UNITED STATES OF AMERICA
In the Matter of
Financial Asset Management, Inc.,
James B. Rader and Debra L.
|ORDER INSTITUTING PROCEEDINGS, MAKING FINDINGS, AND IMPOSING A CEASE-AND-DESIST ORDER|
The Commission deems it appropriate to institute public administrative proceedings pursuant to Section 8A of the Securities Act of 1933 ("Securities Act"), Section 21C of the Securities Exchange Act of 1934 ("Exchange Act"), and Section 203(k) of the Investment Advisers Act of 1940 ("Advisers Act") against Financial Asset Management, Inc., James B. Rader and Debra L. Kennedy (collectively, "Respondents"), and such proceedings are hereby instituted.
In anticipation of the institution of these proceedings, each of the Respondents has submitted an Offer of Settlement that the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceeding brought by or on behalf of the Commission or in 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., each of the Respondents, without admitting or denying the findings contained herein, except that each of the Respondents admits to the jurisdiction of the Commission over it or him/her and over the subject matter of these proceedings, consents to the issuance of this Order.
The Commission makes the following findings:
Financial Asset Management, Inc. ("FAM") is registered with the Commission as a broker- dealer pursuant to Section 15(b) of the Exchange Act. FAM has its principal office in Columbus, Ohio.
James B. Rader, age 56, resides in Columbus, Ohio and is the owner and President of FAM. Mr. Rader holds Series 7 and Series 24 securities licenses.
Debra L. Kennedy, age 49, resides in Columbus, Ohio and is the Vice President, Treasurer and Secretary of FAM. Ms. Kennedy holds Series 7 and Series 53 securities licenses.
B. The Commission's Related Securities Fraud Case
On January 18, 2000, the Commission filed a securities fraud lawsuit in the United States District Court for the Southern District of New York against Manhattan Investment Fund Ltd. ("the Fund"), Manhattan Capital Management, Inc. ("MCM"), and Michael W. Berger.1 The Fund, based in the British Virgin Islands, was an unregistered hedge fund that began operations in 1996. MCM, based in New York City, was the Fund's investment adviser. Berger, an Austrian citizen living in New York City, owned and operated MCM.
The Commission's lawsuit charged Berger, MCM, and the Fund (collectively referred to hereinafter as "the Defendants") with fraud in violation of Securities Act Section 17(a), Exchange Act Section 10(b) and Rule 10b-5 thereunder. It also charged Berger and MCM with fraud in violation of Advisers Act Section 206(1) and (2). As alleged in the Commission's complaint, between 1996 and January 2000, the Defendants raised over $593 million from approximately 280 investors by grossly overstating the investment performance and market value of the Fund's holdings. Among other things,Berger created phony account statements that portrayed the Fund as profitable, with hundreds of millions of dollars in assets in an account at FAM, the Fund's executing broker. In reality, the Fund held no assets at FAM, and had lost in excess of $394 million of investors' money during the late 1990s through an investment strategy centered on the short-selling of Internet stocks.
C. FAM's Relationship With the Fund
Throughout the relevant period, Berger had a close professional and personal relationship with Respondent James Rader, and the Fund maintained a brokerage account at FAM. By virtue of its role as an executing broker for the Fund, FAM collected substantial commission income from the Fund's trades. In fact, between 1996 and 1999, the commissions generated by the Fund's trades accounted for at least 10-33% of FAM's annual revenues.
As an executing broker, FAM never held any of the Fund's securities or other assets, nor did it generate any account statements for the Fund. During the relevant period, all the transactions of the Fund were cleared through Bear Stearns Securities Corporation in New York City. Bear Stearns held the vast majority of the Fund's cash and securities, and generated the only genuine monthly account statements and daily trading summaries for the Fund.
As part of his ongoing fraud, Berger falsely represented to the Fund's administrator, the Fund's auditor, and the Fund's investors that FAM held the vast majority of the Fund's cash and securities. Berger also fabricated phony account statements purportedly from FAM, which detailed the fictitious trading the Fund was supposedly conducting through FAM.
D. The Respondents' Unlawful Conduct
1. Contributing to Berger's Scheme to Mislead the Fund's Auditors
The Fund engaged Deloitte and Touche (Bermuda) ("Deloitte") to audit its financial statements for the years ended December 31, 1996, 1997 and 1998. Each year, as part of its audit process, Deloitte, through the Fund's administrator, Fund Administration Services (Bermuda) Limited (the "Fund administrator"),2 sent audit confirmation requests to FAM. Debra Kennedy responded to these requests on behalf of FAM. Each request sought a list of any investments that the Fund held at FAM, and requested FAM to furnish its response to Deloitte.
In each of the three years in question, just before the audit confirmation letters were sent out, Berger requested that Kennedy send FAM's responsive information directly to him, rather than to Deloitte, because he was purportedly "collecting responses" for the auditors. Notwithstanding the unusual nature of Berger's request, and without consulting Deloitte about its propriety, Kennedy complied with Berger'srequest. Thus, each year Kennedy, with Rader's approval, prepared cover letters on FAM letterhead addressed to Deloitte, attached copies of the requested Fund account statements that FAM had received from Bear Stearns, and forwarded the package to Berger without any notification to Deloitte.
This circumvention of the audit confirmation process, in addition to the acts discussed below, made it possible for Berger to perpetrate his fraudulent scheme. Each year, upon receipt of FAM's audit response package, Berger removed the attached Bear Stearns account statements, substituted fictitious year-end account statements designed to appear as if generated by FAM, and sent them (sometimes via facsimile from a fax machine reprogrammed to appear to be from FAM) to Deloitte. In two of the three years in question, the fictitious year-end account statements were sent along with a forged cover letter purportedly coming from Kennedy. One year, a FAM employee provided Berger with an Airborne Express envelope addressed to Deloitte (which Berger used to send the fictitious FAM statements) that inaccurately showed FAM in Ohio as the sender/return addressee of the envelope.
The fabricated FAM account statements materially overstated the assets and investment performance of the Fund. In reliance on these statements, Deloitte issued unqualified audit reports on the Fund's financial statements for its 1996, 1997 and 1998 fiscal years. These audited financial statements were erroneous and misleading and were sent to investors in the Fund. Had the Respondents sent FAM's audit confirmation responses directly to Deloitte in any of the three years in question, Berger's fraudulent scheme would likely have been instantly exposed.
2. Contributing to Berger's Scheme to Mislead the Fund's Administrator
In addition to undermining the audit process for the Fund, FAM's propinquity to Berger made it possible for Berger to mislead the Fund administrator. In May 1999, an employee of the Fund administrator requested that Kennedy provide him with a copy of the Fund's "portfolio valuation" as of April 30, 1999. Kennedy knew that FAM, as the Fund's executing broker, did not prepare or maintain any such documents, which would ordinarily be generated by the Fund's clearing broker, Bear Stearns. Nevertheless, without inquiring why the employee of the Fund administrator would direct such a request to FAM rather than to Bear Stearns, or telling the employee that FAM did not prepare portfolio valuations for the Fund, Kennedy simply assured the employee that she would "take care of it." Kennedy then forwarded the request to Berger, making it possible for Berger to continue his fraud.
After Kennedy forwarded the Fund administrator's request to Berger, Berger prepared a fictitious portfolio valuation, designed to appear as if generated by FAM, and faxed it to the Fund administrator. In doing so, moreover, Berger reprogrammed his fax machine to make it appear as if the fabricated portfolio valuation was being sent directly from FAM. Berger's fictitious portfolio valuation materially overstated the assets and performance of the Fund.
Later the same month, Kennedy received a fax from the same employee of the Fund administrator, thanking her for providing the portfolio valuation and requesting her to arrange to have a schedule of the Fund's purchases and sales of securities (for the period from January 1, 1999 through April 30, 1999) forwarded to the Fund administrator. Again, Kennedy knew that FAM did not prepare or maintain such schedules, and she knew that she had not previously sent the Fund administrator any portfolio valuations for the Fund. Nevertheless, without disclosing to the Fund administrator that the portfolio valuation hadin fact come from some source other than FAM, and without suggesting that the Fund administrator direct its requests to Bear Stearns as clearing broker, Kennedy, with Rader's knowledge and approval, forwarded the Fund administrator's request to Berger, making it possible for Berger to again mislead the Fund administrator.
After Kennedy forwarded to Berger this request from the Fund administrator, Berger created a fictitious schedule of the requested information, again designed to appear as if generated by FAM, and faxed it from his reprogrammed fax machine so that it appeared as if sent directly from FAM. This fictitious schedule of the Fund's purchases and sales materially overstated the Fund's assets and performance.
By simply forwarding the Fund administrator's requests to Berger, without any further inquiry and without any disclosure to the Fund administrator that FAM itself did not prepare or maintain the types of documents being requested, the Respondents made it possible for Berger to perpetrate his fraudulent scheme. Had Kennedy and Rader disclosed to the Fund administrator that FAM was merely the firm's executing broker, and suggested that the Fund administrator contact Bear Stearns for the requested information, Berger's fraud would likely have become apparent to the Fund administrator.
3. Misrepresentations About Custodial Services
On January 4, 2000, as Berger's scheme was unraveling, Berger drafted a facsimile for FAM to send to the Fund administrator. The facsimile included language stating: "FAM provides custodial services to Manhattan Investment Fund, Limited." The facsimile also stated that FAM provides "Monthly statements showing position details and schedules of Realized Gains and Losses [to the Fund administrator]." That same day, at Berger's request, Rader signed the facsimile and sent it to the Fund administrator.
Berger's irregular request was another indication that Berger was perpetrating a fraudulent scheme. Rader knew that FAM was not the Fund's custodial broker and never directly provided "monthly statements showing position details and schedules of realized gains and losses" to the Fund administrator, yet he sent the facsimile anyway. Prior to sending the facsimile, Rader never questioned Berger as to the basis of the facsimile, nor did he ask Berger why he shouldn't represent that Bear Stearns, the Fund's actual custodial broker, provided custodial services to the Fund. Rader also never inquired with Bear Stearns as to whether he could make these "custodial services" representations to the Fund administrator. Moreover, Rader sent the facsimile despite the fact that he had engaged in previous conversations with individuals at Bear Stearns and Deloitte as recently as late December 1999 concerning questions those firms had about Berger and the Fund's practices.
Rader's facsimile contributed to the deception created by Berger that FAM was the Fund's custodial broker, and that FAM provided monthly statements showing realized gains and losses to the Fund administrator. The facsimile enabled Berger to continue to misrepresent to the Fund administrator and the Fund's investors that the FAM statements accurately reflected the assets and investment performance ofthe Fund.3
E. Legal Analysis
Securities Act Section 8A, Exchange Act Section 21C and Advisers Act Section 203(k) authorize the Commission to issue cease-and-desist orders against those who "cause" others to violate the federal securities laws. A person is a "cause" of another's violation if the person "knew or should have known" that his or her act or omission would contribute to such a violation. See Securities Act Section 8A; Exchange Act Section 21C; Advisers Act Section 203(k).
Here, as described in detail above, FAM, Kennedy and Rader repeatedly took steps that contributed to the fraudulent scheme perpetrated by Berger. For example, they failed to comply with unambiguous requests to transmit FAM's audit confirmation responses to Deloitte in Bermuda. Instead, Kennedy and Rader, per Berger's request, followed the unusual procedure of forwarding FAM's responses to Berger. The Commission has stated that "the confirmation procedure is an integral and vital part of the auditing process. Subversion of the process corrupts the integrity of the audit and can injure investors by facilitating the injection of false financial information into the marketplace." In the Matter of Troy Lee Wood, 1996 SEC LEXIS 3050, **9-10, Exchange Act. Rel. No. 37905 (Oct. 31, 1996) (internal citations omitted). By forwarding FAM's audit confirmation responses to Berger, Kennedy and Rader undermined the audit process and made it possible for Berger to perpetrate his fraudulent scheme.
Kennedy and Rader also helped Berger perpetrate the mistaken impression, held by the Fund administrator, that FAM generated portfolio valuations, purchase and sale schedules and other financial documents for the Fund. Kennedy's and Rader's delegation of the Fund administrator's document requests to Berger, and corresponding failure to inquire further with the Fund administrator concerning the basis of its requests for Fund account documents, made it possible for Berger to perpetrate his fraudulent scheme.
Lastly, Rader's facsimile of January 4, 2000 to the Fund administrator perpetuated the false impression that FAM was the Fund's custodial broker, and that FAM provided monthly statements showing realized gains and losses to the Fund administrator. The facsimile made it possible for Berger to continue to misrepresent to the Fund administrator, Deloitte, and the Fund's investors that the forged FAM statements that he created accurately reflected the assets and investment performance of the Fund.
As principal officers of FAM, Rader and Kennedy at all times acted within the scope of their employment. Consequently, their acts are attributable to FAM. Therefore, for the reasons stated above, the Respondents should be deemed a "cause" of the Defendants' fraud violations, within the meaning of Securities Act Section 8A, Exchange Act Section 21C and Advisers Act Section 203(k).
In any cease-and-desist proceeding, the Commission is authorized to order a respondent to disgorge any unlawful gains, with interest. See Securities Act Section 8A(e); Exchange Act Section21C(e); Advisers Act Section 203(k)(5). As a result of its conduct, FAM received approximately $641,877 in commissions from the Fund's trades, and it should be ordered to disgorge those commissions in order to deprive it of its unjust enrichment.
Based upon the foregoing, the Commission finds that:
A. FAM, Rader and Kennedy were causes, within the meaning of Securities Act Section 8A, Exchange Act Section 21C and Advisers Act Section 203(k), of violations by Berger, MCM and the Fund, of Securities Act Section 17(a), Exchange Act Section 10(b) and Rule 10b-5 thereunder, and Advisers Act Section 206(1) and 206(2); and
B. FAM has submitted a sworn Statement of Financial Condition dated June 18, 2001 and other evidence and has asserted its financial inability to pay disgorgement plus prejudgment interest. The Commission has reviewed the sworn financial statement and other evidence presented by FAM, and has determined that FAM does not have the financial ability to pay disgorgement in excess of $25,000.
In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offers of Settlement submitted by FAM, Rader and Kennedy.
Accordingly, IT IS HEREBY ORDERED, pursuant to Securities Act Section 8A, Exchange Act Section 21C and Advisers Act Section 203(k):
A. That FAM, Rader and Kennedy cease and desist from causing any violations of, and any future violations of, Securities Act Section 17(a), Exchange Act Section 10(b) and Rule 10b-5 thereunder, and Advisers Act Section 206(1) and (2), by another person or entity;
B. That within 10 days of the entry of this Order, FAM shall pay disgorgement in the amount of $641,877 plus prejudgment interest, but that payment of all amounts in excess of $25,000 be waived based upon FAM's sworn representations in its Statement of Financial Condition dated June 18, 2001 and other documents submitted to the Commission. Such payment shall be (a) made by United States postal money order, certified check, bank cashier's check or bank money order; (b) made payable to the Securities and Exchange Commission; (c) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (d) submitted under cover letter that identifies FAM as a Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Russell G. Ryan, Assistant Director, Division of Enforcement, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C.20549-0806; and
C. That the Division of Enforcement ("Division") may, at any time following the entry of this Order, petition the Commission to: (1) reopen this matter to consider whether FAM provided accurate and complete financial information at the time such representations were made; and (2) seek an order directing payment of disgorgement and prejudgment interest. No other issue shall be considered in connection with this petition other than whether the financial information provided by FAM was fraudulent, misleading, inaccurate or incomplete in any material respect. FAM may not, by way of defense to any such petition: (1) contest the findings in this Order; (2) assert that payment of disgorgement and interest should not be ordered; (3) contest the amount of disgorgement and interest to be ordered; or (4) assert any defense to liability or remedy, including, but not limited to, statute of limitations defense.
By the Commission.
Jonathan G. Katz
|1||SEC v. Michael Berger, Manhattan Investment Fund Ltd., and Manhattan Capital Management, Inc., No. 00 Civ. 0333 (DLC) (HP) (S.D.N.Y.). Upon filing its case, the Commission sought and obtained a temporary restraining order, an asset freeze, and the appointment of a receiver to take control of the Fund and its remaining assets. See Litigation Release Nos. 16412 (Jan. 19, 2000) and 16414 (Jan. 20, 2000). The case is still pending.|
|2||The Fund administrator performed various administrative functions for the Fund, including calculating the net asset value ("NAV") of the Fund, reporting the NAV directly to investors on a monthly basis, and providing information to the Fund's auditors in connection with its audits of the Fund's annual financial statements.|
|3||In fact, between January 4, 2000 and January 18, 2000 (the day the Commission filed its action against the Defendants), the Fund received an additional $1.35 million from investors.|
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