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U.S. Securities and Exchange Commission

INITIAL DECISION RELEASE NO. 142

ADMINISTRATIVE PROCEEDING
FILE NO. 3-9439

United States of America
Before the
Securities and Exchange Commission
Washington, D.C.

In the Matter of

JOSEPH F. REESE

 

INITIAL DECISION

May 6, 1999

Appearances:   Jeffrey W. Kobrick and Thomas J. Rappaport for the Division of Enforcement, Securities and Exchange Commission.

Respondent Joseph F. Reese, pro se.

Before:  Carol Fox Foelak, Administrative Law Judge

Summary

Joseph F. Reese was charged with violating the antifraud provisions of the Securities Act of 1933 by offering for sale "prime bank" securities. This Initial Decision finds that Reese contacted the Office of the Treasurer of the State of Connecticut several times between September 1995 and January 1996 to offer "prime bank" instruments, which he advised offered enormous returns with no risk, under secret conditions. The Treasurer declined Reese's proposal. "Prime bank" schemes exist only as fraud. The Decision concludes that Reese's proposal violated the antifraud provisions of the securities laws and orders him to cease and desist from such violations.

I. Introduction

A. Procedural Background

The Securities and Exchange Commission (Commission) initiated this proceeding by an Order Instituting Proceedings (OIP) on September 25, 1997, pursuant to Section 8A of the Securities Act of 1933 (Securities Act). I held a hearing in New Haven, CT, on March 31, 1998, to determine whether the allegations in the OIP were true and, if so, whether Joseph F. Reese should be ordered to cease and desist from violations of Section 17(a) of the Securities Act. The Division of Enforcement (Division) called four witnesses from whom testimony was taken, including Respondent Reese. Respondent Reese cross examined the Division's witnesses. Eight exhibits offered by the Division and one exhibit offered by the Respondent were admitted into evidence. 1

My findings and conclusions are based on the record. Pursuant to the Administrative Procedure Act,2 I considered the following posthearing pleadings: (a) the Division's May 22, 1998, Proposed Findings of Fact and Conclusions of Law; and (b) the Respondent's June 26, 1998, Proposed Findings of Fact and Conclusion of Law. I applied preponderance of the evidence as the standard of proof. I considered and rejected all arguments and proposed findings that are inconsistent with this decision.

B. Allegations and Arguments of the Parties

The OIP alleges that Reese violated Section 17(a) of the Securities Act by offering for sale and/or soliciting the Office of the Treasurer of the State of Connecticut (Treasurer or Treasurer's Office) to purchase unregistered, nonexistent, "prime bank" securities during the period September 1995 through January 1996. In its posthearing filing the Division argues that the evidence shows that the Respondent solicited the Treasurer to buy "prime bank" securities, that he made material misrepresentations in doing so, and that he did so with scienter. The Respondent argues that the Commission does not have jurisdiction, that he engaged in no fraud, and that he engaged in no solicitation, but merely responded to a request for information. There is relatively little dispute between the parties as to the facts. However, there are questions as to the conclusions to be drawn from the facts: Was the investment Reese discussed with the Treasurer a security? Was his course of dealing with the Treasurer an "offer or sale" of any securities within the meaning of Section 17(a) of the Securities Act? What was his state of mind concerning the investment?

The Division seeks an order pursuant to Section 8A of the Securities Act that the Respondent cease and desist from violations of Section 17(a) of the Securities Act. The Respondent contends that the proceeding should be dismissed.

II. Findings of Fact

A. Respondent

Reese has been in the theatrical business, providing production and technical services, between 1975 and 1979 and from 1994 to the present. Tr. 137-38. He was a mortgage broker from 1990 to 1994. Tr. 138. He worked for Prudential Insurance from 1984 to 1986 and 1989 to 1990; his duties included selling insurance, annuities, and mutual funds. Tr. 138-39, 145-46. He worked for Merrill Lynch during the year 1987. Tr. 138, 140. He had a Series 7 license, which expired in approximately 1993. Tr. 138-41. He would like to reenter the securities industry. Tr. 138, 143. His educational background is three years of college and some insurance courses and courses offered by Merrill Lynch while he was working there. Tr. 137, 145-46.

B. The Office of the Treasurer of the State of Connecticut

Christopher Burnham was elected Treasurer of the State of Connecticut in 1994 and served from January 1995 until July 1997. Tr. 13. His business career on Wall Street included securities, commodities and investment banking. Tr. 12-13. Harold Johnson has been a career employee in the Treasurer's Office since 1981; he has held the position of principal investment officer since 1993. Tr. 50-52. He received an MBA in finance from Loyola University in Chicago in 1975, and became a Chartered Financial Analyst in 1984. Tr. 51-54. Prior to joining the Treasurer's Office he worked as a financial analyst and investment analyst. Tr. 52. Burnham considers Johnson's qualifications, knowledge, and performance to be outstanding, and relied on his expertise daily. Tr. 22-24, 35-36, 41.

At the time at issue Johnson's duties were to manage the short-term investment fund of the State of Connecticut (STIF) and the pension cash reserve fund (CRA). Tr. 23, 54-65. The STIF contained the operating funds of the State, State agencies, and about 105 towns; they used it like a bank account. Tr. 54-55. The CRA contained the cash portion of the pension account for State employees, teachers, and judges. Tr. 56-57. Johnson managed these funds conservatively; safety is the prime concern so that operating cash is available to the State, towns, and agencies. Tr. 57-58. He invested the funds' assets in bankers acceptances, high grade commercial paper, overnight repurchase agreements, U.S. Treasury securities and U.S. government agency securities. Tr. 58-64. He researched all investments, through information from rating firms, major broker-dealers, and corporations' disclosure documents. Tr. 60-63. The rate of return on the two funds in 1995 was approximately 5.62%, and they totaled about $3 billion. Tr. 23, 55, 63-65.

C. Reese's Dealings with the Office of the Treasurer

Reese approached Burnham at a Republican state convention in Connecticut on September 16, 1995. Tr. 14-18, 35-38; Div. Ex. 1 at Stip. 3, Div. Ex. 7 at 181-83. Burnham believed he was a delegate to the convention. Tr. 14, 17, 38. Reese was, however, working for a contractor to the convention on lighting, set-up, and security. Tr. 182; Div. Ex. 7 at 181-82. Reese suggested that "prime bank debentures" would be a suitable investment for the State, and Burnham invited him to follow up in writing in accord with his usual procedure for dealing with prospective vendors. Tr. 16-17, 38-40; Div. Ex. 7 at 183.

Reese responded by a letter dated September 18, 1995, to which was attached an eight page document entitled "THE MECHANICS OF PRIME BANK SLC'S AND GUARANTEES." Tr. 18-22, 160-61; Div. Ex. 1 at Stip. 4, Div. Ex. 3. Reese received the document anonymously in the mail in 1992 and does not know its source. Tr. 160-65, 180-81; Div. Ex. 3 at 2-9. According to the document, the Federal Reserve (Fed) engages in a secret program, using "Prime Bank Guarantees" and "Standby Letters of Credit," to control the amount of dollars in circulation outside the U.S. To do this the Fed secretly licenses a small number of "commitment holders" and identifies a list of about 100 high quality banks that can deal in the secret instruments. An investor deals with a "commitment holder," which insists on receiving $100 million cash up front. The "commitment holder" places the funds in an account at a bank. The actual trading is between two banks, using these funds. All activities are conducted off the banks' balance sheets. The document acknowledges that yields are extraordinarily high for low risk instruments and provides an obtuse explanation concerning this. The document warns that it is difficult for an investor to find a legitimate "commitment holder" because pretenders outnumber legitimate "commitment holders." There are many bad players, but they can be distinguished because they lack financial acumen and ask for fees up front. These bad players have caused the U.S. government to issue warnings. Div. Ex. 3 at 2-9. The document also states, "Prime Bank Guarantee's or SLC's are short hand terms and are trade jargon, the proper name for such is BANK DEBENTURES!" Div. Ex. 3 at 2.

On October 21, 1993, the Board of Governors of the Federal Reserve System and other U.S. Government agencies issued an Interagency Advisory entitled "WARNING CONCERNING 'PRIME BANK' NOTES, GUARANTEES, AND LETTERS OF CREDIT AND SIMILAR FINANCIAL INSTRUMENTS" (Interagency Advisory). 3 Div. Ex. 9. The Interagency Advisory warned against schemes like that described in Division Exhibit 3 and like the program Reese was recommending to the State of Connecticut, characterizing them as "questionable," "illegal," "dubious," "suspicious," and "bogus." Div. Ex. 9. Reese was aware of the Interagency Advisory at the time he was recommending his program to the State of Connecticut. Tr. 182.

The program Reese was recommending to the State of Connecticut is also known as a roll program. Tr. 147-50. As of September 1995, Reese had not documented a successful roll program. Tr. 165-67. However, he believes that certain individuals have engaged successfully in such programs on the basis that "nobody got arrested and everybody is living a nice lifestyle." Tr. 146-47, 157. He believes that secrecy is essential to the high returns of such programs while the ordinary investor is constrained to meager returns. Tr. 112, 185-86.

Burnham gave Reese's September 18 letter and the document to Johnson for review. Tr. 22-24, 39, 65-66. Johnson concluded that the proposal was fraudulent and decided not to pursue the investment; he reported this to Burnham. Tr. 24-25, 42, 66-79, 115-16. Johnson contacted the Commission. Tr. 25, 78-79, 116, 132.

In early November Reese telephoned Burnham's office to follow up, and a meeting was scheduled. Tr. 25-28, 79-80; Div. Ex. 1 at Stip. 5. During a conversation about the meeting, Reese told Johnson that the prime bank debentures were guaranteed by the Fed; Johnson said he would check this with the Fed, and Reese said the Fed would deny it. Tr. 81, 117. Reese also said he would send further information, and did so, the same day. Tr. 85, 167-69; Div. Ex. 1 at Stip. 6, Div. Ex. 4.

The cover page of Division Exhibit 4 is dated November 8 and includes Reese's note, "Please call with any questions or concerns." Tr. 89. The next page is a memo entitled "Procedures JFR Investment Program 5," which describes the steps that would occur in the investment he was proposing. There are fourteen additional pages of attachments, most of which Reese received anonymously in the mail in 1992. Tr. 180-81; Div. Ex. 4 at 3-16.

Johnson contacted the Fed right after the conversation with Reese, but received a vague response. Tr. 81-83, 117. Shortly thereafter, an FBI agent, Michael Clark, called Burnham about the matter, and the meeting was rescheduled to allow Clark to attend, posing as a staff member. Tr. 27, 83-85. The meeting of Reese, Clark, Johnson, and Larry Wilson, another employee of the Treasurer's Office, took place on November 14; Burnham appeared briefly and made introductions. Tr. 28, 90-104, 127-35, 169-177; Div. Ex. 1 at Stip. 8.

The November 14 meeting lasted an hour or two. Tr. 90. Reese started by saying he was not soliciting and that his presentation concerning bank debentures was for informational purposes only. Tr. 91, 127, 169-70, 182. Johnson, however, understood Reese to be proposing an investment, of $100 million. Tr. 91. Reese explained that Johnson would receive a certificate and a guarantee from one of the top twenty-five banks in Europe, such as National Westminster Bank, of return of principal with 8% interest. Tr. 93-96. The instrument would be purchased at a steep discount, such as 70% of par. Tr. 92-93. Additionally there would be a trading program, whereby the instrument would be repeatedly sold and repurchased, forty times in a year, with a minimum profit of 2% on each transaction; Reese's compensation would be one third of the profit above the minimum. Tr. 96-101, 110-12. The investment involved one of eight "commitment holders" licensed by the Fed. Tr. 99-100. Reese said that he had access to a "commitment holder," whom he would not identify, saying that the State could then deal directly with the "commitment holder" and cut Reese out. 4 Tr. 99, 184. Reese stated the minimum profit to the State of Connecticut would be 88%, with almost no risk. Tr. 96, 101. Reese stated secrecy was essential. Tr. 101. He cautioned Johnson that if he spoke to the Fed or the Commission, he "would stir up a hornet's nest," and they would deny the existence of the secret program. Tr. 101, 182. Johnson asked for the name of a previous investor so he could discuss the program with him, but Reese responded that he could not reveal the names of other investors. Tr. 103-04.

A few days later Reese telephoned Johnson to ask if he had decided to go ahead with the investment. Tr. 105; Div. Ex. 1 at Stip. 9. Johnson told him he could not invest without speaking to previous investors. Tr. 105. Reese's November 14 presentation had bolstered Johnson's decision not to pursue the investment. Tr. 106-08. Johnson felt that fraud was indicated by Reese's claim that the rate of return was extremely high with no risk and by his insistence on secrecy and refusal to identify even one previous investor. Tr. 106-08.

On November 28, 1995, Commission staff questioned Reese pursuant to a Formal Order of Investigation about the Connecticut matter and other prime bank type dealings. Div. Ex. 7. In January 1996 Reese sent Burnham a letter referencing Johnson's disinclination to invest and recommending that Burnham review his information. Tr. 29, 109-110; Div. Ex. 5. The letter concludes by stating, "If you . . . wish to move forward please drop a note to my home address. I will gladly meet with you or your associates again." Div. Ex. 5. Burnham forwarded the letter to Johnson, who understood it as another attempt to persuade the Treasurer to invest, and put it in his file. Tr. 109-10.

D. Expert Testimony

James E. Byrne, Professor of Law at George Mason University and Director of the Institute of International Banking Law and Practice, was accepted as an expert on prime bank schemes. Tr. 204-13. Byrne explicated some of the terms used by Reese. A debenture is a medium term debt instrument, such as a bond. Tr. 214. An independent guarantee is an undertaking to pay contingent on presentation of certain documents; a guarantee has a date of expiration when the obligation to honor it ceases; a standby letter of credit is similar. Tr. 214-16. Such instruments might be used, for example, by a municipality with a poor rating that wanted to issue bonds; a bank of the highest credit rating would issue a guarantee or standby letter of credit, which would enhance the investment quality of the bonds. Tr. 215. Neither is a debenture, debt instrument, negotiable instrument, or investment vehicle. Tr. 214-16. The notion of trading letters of credit, standby letters of credit or independent guarantees is unthinkable. Tr. 217.

What are described as prime bank schemes typically are programs that offer esoteric instruments associated with international banking and contain an opportunity to obtain returns on the instrument itself and on some kind of trading; they derive their supposed credibility from association with a major bank. Tr. 218-19. They mutate but have some common characteristics. Tr. 219. They do not make economic sense because the returns are disproportional to the risk, and it is hard to pin down exactly who is obligated and why it would pay such an excessive rate. Tr. 220-23. They do not make transactional sense: a bank which agreed to pay a dollar plus interest for something for which it only received 70 cents would have to earn the full face amount plus interest at the time the obligation comes due; what is the transactional source of the funding, whether from the bank or the customer? Tr. 224-25. Prime bank schemes are usually unduly complex, with layers upon layers of people involved for no understandable reason except to diffuse blame when the scheme collapses; banks do not need intermediaries to issue paper. Tr. 229. They also have a dimension of secrecy that is inexplicable and contrary to the best interests of the parties involved; the market must be transparent for the borrower to obtain the lowest rate possible, and the market for trading debentures is public, not secret. Tr. 226-27.

Byrne opined that Reese's proposal was not a legitimate scheme. Tr. 231-35. He stated it is not clear what is traded, who is doing it, or why. Tr. 232-33. The Fed does not associate itself with such undertakings. Tr. 233. The proposal uses terms such as "KTT" and "conditional SWIFT" in a manner used only in fraudulent schemes. Tr. 233-34. Additionally, there are the elements of secrecy and complexity. Tr. 234. The proposal makes no economic or transactional sense and depends on a nonexistent secondary market. Tr. 234.

III. Conclusions of Law

In this section it is concluded that Reese violated, as charged in the OIP, Section 17(a) of the Securities Act. Section 17(a)(1) makes it unlawful "in the offer or sale of any securities," by jurisdictional means, to "employ any device, scheme, or artifice to defraud." Reese's course of conduct was "in the offer or sale of any securities," and he acted with scienter.

A. Securities

The proposed investment which Reese discussed with the Treasurer was a security within the meaning of the federal securities laws despite its nonexistence and the attempt to cloak it as a bank deposit. The proposal was a type of prime bank scheme that courts have found subject to the antifraud provisions of the securities laws; the fact that the investments being offered do not exist does not remove them from the reach of the antifraud provisions. See SEC v. Lauer, 52 F.3d 667, 670 (7th Cir. 1995); SEC v. Gallard, 1997 U.S. Dist. LEXIS 19677, at *6-*8 (S.D.N.Y. 1997).

While it is difficult to pin down exactly what Reese was offering because of the obfuscation characteristic of a prime bank scheme, Reese repeatedly referred to his investment product as "debentures." A debenture is a security. See Section 2(a)(1) of the Securities Act; Landreth Timber Co. v. Landreth, 471 U.S. 681, 685-86 (1985).

In the alternative, Reese's investment product was an investment contract within the meaning of Section 2(a)(1) of the Securities Act and SEC v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946). 5 See Lauer, 52 F.3d at 670. This conclusion assumes that the common enterprise requirement of Howey is met by "strict vertical commonality" in that Reese's profits were tied to the profits earned on the trading scheme. 6 The Circuit Courts differ on whether "horizontal," "strict vertical," or "broad vertical" commonality suffice to meet the common enterprise requirement, 7 and the Courts of Appeal for the Second and D.C. Circuits have not spoken definitively on the issue. In Revak v. SEC Realty Corp., 18 F.3d 81, 87-88 (2nd Cir. 1994), the court rejected "broad vertical commonality" and specifically declined to address the question of whether "strict vertical commonality" suffices. See also, SEC v. Life Partners, Inc., 87 F.3d 536, 543-44 (D.C. Cir. 1996). However, "strict vertical commonality" has been held to suffice in cases in the District Court for the Southern District of New York. See Walther v. Maricopa International Investment Corp., 1998 U.S. Dist. LEXIS 5475, at *19-*21 (S.D.N.Y. 1998) (citations omitted). A conclusion that "strict vertical commonality" in the absence of "horizontal commonality" meets the common enterprise requirement of Howey better serves the remedial purposes of the securities laws than to require "horizontal commonality" in all cases. See Louis Loss & Joel Seligman, Securities Regulation 3A.1.d.(i)(2) (3d ed. 1989).

B. Offer or Sale

The activities at issue in this proceeding were "in the offer or sale of" securities, by jurisdictional means. Section 2(a)(3) of the Securities Act provides, "The term . . . 'offer' shall include every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value." See Pinter v. Dahl, 486 U.S. 622, 643 (1988); U.S. v. Naftalin, 441 U.S. 768, 773 (1979).

Reese's course of action, starting with his September 1995 approach to Burnham at the Republican convention and ending with his January 1996 letter to Burnham, was "in the offer of" securities. He solicited the Treasurer's Office to invest money in a prime bank scheme over a period of four months. During that period he sent letters and materials concerning prime bank debentures, offered to meet and answer questions, made a presentation to the Treasurer's Office on November 14, and followed up with a phone call to Johnson to ask if he had decided to invest. Johnson understood his actions as soliciting an investment.

Reese's careful use of such terms as "information" and his disclaimer at the beginning of the November 14 meeting that it was not a solicitation do not show that he was not soliciting. Rather, they show an intent, through formulaic utterances, to avoid legal liability. Indeed, at the November 14 meeting, he declined to identify his "commitment holder" on the ground that the State would go ahead with the investment directly and cut Reese out. This underscores the fact that he was soliciting and not just providing a disinterested presentation of information.

Reese argues that Johnson showed bad faith after he decided not to invest by continuing to receive Reese's phone calls and arranging a meeting. This argument is inconsistent with Reese's attempt to rekindle Burnham's interest in January 1996 after Johnson told Reese in November 1995 that he had decided not to invest. Throughout the four month period, it was Reese who initiated and pursued contact with the Treasurer's Office; the Treasurer's Office did not seek him out to purchase prime bank securities.

C. Scienter

Scienter is required to establish violations of Section 17(a)(1) of the Securities Act; it is "a mental state embracing intent to deceive, manipulate, or defraud." Aaron v. SEC, 446 U.S. 680, 686 & n.5, 695-97 (1980); see also Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976).

Recklessness can satisfy the scienter requirement. David Disner, 52 S.E.C. 1217, 1222 & n.20 (1997); see also SEC v. Steadman, 967 F.2d 636, 641-42 (D.C. Cir. 1992); Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990). Reckless conduct is conduct which is "'highly unreasonable' and which represents 'an extreme departure from the standards of ordinary care . . . to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it.'" Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 47 (2d Cir. 1978) (quoting Sanders v. John Nuveen & Co., 554 F.2d 790, 793 (7th Cir. 1977)).

The record shows Reese's scienter; his intent was to deceive and defraud. He was aware of the Interagency Advisory. He cautioned Johnson against requesting information from the Fed or from the Commission about his proposed investment. He warned that the Fed would deny such investments exist. He declined to identify other investors. He stressed the need for secrecy. His explanation for returns far too good to be true was that investments like his were known only to a few who kept them secret to constrain the ordinary investor to meager returns. The conclusion to be drawn from these facts is that Reese knew his proposal was not legitimate and wished to prevent Johnson from discovering this. He refers to the State as a "sophisticated investor" capable of doing its own due diligence, but this status does not immunize him from liability for fraud, particularly when he actually sought to restrict Johnson's research into his prime bank scheme.

In the alternative, Reese was reckless in not knowing that his trading program was a "device, scheme, or artifice to defraud." Promised returns far too good to be true are an indication of fraud. He recommended the trading program even though he was aware of the Interagency Advisory. He had never actually successfully completed a program or documented a successful program, yet recommended it anyway. He did not know the identities of the "commitment holders" involved in his program. He relied on anonymous information that he received in the mail.

D. Material Misrepresentations

The record also shows material misrepresentations within the meaning of Securities Act Section 17(a). In a nutshell, his representation that the investment he recommended existed was false. The standard of materiality is whether or not a reasonable investor or prospective investor would have considered the information important in deciding whether or not to invest. See Steadman, 967 F.2d at 643; see also Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 240 (1988); TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). Clearly a reasonable investor would consider the nonexistence of the investment important in deciding whether or not to invest. For the reasons stated above, the material misrepresentations were made with scienter.

IV. Sanction

The Division requests a cease and desist order. Reese requests that the proceeding be dismissed. For the reasons discussed below, a cease and desist order will be entered.

A. Sanction Considerations

When the Commission determines administrative sanctions, it considers:

the egregiousness of the defendant's actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant's assurances against future violations, the defendant's recognition of the wrongful nature of his conduct, and the likelihood that the defendant's occupation will present opportunities for future violations.

Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979) (quoting SEC v. Blatt, 583 F.2d 1325, 1334 n.29 (5th Cir. 1978)), aff'd on other grounds, 450 U.S. 91 (1981).

B. Cease and Desist Order

Pursuant to Section 8A of the Securities Act, if the Commission finds that a person "is violating, has violated, or is about to violate" any provision of the Act, it may enter a cease and desist order against "such person, and any other person that is, was, or would be a cause of the violation, due to an act or omission the person knew or should have known would contribute to such violation." As concluded above, Respondent Reese violated Section 17(a) of the Securities Act. Further, the record shows a reasonable likelihood of such violations in the future. The relevant factors to consider when assessing the likelihood of recurrent violation include "'whether a defendant's violation was isolated or part of a pattern, whether the violation was flagrant and deliberate or merely technical in nature, and whether the defendant's business will present opportunities to violate the law in the future.'" Steadman, 967 F.2d at 648 (quoting SEC v. First City Fin. Corp., 890 F.2d 1215, 1228 (D.C. Cir. 1989)).

Reese's violations consisted of several discrete acts and omissions over a period of several months. Thus his violations were not isolated but were part of a pattern. The violations were "flagrant and deliberate" and not "merely technical." He presently intends to resume working in the securities industry. He has shown no recognition that so called prime bank securities are a fraud. His clinging to the idea that they are a good investment albeit a secret known only to a select few goes beyond presenting a vigorous defense in this proceeding. Because of his continuing endorsement of the validity of "prime bank" securities his business will present opportunities to violate the law in the future. In fact he may seek such opportunities. Accordingly, it is appropriate to order him to cease and desist from committing or causing any violations or future violations of Section 17(a) of the Securities Act.

V. Record Certification

Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. 201.351(b), I hereby certify that the record includes the items set forth as of the record index issued by the Secretary of the Commission on May 28, 1998.

VI. Order

Based on the findings and conclusions set forth above:

It is ordered that, pursuant to Section 8A of the Securities Act, Joseph F. Reese cease and desist from committing or causing any violations or future violations of Section 17(a) of the Securities Act.

This order shall become effective in accordance with and subject to the provisions of Rule 360 of the Commission's Rules of Practice, 17 C.F.R. 201.360. Pursuant to that rule, a petition for review of this initial decision may be filed within 21 days after service of the decision. It shall become the final decision of the Commission as to each party who has not filed a petition for review pursuant to Rule 360(d)(1) within 21 days after service of the initial decision upon him, unless the Commission, pursuant to Rule 360(b)(1), determines on its own initiative to review this initial decision as to any party. If a party timely files a petition for review, or the Commission acts to review as to a party, the initial decision shall not become final as to that party.

 

_________________________
Carol Fox Foelak
Administrative Law Judge


Footnotes

-[1]-   Citations to exhibits offered by the Division and the Respondent and to the transcript of the hearing will be noted as "Div. Ex. __," "Resp. Ex.__," and "Tr.__" respectively.

-[2]-   See 5 U.S.C § 557(c).

-[3]-   The other agencies were the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision. Div. Ex. 9.

-[4]-   Actually Reese did not know the name of the "commitment holder." Tr. 184.

-[5]-   An investment contract is defined as an investment of money in a common enterprise with an expectation of profit solely through the effort of others. See Howey, 328 U.S. at 301.

-[6]-   Under the "strict vertical commonality" formulation, the common enterprise requirement is met if the fortunes of the investor are tied to those of the promoter. Brodt v. Bache & Co., 595 F.2d 459, 460-61 (9th Cir. 1978). "Broad vertical commonality" requires only that the fortunes of the investors be linked to the efforts of the promoter. Long v. Schultz Cattle Co., 881 F.2d 129, 140-41 (5th Cir. 1989). "Horizontal commonality" is lacking since there is no indication in the record that the funds of the State of Connecticut were to be pooled with those of other investors.

-[7]-   See Louis Loss & Joel Seligman, Securities Regulation §3A.1.d.(i)(2) (3d ed. 1989).

http://www.sec.gov/litigation/aljdec/id142cff.htm


Modified:06/22/1999