for supervising the Houston office.n47 He hired and fired personnel and handled customer complaints. He also received a sales override commission for exercising that authority. Reid admits that he never instructed any DSC salesman to inform customers about WPPSS' adverse financial, litigation, credit, or business status.n48 Reid's only efforts with respect to WPPSS disclosures involved his attempts, from time to time, to circulate written and oral information about WPPSS. He had no procedure to provide accurate information to Houston salesmen or to maintain that information for reference.n49 Thus, new salesmen were dependent on "more senior" salesmen to obtain the information. Reid essentially relied on Houston salesmen to inform themselves concerning the material facts about WPPSS 4 and 5 Bonds, a practice not commensurate with his supervisory obligations.n50 Reid had notice of these deficiencies. He received customer complaints that various Houston salesmen had failed to disclose material facts in connection with sales of WPPSS 4 and 5 Bonds, which should have alerted him that DSC's procedures were inappropriate. Notwithstanding these complaints, Reid took no effective steps to ensure that his salesmen had and conveyed adequate information concerning WPPSS and WPPSS 4 and 5 Bonds. Given the general inexperience of the salesmenn51 and the complicated, rapidly changing conditions surrounding WPPSS 4 and 5 Bonds, Reid was unreasonable in assuming that novice salesmen, with little or no assistance, could obtain and understand the material information about WPPSS 4 and 5 Bonds. Moreover, he was aware that material information was not being conveyed to DSC customers.n52 Thus, under Section 15(b)(6) of the Exchange Act and MSRB Rule G-27, we find that he failed reasonably to supervise Houston salesmen with respect to WPPSS 4 and 5 Bonds. While the prevailing view at DSC regarding WPPSS may have been positive, we believe someone with Reid's experience should have recognized the significant negative factors present and the need for their disclosure. Edward J. Blumenfeld 47 S.E.C. 189, 190-1 (1979); Willard G. Berge 46 S.E.C. 690, 694 (1976), aff'd sub nom., Feeney v. SEC, 564 F.2d 260 (8th Cir. 1977). B. Other Antifraud Violations by Reid with Respect to Municipal Securities. At Reid's instigation, DSC -- particularly its Houston office -- offered and sold to the public Cheneyville revenue bonds and Vanceburg bond anticipation notes. Both were obscure, thinly-traded securities. As set forth below, we find that Reid willfully violated, or willfully aided and abetted violations of, Section 17(a) of the Securities Act and Section 10(b), 15(c)(1) and 17(a) of the Exchange Act and Rules 10b-5, 15c1-2 and 17a-3 thereunder and MSRB Rules G-8, G-17 and G-19 in connection with the sale of these securities. 1. Cheneyville Revenue Bonds. In April 1982, the Westside Habilitation Center, located in Cheneyville, Louisiana, issued $13.55 million in revenue bonds, bearing interest rates ranging from 14 percent to 16-1/2 percent, to construct a facility for the mentally retarded. The project experienced immediate difficulties. In October 1983, Cheneyville's developer sued the bond trustee to determine whether the next bond interest payment would be made from the debt reserve fund or the construction reserve fund. If the developer were successful in preventing the use of the construction reserve fund to pay interest on the bonds, over $1 million in reserves would no longer be available to service the bonds. Moreover, once the debt reserve fund was depleted (which would occur after two additional -- for a total of three -- interest payments) Cheneyville would be completely dependent on operating income to meet its interest obligations. However, the Cheneyville facility was not meeting its occupancy or revenue forecasts.n53 By the fall of 1984, Cheneyville could not service the bonds. Cheneyville defaulted on the October 1984 interest payment and filed for bankruptcy in 1985. n54 Reid claims that he was unaware of the problems surrounding Cheneyville and relied on information provided by other DSC salesmen that the facility was doing well and able to meet its financial obligations.n55 However, the law judge credited Larry Greenfield, one of Reid's customers, who began liquidating his Cheneyville holdings through Reid in August 1983. Greenfield testified that, in the summer and fall of 1983, he and Reid discussed rumors that Greenfield had heard about Cheneyville's problems, as well as an October 1983 written update from the co-manager of the initial Cheneyville underwriting, describing the litigation. Greenfield and Reid also discussed why the price of Cheneyville bonds, which bore an interest rate of 16 1/2 percent, was falling during a period of low inflation.n56 According to Greenfield, Reid blamed the price decline on the pending litigation.n57 Knowing this information, in May 1984, Reid nonetheless bought the bonds for the account of Louis Loeser, over which he exercised de facto discretionary authority. Reid made the purchase without first discussing it with Loeser. In June 1984, Reid sold Cheneyville bonds to Jimmy Bird who purchased the bonds at par. Reid did not disclose Cheneyville's problems, and, when Bird expressed concern about the safety of the bonds in light of their high rate of interest, Reid told Bird falsely that the issuer had an "entire city block" of real estate that was "more than enough" to secure its obligations to the bondholders. When Cheneyville defaulted on its October 1984 interest payment, Reid continued to mislead Bird and, toward this end, caused DSC to pay Bird's interest coupon (which the issuer had returned unpaid), assuring Bird that the problem had been caused by a change of trustees.n58 In light of Cheneyville's precarious financial situation, these bonds were unsuitable for Loeser and Bird, both of whom had told Reid that they wanted safe investments.n59 2. Vanceburg (Kentucky) Bond Anticipation Notes. In 1979, the City of Vanceburg, Kentucky issued bonds to construct an electric power plant, to be repaid from the sale of electric power to the plant's customers. Because of cost overruns, the project could not be completed with the proceeds of the original bond issue. In June 1982, Vanceburg issued bond anticipation notes bearing 10-1/2 percent interest, due June 1, 1984, by which time Vanceburg anticipated issuing a second bond offering. The City of Hamilton, Ohio, which was the chief prospective customer for the plant's power, had agreed to be liable for 90 percent of the debt service on the anticipated 1984 offering (although it was not liable on the notes). However, in January 1984, Hamilton sued Vanceburg, alleging fraud and mismanagement and seeking to void its contract with Vanceburg and $10 million in damages. As a result, Moody's, which had initially assigned the notes its second highest grade for securities of this type, suspended the ratings of both the notes and the bonds, pending clarification of the suit's impact on the credit quality of the issuer's debt. S&P, which had not rated the notes, lowered the bonds' rating to a speculative grade. Both actions were reported in municipal bond publications. The suit hampered Vanceburg's efforts to issue additional bonds to pay off the notes. In March 1984, Reid purchased Vanceburg notes for a DSC customer at 97-3/4, which he admitted was a low price for notes due to mature in less than three months. Reid claims that the trader he purchased the notes from told him that there was nothing wrong with the notes and that the notes were rated investment grade by both S&P and Moody's.n60 A day or so after this purchase, several salesmen asked Reid to add the notes to DSC's inventory. Without further investigation of the financial condition of the notes, Reid added them to the inventory with a notation that the notes were rated investment grade by Moody's. When another DSC trader told Reid that he was unable to verify that rating, Reid removed the reference to the rating but made no effort to determine the then-current rating. Separately, three Houston salesmen contacted the Vanceburg fiscal agent who told them that the notes were "fully funded." Without further inquiry, the salesmen assumed, incorrectly, that this statement meant that the money to pay off the notes had been raised and was on deposit in the bank. One of these salesmen, Joseph Stafford, then sold $450,000 worth of the notes to Charles Epps, conditioned on Epps' verifying that funds to pay off the notes were on deposit. Epps cancelled the purchase when he determined that the funds were not on deposit. Reid spoke directly to Epps who confirmed that the money had not yet been raised. Following the cancellation, Sheldon ordered Reid to liquidate the notes. Instead, Reid gave Stafford "a few days" to resell the notes and offset the loss which DSC would otherwise require Stafford to bear. Reid also directed Stafford to determine the status of the Vanceburg bond offering. According to Reid, Stafford informed him that, although the money was not then on deposit, a new issue would be sold within two weeks (the time that the notes were due), to pay the principal and interest.n61 The efforts to refinance the notes, however, proved to be unsuccessful, and the notes went into default on June 1, 1984. n62 In May 1984, Reid sold to Loeser's account $50,000 worth of the notes returned by Epps, without consulting with Loeser before the transaction. Thus, Reid effectively recommended the notes to Loeser without informing him of the issuer's troubles. In mid-June after the default, Reid purchased an additional $25,000 in notes for Loeser's account.n63 Given Loeser's conservative investment goals, these purchases were unsuitable for his account. Moreover, Reid backdated the second purchase to make it appear that the purchase occurred in May, prior to the default.n64 Reid also encouraged other Houston salesmen to offer Vanceburg notes to customers, and the salesmen offered these notes to customers seeking safe investments. Houston salesman represented to customers that the money to repay the Vanceburg notes was on deposit and failed to disclose the pending litigation, the rating suspension, or any other negative information. In the face of these facts, Reid claims that he acted properly. He contends that the Houston office was in "regular" contact with Vanceburg officials and others associated with the notes, and received from them encouraging, albeit misleading, information. The record does not support this version of events. Although Reid testified in another context that bond ratings "are the most important ingredient in the bond business," he did not ascertain the publicly available information about the status of Vanceburg's ratings. He claimed to rely instead on the information provided by the selling trader, information that had been questioned by another DSC trader.n65 Reid was clearly reckless in assigning Stafford, who was being made responsible for DSC's loss as a result of the broken Epps trade, the task of DSC's further investigation of Vanceburg. Not only was Stafford not sufficiently disinterested in the result of the research since he would be held responsible for DSC's loss, he was inexperienced. Significantly, even after Reid knew that Epps had cancelled his purchase because the money to pay the notes was not on deposit, Reid willfully encouraged DSC salesmen to continue to sell Vanceburg notes to any customer without full disclosure of both the problems with the issue and the difficulty in obtaining accurate information -- and regardless of suitability.n66 C. Unfair Pricing of Municipal Securities. As described below, Reid charged, and/or aided and abetted the charging of, excessive markups on the sale of WPPSS 4 and 5 Bonds and Cheneyville bonds. 1. WPPSS 4 and 5 Bonds. Between October 1982 and June 1983, DSC charged undisclosed markups ranging from 6 percent to as high as 15 percent in 109 transactions in WPPSS 4 and 5 Bonds. These excessive markups violated Rules G-17 and G-30 of the MSRB. n67 The law judge also found that, to the extent these markups exceeded 8 percent, they violated Section 17(a) of the Securities Act, and Sections 10(b) and 15(c)(1) of the Exchange Act and Rules 10b-5 and 15c1-2 thereunder.n68 We affirm these findings.n69 We have consistently held that, at the least, markups of more than 10% are fraudulent in the sale of equity securities. And we have found markups in excess of 7% fraudulent in connection with such sales. Markups on municipal bonds are generally lower than those for equity securities (emphasis in original). Id. at 192. Reid argues that, because DSC was a market maker in WPPSS 4 and 5 Bonds, DSC's contemporaneous costs were not the appropriate bases to use in calculating its markups. However, the law judge found that DSC was not a market maker in WPPSS 4 and 5 Bonds, and this finding is supported by the record, including the testimony of DSC's head trader. Thus, calculations based on DSC's contemporaneous costs were appropriate. Reid complains that the law judge improperly placed the burden of proof on him to demonstrate that DSC's markups in WPPSS 4 and 5 Bonds were not excessive. The Administrative Procedure Act (the "APA") expressly places the burden of proof -- that is the burden of presenting some evidence -- on the proponent of an issue, in this case the Division with respect to the excessiveness of markups. Once the Division presented evidence of these markups, the burden shifted to Reid to refute that evidence.n70 Reid did not introduce any countervailing evidence either that other factors should be considered in evaluating DSC's markups or that contemporaneous costs were not a valid basis for calculating DSC's markups. We are satisfied that the record establishes excessive markups by a preponderance of the evidence.n71 Reid also contends that he cannot be held accountable for the resulting markups because the prices were set by traders in DSC's New York office. However, Reid purchased many of the WPPSS 4 and 5 Bonds for the Houston office, and most of these bonds were sold by Houston salesmen on the same or next day. Reid further admitted that, since he purchased the bonds, he knew what the markup on them was. Nevertheless, Reid admitted that he did not challenge any of the New York trading desk's prices.n72 Reid was an experienced principal, trader, and branch manager. DSC's procedures manual, which Reid admitted reviewing, notes: It is the practice in the municipal bond industry to charge a retail customer a price which is no more than one quarter of one percent to five percent over the current market price for a bond.n73 Thus, Reid knowingly and substantially assisted conduct that he knew, or was reckless in not knowing, was violative of the markup restrictions. 2. Cheneyville. Between January and November 1984, DSC charged markups of between 5 and 9 percent on over 70 sales of Cheneyville bonds. The finding of the law judge that Reid traded Cheneyville bonds for DSC and set their markups "in concert with . . . the salesmen" is fully supported by the record. n74 These markups were clearly excessive in violation of MSRB markup restrictions and, in several instances, fraudulent.n75 In addition, Reid sold Cheneyville bonds to the accounts of favored customers at prices close to DSC's contemporaneous costs. He repurchased the bonds from the favored accounts at a profit to those accounts. He then sold these same bonds to non-favored customers at a still higher price.n76 Reid's interpositioning of favored accounts between the dealer market and non-favored accounts resulted in fraudulent, effective markups of as much as 10 percent. This interpositioning on Reid's part demonstrates clear scienter and, in our view, was particularly egregious.n77 In other instances he sold the bonds short to non-favored customers and covered the resulting short position by repurchasing the bonds from the favored account at a profit to that account but at a price below that charged the non-favored customers. V. Sheldon's Failures of Supervision. We have made clear that it is critical for investor protection that a broker establish and enforce effective procedures to supervise its employees.n78 Ultimately, it is the broker-dealer's president who is responsible for compliance with all of the requirements imposed on his firm unless and until he reasonably delegates particular functions to another person in that firm, and neither knows nor has reason to know that such person's performance is deficient.n79 As detailed below, we find that, under Section 15(b)(4)(E) and 15(b)(6) of the Exchange Act and MSRB Rule G-27, Sheldon failed repeatedly to discharge this obligation. A. Sales of Cheneyville and Vanceburg Securities. As described above, DSC sold Cheneyville and Vanceburg securities to persons for whom they were not suitable and on the basis of material misrepresentations and omissions. Sheldon admitted responsibility for supervising the branch offices, although he also asserts that he delegated the duty to supervise sales to the branch managers, including Reid. We have repeatedly warned that "supervisory procedures which rely solely on supervision by branch managers" are not sufficient.n80 Nonetheless, Sheldon neither monitored, nor established procedures to monitor, DSC branch managers to determine whether they were carrying out their supervisory responsibilities. n81 Sheldon also neither identified nor corrected weaknesses in DSC's sales procedures and suitability standards. As noted, DSC placed the entire burden of investigating and evaluating the appropriate disclosure for a security on DSC's registered representatives, but provided no guidance through its procedures manual, training, its supervisory staff, or otherwise to the salesmen as to the manner in which they should comply with these regulatory requirements. This policy was inappropriate. It raises particular concerns with respect to troubled securities, such as Cheneyville and Vanceburg, especially since many of DSC's salesmen were novices. At a minimum, Sheldon had an obligation to ensure that DSC provided its salesmen with the means to obtain adequate information about these securities and with effective direction for its appropriate disclosure.n82 Sheldon ignored repeated indications of irregular conduct which should have alerted him to the problems in the Houston office. He received several customer complaints that DSC salesmen had failed to inform customers of the most fundamental information about securities DSC recommended, including ratings and financial information about, and litigation involving, the issuer. He had specific knowledge that Epps had cancelled his Vanceburg transaction because the Houston office had provided Epps with erroneous information. Nonetheless, although he ordered Reid to liquidate the notes into the market, he did not even ascertain whether this order was followed or whether Houston salesmen, including Reid, were continuing to market Vanceburg notes without adequate disclosure. B. Markups in Municipal Securities. Sheldon admits responsibility for supervising DSC's traders and ensuring that markups were not unfair or fraudulent. Sheldon contends that DSC's markups were not unfair or fraudulent.n83 However, as discussed in Section IV, C, supra, we affirm the law judge's finding that these markups were excessive and, in many instances, fraudulent. The DSC procedure manual stated that the appropriate markup for municipal bonds sold to retail customers was between 1/4 to five percent above the market price of the bond and warned DSC employees that excessive markups could be fraudulent.n84 Sheldon nonetheless failed to provide a mechanism to review DSC's pricing of municipal bonds to achieve compliance with even this internal guideline or to detect interpositioning.n85 Sheldon further contends that penalizing DSC and him for charging markups above specific percentages amounts to price fixing and, as such, violates the federal antitrust laws. However, neither the MSRB rules governing markups nor this Commission's markup cases set prices for securities. Instead, they seek to ensure that these prices are fair by providing guidance as to what prices are unfair.n86 In any event, the Supreme Court has recognized that the antitrust laws are deemed repealed to the extent necessary to permit the securities laws to function in the manner envisioned by Congress, n87 and this Commission has held that this implicit repeal applies in the context of markups.n88 Sheldon asserts that the markup policy violates the prohibition against restraints on interstate commerce. The interstate commerce clause prohibits the several states, not the Federal government, from imposing restraints on interstate commerce. See generally, J. Nowak, Constitutional Law (2d ed.) 266-291 (1983). C. Misrepresentation of SIPC Coverage of GSI. Customer accounts at DSC -- but not GSI -- were insured by SIPC.n89 However, the Firms shared office space and sales personnel, creating the potential for confusion among customers about whether particular securities transactions were covered by SIPC. Sheldon failed to take measures to prevent this confusion, resulting in violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act. Sloppy office procedures exacerbated this problem by further blurring the distinctions between the Firms. Salesmen sent SIPC brochures to government securities customers. The Firms also used DSC business cards and DSC stationery, both noting SIPC membership, when sending correspondence concerning GSI government securities transactions. In the Los Angeles office, a SIPC decal was affixed on the Firms' front door.n90 Customers testified that they understood that their investments through GSI were protected by SIPC.n91 In response to the Division's introduction of a photograph taken after the Firms had closed showing such a sign on the entrance to the Los Angeles office, Sheldon introduced a SIPC sticker, Sheldon Exhibit B (which is missing from the record, see n. 1, supra), to demonstrate that the sticker was capable of being moved. Sheldon did not, however, adduce any evidence indicating that the sticker had in fact been moved. Our conclusion that the sign was displayed prominently by the Firms' Los Angeles office is confirmed by the record. Reid introduced a check made payable to GSI, Reid Exhibit B (which is one of the exhibits missing from the record, see n. 1, supra), to refute a customer's testimony that he believed his purchase of a government security was covered by SIPC. While this check shows that the customer knew that there were two firms, it does not undermine his testimony that he was confused about the differences between GSI and DSC. Reid also introduced a letter written to this customer by a Houston salesman shortly after the Firms closed, Reid Exhibit C (which is also missing from the record), to demonstrate that he had no control over the misrepresentations made to this customer. However, our findings as to Reid's violations concerning representations of GSI's SIPC membership are based on Reid's testimony. Sheldon notes that the Firms' procedures manual stated that "[e]ach new customer is to be informed by his representative. . . of the difference between Donald Sheldon & Co., Inc. and its subsidiary Donald Sheldon Government Securities Inc." However, this statement does not explain to a salesperson what those differences are or their import.n92 And aside from a single meeting in the Los Angeles office, there appears to have been no effort made to inform salesmen of the importance of the distinction between the Firms.n93 Sheldon thus failed to exercise reasonable supervision.n94 D. Salesman's Misappropriation. In 1982, a salesman in the Firms' New York office, Jonathan Smith, purchased large numbers of bonds for non-existent customers. Although the scheme cost the Firms approximately $60,000 and required DSC to reimburse a customer, the incident was not reported to the NASD, and Smith was permitted to retain his position. Sheldon, who was aware of this scheme, was on notice that Smith could not be trusted and required the strictest scrutiny. Sheldon required Smith to sit next to the New York sales manager, who, in turn, was instructed to observe Smith and answer his questions. Sheldon delegated responsibility for overall supervision to Jack Manion, a principal of the firm. However, this oversight lapsed after Manion's death in the spring of 1983. And, beginning about December 1982 (almost immediately following the discovery of his first scheme), Smith began to steal customer funds and securities. Smith confessed his misappropriation in October 1984 and was terminated.n95 Sheldon claims that DSC had procedures in place to prevent access by salesmen, including Smith, to customer funds and securities, and that the operations supervisor failed to enforce these procedures, making Smith's theft possible.n96 Even if DSC's procedures were adequate for a typical salesman, however, Sheldon was on notice that Smith required extraordinary supervision and failed to provide sufficient measures.n97 VI. Markups of Government Securities. The Commission has observed that "mark-ups on government securities, like mark-ups on corporate and municipal debt securities, usually are smaller than those on equity securities."n98 Similarly, the Division's expert witness noted that it was industry practice to charge markups of no more than four percent on government securities.n99 Sheldon admitted that it was GSI's policy to charge an undisclosed markup of five basis points over the market price on discount mortgage-backed government securities "across the board." As a result, customers were defrauded in that they purchased securities at prices that bore no reasonable relationship to the prevailing market price. n100 Sheldon challenges the competence of the Division's expert, claiming that he had limited experience and was personally hostile to Sheldon, based on past personal disputes. However, the law judge concluded the expert's testimony was not tainted by bias. In any event, our findings are based on Sheldon's admitted markup policy. GSI's markup policy necessarily produced markups in excess of five percent -- and often of eight percent or above -- on discount mortgage-backed government securities.n101 Indeed, GSI's inalterable policy of a five point markup precluded pricing these securities based on the particular circumstances of the sale or the market for the securities. We therefore hold that Sheldon, through this markup policy, willfully violated or willfully aided and abetted violations of Section 17(a) of the Securities Act and Sections 10(b) and 15(c)(1) of the Exchange Act and Rules 10b-5 and 15c1-2 thereunder.n102 VII. Miscellaneous Procedural Issues. Sheldon and Reid raise a variety of issues, which they contend rendered these proceedings defective. For the reasons set forth below, we conclude that none of these contentions is meritorious. A. Sheldon asserts that the financial problems of the Firms were due not to his mismanagement but, rather, to the disruption of the Firms' operations caused by the Division's investigation.n103 Scrutiny from inspections and investigations is an aspect of doing business in a regulated industry.n104 Securities firms are not excused from compliance with regulatory requirements because they are being examined and/or inspected.n105 B. Sheldon claims that the Division withheld exculpatory information, misled witnesses, and even encouraged their lying. He charges that the law judge improperly excluded testimony regarding this alleged intimidation and ignored its presence. Although the law judge gave him numerous opportunities to make and support his allegations, Sheldon cited, in the most general terms, only a few instances of alleged misconduct.n106 For example, Sheldon claims that a GSI customer misrepresented the amount she expected to recover from the GSI bankruptcy. However, when the witness testified on redirect, she made clear that her estimate of her recovery had been based on information she had received from the bankruptcy trustee and the custodian of GSI's funds, not the Division.n107 Sheldon similarly complains that one witness testified that his plans to retire "fell through" since his funds were not available because of GSI's bankruptcy. Sheldon claims that this statement is untrue because ultimately the GSI customers recovered most of their funds in bankruptcy. We fail to see how this eventual recovery makes the witness' statement that his retirement was delayed a lie.n108 Sheldon also claims that certain of his witnesses were intimidated by the Divisionn109 and, as a result, slanted their testimony or declined to testify. n110 Sheldon called Donald Wheeler, owner and principal of a municipal securities firm. Wheeler, who is an attorney, testified that he had second thoughts about testifying on Sheldon's behalf after he was contacted by the Division. However, Wheeler did testify and stated unequivocally that his testimony was unaffected by this contact, and the law judge credited this testimony.n111 Sheldon's two other allegations of intimidation are also not supported by the record.n112 A second witness asked Sheldon not to call him as a witness because he wanted to avoid "an adversarial position with the SEC staff." A witness' independent desire not to testify is not evidence of improper staff conduct. In addition, Sheldon did not cross-examine this witness when he testified for the Division. C. Sheldon and Reid claim that they are the victims of selective prosecution with respect to the sale of WPPSS securities. They rely on a 1988 statement accompanying the transmission to Congress of a staff report on the collapse of WPPSS, n113 that the Commission had determined to "close its investigation into transactions in WPPSS securities without initiating any enforcement actions."n114 Thus, Sheldon and Reid claim that charging them with securities violations for the WPPSS 4 and 5 bonds transactions demonstrates selective prosecution by the Commission. The Transmittal Letter, however, clearly related to the "participants in offerings of WPPSS securities," and not, as in this case, to any activity in the secondary market in those securities.n115 In any event, to demonstrate selective prosecution, Sheldon and Reid must establish both that they were singled out for enforcement action while others who were similarly situated were not, and that the action was motivated by arbitrary or unjust considerations, such as race, religion or the desire to prevent exercise of a constitutionally-protected right.n116 They have failed to do so. Given the scope of the violations we have found and the variety of securities in which those violations occurred, the Commission's prosecution of these respondents is amply justified. D. Sheldon also charges that the attorneys he retained during the investigation phase of this matter were adversely influenced in assisting him because Rule 2(e) of our Rules of Practice authorizes this Commission to discipline professionals who appear or practice before it. He asserts that this in terrorem effect forced him to proceed pro se at the hearing stage of these proceedings and therefore deprived him of effective assistance of counsel. Nevertheless, none of Sheldon's three former attorneys, two of whom testified in these proceedings, even hinted that possible disciplinary action by this Commission influenced their representation.n117 There is nothing in the record to indicate that Sheldon's relationship with his lawyers was improperly affected by this Commission, our staff or by any authority conferred on it.n118 VIII. Public Interest. Respondents contend that the sanctions assessed by the law judge are too severe. The Division of Enforcement maintains that the sanctions imposed by the law judge on Sheldon (a bar) and Pattison (a 45-day suspension) are appropriate, but that, in light of Reid's serious misconduct, those assessed against him (a bar with the right to reapply in two years to become associated in a non-supervisory capacity) are too lenient. Reid, the Division argues, should receive an unqualified bar.n119 We agree with the staff. Accordingly, we shall affirm the sanctions imposed on Sheldon and Pattison. We further conclude that the public interest requires that Reid be barred from association with any broker or dealer. In assessing sanctions, we are guided by the factors cited by the court in Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd, 450 U.S. 91 (1981):n120 [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. A. Sheldon. Given Sheldon's serious individual misconduct and his total abdication of the responsibility that his position at the Firms imposed, an unqualified bar of Sheldon from association with any broker, dealer or municipal securities dealer is amply justified.n121 Sheldon willfully aided and abetted violations of antifraud and customer protection provisions (in connection with the Firms' use of fully-paid securities), as well as of net capital requirements, exposing the Firms' customers to financial risk. He further propounded misleading and irresponsible advertising which failed to disclose or downplayed material adverse information. This case also graphically demonstrates the mischief that can be wrought on the investing public when there is a total failure to establish or abide by the supervisory requirements imposed on the securities industry.n122 It is difficult to envision a more pervasive supervisory vacuum -- failure to establish and enforce adequate supervisory procedures, hiring inexperienced sales representatives while failing to provide them with adequate information concerning the securities in which the Firms specialized and discouraging them from performing any independent investigation of the issuers. In addition, Sheldon purposefully determined not to establish any compliance procedures at GSI. This structure allowed and effectively encouraged the broad range of serious violations found in this case. n123 While each customer ultimately received the full value of his "net equity claim" (as defined in 11 U.S.C. § 741 (6)), the customers had to wait almost a year to receive 92 percent of such claims and almost 4 years to receive the balance, and received no interest during this period. Sheldon also refuses to concede that the trustee's ability to pay out these amounts was in part due to the fact that SIPC made a $500,000 contribution to settle claims by GSI customers against SIPC. Significantly, Sheldon does not acknowledge the gravity of what his Firms did in using customers fully-paid securities to finance his operations.n124 This attitude compounds our concerns about any possible future role he might have in the securities industry. We consider the sanction imposed on Sheldon by the law judge to be fully warranted as a means of protecting public investors from any repetition of his misconduct.n125 Sheldon contends, in connection with a similar observation by the law judge, that this amounts to penalizing him for not confessing and suggests a lack of impartiality. We disagree. It is not Sheldon's refusal to concede misconduct during the course of these proceedings, but his fundamental lack of appreciation for the importance of the provisions at issue that, among other things, leads us to conclude that a bar is appropriate. Arthur Lipper Corp., 46 S.E.C. 78, 101 (1975) (failure of a respondent to recognize the magnitude of his misconduct can indicate likelihood of repeating it), rev'd on other grounds, 547 F.2d 171, 184 (2d Cir. 1976), cert. denied, 434 U.S. 1009 (1978). B. Reid. Reid asserts that his sanction should be lessened in light of his record in the securities business and claims that sanctions for markups are generally less severe and that his supervisory violations were not extreme.n126 Reid's effort to portray his numerous instances of misconduct as relatively insignificant and an aberration from an otherwise unblemished career is unpersuasive. Reid engaged in serious fraud upon his own customers in connection with sales of Cheneyville and Vanceburg securities. He compounded this fraud by attempting to disguise his actions by, in at least one instance, backdating firm records.n127 He disguised the amount of Cheneyville markups by interpositioning the accounts of favored customers between the market and the accounts of less favored customers. In addition, salesmen in the Houston office, which he was charged with supervising, repeatedly violated the antifraud and suitability provisions. As manager of that office, he encouraged salesmen on several occasions to sell securities without adequate information. He also admits that he never instructed his salesmen on their duties of disclosure. Finally, he was responsible for the charging of excessive markups by DSC. This is not the first time Reid has engaged in such misconduct. In 1979, we sanctioned Reid for charging an institutional customer excessive prices in bond transactions.n128 Yet at DSC he continued to charge excessive markups in municipal securities. Given the gravity of Reid's offenses, and particularly the fact that many of his own customers were victims of this misconduct, we believe that the protection of public investors necessitates Reid's total bar from association with any broker, dealer or municipal securities dealer.n129 Our determination of the appropriateness of Reid's sanction is based on our review of the record before the law judge (except as noted in n. 1, 49 and 91). The Division's motion to adduce additional evidence under Rule 21(d) of our Rules of Practice in the form of investigative testimony given by Reid in an unrelated matter is hereby denied in all respects. C. Pattison. Pattison violated antifraud provisions in connection with the sale of WPPSS 4 and 5 Bonds to two customers. He points to his lack of experience and inadequate supervision as reasons for reducing his sanction.n130 While his misconduct was far less significant than that of the other two respondents, it nevertheless warrants the 45-day suspension imposed by the law judge. An appropriate order will issue.n131 By the Commission (Commissioners SCHAPIRO, ROBERTS, and BEESE); Chairman BREEDEN not participating. ORDER IMPOSING REMEDIAL SANCTIONS On the basis of the Commission's opinion issued this day, it is ORDERED that Donald T. Sheldon and Bruce W. Reid be, and they hereby are, barred from association with any broker, dealer or municipal securities dealer; and it is further ORDERED that Gregory L. Pattison be, and he hereby is, suspended from being associated with a broker, dealer or municipal securities dealer for a period of 45 days. The suspension shall be effective as of the opening of business on November 30, 1992. By the Commission. To Contents    Footnotes -[n1]- Following issuance of the initial decision by the law judge, certain of the exhibits in this case were misplaced, and, despite an exhaustive search, have not been located. Consequently, we have, to the extent possible, reconstructed the missing exhibits, and hereby admit as additions to the record these reconstructed exhibits: Sheldon Exhibits D, F, I, L, M, N, P, R, S, T, U; Reid Exhibits A, D, F; and Pattison Exhibit A. -[n2]- The Commission brought proceedings against several other persons associated with the Firms. These proceedings were concluded on the basis of settlement offers accepted by the Commission and, in one case, by default. See Donald T. Sheldon (Melvin Feldman), Securities Exchange Act Rel. No. 24129 (February 24, 1987), 37 SEC Docket 1294; Donald T. Sheldon (Gary Himber), Securities Exchange Act Rel. No. 24128 (February 24, 1987), 37 SEC Docket 1292; Jonathan Smith, Securities Exchange Act Rel. No. 23375 (June 26, 1986), 35 SEC Docket 1709; Joseph H. Stafford, Securities Exchange Act Rel. No. 23366 (June 23, 1986), 35 SEC Docket 1693; Douglas J. Ebbitt, Securities Exchange Act Rel. No. 23270 (May 23, 1986), 35 SEC Docket 1313; Paul A. Steets, Securities Exchange Act Rel. No. 23271 (May 23, 1986), 35 SEC Docket 1315; Mary A. Schad, Joseph A. Jennings, Securities Exchange Act Rel. No. 23057 (March 24, 1986), Securities Investor Protection Act Rel. No. 130 (March 24, 1986), 35 SEC Docket 551. -[n3]- See n. 27, infra. -[n4]- DSC and GSI ceased retail operations at the close of business on July 26, 1985. On July 30, 1985, the Commission brought an injunctive action against the Firms and, on that date, obtained a temporary restraining order and the appointment of a temporary receiver. Subsequently, the Firms were permanently enjoined from further violations of the securities laws and a trustee was appointed for each. -[n5]- DSC also maintained an office in Honolulu. Reid briefly operated a branch office of the Firms in Memphis, Tennessee. -[n6]- Following the departure in June 1983 of the Los Angeles branch manager, Sheldon failed to appoint a successor. Eventually, a group of three salesmen took charge of the day-to-day operation of the office, but all important decisions had to be made by Sheldon who was rarely present in that office. -[n7]- For example, Sheldon admitted that, at various times, the managers of the Firms' Pompano Beach, Los Angeles, and Hawaii offices were not registered principals. -[n8]- Although some personnel appear to have been specifically assigned to DSC or GSI, the back office of both Firms was essentially a joint operation headed by Mary Schad, the Firms' financial officer, who reported to Sheldon. -[n9]- The securities were pledged to collateralize both ordinary lines of credit and "repurchase agreements." Although a repurchase agreement or "repo" is structured as a sale and repurchase of securities, it is economically equivalent to a collateralized loan. A firm, in this case GSI, receives cash in exchange for securities, subject to an agreement to repurchase the securities, by repaying subsequently an amount that exceeds the original amount. In effect the lender uses these securities as collateral for its loan. -[n10]- According to a leading commentator: -[n11]- The Firms violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, as well as Section 15(c)(1) of the Exchange Act and Rule 15c1-2 thereunder, which prohibit broker-dealers from effecting transactions in, or inducing or attempting to induce the purchase or sale of, securities by fraudulent means. DSC further violated MSRB Rule G-17 which prohibits, in the conduct of a municipal securities business, unfair dealing with customers, and deceptive, dishonest or unfair practices. -[n12]- Under Section 15(c)(3) of the Exchange Act and Rule 15c3-3 thereunder, DSC was required promptly to obtain and thereafter maintain the physical possession or control of all fully-paid securities. -[n13]- Under Section 15(c)(3) of the Securities Exchange Act of 1934 and Rule 15c3-1 thereunder, DSC was required to maintain "net capital," i.e., assets less certain deductions or "haircuts," of the greater of 6 2/3 percent of the firm's aggregate indebtedness, or $25,000. -[n14]- As of the end of its fiscal year, GSI had total assets of about five million dollars, including its roughly two million dollar receivable from Group. It also owed, at such time, approximately four million dollars in bank loans. -[n15]- Sheldon claims that Chase terminated its relationship with the Firms because of Chase's concerns about a pending Commission investigation, not the Firms' operations. While a memorandum prepared by a junior Chase employee lists the investigation as a factor to be considered by Chase in its determination whether to continue the relationship, a Chase vice president who was instrumental in making this determination did not allude to the investigation in his testimony and Sheldon did not cross-examine him on this point. -[n16]- Other failures noted by the NASD included incorrect computation of the Customer Reserve Formula and a corresponding reserve account deficiency of over half a million dollars, routine late filings of financial reports, and failure to complete customer account cards. -[n17]- We do not credit Sheldon's statement that he could not recall receiving the October 1984 NASD letter. The letter was properly addressed to Sheldon, was received by DSC in New York and its contents were important. Moreover, Sheldon indicated in testimony that he was operating out of the New York office at about the time the letter was received. He further observed that, if mail were received by an office in which he was then located, "it would be delivered to me for sure." Moreover, Sheldon did not deny receiving the February 1985 follow-up letter. -[n18]- We would disagree with Sheldon to the extent he suggests that the reason for this failure was a difficulty in removing the lien on a portion of a government security that had been pledged when customer payment was received for that portion. This explanation is not supported by the record. According to the GSI trustee's accountant, GSI "did segregate [fully-paid] securities" and it was "only from time to time that they did not segregate the securities." The facts of this case strongly suggest that it was a lack of cash, and not technical difficulties related to the handling of certificates, that caused the securities to remain under lien. Moreover, in any case where redemption of government securities after customer payment would not be feasible, it then would be improper for a firm to sell the securities to customers -- at least where no disclosure to customers was made. -[n19]- This latter case, relating to the pledge of securities pursuant to repurchase agreements, did not involve the failure to remove securities from pledge once they had become fully-paid. Instead, it involved the active step of selecting fully-paid securities as collateral for a new round of financing for the firm. -[n20]- Sheldon states that DSC instructed SEPAC to segregate customer fully-paid securities, and suggests that the failure to do so may have been the result of SEPAC's error. The record indicates, however, that the failure to segregate DSC customer securities was not the result of SEPAC's failure to follow instructions, but rather the result of DSC's lack of funds. -[n21]- Sheldon claims that the law judge gave excessive weight to the testimony of Neill who, according to Sheldon, had no experience with any government securities firm except GSI, and did not understand the mechanics of repurchase agreements. However, we find no support for the suggestion that Neill lacked the competence to assess adequately the situation. -[n22]- Sheldon also testified that around this time his operations manager, Mort Wasserman, approached him to discuss concerns Neill had raised with Wasserman over GSI's failure to segregate customer securities that had been fully paid. Sheldon claims that Wasserman told him that such segregation was not possible. Testimony by other witnesses, however, indicates that Wasserman recognized that the failure to segregate was a problem that needed to be addressed. More