SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 39057 / September 11, 1997 Admin. Proc. File No. 3-9174 : In the Matter of the Application of : : MONROE PARKER SECURITIES, INC. : 2500 Westchester Avenue : Purchase, New York 10577 : : For Review of Denial of Access by the : : NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.: : OPINION OF THE COMMISSION REGISTERED SECURITIES ASSOCIATION -- REVIEW OF DENIAL OF ACCESS Request to Amend Restrictive Agreement Registered securities association denied member's request to have restrictive agreement modified to increase the number of firm's registered representatives from 75 to 175. Association further denied firm's request to expand the number of issuers of securities in which the firm was authorized to make markets from 10 to 25. Association articulated a clear basis for denying only the increase in number of registered representatives. Held, appeal dismissed in part and remanded in part. APPEARANCES: Bill T. Singer, Jenice L. Malecki, Vincent P. Liberti, and David H. Jarvis, of Singer Zamansky, LLP, for Monroe Parker Securities, Inc. Alden S. Adkins and Norman Sue, Jr., for NASD Regulation, Inc. Appeal Filed: October 22, 1996 Briefing Completed: February 28, 1997 I. Monroe Parker Securities, Inc. ("Monroe Parker" or the "Firm"), a member of the National Association of Securities Dealers, Inc. ("NASD"), has applied for review of a decision by the NASD, dated October 8, 1996. The NASD denied Monroe Parker's request to modify the terms of its restrictive agreement to permit the Firm to expand the number of its registered representatives from 75 to 175 and the number of issuers of securities in which it was authorized to make markets from 10 to 25. Our findings are based on an independent review of the record. II. Monroe Parker has been conducting business as a broker-dealer since 1994. The NASD conditioned its approval of Monroe Parker's membership application on the Firm's entering into a restrictive agreement limiting to 75 the number of registered representatives engaged in sales and trading activities and to 10 the number of issuers of securities in which Monroe Parker could make markets. In April 1995, a year after joining the NASD, Monroe Parker applied for permission to increase the scope of its operations. Monroe Parker sought to increase to 175 the number of registered representatives engaged in sales and trading and to 25 the number of issuers of securities in which it could make markets. <(1)> The NASD Restrictive Agreement Subcommittee ("RAS") initially denied the application. <(2)> Thereafter, NASD staff and Monroe Parker unsuccessfully attempted to negotiate a resolution of Monroe Parker's requests. During this period, the RAS also requested additional information from the Firm. <(3)> On December 27, 1995, the RAS again denied the request for modification because it was concerned that Monroe Parker was not adequately supervising its staff. The RAS identified three areas of concern: 1) potentially significant sales practice problems evidenced by the number of canceled initial transactions; 2) insufficient number of qualified Series 24 principals to supervise employees; and 3) potential conflict of interest in members of the compliance department also serving as sales supervisors. Monroe Parker contested the RAS' decision, and hearings were held before the District Business Conduct Committee ("DBCC") in February 1996. Monroe Parker's director of compliance, Richard Levitov, testified that Monroe Parker engaged in telephone solicitations targeted at individuals, identified by Dun & Bradstreet, who owned companies with revenues in excess <(1)> At the time of the application, Monroe Parker employed approximately 67 registered representatives along with about 75 "broker trainees," who were unregistered. See infra note 15. At that time, Monroe Parker was making markets in the securities of 10 issuers. <(2)> Former Part I, Section 3(a) of Schedule C to the NASD By-Laws, now Rule 1013(a), provides that applications for modification of restrictive agreements are reviewed by a subcommittee designated by the District Business Conduct Committee. <(3)> The RAS sought documents related to cancellations of transactions, Regulation T extensions, and customer complaints. ======END OF PAGE 2====== of one million dollars per year. Generally, Monroe Parker solicited initial transactions in well-known stocks that were either listed on the New York Stock Exchange or quoted on the Nasdaq National Market System. The NASD staff asserted that the Firm's supervision of its registered representatives was not adequate. In support of this position, the staff cited the Firm's high rate of cancellations of initial transactions in new accounts ("reneges") <(4)> and the Firm's failure to investigate or correct its sales practices. The evidence indicates that, between August 1994, when the Firm began conducting business, and December 1995, 37.7 percent of initial transactions resulted in reneges. Of a total of 3,606 initial customer transactions executed during this period, 1,362 resulted in reneges. Reneges accounted for 61.82 percent of the Firm's total canceled transactions. Under the Firm's policy, any loss resulting from a renege was divided equally between the registered representative and the Firm. On the other hand, if a sellout occurred in a pre-existing account, the registered representative assumed all of the loss. Levitov stated that the Firm was willing to share in the losses from reneges because it did "not want to discourage brokers shying away[,] . . . being concerned with opening new accounts, because of being afraid of taking 100% of a loss, if it would be split that way . . . ." Levitov testified that he found the Firm's renege rate acceptable and believed that it was merely "a cost of doing business." Levitov had previously worked at Drexel Burnham Lambert, and he claimed that one Drexel branch office had engaged in telephone solicitations and experienced a six percent renege rate. He also noted that an NASD newsletter had stated that a five percent renege rate was appropriate for inter-dealer transactions in municipal securities. In his testimony, Levitov, however, grossly underestimated the rate of reneges in Monroe Parker's new customers' accounts. He testified that reneges were about 8 percent, rather than the accurate figure of about 38 percent. Levitov also testified that he made no independent effort to determine the cause of any cancellations because he did not find them troublesome. He would investigate a particular renege only if a customer complained about an unauthorized trade. His investigation of such a customer complaint, moreover, consisted merely of asking the registered representative to explain the trade. Levitov would accept the explanation without further inquiry. <(4)> Monroe Parker identified any initial transaction in a new account which was not paid for by settlement date as a "renege." Monroe Parker described other transactions which were canceled and sold for non- payment as "sellouts." The NASD accepted these definitions for purposes of its opinion, and, for continuity, we will use them as well. ======END OF PAGE 3====== The DBCC denied Monroe Parker's request on March 27, 1996. The DBCC found that the Firm's rate of reneges was a "red flag" stating: "On the basis of our collective experience in the securities business, we believe that for a firm of virtually any size to experience the number of reneges that Monroe Parker does is an indication that something is defective in its sales practices." The DBCC concluded that Monroe Parker had not demonstrated that the requested modifications were justified. <(5)> The DBCC denied Monroe Parker's request to expand the number of markets it makes because the DBCC claimed that neither the Firm nor NASD staff had presented any information directly bearing on the appropriateness of the requested modification. <(6)> On appeal, the National Business Conduct Committee ("NBCC") noted that "the renege rate, while somewhat improved since the DBCC decision in this matter, is nonetheless still clearly indicative of persistent operational and supervisory problems." <(7)> The NBCC also noted that it was not favorably impressed with the Firm's compliance procedures based on notes drafted by NASD staff following an examination of the Firm and based on a Letter of Caution issued to the Firm on March 13, 1996. <(8)> The NBCC found that Monroe Parker had not made a sufficient showing to justify the requested expansion of the number of registered representatives and the number of <(5)> Under the rules in effect at the time of the application, Part I, Section (3)(a) of Schedule C to the NASD By-Laws, required the applicant to demonstrate that modifications were appropriate. The NASD has recently revised and renumbered its Rules of Practice, and this provision is now Rule 1013. <(6)> Monroe Parker, in fact, had submitted resumes of its traders as well as records indicating that the traders had clean disciplinary records. The Firm had also submitted correspondence from NASD staff indicating the staff's willingness to allow the Firm to raise the number of markets it made under certain conditions. <(7)> Information submitted before the NBCC indicated that, in January 1996, the monthly renege rate was 37.08 percent; in February 1996, it was 32.66 percent; and in March 1996, 26.99 percent. <(8)> The staff's exit interview notes and Letter of Caution indicate that the Firm, among other things, failed to calculate and maintain accurate net capital, failed correctly to maintain and file its sales literature and advertisements, and failed to have adequate supervisory procedures. ======END OF PAGE 4====== markets. <(9)> This appeal followed. III. We review the NASD's denial of Monroe Parker's application for modification of its restrictive agreement under Section 19(f) of the Securities Exchange Act of 1934 ("Exchange Act"), which requires us to find that the specific grounds on which such denial is based exist in fact, that the denial "is in accordance with [NASD rules], and that such rules . . . were applied in a manner consistent with the purposes of" the Exchange Act. Monroe Parker does not contest the NASD's computation of its renege rate. It claims that the public is not harmed by its practices because the Firm does not require new clients to deposit initial funds. We note initially that the Firm's explanations to us of its renege rate are not supported by the record. Levitov suggested that the renege rate could be caused by "buyer's remorse." However, more than a third of the reneges involved profitable positions, indicating that many customers were cancelling transactions despite potential earnings. Moreover, the Firm's solicitations were directed to what it asserts were sophisticated customers. The NASD noted that such customers would less likely be susceptible to buyers' remorse. We agree. Levitov also suggested that the implementation of "T+3 settlement" in June 1995 might be a factor in the level of reneges. <(10)> If the change in settling customer accounts was responsible for the high rate of reneges, however, the rate would have gone up in the months immediately following implementation of the new policy. It did not. Indeed, the rate was relatively stable both before and after the implementation of T+3 settlement. Levitov contended that initial transactions were canceled at a high rate because neither the Firm nor its clearing agent, J.B. Oxford, were well known. Indeed, the Firm asserts that the renege rate is justified because it is a small broker-dealer. The Firm claims that it cannot afford large advertising campaigns and that "[c]old calling is the only economically viable option for a small, entrepreneurial firm." The Firm, <(9)> The NBCC found that the Firm's application was deficient with respect to the showing required by three provisions of Schedule C to the NASD By-Laws: Section 1(c)(3) (the Firm's proposed internal procedures, including compliance procedures); Section 1(c)(5)(D) (supervisory personnel, methods and procedures); and Section 1(c)(6) (other factors relevant to the scope and operation of [the firm's] business). <(10)> T+3 settlement means that customers must pay for transactions within three days of the trade, or the transaction is canceled. The Firm does not allow extensions on initial transactions. ======END OF PAGE 5====== moreover, encouraged registered representatives to engage in aggressive sales tactics by sharing any losses caused by cancellations in new accounts. The Firm further complains that the NASD merely relied on the NBCC's "collective judgment" that the Firm's rate of reneges was too high. We agree, however, that the Firm's renege rate, by any objective standard, was a "red flag" that should have indicated an urgent need for investigation of the Firm's sales practices. We have frequently found that excessive reneges or cancellations are indicative of underlying compliance problems and may be evidence of violations. <(11)> Our concern is heightened by the Firm's casual response to the excessive cancellations. Its failure to investigate or institute remedial measures demonstrates a lack of adequate supervision and displays deficiencies in Monroe Parker's compliance procedures. <(12)> As noted above, Levitov testified that he believed that the percentage of reneges was a fraction of the actual rate. At the same time, Levitov stated that "there is like a built in two to four reneges a day. . . . It is something that I've seen as a continuous pattern." Levitov, moreover, did nothing to investigate reneges unless he received a customer complaint. The Firm asserts that, in denying its application, the NASD has somehow established a "renege rule" that is illegal and unenforceable because this alleged rule was not approved by the NASD's membership or by this Commission, as required. The NASD's decision did not purport to set an appropriate level of reneges. Rather, it observed that the reneges were numerous and persistent. Monroe Parker did not give an adequate explanation for the rate and did not investigate to determine whether the registered representatives were engaging in violations. <(13)> These <(11)> See Reynold F. Vaughan, III, 51 S.E.C. 1078 (1994) (canceled orders indicated unauthorized trading); Frank J. Custable, Jr., 51 S.E.C. 855 (1993) (same); Wedbush Securities, Inc., 48 S.E.C. 963 (1988) (same). Indeed, in one of the cases Monroe Parker cites in its brief, Shearson Lehman Brothers, Inc., 1991 WL 424425 (NYSE) (May 14, 1991), the firm's failure properly to cancel transactions as requested by customers was evidence of violations of Regulation T. <(12)> The staff's exit interview notes and Letter of Caution also indicate problems in the Firm's supervision and procedures. <(13)> Monroe Parker argues that, because the Firm and the registered representatives share any losses, customers are not harmed. However, merely because there is no monetary harm to a customer does not mean that an unauthorized trade is not a violation. If the reneges in fact result, even in part, from unauthorized trades, it is also possible that unauthorized trades could be (continued...) ======END OF PAGE 6====== matters, together with the Letter of Caution and exit interview notes introduced before the NBCC, <(14)> were properly considered by the NASD in assessing the Firm's procedures. Thus, we find that, on the record before us, the NASD's refusal to allow Monroe Parker to add additional registered representatives appears consistent with the purposes of the Exchange Act. <(15)> Monroe Parker argues that its supervisory and compliance procedures are adequate and appropriate and that the NASD had no basis for denying its application. Specifically, Monroe Parker argues that it has complied with all regulations, that it has demonstrated good faith by "throwing its files wide open," and that it has revised its procedures and compliance manual in accordance with the NASD's requests. Monroe Parker, however, is required to comply with all NASD rules and requests, independent of any request to modify its restrictive agreement. <(16)> Monroe Parker contends that there is no basis for continuing the restriction on the number of markets it makes. <(17)> The Firm notes that it presented evidence of the appropriateness of the application for increased markets, including: resumes of its traders, demonstrating their <(13)>(...continued) occurring that are subsequently ratified by the customers. The fact that a customer ultimately accepts a trade does not mean that the transaction was properly authorized. Frank J. Custable, Jr., 51 S.E.C. 643, 650 (1993). <(14)> See supra note 8 and accompanying text. <(15)> We note that, during the NASD staff's investigation of the Firm, the Firm employed 75 unregistered broker "trainees," who were paid by the registered personnel whom they assisted and who engaged in cold-calling to identify prospective clients. A staff member testified that, when he interviewed certain of Monroe Parker's registered representatives, four of the representatives stated that these trainees were "qualifying" prospective clients, i.e. asking for information about potential customers' financial status and investment experience or objectives. This does not appear to be consistent with NASD rules. <(16)> Moreover, the revisions to the compliance procedures do not appear to be related to Monroe Parker's methods of soliciting business. <(17)> The Firm points out that, during negotiations with NASD staff and in an initial RAS determination, the Firm was to be allowed to make markets in 40 issuers of securities, subject to an increase in the Firm's net capital. ======END OF PAGE 7====== years of experience; records showing that the traders have clean disciplinary histories; and correspondence demonstrating that the NASD had agreed to allow the Firm to make additional markets. <(18)> It is not clear how the Firm's identified supervisory and compliance problems impact on its request to increase the number of issuers of securities in which it makes markets. Because the connection between these inadequacies in compliance and supervision and an increase in the number of issuers of securities in which the Firm may make markets is not clear, we remand this part of the NASD's decision for a more detailed explanation. <(19)> IV. The Firm claims that it was denied due process in the NASD proceedings. Specifically, Monroe Parker complains that it was not given the opportunity to appear or provide evidence at the RAS hearing. The NASD By-Laws do not provide for oral hearings before the RAS. Moreover, the Firm requested and received a full hearing before the DBCC as provided by the By-Laws. The Firm also contends that the RAS denied it a meaningful hearing because the RAS "tabled" the proceedings and took one and one-half years to reach a decision. The proceedings before the RAS were delayed, at least in part, by the Firm's request that they be adjourned to allow negotiations with NASD staff to take place. <(20)> The Firm also claims that the various panels did not fairly consider the evidence. Monroe Parker complains that it was prejudiced because there were several volumes of documents present during the DBCC hearing to which NASD staff referred. The Firm claims that it did not have a chance to review these documents. Although we do not condone these procedures, there has been no prejudice to the Firm. NASD counsel represented that these documents constituted the bases for charts, which were admitted into evidence, that represented the Firm's renege rate. Monroe Parker did not challenge the staff's calculation of the Firm's rate of reneges. Moreover, the Firm's counsel, in fact, had an opportunity to review these documents <(18)> It is not clear whether the NASD considered this evidence in its determination. <(19)> See First Potomac Investment Services, Inc., 50 S.E.C. 848 (1992) (remanding denial of proposed modification and ordering NASD specifically to address firm's justifications). <(20)> We note that the RAS issued its final decision eight months after the Firm's application. ======END OF PAGE 8====== during a continuance in the proceedings, but there is nothing in the record to suggest that he did so. <(21)> The Firm also contends that the panels relied on hearsay evidence of the NASD staff and the panels' "collective experience." <(22)> NASD proceedings are not governed by the Federal Rules of Evidence, and "hearing panels have great latitude in permitting evidence and testimony from witnesses that might be excluded on relevance and hearsay grounds before other tribunals." <(23)> The mere fact that the panel members were not associated with firms of the same type as the applicant does not mean that they were unqualified to evaluate the conduct here. <(24)> Moreover, the initial decision was voted on by the entire DBCC and sustained by the NBCC. In any event, we note that any prejudice would be cured by the de novo review accorded by this Commission. <(25)> For the reasons stated above, the appeal is dismissed with regard to Monroe Parker's request to expand the number of registered representatives that the Firm can employ. <(26)> It is remanded with regard to the Firm's request to expand the number of markets <(21)> Similarly, although the Firm contends that it was prejudiced because it did not receive a list of rebuttal witnesses, it did not seek to have additional witnesses testify or request that NASD witnesses be recalled. The NASD has recently proposed new rules that, if adopted, will clarify when document and witness list exchanges should take place. SR-NASD-97- 28 at 9241(c), Securities Exchange Act Rel. No. 38531, (April 21, 1997). <(22)> The Firm also complains that an NASD staff member made comments to the Firm's counsel during unrelated proceedings, indicating a purported bias by the staff member against Monroe Parker. This staff member was not assigned to and had no responsibility over this matter. Moreover, "the staff does not decide cases . . . allegations of staff bias . . . do not suggest that the fairness of the hearing itself was compromised." Frank J. Custable, 51 S.E.C. at 650 (citation omitted). <(23)> Rita H. Malm, Securities Exchange Act Rel. No. 35000 (Nov. 23, 1994), 58 SEC Docket 121. <(24)> Id. Nor is Monroe Parker entitled to a hearing panel made up of any specific type of broker-dealer. Stephen Russell Boadt, 51 S.E.C. 683, 685 (1993). <(25)> See Conrad C. Lysiak, 51 S.E.C. 841, 847 (1993); Gilbert A. Zwetsch, 50 S.E.C. 816, 820 (1991). <(26)> As noted by the NASD, the Firm may seek to renew its application at some later date in light of additional favorable information. ======END OF PAGE 9====== it makes. We do not intend to suggest any view as to the outcome on remand. An appropriate order will issue. <(27)> By the Commission (Chairman LEVITT and Commissioners WALLMAN, JOHNSON, and HUNT). Jonathan G. Katz Secretary <(27)> All of the contentions advanced by the parties have been considered. They are rejected or sustained to the extent that they are inconsistent or in accord with the views expressed herein. ======END OF PAGE 10====== SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. Admin. Proc. File No. 3-9174 : In the Matter of the Application of : : MONROE PARKER SECURITIES, INC. : 2500 Westchester Avenue : Purchase, New York 10577 : : For Review of Denial of Access by the : : NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.: : ORDER DISMISSING APPEAL OF DENIAL OF ACCESS IN PART AND REMANDING IN PART On the basis of the Commission's opinion issued this day, it is ORDERED that the appeal of MONROE PARKER SECURITIES, INC. of the denial of modification of its restrictive agreement to raise the number of registered representatives that may associate with the firm, be, and it hereby is, dismissed; ORDERED that the action of the National Association of Securities Dealers, Inc. in restricting the number of securities in which MONROE PARKER SECURITIES, INC. can make a market, be, and it hereby is, remanded. By the Commission. Jonathan G. Katz Secretary