UNITED STATES OF AMERICA
|In the Matter of
LESLIE E. ROSSELLO
|ORDER INSTITUTING PUBLIC PROCEEDINGS
PURSUANT TO SECTION 8A OF THE SECURI-
TIES ACT OF 1933 AND SECTIONS 15(b), 19(h)
AND 21C OF THE SECURITIES EXCHANGE
ACT OF 1934, MAKING FINDINGS, IMPOSING
REMEDIAL SANCTIONS AND MONETARY
PENALTIES, AND IMPOSING CEASE-AND-
The Securities and Exchange Commission ("Commission") deems it appropriate in the public interest and for the protection of investors that public administrative and cease-and-desist proceedings be instituted against Leslie E. Rossello ("Rossello") pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Sections 15(b), 19(h), and 21C of the Securities Exchange Act of 1934 ("Exchange Act"). In anticipation of the institution of these proceedings, Rossello has submitted an Offer of Settlement, which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and prior to a hearing pursuant to the Commission's Rules of Practice, 17 C.F.R. § 201.100 et seq., Rossello, by her Offer of Settlement, admits the jurisdiction of the Commission over her and the subject matter of these proceedings and consents to the entry of this Order Instituting Public Proceedings, Making Findings, Imposing Remedial Sanctions and Monetary Penalties, and Imposing Cease-and-Desist Order without admitting or denying the Commission's findings except for those contained in Section III.A., which are admitted.
Accordingly, IT IS HEREBY ORDERED that proceedings pursuant to Section 8A of the Securities Act and Sections 15(b), 19(h) and 21C of the Exchange Act be, and hereby are, instituted.
On the Basis of this Order and Rossello's Offer of Settlement, the Commission finds the following:
Rossello was, at all times relevant to this proceeding, a registered representative in the Atlanta, Georgia branch office of a registered broker-dealer. Rossello was employed by the broker-dealer from October 1984 until June 1998, at which time she voluntarily resigned. During her tenure, she was not the subject of any customer complaints. For the relevant period, Rossello maintained about 1500 accounts on behalf of customers.
B. MUTUAL FUND SWITCHING
On forty-eight different occasions, from March 1994 through November 1996, Rossello recommended to seven customer accounts that following the sale of shares of one mutual fund, the proceeds be used to buy shares of another fund from a different fund family. As a result of these transactions, Rossello's customers incurred approximately $157,000 in contingent deferred sales charges ("CDSCs")1 and front-end load fees.2 The average time that Rossello's customers held the funds that she switched in these transactions was eight months; some funds were held for only two months before being switched. By switching from a mutual fund in one family of funds to a fund in another mutual fund family, the commissions Rossello and the broker-dealer received were increased. A number of these switches were between funds with identical or very similar investment objectives. If Rossello had advised those customers to transfer their investments to a different fund in the same family of mutual funds, Rossello and the broker-dealer would have received little or no compensation.
Several of the transactions exhibit a circular switching pattern, where Rossello's customers engaged in a series of mutual fund switches incurring thousands of dollars of CDSCs and front-end load fees, only to later buy back into the same mutual funds that they sold in the first instance. In one example of such switching circularity, an eighty-nine-year-old investor, within a two and a half year period, switched from fund A to fund B, redeemed more shares of fund A to buy fund C, then switched from fund C to fund B, redeemed the shares of fund B to switch back to fund A, switched next to fund D, then to fund E, back to fund D, and finally switched back to fund A again.
C. MISREPRESENTATIONS AND OMISSIONS
Rossello initiated most, if not all, of the mutual fund switches. In these transactions, she always recommended the funds that her customers purchased with the proceeds from the funds they sold. Rossello on occasion verbally failed to inform several customers about the correct amount of the CDSCs that would be incurred when certain mutual funds were sold, although these were reflected in trade confirmations subsequently sent by the broker-dealer. Rossello did not disclose to her customers that they had the option of exchanging their fund shares at little or no cost to another fund in the same family.
Letters sent by Rossello to certain of her customers seeking approval of these switch transactions contained misleading or incorrect information. Rossello marked many of these switch transactions "unsolicited," although the mutual funds out of and into which the client switched were recommended by Rossello. A majority of the misstatements contained in the switch letters involved Rossello's material understatement by thousands of dollars, and in two instances by as much as $5,000, of the CDSCs incurred by her customers. A few overstated the CDSCs. On occasion, the switch letters incorrectly stated that the customers incurred front-end sales charges when they purchased the funds when, in fact, they incurred CDSCs on sales of the funds. Rossello represented that several customers' mutual fund switches were motivated by tax reasons. However, tax considerations played no role in these customers being convinced by Rossello to follow her switch recommendations.
D. UNSUITABLE TRANSACTIONS
Rossello knew that mutual funds are generally long-term investments and not suitable for short-term trading. Rossello also knew that the funds her customers sold after short holding periods were part of large fund families and thus their shares could have been exchanged for those of other funds within the same families at little or no cost. Rossello's customers relied on her advice, and routinely followed her recommendations. Rossello failed to disclose the unsuitable nature of these transactions to her customers.
E. LEGAL DISCUSSION
1. Mutual Fund Switching
Section 17(a) of the Securities Act, which proscribes fraudulent conduct in the offer or sale of securities, and Section 10(b) of the Exchange Act and Rule l0b-5 thereunder, which proscribe fraudulent conduct in connection with the purchase or sale of securities, prohibit essentially the same type of conduct. See United States v. Naftalin, 441 U.S. 768, 773 n.4 (1979). To prove violations of Sections 17(a)(1) and 10(b) and Rule 10b-5, the Commission must show that the defendants acted with scienter, Aaron v. SEC, 446 U.S. 680, 691 (1980), and that any misrepresentations or omissions were material. Basic, Inc. v. Levinson, 485 U.S. 224, 238 (1988); TSC Indus. v. Northway, Inc., 426 U.S. 438, 449 (1976).
Mutual fund switching involves "liquidat[ing] holdings of investment company shares and us[ing] the proceeds to purchase shares of various other investment companies." Charles E. Marland & Co., Inc., 45 S.E.C. 632, 634 n.6 (1974). Mutual fund switching violates the antifraud provisions of the federal securities laws when registered representatives, in order to increase their compensation, induce investors to incur the costs associated with redeeming shares of one mutual fund and purchasing the shares of another fund and the benefit to the customer does not justify those costs. See Russell L. Irish, 42 S.E.C. 735, 736-40 (1965), aff'd, Irish v. SEC, 367 F.2d 637 (9th Cir. 1966), cert. denied, 386 U.S. 911 (1967). "In switches from one [mutual fund] to another . . . the very diversification of the trust portfolios decrease[s] the likelihood that any marketwise benefit [will] be gained by the customers, since they [are] continuously in the market, yet repeatedly paying substantial selling loads." Thomas Arthur Stewart, 20 S.E.C. 196, 201-202 (1945); Irish, 42 S.E.C. at 739. Even where each customer signs a form "stating that in connection with his sale of specified fund shares he understands that there was a sales charge applicable to his purchase of other specified shares," mutual fund switching can be improper. Charles E. Marland & Co., 45 S.E.C. at 635.
Rossello willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder when she induced the switches discussed above for her benefit rather than that of her customers. Although Rossello's customers had the option of exchanging their investment to a similar fund in the same mutual fund family at little or no cost, they paid sales charges to switch outside of the fund family because Rossello, in whom they had placed great trust, recommended that they do so. Those recommendations resulted in switches which generated additional commissions for Rossello and the broker-dealer.
2. Misrepresentations And Omissions Of Material Facts
Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 also make it unlawful to make any untrue statement of material fact or omit to state material facts in the offer or sale, or purchase or sale, respectively, of securities which are necessary to make the statements made not misleading. A fact is material if there is a substantial likelihood that a reasonable investor would consider the information to be important. Basic, Inc. v. Levinson, 485 U.S. at 231-32. "To the extent there are sales charges associated with such a purchase or sale [of mutual funds], such as contingent deferred sales charges on either the fund to be liquidated or the fund to be purchased, members should discuss with the customer the effect of those charges on the anticipated return on investment." NASD Reminds Members of Mutual Fund Sales Practice Obligations, Notice to Members 94-16 (Mar. 1994).
Rossello routinely failed to discuss with her customers the effect of the cost of the switch on anticipated returns. Several customers were not told of the correct amount of the CDSC associated with the sale of the fund they were switching from or, in some instances, that they would even incur a CDSC, although CDSCs were subsequently reflected in trading confirmations. Rossello did not tell customers that they could have exchanged their investment to a fund in the same mutual fund family at little or no cost. Rossello, who personally signed the switch letters, sent many of her customers switch letters containing incorrect information about the percentage and dollar amount of the CDSC incurred.
The misrepresented and omitted facts may be deemed material and may have been important to a reasonable investor. Reasonable investors consider the cost of the transactions an important fact in their deliberations. Thus, Rossello misrepresented or omitted material facts when she failed to disclose that these customers would pay CDSCs, misstated or failed to disclose the amount of the CDSCs, and failed to disclose that they could have switched to a comparable fund at no cost.
3. Unsuitable Recommendations
Mutual fund shares generally are suitable only as long-term investments and cannot be regarded as a proper vehicle for short-term trading, especially where such trading involves new sales loads . . . . Where . . . a pattern of similar switching transactions in fund shares is established, it is incumbent upon the person responsible to demonstrate the unusual circumstances which justified such a clear departure from the manner in which investments in mutual funds are normally made.
Kenneth C. Krull, Exchange Act Rel. No. 40768, 68 SEC Docket 2324, 2329 (Dec. 10, 1998) (quoting Winston H. Kinderdick, 46 S.E.C. 636, 639 (1976)), reconsideration denied, Exchange Act Rel. No. 41008, 69 SEC Docket 60 (Feb. 1, 1999), appeal pending, Case No. 99-70290 (9th Cir. 1999).
In Kinderdick, the Commission further concluded that "[a] pattern of switches from one fund to another by several customers of a registered representative, where there is no indication of a change in the investment objectives of the customers and where new sales loads are incurred, is not reconcilable with the concept of suitability." Kinderdick, 46 S.E.C. at 639.
Rossello recommended that these customers sell their shares of one fund and purchase shares of another fund. The average length of time that these seven customer accounts held any fund position from March 1994 to November 1996 before it was switched was approximately eight months. The vast majority of the switches recommended by Rossello were to funds with similar investment objectives. Rossello's customers incurred sales loads every time they switched into another mutual fund because of Rossello's recommendations. Every fund that Rossello's customers sold was part of a large fund family, and therefore their investments could have been switched into another fund (although not always a similar objective) within that family at little or no cost.
Making unsuitable recommendations to customers without disclosing the unsuitability of those solicited investments, in breach of an affirmative duty to disclose arising from a fiduciary or similar relationship of trust and confidence, violates Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. See Brown v. E.F. Hutton Group, Inc., 991 F.2d 1020, 1031 (2nd Cir. 1993); see also National Union Fire Ins. Co. v. Woodhead, 917 F.2d 752, 757 (2d. Cir. 1990).
Rossello owed a fiduciary duty to her customers. Her customers relied on her advice and routinely followed her recommendations. Rossello had an affirmative duty to disclose the unsuitable nature of the frequency of these particular mutual fund switches to her customers. See Davis v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 906 F.2d 1206 (1214-17 (8th Cir. 1990); Gochnauer v. A.G. Edwards & Sons, Inc., 810 F.2d 1042, 1049 (11th Cir. 1987).
On the basis of this Order and Rossello's Offer of Settlement, the Commission finds that Rossello willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and Section 17(a) of the Securities Act of 1933 ("Securities Act").
ACCORDINGLY, IT IS ORDERED that:
By the Commission.
Jonathan G. Katz
|1||"B" class shares of a mutual fund are sold to investors without a front-end load fee; however, an investor generally must pay a CDSC if he or she redeems the shares within five years. CDSCs are usually incurred at the rate of 5% of the dollar value of shares redeemed within one year of purchase and decline one percentage point each year thereafter. The CDSC is retained by the mutual fund to offset the commission paid to the broker when the fund was sold.|
|2||Front-end load fees are sales charges applied upon the purchase of a load mutual fund. A broker's commission is paid out of the front-end load fee.|
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