UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION Investment Advisers Act of 1940 Release No. 1614 / February 10, 1997 ADMINISTRATIVE PROCEEDING File No. 3-9243 - - - - - - - - - - - - - - - x : In the Matter of : : ORDER INSTITUTING PUBLIC OAKWOOD COUNSELORS, INC. : PROCEEDINGS, MAKING FINDINGS, and PAUL J. SHERMAN, : IMPOSING REMEDIAL SANCTIONS, : AND ISSUING CEASE-AND- Respondents. : DESIST ORDER : - - - - - - - - - - - - - - - x I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest to institute public administrative proceedings pursuant to Sections 203(e), (f) and (k) of the Investment Advisers Act of 1940 ("Advisers Act"), against Oakwood Counselors, Inc. ("Oakwood") and Paul J. Sherman ("Sherman"). In anticipation of the institution of these proceedings, Oakwood and Sherman have submitted Offers of Settlement ("Offers") to the Commission, 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 in which the Commission is a party, and without admitting or denying the findings contained herein, except as to Paragraphs II.A. and B., which are admitted, Oakwood and Sherman consent to the issuance of this Order Instituting Public Proceedings and Findings, Cease and Desist Order, and Order Imposing Remedial Sanctions ("Order") and to the entry of the findings, cease and desist order, and remedial sanctions set forth below. Accordingly, IT IS ORDERED that proceedings pursuant to Sections 203(e), (f) and (k) of the Advisers Act be, and hereby are, instituted. ==========================================START OF PAGE 2====== II. On the basis of this Order and the Offers, the Commission makes the following findings: RESPONDENTS A. Oakwood has been registered with the Commission as an investment adviser pursuant to Section 203(c) of the Advisers Act since July 16, 1973. As of August 9, 1995, Oakwood had a total of 197 accounts with approximately $46,500,000 in assets under management. Oakwood generally manages accounts on a discretionary basis. B. Sherman is, and at all relevant times was, the president and sole owner of Oakwood. Sherman has at all relevant times made all investment decisions with respect to client accounts. INTRODUCTION C. This proceeding involves Oakwood's failure to disclose to its clients a soft dollar arrangement with a broker-dealer. The term "soft dollars" generally describes an arrangement whereby an investment adviser uses commission dollars generated by securities trades executed in advisory client accounts to pay for research, brokerage, or other products, services, or expenses. THE SOFT DOLLAR ARRANGEMENT D. In or about January 1989, Oakwood entered into a soft dollar arrangement with a broker-dealer ("Broker"). Sherman made the decision to enter the arrangement and negotiated the arrangement on Oakwood's behalf. E. From the beginning of the arrangement through March 1991, Oakwood accrued soft dollar credits at a ratio of 2 to 1. The ratio from April 1991 through July 1995 was 1.75 to 1. Thus, for every $2.00 in Broker commissions generated by portfolio trades until April 1991 (and for every $1.75 thereafter), Oakwood accrued a soft dollar credit of $1.00. F. Oakwood used these soft dollar credits to pay for most of its expenses other than rent, salaries, and accounting fees. Oakwood used the soft dollar credits to pay for phone bills, office equipment, client solicitation fees, and client accounting and marketing expenses, as well as research and brokerage services. OAKWOOD'S FAILURE TO DISCLOSE THE SOFT DOLLAR ARRANGEMENT G. Oakwood's Form ADV, filed on March 24, 1986, contained a "no" answer to Part II, Item 13.A., which asks: "Does the applicant . . . have any arrangements . . . where it . . . is paid cash by or receives some economic benefit (including commissions, equipment or non-research services) from a non- client in connection with giving advice to clients?" In light of the soft dollar arrangement, this answer became false in January 1989. The false answer remained in Oakwood's Form ADV until an amendment to Oakwood's Form ADV was filed on August 24, 1995. H. Part II, Item 12 of Form ADV requires investment advisers to disclose the factors they employ in selecting brokers and determining the reasonableness of their commissions. If the value of products, research and services provided by a broker is a factor, then Item 12 requires a description of those products, research and services. Oakwood's Form ADV contained the following disclosure in response to Part II, Item 12.B: Clients may direct business to a broker of their choice. Otherwise, brokers are chosen by Oakwood based on Oakwoods' [sic] judgement of the broker's efficiency, execution and back office capability. Oakwood receives unsolicited research material from brokers, but does not compensate these brokers in any way through client commissions. Some brokers produce reports for some of Oakwoods' [sic] clients, but this is not a factor in placing business. From the time the soft dollar arrangement was initiated, this disclosure created the false impression that Oakwood was not compensating any broker-dealer for research through client commissions. In addition, the statement failed to disclose that Oakwood was using soft dollar credits generated by its client accounts to pay for other products, services, and expenses, such as phone bills, office equipment, client solicitation fees, and client accounting and marketing expenses. I. On January 2, 1991, Oakwood filed the first amendment to its Form ADV after initiation of the soft dollar arrangement (the "1991 ADV Amendment"). By filing the 1991 ADV Amendment, Oakwood represented that all unamended portions of its Form ADV were accurate and complete. The 1991 ADV Amendment reiterated Oakwood's response to Part II, Item 12.B and incorporated the answer to Part II, Item 13.A ("Items 12.B. and 13.A."). By January 1991, the responses to Items 12.B and 13.A. were misleading. J. Oakwood subsequently filed additional amendments to its Form ADV incorporating the same answers to Items 12.B. and 13.A. as were contained in the 1991 ADV Amendment. The subsequent ==========================================START OF PAGE 3====== amendments to Oakwood's Form ADV were filed on September 3, 1991, September 18, 1991, February 27, 1992, July 14, 1992, March 29, 1993, and September 15, 1993. K. Sherman reviewed and signed Oakwood's Form ADV, as well as the 1991 amendment and subsequent amendments to Oakwood's ADV, containing misleading statements. L. Oakwood also filed annual reports with the Commission on Form ADV S ("Forms ADV S"). In filing its Forms ADV S, Oakwood represented that its Form ADV remained accurate and that no amendment to its Form ADV was required. During the period of the soft dollar arrangement, that representation was false. Sherman reviewed and signed Oakwood's Forms ADV S filed on February 27, 1992, March 29, 1993, March 14, 1994, and March 17, 1995. M. The existence and material terms of the soft dollar arrangement were not disclosed to Oakwood's clients in its Form ADV as amended and were not otherwise disclosed to Oakwood's clients. III. LEGAL ANALYSIS A. An investment adviser has a duty to disclose to clients all material information which might incline an investment adviser consciously or unconsciously to render advice which is not disinterested. SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191-92 (1963). A fact is material if there is a substantial likelihood that a reasonable investor would consider it important. Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988). B. Soft dollar arrangements are material because of the potential conflict of interest arising from an adviser's receipt of some benefit in exchange for directing brokerage on behalf of client accounts. See Kingsley, Jennison, McNulty & Morse, Inc., 55 SEC Docket 2434, 2441 (Dec. 23, 1993); Interpretive Release Concerning the Scope of Section 28(e) of the Securities Exchange Act of 1934, Exchange Act Release No. 23170, 35 SEC Docket 905, 909 (Apr. 23, 1986) ("1986 Soft Dollar Release"). C. Moreover, disclosure of soft dollar arrangements is specifically required by Form ADV.1/ See S Squared Technology 1/ The "safe harbor" provided by Section 28(e) of the Securities Exchange Act of 1934 ("Exchange Act") does not excuse an investment adviser from these disclosure (continued...) ==========================================START OF PAGE 4====== Corp., Advisers Act Release No. 1575 (Aug. 7, 1996). Form ADV embodies mandatory disclosure requirements to ensure that material information regarding brokerage placement practices and policies is disclosed to investors. See Investment Adviser Requirements Concerning Disclosure, Recordkeeping, Applications for Registration and Annual Filings, Advisers Act Release No. 664 (Jan. 30, 1979); Disclosure of Brokerage Placement Practices By Certain Regulated Investment Companies and Certain Other Issuers, Advisers Act Release No. 665 (Jan. 30, 1979) ("1979 Soft Dollar Release"). D. Items 12 and 13, and Schedule F, of Part II of Form ADV require registrants to disclose soft dollar arrangements with broker-dealers. For investment advisers who have discretionary authority to select the broker-dealers to be used to execute trades in client accounts, Item 12.B. requires a description of the factors considered in selecting brokers and determining the reasonableness of their commissions. Further, Item 12.B. requires advisers to describe the "products, research and services" received from broker-dealers, if the value of such "products, research and services" is a factor in selecting broker-dealers.2/ Item 13 requires an investment adviser to disclose and describe any arrangement whereby it receives an economic benefit from a non-client in connection with giving advice to clients.3/ These disclosure requirements are designed to "assist clients in determining whether to hire an adviser or continue a contract with an adviser, and permit them to evaluate any conflicts of interest inherent in the adviser's arrangements for allocating brokerage." Kingsley, 55 SEC Docket at 2441-42; see S Squared, Advisers Act Release No. 1575. 1/(...continued) obligations. The safe harbor protects an investment adviser only from charges of breach of fiduciary duty for failing to obtain the lowest available commission rate where the amount of commission is reasonable in relation to the value of brokerage and research services provided. 1986 Soft Dollar Release, 35 SEC Docket at 907 n.10. 2/ See 1986 Soft Dollar Release, 35 SEC Docket at 909. There is a presumption that receipt of non-research and non- brokerage products or services, except where nominally valued, is a factor in the selection of brokers. 1979 Soft Dollar Release at n.6. 3/ The 1986 Soft Dollar Release noted the relevance of Form ADV, Part II, Item 13 to soft dollar disclosure. 35 SEC Docket at 909 n.32. ==========================================START OF PAGE 5====== VIOLATIONS OF SECTION 207 OF THE ADVISERS ACT E. Section 207 of the Advisers Act makes it unlawful for any person willfully to make any untrue statement of material fact in any registration application or report filed with the Commission or willfully to omit to state in any such application or report any material fact required to be stated therein.4/ A person violates Section 207 by filing false amendments to Form ADV or false Forms ADV S. In the Matter of Stanley Peter Kerry, Advisers Act Release No. 1550 (January 25, 1996). F. Oakwood's "no" answer to Item 13.A. in its Form ADV in effect from January 1989 forward was false. Oakwood was in fact receiving an economic benefit from Broker, a non-client, in the form of soft dollar credits. Oakwood's response to Item 12.B. in its Form ADV in effect from January 1989 forward was misleading in that the response failed to disclose the soft dollar arrangement with Broker and thereby falsely suggested that Oakwood did not consider any soft dollar arrangement as a factor in selecting brokers. G. Oakwood's omissions and false and misleading disclosures regarding its soft dollar arrangement were material. H. Oakwood and Sherman willfully violated Section 207 in that they willfully made untrue statements of material fact in Oakwood's Form ADV and failed to disclose in Oakwood's Form ADV the existence of the soft dollar arrangement and the products, research, and services received from Broker. I. Oakwood and Sherman willfully violated Section 207 by falsely stating in Oakwood's Forms ADV S that no amendment to Oakwood's Form ADV was required, when, in fact, Oakwood was required to amend its Form ADV to disclose the existence of the soft dollar arrangement and the products, research, and services received from Broker. VIOLATIONS OF SECTIONS 206(1) AND 206(2) OF THE ADVISERS ACT J. Sections 206(1) and (2) prohibit an investment adviser from employing any device, scheme, or artifice to defraud clients or from engaging in any transaction, practice or course of business that operates as a fraud on clients. Sections 206(1) and (2) establish a fiduciary duty for investment advisers to act 4/ Section 204 of the Advisers Act and Rule 204-1 thereunder require periodic filing and amendment of Forms ADV by investment advisers. Pursuant to Rule 204-1(d), a Form ADV or an amendment thereto is a "report" within the meaning of Section 207. ==========================================START OF PAGE 6====== for the benefit of their clients. Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979). An investment adviser's failure to disclose its soft dollar practices violates Sections 206(1) and 206(2). S Squared, Advisers Act Release No. 1496 (Section 206(2)); SEC v. Tandem Capital Management, Inc., Litigation Release No. 14670, 60 SEC Docket 1331 (October 2, 1995)(Sections 206(1) and (2)); Louis A. Acevedo, Advisers Act Release No. 1496, 59 SEC Docket 1491 (June 6, 1995)(Sections 206(1) and (2)); SEC v. Galleon Capital Management, Litigation Release No. 14315, 57 SEC Docket 2939 (Nov. 1, 1994)(Sections 206(1) and (2)). Scienter is an element of a Section 206(1) violation. Steadman v. SEC, 603 F.2d 1126, 1134 (5th Cir. 1979). Proof of scienter is not required to establish a violation of Section 206(2). SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 195 (1963). K. Oakwood willfully violated Sections 206(1) and (2) by making materially false and omissive statements in its Form ADV and by failing otherwise to disclose to its clients the existence and material terms of its soft dollar arrangement. L. Sherman aided and abetted and caused Oakwood's violation of Sections 206(1) and (2) by knowingly, recklessly and negligently making materially false and omissive statements in Oakwood's Form ADV and by failing otherwise to disclose to Oakwood's clients the existence and material terms of Oakwood's soft dollar arrangement. M. As a result of Oakwood's and Sherman's violative conduct, Oakwood was unjustly enriched by $298,499.00. IV. Based on the foregoing, the Commission finds that: 1. Oakwood willfully violated Sections 207 and 206(1) and 206(2) of the Advisers Act; 2. Sherman willfully violated Section 207 of the Advisers Act and willfully aided and abetted and caused Oakwood's violations of Sections 206(1) and 206(2) of the Advisers Act. V. In view of the foregoing, it is in the public interest to impose the sanctions specified in the Offers of Settlement. Accordingly, IT IS HEREBY ORDERED that: ==========================================START OF PAGE 7====== A. Oakwood shall be, and hereby is, censured; B. Oakwood shall, effective immediately, cease and desist from committing or causing any violation and any future violation of Sections 207 and 206(1) and 206(2) of the Advisers Act; C. Oakwood shall, within ten (10) days of the date of this Order, pay $419,763.00, which shall represent disgorgement of $298,499.00 and prejudgment interest of $121,264.00. Payment shall be made by postal money order, certified check, bank cashier's check or bank money order, payable to the order of the "United States Securities and Exchange Commission." The payment shall be transmitted to the Secretary, Securities and Exchange Commission ("Secretary"), 450 Fifth Street, N.W., Mail Stop 6-9, Washington, D.C. 20549, under cover of letter identifying the name and number of this administrative proceeding and the Respondent (Oakwood), and specifying that the payment is disgorgement and prejudgment interest. A copy of the cover letter and payment shall be simultaneously transmitted to Wayne M. Carlin, Assistant Regional Director, Securities and Exchange Commission, 7 World Trade Center, New York, New York 10048. D. The disgorgement and prejudgment interest paid by Oakwood shall be held by the Secretary, to be utilized for payment to persons eligible to receive such funds pursuant to a plan of distribution, which shall be submitted by the Division of Enforcement within 60 days from the date of the payment by Oakwood. In the event that all or any portion of these funds remain after adjudication of any claims and disbursements of any funds, the remainder shall be disbursed to the United States Treasury. In no event shall any portion of these funds be returned to Oakwood or its agents, successors, or assigns. E. Oakwood shall, within thirty (30) days of the date of this Order, pay a civil money penalty in the amount of $25,000 to the United States Treasury. Such payment shall be: (1) made by United States postal money order, certified check, bank cashier's check or bank money order; (2) made payable to the Securities and Exchange Commission; (3) delivered to the Secretary, Securities and Exchange Commission, 450 5th Street, N.W., Mail Stop 6-9, Washington, D.C. 20549; and (4) submitted under cover letter which identifies Oakwood as a Respondent in these proceedings, and states the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Wayne M. Carlin, Assistant Regional Director, Northeast Regional Office, Securities and Exchange Commission, 7 World Trade Center, 13th Floor, New York, NY 10048; F. Oakwood shall comply with its undertakings as specified in its Offer of Settlement: ==========================================START OF PAGE 8====== 1. So long as Oakwood has any soft dollar arrangement with any broker-dealer, (a) whenever Oakwood's soft dollar arrangements change or commence or whenever Oakwood files an amendment to its Form ADV, consult legal counsel familiar with the provisions of the Advisers Act and Exchange Act concerning disclosure of Oakwood's soft dollar arrangements in its Form ADV or otherwise; and (b) make any additional or modified disclosures counsel deems necessary to comply with the requirements of the Advisers Act and Exchange Act concerning brokerage commissions on trades for advisory clients and soft dollar arrangements; 2. Within thirty (30) days of the date of this Order, file with the Commission and provide each of its advisory clients an amended Form ADV disclosing all material terms of any soft dollar arrangement it has with any broker-dealer; 3. Within thirty (30) days of the date of this Order, provide notice disclosing the material terms of this Order, in a form acceptable to the staff of the Commission, to all of its current clients; 4. Within forty five (45) days of the date of this Order, file an affidavit with the Commission's staff, addressed to the attention of the Regional Director of the Commission's Northeast Regional Office, 7 World Trade Center, 13th Floor, New York, NY 10048, setting forth the details of its compliance with the undertakings set forth in subparagraphs F.1., 2. and 3. above; 5. For a period of one (1) year of the date of this Order, provide notice disclosing the material terms of this Order, in a form acceptable to the staff of the Commission, to all of its prospective clients; 6. Within one (1) year from the date of this Order, file an affidavit with the staff of the Commission certifying its compliance with subparagraph F.5. above. IT IS FURTHER ORDERED that: I. Sherman shall be, and hereby is, censured; J. Sherman shall, effective immediately, cease and desist from committing or causing any violation and any future violation of Sections 207 and 206(1) and 206(2) of the Advisers Act; K. Sherman shall, within thirty (30) days of the date of this Order, pay a civil money penalty in the amount of $25,000 to the United States Treasury. Such payment shall be: (1) made by United States postal money order, certified check, bank cashier's check or bank money order; (2) made payable to the Securities and ==========================================START OF PAGE 9====== Exchange Commission; (3) delivered to the Secretary, Securities and Exchange Commission, 450 5th Street, N.W., Mail Stop 6-9, Washington, D.C. 20549; and (4) submitted under cover letter which identifies Sherman as a Respondent in these proceedings, and states the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Wayne M. Carlin, Assistant Regional Director, Northeast Regional Office, Securities and Exchange Commission, 7 World Trade Center, 13th Floor, New York, NY 10048. By the Commission. Jonathan G. Katz Secretary ==========================================START OF PAGE 10======