U.S. Securities & Exchange Commission
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U.S. Securities and Exchange Commission

United States of America
before the
Securities and Exchange Commission

Securities Act of 1933
Release No. 8246 / June 26, 2003

Securities Exchange Act of 1934
Release No. 48096 / June 26, 2003

Administrative Proceeding File No. 3-9884


In the Matter of

Pryor, McClendon, Counts & Co., Inc.;
Raymond J. McClendon;
Allen W. Counts;
and Theresa A. Stanford,

Respondents.


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Order Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order Against Theresa A. Stanford

I.

The Commission instituted public cease-and-desist proceedings against Theresa A. Stanford ("Stanford") pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") on April 29, 1999.

II.

Stanford 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 without admitting or denying the findings contained in this order (except that Stanford admits that the Commission has jurisdiction over her and over the subject matter of these proceedings), Stanford consents to the entry of the findings and the imposition of the remedial sanctions and the cease-and-desist order set forth below.

III.

On the basis of this order and Stanford's Offer of Settlement, the Commission finds the following:1

A. FACTS

1. Respondent: Theresa A. Stanford

From 1977 until April 1999, Stanford worked for the City of Atlanta's Finance Department. During the majority of that period (from 1983 until June 1994), Stanford was the City's Investment Officer, responsible for managing the City's securities portfolio.

2. Summary

From at least March 1992 through April 1994, Stanford engaged with others in a scheme to defraud the City of Atlanta, which violated the federal securities laws. During that period, Stanford used her authority as the City of Atlanta's Investment Officer to steer to a registered broker-dealer, Pryor, McClendon, Counts & Co., Inc. ("PMC"), approximately $9.8 billion in purchases and sales by the City of zero-coupon securities issued by the United States Treasury, which are referred to as "Separate Trading of Registered Interest and Principal Securities" or STRIPS. The City's STRIPS transactions with PMC accounted for more than 90 percent of the City's STRIPS transactions during that period. Stanford virtually eliminated PMC's competition for the STRIPS business by concealing the City's STRIPS holdings from other broker-dealers. In that period, Stanford also caused the City to turn over the STRIPS portion of its securities portfolio more than eight times, and PMC received approximately $15.3 million in compensation from that activity. Throughout this period, PMC and Stanford's husband maintained a financial and business relationship that was not disclosed to the City. That relationship included a $30,000 payment that Stanford's husband received from PMC through a conduit, more than $286,000 in professional fees paid to a firm owned by Stanford's husband by PMC, and other valuable gifts.

3. The Scheme

a. Stanford Directs the City's STRIPS Business to PMC

As the City's Investment Officer, Stanford's duties and responsibilities included fielding proposals made by broker-dealers for securities transactions designed to enhance the value of the City's securities portfolio. The City maintained a list of broker-dealers with whom the City could engage in securities transactions. On a monthly basis, the City mailed to those broker-dealers a report known as a "swap report." The purpose of the swap report was to inform those broker-dealers of the City's securities holdings in order to facilitate ideas for proposed securities purchases and sales beneficial to the City.

From March 1992 to April 1994, the City's portfolio ranged from approximately $1 billion to $1.4 billion, with approximately 40 percent to 60 percent of the portfolio consisting of STRIPS. The remaining securities in the portfolio generally were other United States Treasury and agency securities. During this period, Stanford caused the City to engage in approximately $9.8 billion in STRIPS purchases and sales with PMC. All or nearly all of the City's STRIPS transactions with PMC were done at PMC's recommendation. Those STRIPS transactions with PMC accounted for approximately 92 percent of the dollar amount of all STRIPS purchased and sold by the City.

Prior to March 1992 and before the City acquired the majority of the STRIPS, Stanford instructed her assistant to delete from the swap report all references to the City's STRIPS before mailing the swap report to broker-dealers every month. Throughout the period March 1992 through April 1994, Stanford knew that the City's STRIPS did not appear on the swap report mailed to broker-dealers. She also knew that by causing the deletion of the STRIPS from the swap report, she had virtually eliminated PMC's competition for the City's STRIPS business. In addition, PMC regularly received an internal City report known as a "security recall report," which other broker-dealers did not receive. That security recall report showed all of the City's fixed-income securities holdings, including all STRIPS.

b. The Stanfords Receive Undisclosed Benefits from PMC

Beginning no later than March of 1992, Stanford and her husband, Charlie Stanford, began to receive financial benefits from PMC. In March 1992, Mr. Stanford received $30,000 from PMC, funneled through a conduit. Mr. Stanford used some of that money to capitalize, and set up office space for, his newly-formed company, Montclaire Financial Group, Inc. ("Montclaire"). From May 1992 until April 1994, PMC subcontracted substantial work to Montclaire, paying Montclaire $286,560 for services, $31,044 for expenses, and another $7,642 not designated as either. PMC's payments to Montclaire accounted for nearly all of Montclaire's revenue during that period. In addition to that revenue and the $30,000 payment, PMC gave the Stanfords two tickets to the 1993 Super Bowl and two tickets to the 1994 Super Bowl. Stanford never disclosed, and the City never learned of, the financial and other benefits that Stanford and her husband received from PMC.

c. Stanford Churns the City's STRIPS

Stanford compounded the benefits that PMC received from the scheme by churning the STRIPS portion of the City's portfolio. The City's stated investment policy was to pursue "a prudent, yet aggressive investment policy of maximizing investment income while minimizing risk" and to "hold investments until maturity." Yet from March 1992 until February 1994, Stanford and others caused the City to engage in STRIPS purchases and sales with PMC that turned over the STRIPS portion of the City's portfolio 8.6 times, or at an annual rate of 4.5 times. Stanford effected frequent trades of STRIPS back and forth, generally within a narrow range of maturities. That course of trading provided PMC with approximately $15.3 million in revenues from markups and markdowns charged on the STRIPS transactions.2 The trading, however, provided no benefit to the City, but instead materially diminished the City's investment returns, essentially through unnecessary transaction costs in the form of markups and markdowns received by PMC.3

B. LEGAL ANALYSIS

1. Stanford Engaged in a Scheme to Defraud, and Failed to Disclose Material Information to, the City

Generally, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit the use of schemes, practices or courses of business that operate as frauds, or the making of material misrepresentations or omissions, in connection with the purchase or sale of securities. Section 17(a) of the Securities Act prohibits similar conduct in the offer or sale of securities.

Stanford defrauded the City through a scheme in which she, through deceit, set aside a substantial portion of the City's securities portfolio for PMC and then funneled virtually all of the City's STRIPS business to PMC while she and her husband received undisclosed benefits from PMC. See, e.g., Superintendent of Insurance v. Bankers Life & Cas. Co., 404 U.S. 6, 12-13 (1971) ("in connection with" requirement satisfied where investor was deceived into authorizing sale of securities by misrepresentation about what would be done with proceeds, regardless of the "purity of the security transaction and the purity of the trading process"). In addition, Stanford, as the City's agent, had a duty to disclose to her principal, the City, all material facts relevant to the management of the City's securities portfolio. Jerlyn Yacht Sales, Inc. v. Wayne R. Roman Yacht Brokerage, 950 F.2d 60, 68 n.14 (1st Cir. 1991); Restatement (Second) of Agency § 390, Comment a.4 Stanford breached her duty by failing to disclose the following material facts: She and her husband received $30,000 and other benefits from PMC. Her husband had an ongoing business and financial relationship with PMC. She was eliminating competition for the City's STRIPS business by effectively setting aside the business for PMC. Basic v. Levinson, 485 U.S. 224, 231-32 (1988) (quoting TSC Industries v. Northway, Inc., 426 U.S. 438, 449 (1976)) (An undisclosed fact is material if there is "a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available."). Stanford knew, or was reckless in not knowing, that setting aside through deceit the City's STRIPS business for PMC defrauded the City. Stanford also knew, or was reckless in not knowing, that her husband's ongoing, undisclosed business and financial relationship with PMC and her and her husband's receipt of money and other benefits from PMC created a conflict of interest material to the City. Based on the foregoing, Stanford violated Section 10(b) of the Exchange Act and Rule 10b-5 and Section 17(a) of the Securities Act.

2. Churning

Stanford also violated the antifraud provisions of the federal securities laws by churning the STRIPS portion of the City's portfolio. Churning refers to excessive turnover in a controlled account for the purpose of increasing the amount of compensation received by the broker-dealer. See, e.g., Armstrong v. McAlpin, 699 F.2d 79, 90 (2d Cir. 1983). Proof of churning requires a showing (1) that the churner had either explicit or de facto control over trading in the account, (2) that trading in the account was excessive in light of the investor's objectives, and (3) that the churner acted with scienter. See, e.g., Miley v. Oppenheimer & Co., 637 F.2d 318, 324 (5th Cir. 1981); In the Matter of Donald A. Roche, Exchange Act Rel. No. 38742 (June 17, 1997).

Churning typically involves a violation by a broker-dealer or its associated persons. However, when an investor has an agent making its investment decisions, the agent is a "potential churner." Armstrong, 699 F.2d at 90; Ruiz v. Charles Schwab & Co., 736 F. Supp. 461, 462-63 (S.D.N.Y. 1990). For purposes of churning analysis, Stanford controlled the City's securities portfolio because the City authorized her to engage in securities transactions on its behalf.

When trading exceeds the customer's investment objectives in a controlled account, churning is established. No bright-line rule establishes whether any particular turnover rate is per se excessive. However, annual turnover rates above three times are frequently found excessive. See, e.g., In the Matter of Laurie Jones Canady, Exchange Act Rel. No. 41250 (April 5, 1999) (turnover rates ranging from 3.83 to 7.28 times held excessive); In the Matter of Donald A. Roche, supra (turnover rates of 3.3, 4.6, and 7.2 times held excessive); In the Matter of Gerald E. Donnelly, Exchange Act Rel. No. 36690 (Jan. 5, 1996) (turnover rates ranging from 3.1 to 3.8 times held excessive) In the Matter of the Application of John M. Reynolds, Exchange Act Rel. No. 30036 (Dec. 4, 1991) (turnover rate of 4.81 times held excessive).

Stanford caused the City to turn over the STRIPS in its portfolio at an annual rate of approximately 4.5 times. That rate of turnover exceeded the rate of turnover that Stanford's portfolio management produced in the rest of the portfolio and also exceeded the turnover expectations of the City. Moreover, that trading was inconsistent with the City's stated policy of "maximizing investment income while minimizing risk." The frequent trading of STRIPS back and forth within a narrow range of maturities diminished the City's investment returns, principally because of the transaction costs in the form of markups and markdowns received by PMC. See, e.g., In the Matter of Russell Irish, 42 S.E.C. 735 (1965) (frequent switching back and forth between mutual funds or between different series in the same mutual fund held excessive). Stanford knew or was reckless in not knowing that the turnover she caused in the City's accounts was inconsistent with the City's investment objectives, provided no benefit to the City, and generated revenue for PMC at the City's expense by diminishing the City's investment returns.

IV.

Based on the foregoing, the Commission finds that Stanford violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.

V.

In view of the foregoing, the Commission finds that it is appropriate to impose the relief agreed to in Stanford's offer. Accordingly, it is hereby ordered, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, that:

Stanford cease and desist from committing or causing any violations, and any future violations, of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.

By the Commission.

Jonathan G. Katz
Secretary

Endnotes

1 The findings herein are made pursuant to Stanford's offer of settlement and are not binding on any other person or entity in these or any other proceedings.

2 When a broker-dealer acts as a principal rather than agent in a securities transaction with a customer, instead of charging a commission, the broker-dealer receives compensation for the transaction by adding a markup to the prevailing wholesale market price of the security in a sale to the customer; or subtracting a markdown from the prevailing wholesale market price in a purchase from the customer. In re Lehman Bros. Inc., Exchange Act Release No. 37673 (Sept. 12, 1996), 62 SEC Dkt. 2324, 2330.

3 For example, on March 12, 1993, the City's general pension fund held a particular STRIPS security that had a market value that day of $27,389,030. Through a series of STRIPS-for-STRIPS exchanges or "swaps," Stanford caused the City to turn that investment over six times in 194 days, ending with a STRIPS security that had a market value of $27,525,520, on September 22, 1993. The City received $136,490 in total return from these exchanges, which translates to an annual rate of return of less than 1 percent. However, to effect this series of swaps, the City paid transaction costs to PMC (in the form of markups and markdowns) totaling $491,776-more than 3½ times the City's total return from those swaps.

4 In addition, the Atlanta City Code and Finance Department guidelines both prohibited Stanford from directing to PMC any securities business from the City. Section 2-812 of the Atlanta City Code provides that if a member of a City employee's immediate family is negotiating or seeking a business or professional relationship with a business entity, then the City employee may not participate in any decision-making related to any City contract in which the business entity has a financial interest. In addition, the Finance Department's investment manual included ethics provisions that prohibited any private dealings between the Investment Officer or her close relatives and any firm from or to which the City purchased or sold securities. The manual also required that Stanford make quarterly disclosure of any "entertainment, gifts, or other items of monetary value" that she received from anyone employed by such a firm.

 

http://www.sec.gov/litigation/admin/33-8246.htm


Modified: 06/26/2003