Frank Susman and Gregory K. Allsberry for Respondents
BEFORE: Stephen L. Grossman, Administrative Law Judge
The Securities and Exchange Commission (Commission) initiated this proceeding by an Order Instituting Proceedings (OIP) on May 29, 1997, pursuant to Sections 8A of the Securities Act of 1933 ("Securities Act"); Sections 15(b)(6), 19(h), 21B and 21C of the Securities Exchange Act of 1934 ("Exchange Act"); and Sections 203(e), (f), (i) and (k) of the Investment Advisers Act of 1940 ("Advisers Act").
The OIP set out four allegations. First, it alleges that Respondent Kenny was involved in a scheme to defraud. He misrepresented material facts to two individuals in violation of the antifraud provisions of the federal securities laws, Sections 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Second, Respondent Kenny was involved in a scheme to defraud two insurance companies. He aided, abetted, and caused violations of the antifraud provisions of the federal securities laws, Section 17a of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Third, Respondent Nicholson/Kenny had an investment advisory relationship with one of the insurance companies. Respondent Kenny and Respondent Nicholson/Kenny breached their fiduciary duty with the insurance company by making representations, failing to disclose prior misrepresentations, acted in violation of Florida state law, and misappropriating funds. They violated Sections 206(1) and 206(2) of the Advisers Act. Finally, Respondents violated Section 207 of the Advisers Act by filling false Forms ADV.
A hearing was held in Memphis, Tennessee on December 7-11, 1998 and in San Antonio, Texas on December 15-18, 1998. The Division of Enforcement (Division) filed its Post Hearing Brief and Proposed Findings of Fact and Conclusions of Law on March 10, 1999. Respondents filed their Proposed "Initial Decision" on April 7, 1999 and the Division filed its Reply Brief on April 26, 1999.1
The Division requests that cease and desist orders be entered against all Respondents, that Respondents be ordered to pay disgorgement in the amount of $1,333,000 and an equal amount in civil penalties.
II. Findings of Fact
a. Seeds of a Scheme
i. Respondent Kenny Relationship to Mr. Wilson
John "Jack" Kenny (Mr. Kenny), a law school graduate, but not a lawyer, has been a licensed broker since 1981. (Tr. 180.) Mr. Kenny received several Security licenses, including a Series 7, a general securities license for registered representatives under federal securities law; a Series 63, a general securities license for the states; and a Series 24, general principal's license. Mr. Kenny was licensed to do business in 20 or more states throughout the United States when he worked at Pauli & Company. (Tr. 101-104.)
Mr. Kenny worked at Kidder Peabody from 1981 until 1983. He then worked at PaineWebber Jackson & Curtis from 1983 until 1990. While at PaineWebber, the National Association of Securities Dealers (NASD) issued Mr. Kenny a letter of caution in response to his sending a letter to a client that referred the client to another investment entity, without the approval of PaineWebber. Mr. Kenny also worked for Rogers & Woolsey First Affiliated Securities for a year and a half. (Tr. 104-114.)
Mr. Kenny was a First Vice President at Dean Witter Reynolds office in St. Louis, Missouri, from 1990-1992. Robert Drake (Mr. Drake) was Mr. Kenny's supervisor at Dean Witter. While at Dean Witter, one of Mr. Kenny's clients, Doug McClain (Mr. McClain), introduced him to Robert Wilson (Mr. Wilson). Mr. Kenny became Mr. Wilson's broker at Dean Witter. Mr. Wilson maintained an account under the name of Earnscliffe Trust. At Mr. Wilson's request, Mr. Kenny provided Mr. Wilson with a letter, dated October 24, 1990, which stated that Mr. Wilson's account at Dean Witter was in good standing. Mr. Wilson used the letter as a reference within a brochure and other correspondence in efforts to promote his bond investment program, and potentially imply the support of Dean Witter for the program. Dean Witter sued Mr. Wilson and was able to prevent him and companies associated with him from using the Dean Witter name in any improper and unauthorized manner. The Earnscliffe Trust account at Dean Witter was subsequently closed. (Tr. 115-162.)
While at Dean Witter, Mr. Kenny managed a Trinity Capital account, opened by Mr. McClain. Mr. McClain expressed an interest in purchasing 200,000 shares of an initial public offering of Austrian Stock Index Growth Notes, at $10 per share; however after the order was placed, Mr. McClain indicated that he could not pay. After Mr. Kenny talked to Mr. McClain, Mr. Drake contacted Mr. McClain to determine if there was a way to salvage the deal. Goldman Sachs, the IPO underwriter, granted Dean Witter a week's extension for Mr. McClain, through Dean Witter, was able to obtain a week's extension on the purchase from the IPO underwriter, Goldman Sachs. Dean Witter accepted, and held the 200,000 shares at $10 per share until Mr. McClain could pay for them. After the week passed, Mr. McClain still did not pay for the shares. Dean Witter granted Mr. McClain another week's extension. After that week, Mr. McClain still did not purchase the shares. The shares were held by Dean Witter, and had devalued to $9 5/8 per share as compared to the original purchase price of $10. Dean Witter, after being unsuccessful in recouping funds from Mr. McClain, sold the 200,000 shares back to Goldman Sachs at $9 5/8 per share. Dean Witter attempted to obtain the difference between the purchase and the resell prices from Mr. McClain, but Mr. McClain refused to pay. (Tr. 168-174.).
Mr. Kenny and Chris Pauli were introduced in 1989 by a mutual acquaintance, John Gephardt. (Tr. 417.) Mr. Pauli has twenty years experience in the securities industry. (Tr. 446.) Chris and Jean Marie Pauli recruited Mr. Kenny to work at Pauli & Company. The recruiting sessions included sailing for ten days aboard a 60-foot sailboat. Pauli & Company was an introducing broker and had an association with Bear Stearns Securities Corporation, which acted as the clearing broker. (Tr. 195-196.) Pauli & Co. operated as a "S" corporation, a NASD broker dealer, and a SEC registered broker dealer. (Tr. 416.) As of December 1998, Pauli & Co. was closing down and had filed a broker dealer withdrawal on December 31, 1996. (Tr. 416.) Bear Stearns processed the accounts, actually held the funds and conducted the trades on the market, and generally acted as custodian of the account. (Tr. 195-196.) Bear Stearns issued the monthly statements, the trade slips, and confirmations on behalf of Pauli and Company from Bear Stearns office in New York. (Tr. 195-196.)
Mr. Kenny understood that he would receive 10 percent ownership upon joining Pauli & Company, and, if certain levels of production were met, he could purchase an additional 10 percent of the company and have his name added to the company title. Mr. Kenny worked at Pauli & Company as the Managing Director of Institutional Sales from July 1992 until March 1995. He was in charge of assisting portfolio managers of large accounts. Mr. Kenny's salary was based upon a sliding percentage of gross sales less internal charges attributed to that sale or spread across all sales. During Mr. Kenny's tenure with Pauli & Company he made approximately $300,000 annually. (Tr. 175-180.)
Mr. McClain and Mr. Wilson became clients of Mr. Kenny at Pauli & Company. Mr. McClain was employed in Mr. Wilson's entities. At one point he was the Director of Mr. Wilson's Euro America Insurance Company Limited. In November 1993, Mr. McClain delivered some Mexican bonds, on behalf of Mr. Wilson, to the Pauli & Co. offices. Mr. Wilson had purchased the bonds, which had an estimated face value of 100 million dollars, offshore. Mr. Kenny issued a letter, on behalf of Pauli & Company, to enable Mr. McClain to courier the bonds and deposit them at Pauli & Company. Mr. Kenny called to verify the bond issuance and found that the bonds were fraudulent. Mr. Kenny notified the Federal Bureau of Investigation, and they took possession of the bonds. (Tr. 1042-1046.)
Mr. Wilson made a capital investment into Pauli & Company in the form of 25,000 shares of DNK Wholesale Drug, valued at $100,000. (Tr. 418.) Mr. Wilson consistently made promises that would benefit Pauli & Company and did not follow through on those promises. (Tr. 1025.) In October 1992, Mr. Wilson began discussions to purchase an interest in Pauli & Company. The purchase plans varied from providing $750,000 cash and investing over 10 million dollars in an equity loan to Pauli & Co., to lending Pauli & Co. 11 million dollars contingent upon Mr. Wilson receiving the 25,000 shares of DNK Wholesale Drug from the firm. Mr. Wilson also proposed a 100 million dollar bond trading program that would be underwritten by Pauli & Co., and financed by notes to be offered to the public. (Tr. 444-446.) Mr. Pauli did not understand Mr. Wilson's bond trading program. (Tr. 446-447.) Neither the purchase plans nor the underwriting opportunity was implemented. (Tr. 1025-1035.)
Mr. Wilson arranged for the sale of shares of North American Technologies and Prairie Pacific stock from his Euro Scotia Funding account at Pauli & Co. to C.S. First Boston Bank and from there to a buyer. (Tr. 1047.) C.S. First Boston Bank purchased the stock from Mr. Wilson's Euro Scotia Funding account at Pauli & Company, with Mr. Kenny as the account representative. (Tr. 1049.) After the sale, C.S. First Boston Bank was unable to get the buyer, recommended by Mr. Wilson, to purchase the stock. (Tr. 1049-1050.) Shortly there after in early 1994, C.S. First Boston complained and sought recovery of the funds paid to Pauli & Company for the stock purchased. (Tr. 1049.) C.S. First Boston sued Mr. Wilson and Euro Scotia Funding for the recovery of funds in United States District Court of Southern New York. (Tr. 1058-1059, Div. Ex. 1038.) The court order froze all of Mr. Wilson's assets including those of his company Euro Scotia Funding. (Div. Ex. 1038.) A subsequent court order required that Mr. Wilson and Euro Scotia Funding to liquidate their accounts at Pauli & Co. and Bear Stearns to pay C.S. First Boston Bank. (Div. Ex. 1039.) As the account representative for the Euro Scotia Funding, Mr. Kenny was required to sign a promissory note indicating that if there were a refund, he would have to pay back the commission he received on the deal. (Tr. 1065, Div. Ex. 1041.) The Pauli & Co. account at Bear Stearns was debited by Bear Stearns after Bear Stearns settled the issue and paid funds to C.S. First Boston Bank. (Tr. 1115.) Pauli & Co. never exercised the promissory note to collect the commissions back from Kenny. (Tr. 1114.)
Mr. Wilson paid for a Bloomberg computer and data base access services for Mr. Kenny's use while at Pauli & Company, by transferring funds from Euro Scotia Funding Limited-NAT account to Pauli & Company's bank account whenever Mr. Kenny requested. (Tr. 203-209.) Additionally, $70,000 was transferred from the Euro Scotia Funding Limited-NAT account to Dr. Peter Colinger's bank account for an undisclosed reason. Mr. Kenny and Dr. Colinger were business partners in the areas of import, land, and apparel manufacturing. (Tr. 210-213.)
Mr. Kenny issued letters, at Mr. Wilson's request, stating that Mr. Wilson had conducted over 250 million dollars in transactions with Pauli & Co. in 1993. Pauli & Co. rules and procedures required that letters sent out should be reviewed by supervisory principals either immediately before or after issuance. (Tr. 1073-1074.) The letters Mr. Kenny sent did not have supervisory review. (Tr. 1076.) Normally, when a customer asked, "How does my account stand," rather than writing a letter, a printout of the account statement would be given. However, if a client requests a letter verifying his account information, typically for use with a lender, Pauli & Co. would provide it. (Tr. 1078.)
Pauli & Co., Mr. Kenny as account representative, assisted Mr. Wilson in preparing the business plan and financing research for new company called American Medical Management Systems (AMMS), which would apply Tensiodyne imaging technology for medical purposes. (Tr. 1081.) Mr. Kenny also conducted investment banking and prepared a research report for North American Technologies (NAT) while at Pauli and Company. He worked with John Parrot (Parrot), President of NAT, on these issues, however they met only once, in the spring of 1993. (Tr. 183-186, 1354.) NAT focused on environmental concerns and was introduced to Mr. Kenny and Pauli and Co. by Mr. Wilson. (Tr. 1319, 1327-1328.) NAT entered into a financing arrangement with Mr. Wilson whereby he exercised key shareholder/employee stock options and then would reinvest the proceeds in NAT, Inc. (Tr. 1321.) The stock was owned by Gold Spinners, a company partially owned by Parrot. (Tr. 189.) Funds were placed in the Royal Bank of Canada for NAT through Euro Scotia. (Tr. 1326.) Mr. Wilson explained to Mr. Parrot the aspects of the bond trading program. (Tr. 1330.) NAT shares were placed into the Euro Scotia Funding Limited account, with account designation "NAT." (Tr. 189.) NAT initially keep some control over the account by retaining NAT's sign off authorization on transactions. (Tr. 1330.) Mr. Kenny and Mr. Wilson convinced NAT to relinquish control to Mr. Wilson so that he could conduct the swift moves necessary for the bond trading program. (Tr. 1331, 1368.) Once Mr. Wilson had control over the account, he directed the trades and distributions. (Tr. 189.) NAT and Mr. Parrot did receive monthly statements from Pauli & Company. (Tr. 1362-3, Div. Ex. 521.) The NAT account increased from approximately 2.5 million dollars by 2.1 million dollars while at Pauli & Company, but upon the transfer of all accounts assets to Johnston & Kent in early 1994, at Mr. Wilson's request, all the funds disappeared. (Tr. 1362-63, 1365-6, Div. Ex. 521.)
ii. Respondent Nicholson/Kenny's Relationship to Mr. Wilson
In July 1994, Mr. Kenny was a member of a due diligence team assembled by Mr. Wilson to review the Nicholson Group, a securities firm in Florida that Mr. Wilson was interested in purchasing. (Tr. 1088.) The Nicholson Group was established in 1979 by Robert Nicholson, originally as the Nicholson Report, a newsletter which eventually grew to add money management services. (Tr. 1380.) The Nicholson Group investment philosophy was very conservative because most of the clients were older people who did not want to risk losing their retirement funds. (Tr. 1381-1382.) The Nicholson Group had contracts with its clients stating that the investments made would follow conservative objectives. (Tr. 1384.) The due diligence team did not include Mr. Wilson, but the team conveyed Mr. Wilson's intent to purchase Nicholson Group and use the 50 million dollars in Nicholson Group's client assets in Mr. Wilson's highly speculative bond trading program. (Tr. 371, 1088, 1383-1384.) Mr. Nicholson would not sell the company to Mr. Wilson because of the ethical and contractual obligations to Nicholson Group clients, and his inability to understand Mr. Wilson's bond trading program. (Tr. 1384-1385.) After the deal to purchase Nicholson Group by Mr. Wilson fell through, Mr. Kenny decided he was interested in purchasing the company. (Tr. 375, 1088-1092, 1386.) The purchase price negotiated between Mr. Kenny and Mr. Nicholson was 1.5 million dollars, with $913,000 paid up front and the remaining $600,000 to be paid over three years in annual installments of $200,000. (Tr. 377, 1389.) Joe Galda, who unbeknownst to Mr. Nicholson was Mr. Wilson's attorney, prepared the contract for the sale of Nicholson Group. (Tr. 1388.) Mr. Kenny created NGI Acquisition Corporation in 1994 to purchase the Nicholson Group, and NGI eventually changed its name to Kenny Capital Management. Kenny Capital Management became a holding company for Nicholson/Kenny Capital Management (Nicholson/Kenny), formerly Nicholson Group, and Kenny Securities Corporation (KSC) which was also formed in 1994. (Tr. 375.) Mr. Kenny did not have the funds required to purchase the company and obtained all financing for the purchase from Mr. Wilson. The only collateral required for the loan was Mr. Kenny's signature. (Tr. 384-385.) The closing date for the purchase and the first payment (obtained from Wilson) was in October 1994, but the loan document was not signed until the third quarter of 1995. (Tr. 377-378.) Mr. Kenny also received a 1 million dollar line of credit from Mr. Wilson for operations and setup of the various companies to be owned by Mr. Kenny. (Tr. 384-385, Div. Ex. 323.)
Mr. Kenny, as required by NASD rules that require disclosure of any and all outside investment and activities, informed Pauli & Company about the purchase of Nicholson Group while he was still employed with them. (Tr. 384-385) Mr. Kenny did not inform Pauli & Company about the creation of KSC, which was also formed while he for them. (Tr. 384-385, 1091-1092.) In August 1994, after agreeing to purchase Nicholson Group, Mr. Kenny was the focal point in a proposal that would invest several million dollars into Pauli & Company. The financing again was to be provided by Mr. Wilson. Pauli & Company rejected the offer because of Mr. Kenny's involvement. Mr. Pauli resented Mr. Kenny's absence for several weeks on what was expected to be a due diligence review that turned out to be transaction for the benefit of Mr. Kenny and not the client Mr. Wilson. (Tr. 1088-1092.) Mr. Kenny left Pauli & Company in March 1995. (Tr. 1092.) Pauli & Co. received the first complaints about Mr. Kenny from NFC about six months after he had left. (Tr. 1097.)
In June 1995 KSC obtained a license to engage in the Securities Business. (Tr. 1120.) Mr. Nicholson remained with Nicholson/Kenny to continue to handle the money management duties until he could find a suitable replacement (Tr. 1391.) While Mr. Kenny was well qualified in all the areas of brokerage, he did not have expertise in money management. (Tr. 1391.) Mr. Nicholson worked five to six days a week at Nicholson/Kenny from October 1994 to July 1995, and worked one or two days a week there until 1996. (Tr. 1392.) Mr. Nicholson filed suit against Mr. Kenny in 1996 for falling to pay the $200,000 purchase installments for 1995 and 1996. (Tr.1392-1393.) Mr. Kenny counterclaimed that Mr. Nicholson had fraudulently misrepresented the firm during the sale. (Tr. 1403.) The suit was settled and all outstanding balances were eventually paid by Mr. Kenny. (Tr. 1404.)
John Phelan was hired in January 1995 to replace Mr. Nicholson. (Tr. 1391, 1412.) Mr. Phelan was the onsite manager at Nicholson/Kenny until his departure in June 1998. Mr. Phelan left Nicholson/Kenny over concerns about the amount of litigation and mounting complaints about Mr. Kenny. (Tr. 1413.) Mr. Phelan was responsible for listing the litigation and complaints involving Nicholson/Kenny on the annual ADV forms and amendments filed with the SEC. (Tr. 1413, 1438.) ADV is a form required annually to be filled out by registered investment advisers with the SEC, and requires disclosure of complaints, change of ownership, corporate officers and any other material occurrence. (Tr. 1417.) Mr. Phelan did not list Mr. Kenny's business start-up loan from Mr. Wilson because Mr. Wilson did not exercise control over the venture. (Tr. 1438.)
Mr. Kenny filed a lawsuit against Mr. Phelan and two other employees of Nicholson/Kenny, Jordan Foret, and Cathlene Buchanan, claiming that they took trade secrets from Nicholson/Kenny upon leaving Nicholson/Kenny and forming of Helios International, a capital management firm. (Tr. 1411, 1414.) Mr. Phelan had contacted Nicholson/Kenny clients to defuse a May 1998 newspaper article about Mr. Kenny being involved in securities fraud. (Tr. 1429, 1464.) Several of the Nicholson/Kenny's clients eventually moved to Helios. Nicholson/Kenny had 80 million dollars in assets as of June 1998; Helios had 60 million dollars of those assets by December 1998. (Tr. 1431-1432.) Mr. Kenny stated that reconstructed computer data indicated that Mr. Phelan, Mr. Foret, and Mr. Buchanan, while at Nicholson/Kenny, had actually prepared data to contact Nicholson/Kenny clients for recruitment to Helios International. (Tr. 1573.)
Mr. Phelan had meet Mr. Wilson while at Nicholson/Kenny. (Tr. 1414.) Mr. Wilson used the Nicholson/Kenny's facilities to talk to prospects about his investment programs. (Tr. 1393, 1405.) Mr. Wilson began to have problems with securities regulators in the mid to late 1995, and Mr. Kenny's access to Mr. Wilson as a lender and as his biggest client was hampered. (Tr. 1416.) Mr. Kenny was forced to mortgage his home because he was in some financial straits. (Tr. 1445.) During 1995, Mr. Phelan stated a burly man carrying a gun delivered $9,900 in cash for Mr. Kenny from Mr. Wilson. Mr. Phelan counted the cash and signed a receipt for the funds. He subsequently sent the cash via Federal Express to Mr. Kenny, who was in St. Louis at the time. (Tr. 1418-1420.) Mr. Kenny had no recollection of personally receiving the funds, however, he did say that his wife and other members of his staff recall the funds being delivered and used for the lease buyout payment on the Nicholson/Kenny facility in Florida. (Tr. 1605.)
KSC passed two separate announced intensive audits by NASD, the first in the summer of 1996 and a second during the second quarter of 1998. (Tr. 1983-1985.) Nicholson/Kenny was the subject of an unannounced audit by the SEC in the fall of 1995. While the ADV letter issue arose, Nicholson/Kenny did pass the audit. (Tr. 1985-1986.) KSC entered into a successful joint placement agreement with Mercantile Bank in 1998 on behalf of a private company to assist the company in raising capital. (Tr. 1894-1896.) William Stern, Vice President of Capital Markets Group at Mercantile Bank, conducted a due diligence, but not a deep analysis, on KSC and decided to proceed with the joint placement agreement. (Tr. 1896, 1907.) In the 17 years Mr. Kenny has been involved in securities he has not had a non-Wilson related complaint. (Tr. 1986.) Mr. Kenny is the rainmaker for KSC and Nicholson/Kenny and believes that the firms would close without his presence and contributions to the business. (Tr. 1999-2000.)
b. Respondent Kenny's Dealings with Albert Kaufman
Albert Norman Kaufman (Mr. Kaufman) of San Antonio, Texas, is a 76 year old former enlisted military member and retired salesman/entrepreneur. At the time of his testimony was seeking employment. (Tr. 1151-1152.) Mr. Kaufman has a high school education, and other than following his own stocks and bonds, he did not have any experience trading them. (Tr. 1152.) Mr. Kaufman had recently sold Gulf and Western stock, and placed that with other income being managed by Investment Management Services, account executive Dick Wiggins. (Tr. 1155-1156.)
Mr. Kaufman's stepdaughter and wife introduced him to Mr. McClain in 1992, two years after Mr. Kaufman moved to Texas in 1990. (Tr. 1159.) Mr. McClain represented himself as a minister, and was the husband of the stepdaughter's best friend. (Tr. 1157.) In August 1993, Mr. Kaufman loaned Mr. McClain's brother-in-law, Patrick, $50,000 for a bond required for Patrick's construction company business. Those funds were repaid. (Tr. 1228.) Mr. McClain talked to Mr. Kaufman about investments in the Tri-Northern Company ("Tri-Northern") and a bond trading program. Tri-Northern would mine and sell minerals, such as wollastonite, to replace asbestos. (Tr. 1162.) Tri-Northern, presumably, had the rights to the deposits of the minerals. Mr. Kaufman called the Tri-Northern mine to establish the validity of Mr. McClain claims, and spoke with "Rudy", a geologist, who confirmed Mr. McClain's assertions. (Tr. 1163-1164.) Mr. Kaufman did not conduct any further investigation into Mr. McClain's credentials. (Tr. 1165)
Mr. McClain introduced Mr. Kaufman to Mr. Wilson who described the profitability of his bond trading program to Mr. Kaufman. In June 1993, Mr. McClain convinced Mr. Kaufman to deposit $100,000 in an account with Pauli & Company to be managed by Mr. Kenny. (Tr. 1165-1167.) Mr. Kaufman signed a service agreement with Euro Scotia Funding Limited (ESFL) to open an account at Pauli & Company, granting ESFL authority to conduct bond trading, but not authority to withdraw funds from the account. (Tr. 1167-1169, Div. Ex. 1020.) The account was opened in the name of Euro Scotia Funding Limited - AK. (Tr. 216.) Mr. Kenny claimed that the account was an entity controlled and operated by Mr. Wilson, but was for the benefit of Mr. Kaufman. (Tr. 221, 223.) Mr. Kaufman believed that he had control over the money in the account, and that Mr. Wilson would be the trader of stocks and bonds. (Tr. 1171.)
In September or October 1993, Mr. Kaufman sent Mr. Kenny $30,000 for deposit to "his" account. (Tr. 1178-1179.) Mr. Kenny received the letter and deposited the funds into the Euro Scotia Funding Limited - AK account. (Tr. 219.) In October 1993, Mr. Kaufman sent to Mr. Kenny an additional $20,000 for deposit to his account. (Tr. 1184, Div. Ex. 524.) Mr. Kaufman did so after being advised by Mr. McClain that Tri-Northern stock, which Mr. Kaufman wanted to purchase at Mr. McClain's urging, was going to be available soon. (Tr. 1184.) Mr. Kaufman intended that $20,000 be used to purchase that stock. Tri-Northern was a privately held corporation and the stock was not publicly traded; therefore any stock purchased would have to be issued through using a private placement, and could not be traded by Pauli & Company. (Tr. 224-225.) Mr. Wilson and Samuel Boyd, Mr. Wilson's attorney in Dallas, Texas, consistently told Mr. Kaufman that the Tri-Northern stock would be listed on an exchange. (Tr. 1185.) Mr. Kenny sent a letter on October 22, 1993, to Mr. Kaufman acknowledging the receipt of the funds. On October 25, Mr. Kaufman sent Mr. Kenny $25,000 for deposit into his account. (Tr. 1187.) With the check for $25,000, Mr. Kaufman attached a letter stating that the account total should be $175,000. (Tr. 1187-88, Div. Ex. 526.) Mr. Kaufman did not receive account statements from Pauli & Co., because the Euro Scotia (AK) account was in the name of Mr. Wilson, presumably as the investment advisor. (Tr. 1188, 1241, 1248.) Mr. Kaufman sent all deposits to the account directly to Mr. Kenny, referring each time to "my account." (Tr. 1189.) Each deposit was accompanied by a letter stating Mr. Kaufman's belief of what his account totaled. (Tr. 1189.) Mr. Kenny replied to each letter by giving Mr. Kaufman total amount deposited to the account. (Tr. 1188, 1295.) Mr. Kenny never answered Mr. Kaufman's account balance request directly. Mr. Kenny's actions lulled Mr. Kaufman into believing his deposits were intact when, in fact, they were being depleted by Mr. Wilson. None of Mr. Kenny's letters informed Mr. Kaufman that the available cash was being wired out of the account to North American Technologies. (Tr. 265., Div. Ex. 529.) Mr. Kenny knew Mr. Wilson was transferring assets out of Mr. Kaufman's account. (Tr. 264-265.)
On October 25 1993, $33,318 of Mr. Kaufman's funds were transferred from Euro Scotia (AK) to North American Technologies. (Tr. 320, Div. Ex. 529.) Mr. Kaufman was unaware of the transfer. (Tr. 1192-1193.) In November 1993 there were 13,750 shares of North American Technologies Group placed in the Euro Scotia (AK) account. (Tr. 325, Div. Ex. 529.) Mr. Kaufman never authorized the purchase of North American Technologies Group shares, nor did he ever receive the shares. (Tr. 1210.)
In November 1993, $36,000 was transferred from Mr. Kaufman's account to Euro Scotia Funding-MAP. (Tr. 324, Div. Ex. 529.) On November 13, Mr. Kaufman sent $30,000 to Mr. Kenny for deposit into his account. (Tr. 1194.) Mr. Kaufman stated that there should then be $225,000 in his account. (Tr. 1190, 1197.) Mr. Kaufman by then had sent $205,000 to Mr. Kenny, and with the last deposit, Mr. Kaufman believed Mr. McClain would add $20,000 to the account as Mr. McClain had promised. (Tr. 1198-1199.) On November 16, Mr. Kenny sent Mr. Kaufman a letter indicating that the total deposits to the account totaled $205,000. (Tr. 271, Div. Ex. 530.) The difference apparently was due to Mr. McClain not making the expected deposit. (Tr. 1250-1251, 1299.) The net equity in the account, at the time of Mr. Kenny's letter, was only $137,132. (Tr. 272, Div. Ex. 529.)
In January 1994, $21,770 was transferred from Mr. Kaufman's account to Euro Scotia Funding - MAP. (Tr. 283, 1212, Div. Ex. 469.) Unbeknownst to Mr. Kaufman, in late January 1994 his account with Pauli & Co. was closed. (Tr. 1248.) On February 8, 1994, Mr. McClain sent Mr. Kaufman a letter indicating that Euro Scotia Funding had received $275,000 for the purchase of 91,667 shares of Tri-Northern (the stock Mr. Kaufman had been expecting to buy for the previous 8 months) and that Michael Zwack would be preparing the papers for the transaction. (Tr. 1275-1277, Div. Ex. 198.) In October 1994, Mr. Kaufman received a letter from Peter Dale of Euro Scotia Funding Group indicating that 203,000 shares of Tri-Northern were being held in a master certificate for him. The letter stated delivery of the shares would occur on or about November 15, 1994. (Tr. 1282-1283.) Mr. McClain directed Mr. Kaufman to send Mr. Boyd a letter on May 2, 1995, acknowledging ownership of the 203,000 shares of Tri-Northern, requesting payment of $710,000, and requesting 50,750 shares of Tensiodyne. (Tr. 1284-1285.) Mr. Kaufman never received the shares or the payments.2
During the first six months of 1995, Mr. Kaufman opened an account with Cohig and Associates, a broker/dealer in Denver, Colorado, with Steve Signor as the broker representative. (Tr. 1215, Div. Ex. 1024.) In 1995, Mr. Kaufman and Mr. McClain visited Kenny Securities in Florida, the site of Mr. Kenny's new venture. (Tr. 1214-1215.) While in Florida, but prior to talking to Mr. Kenny, Mr. Kaufman meet with Mr. Wilson concerning the bond trading program. (Tr. 1218.) At separate meetings, Mr. Wilson and Mr. Kenny described in detail the program to Mr. Kaufman. (Tr.1217-1218.) Mr. Kenny offered Mr. Kaufman access to an apartment any time that Mr. Kaufman came to visit Kenny Securities (Tr. 1219), presumably a further inducement to Mr. Kaufman. On June 25, 1995, Mr. Kaufman requested Mr. Signor to transfer $200,000 from the Cohig and Associates account to Kenny Securities, in Boca Raton, Florida. Mr. Kaufman requested the transfer from Cohig to Kenny Securities, based upon Mr. McClain's advice that Kenny Securities would conduct trading much more rapidly. (Tr. 1220.) On July 12, 1995, Mr. Kaufman requested all funds within his Revocable Trust within Cohig & Co. be transferred to Kasner Investments account at Kenny Securities. (Tr. 1293.) Mr. Kaufman received a check from Kasner Investments for $60,000. He assumed the check was a return on his various investments with Mr. McClain and Mr. Wilson. (Tr. 1275.)
c. Respondent Kenny's Dealings with Charles and Anna Smith
Charles G. Smith, Jr. of Memphis, Tennessee, is a 74 year old retired former owner of a helicopter spare parts business. (Tr. 629.) Mr. Smith and his wife, Anna, were looking for an investment company involved in bond trading, believing that bond trading would bring a high return on investment. Mr. Smith had accounts with Bear Stearns, Union Planters, and others brokers in Memphis, Tennessee. Mr. Smith owned various stocks. (Tr. 634.) The Smiths had an estimated worth between 2 and 4.5 million dollars. (Tr. 644.)
Mr. Smith heard that Pauli & Company was in the process of engaging in or was about to engage in a bond trading program. (Tr. 635.) According to Mr. Pauli, Pauli & Co. never attempted to create a bond trading program, nor did it ever contemplate establishing a bond trading program. (Tr. 1102.) Mr. Smith checked with the SEC in Washington, D.C. to find out more about Pauli & Company. He was referred to either a NASD or a SEC regional office in Louisiana and was told that no complaints had been filed against the company. (Tr. 635.) A deciding factor in Mr. Smith's decision to work with Pauli & Co. was their affiliation with Bear Stearns, a nationally known operation. (Tr. 662-663.)
In June 1994, Mr. Smith made an appointment to meet with Pauli & Company in St. Louis, Missouri. (Tr. 636.) The Smiths drove their recreational vehicle (RV) to St. Louis, and stayed at a RV park from which they were picked up in a limousine by Mr. McClain. (Tr. 636.) At the offices of Pauli & Co., the Smiths meet with Mr. Wilson, Mr. McClain, and Mr. Kenny, who was represented as the vice president of Pauli & Company. (Tr. 636, 639.) Mr. Kenny took Mr. Smith around the Pauli & Co. facilities and showed him the operations of the business, and attempted, unsuccessfully, to verify some stock quotes. (Tr. 638.) The Smiths met with Mr. Kenny and discussed establishing an account at Pauli, and about bond trading that would have a rate of return between 10 percent to 33 percent. (Tr. 640-641.) Mr. Kenny, described the investment as the purchase of Treasury bonds and then margining them up to ten times their value. (Tr. 641.) While it would normally take millions of dollars to enter into this type of bond trading, Mr. Kenny told the Smiths that Pauli & Co. had come up with a program to allow parties with a smaller amounts of money to pool their funds. (Tr. 643.) Mr. Kenny claimed that he met separately with the Smiths, and he only talked with them about opening an account at Pauli & Co. (Tr. 989.)
After Mr. Kenny introduced the Smiths to Mr. Wilson, he left the conference room to prepare the paperwork for the opening of the Smiths' account at Pauli & Co., while Mr. Wilson talked to the Smiths. (Tr. 644.) Mr. Wilson offered to sell to the Smiths 50,000 shares of Tensiodyne, at $1.50 per share, in exchange for Mr. Smith's assistance in obtaining business for Tensiodyne. (Tr. 645.) Tensiodyne was described as a company that would use X-ray technology to examine airplane parts to search for corrosion and cracks. (Tr. 645.) Mr. Wilson provided Mr. Smith with books on Tensiodyne, and dropped the names of other individuals who purportedly were involved in Tensiodyne, namely the Rockefeller Foundation, Burt Lance, and Chip Carter. (Tr. 647, 651.) Mr. Smith informed Mr. Wilson and Mr. Kenny, who had returned to the room, that he was interested in going forth with the bond trading program, and any action on the stock purchase would have to be a separate deal entirely. (Tr. 648.)
Mr. Smith requested that Mr. Kenny deposit into the Smiths' account at Pauli & Co. $300,000, which consisted of a $250,000 Treasury bond to be immediately cashed and a $50,000 Treasury bond to be cashed in ten days. (Tr. 653.) Mr. Smith said he only authorized Mr. Kenny to use his funds for the bond trading program and not for anything else. (Tr. 657.) The Smiths filled out and signed all the forms provided by Mr. Kenny on the day the account was opened. (Tr. 653, 712.) Included among the forms signed by the Smiths when they opened their account was a Guaranteed Note issued by Euro American Insurance Company (EAIC) to the Smiths and signed by Mr. McClain, guaranteeing payment of $300,000 with 10 percent interest per annum. (Tr. 710, Div. Ex. 266.) Also included was a Letter of Credit issued by Euro Scotia Group Limited (ESGL) to the Smiths as note holders and signed by Mr. McClain, Mr. Wilson, and the Smiths. (Tr. 710, Div. Ex. 265.) The Letter of Credit was simply a promise by ESGL to pay the Smiths in the event that EAIC did not pay. (Div. Ex. 265.) At the time these documents were signed the Smiths had no prior debt with either company for any amount. (Tr. 712.)
Concurrently, Mr. Wilson suggested to Mr. Smith that he send $50,000 to Mr. Boyd, in exchange for Tensiodyne stock. (Tr. 648.) Mr. Wilson said the funds would be placed in an attorney trust account controlled by Mr. Boyd. (Tr. 649.) Mr. Smith did not agree to purchase shares during the June 24th meeting, but upon his return to Tennessee, he proceeded with a due diligence examination of the Tensiodyne stock. (Tr. 666-667.) Mr. Smith called his stockbroker, Brad Dent, at Union Planters to obtain the Tensiodyne stock selling price. Mr. Smith claimed that he was told the stock was selling at $4.50 per share. (Tr. 652.) Mr. Dent recommended that Mr. Smith purchase the shares at $1.50 per share. (Tr. 652.) At the hearing, Mr. Kenny provided documentation, which indicated that from June 3, 1994 to June 30, 1994, the price for Tensiodyne stock did not go above $2 5/8 per share. (Tr. 1013, Resp. Ex. K246.) Shortly after Mr. Dent's recommendation, Mr. Smith agreed to purchase $50,000 worth of shares of Tensiodyne from Mr. Wilson.(Tr. 652.) The purchase was not handled by Pauli & Company, nor Mr. Kenny. Mr. Smith sent the funds directly to Mr. Boyd in Texas. Mr. Smith never received the stock certificates. (Tr. 652, ) On August 4, 1995 Mr. Boyd sent Mr. Smith a letter informing him that, if there was a concern about where the stock was, to call Nicole Gilbert, Mr. Kenny's assistant, at Pauli & Co. because she had the stock information. (Tr. 652.) Additionally, after Mr. Smith's Pauli & Co. account opened, Mr. Kenny, without obtaining authorization for the transaction from Mr. Smith, used funds in the account to buy 30,000 shares of Tensiodyne at $2.63 per share, which was originally offered for $1.50 a share by Mr. Wilson. (Tr. 677, 647. Div. Ex. 262.) The funds transfer was completed on July 7, 1994.
At the end of June 1994, Mr. Kenny informed Mr. Smith that Pauli & Co was buying a new brokerage in Florida to specifically handle the bond trading program. (Tr. 670-71.) Mr. Kenny advised Mr. Smith to transfer all of Pauli account assets to Mr. Boyd's trust account, until the firm in Florida was purchased. (Tr. 680, 683.) At Mr. Kenny's request, Mr. Smith prepared a letter authorizing the transfer of the cash, T-bills, and shares from the Smiths' Pauli & Co. account to Mr. Boyd's trust account. (Tr. 680.) Mr. Kenny told Mr. Smith that the letter should include the account description for the transfer of $171,000 in cash, $50,000 U.S. Treasury bills, and 30,000 shares of Tensiodyne. (Tr. 677-678, Div. Ex. 264.) Mr. Kenny claimed that Mr. Wilson, not he, instructed Mr. Smith to write the letter. (Tr. 995-996.) Mr. Smith was unaware that he had 30,000 shares of Tensiodyne in his account. He questioned Mr. Kenny about the purchase, telling him that the shares were purchased without Mr. Smith's authorization. (Tr. 676.) Mr. Kenny informed Mr. Smith that he would dispose of the Tensiodyne stock. (Tr. 683.) Mr. Smith was unaware that Mr. Kenny also managed Mr. Boyd's account at Pauli & Company. Mr. Smith did not complain in writing to Pauli & Co. or Bear Stearns concerning Mr. Kenny's unauthorized stock purchase.3
Mr. Smith never received any further information on the account. (Tr. 684.) He attempted to complain to Mr. Kenny. In July 1994, Mr. Smith initiated phone calls to Mr. Kenny, and Mr. and Mrs. Pauli seeking the status of his investments with Pauli & Company. (Tr. 685.) Mr. Smith also made inquiries with Mr. Wilson, Mr. Boyd, and Mr. McClain, seeking the whereabouts of his funds and his stock certificates in Tensiodyne. (Tr. 686.) Mr. Smith did not receive the information he sought from these parties, but did receive a check for $25,000 from a Wilson employee, Gary Long, in response to the numerous phone calls. (Tr. 693-694.)
d. Respondent Kenny's Dealings with National Family Care Life Insurance Company
The National Family Care Insurance Company (NFC), based in Texas, had assets of approximately 10 million dollars. (Tr. 1622, 1625-1626, 1811.) NFC sold supplemental disability income plans, including heart attack, cancer, intensive care, and life insurance. (Tr. 1714.) Robert and Sandra Erwin were the sole shareholders of NFC as well as each chairing the Board of Directors. (Tr. 1626, 1808.) Clyde Tullis, as President of NFC, was responsible for filing the proper forms with Texas and Federal regulators. (Tr. 1623.)
On May 12, 1994, Mr. Wilson presented an investment program to NFC. (Tr. 1626, 1798, 1815.) Mr. Wilson brought with him Mr. McClain and Mr. Boyd, who had represented the Erwins on various transactions. (Tr. 1627, 1818.) Mrs. Erwin believed that Mr. Boyd would represent NFC and the Erwins in regard to the transactions proposed by Mr. Wilson. (Tr. 1818.) NFC representatives in attendance were the Erwins, Mr. Tullis, William O'Neal, and Hector DeLeon. (Tr. 1626, 1815.) Mr. Wilson presented his bond investment program. The program would require NFC to issue a collateralized loan to Mr. Wilson, with an expected yield of up to 10 percent per annum from the investment. (Tr. 1628, 1815-1816, Div. Ex. 69.) Mr. Wilson provided 10K forms from North American Technologies Group, indicating the success of the program and a return on investment of approximately 180 percent. (Tr. 1633, Div. Ex. 112.) He also provided financial statements of his company Euro American Insurance that showed assets of approximately 200 million dollars. (Tr. 1633-1634.)
In order for the program to meet Texas insurance regulations, the investment would have to meet the requirement of being an admitted asset. (Tr. 1639, 1815.) An admitted asset under Texas law is authorized as a proper investment and can be carried and used to offset claim and policy reserves. (Tr. 1626.) A collateralized loan would meet the requirements of the regulations. (Tr. 1815-1816, 1823.)4 Mr. Wilson or his entity, Euro American Insurance company was to provide the collateral for the money loaned. (Tr. 1632.) The return on investment under the program was anywhere from 10 percent to 15 percent. (Tr. 1633.) In order for the collateral account and the NFC account to meet regulatory compliance as admitted assets, they could not be traded on margin. (Tr. 1632.)5
Mr. DeLeon, the attorney for NFC, conducted the due diligence review of Mr. Wilson and his companies, and cautioned NFC about doing business with Mr. Wilson or any of his companies. (Tr. 1762-1763.) William Chu, primarily personal injury attorney and brother of an employee of the insurance company, conducted another diligence analysis and issued a letter to Mr. Kenny indicating that the securities program proposed by Mr. Boyd was in compliance with the State regulations. (Tr. 1735, 1737, 1831-1832, Resp. Ex. K110.)
After the meeting, NFC deposited $300,000 into an account at Mark Twain National Bank, and then began liquidating certificates of deposit (CDs). (Tr. 1638-1639.) The total value of the account accumulated to 9.6 million dollars. The funds remained at Mark Twain National Bank until the middle of June 1994, when the funds were transferred to Pauli & Company. (Tr. 1639.) Mr. Wilson recommended Mr. Kenny as the broker, because Mr. Kenny had worked with him several times before and would do a better job than the broker at Mark Twain National Bank. (Tr. 1640.) In addition to the NFC account involved in the trading, Mr. Erwin had a personal account and an IRA account for his wife and himself involved in the trading and distribution of profits from the bond trading. (Tr. 1814, 1818.) The NFC account balance at the end of June 1994 was approximately 7.7 million dollars. There was indication of margin trading on the June statement. (Tr. 1735.) In mid July of 1994, Mr. Tullis found out that the cash balance in the account was approximately 6 million dollars, while the value of the account was over 10 million dollars. (Tr. 1649.) Mr. Tullis was concerned that the NFC account was again engaged in margin trading. Only the Erwins or Mr. Tullis had authority to authorize margin trading and they had not done so. (Tr. 1649-1650.) Mr. Tullis and Mrs. Erwin heard telephone conversations between Mr. Erwin and Mr. Kenny, where Mr. Erwin told Mr. Kenny to stop any margin trading in the NFC account at Pauli & Company. (Tr. 1745, 1841-1842.) Mr. Kenny agreed to check out the NFC account and take care of any margin trading. (TR. 1842.)
Mr. Kenny and Mr. Erwin signed irrevocable instructions, dated June 15, 1994, regarding the transfer of funds from the NFC account to a trust account controlled by Mr. Boyd. The instructions called for no transfers out of the account that would allow the account value to fall below 6.5 million dollars. (Tr. 1646, Resp. Ex. K159.) Any transfer was conditioned on Mr. Wilson establishing an account for the benefit of NFC as collateral for the NFC funds. The account would be at Pauli & Co. under the control of Mr. Boyd. (Tr. 1644, 1659-1660.)
NFC intended to loan Mr. Wilson 6.4 million dollars once Mr. Wilson had collateral to back the loan. NFC deposited the loan amount into their Pauli & Co. account. (Tr. 1656-57.) On July 20, 1994, Euro American Insurance Company issued a note, signed by Mr. McClain, guaranteeing repayment of the loan from NFC. (Tr. 1678, Div. Ex. 221.) The value of the note was 11.2 million dollars, and was scheduled for payoff on September 29, 1994. (Tr. 1679, Div. Ex. 221.) In late September 1994, Mr. Wilson informed Mr. Tullis that the note for 11.2 million dollars was paid off with the transfer of securities into the NFC account at Pauli & Company. (Tr. 1679.) Mr. Kenny verified, in a letter to Mr. Tullis on October 15, 1994 that there were approximately 11.2 million dollars in investments in the NFC account at Pauli & Company. (Tr. 1681, Div. Ex. 60.) Mr. Kenny did not indicate, however, whether the investment of 11.2 million dollars was on margin or cash basis. (Div. Ex. 60.) Mr. Tullis attempted to verify that the securities were not on margin, and found that the NFC account again had securities on margin, which would violate the filings he had submitted to the Texas insurance commission. (Tr. 1683.) Mr. Tullis told Mr. Kenny not to place margin orders; however, Mr. Kenny stated that he received direction from Mr. Erwin to continue to trade on margin. (Tr. 1937-1939.) Mr. Wilson indicated to Mr. Tullis that the bank had made an error in the transfer. (Tr. 1683.) In the fall of 1994, Mr. Wilson issued bogus account confirmations to NFC. (Tr. 1685-1686, 1943.) In November 15, 1994, Mr. Kenny sent another letter to NFC indicating that the cash balance in NFC account at Pauli & Co. was only $565 at the end of September with U.S. securities totaling approximately 11.2 million dollars. (Tr. 1690, 1802, Resp. Ex. K78., Div. Ex. 64.) Again, though knowing of the concern with respect to margin trading, and NFC's requirement to have unencumbered securities to report as admitted assets, Mr. Kenny failed to disclose the true value of the account. The NFC account value at end of October was $10,000 without any securities in the account. (Tr. 1693, Div. Ex. 64.)
In a letter dated November 30, 1994, Mr. Wilson informed NFC that approximately 11.4 million dollars in bond securities were being held by Euro Scotia Funding and would be transferred to NFC's to pay off the collateralized loan by the end of the year. The 11.4 million dollars was described as the collateral for the NFC loan to Mr. Wilson from the funds in Mr. Boyd's trust account. (Tr. 1694, 1700, Div. Ex. 533.) The December 30, 1994, letter from Mr. Kenny confirmed that $11,400,000 in securities were being held at Pauli & Co. in the NFC's account. (Tr. 1696, Div. Ex. 3.) Mr. Tullis, immediately after receiving Mr. Kenny's letter, requested that Mr. Kenny send a confirmation of the value of securities. (Tr. 1698-1700, Div. Ex. 4.) Mr. Kenny sent Mr. Tullis a fax indicating the breakdown of principal and interest. Again, the margin status was not disclosed. (Tr. 1698-1700, Div. Ex. 4.) Mr. Tullis used the information to document, for the state regulators, that the Pauli & Co. account should be considered as admitted assets under state law. (Tr. 1696.) Mr. Kenny stated he based the letter and the fax on the assumption that Mr. Wilson was going to provide 11.4 million dollars to purchase the bonds. (Tr. 1948-1952., Resp. Div. K251.) Mr. Wilson provided 1.125 million dollars for the bond purchase; thus forcing the bonds to be converted from cash based account to a margin account. (Tr. 1952-1956, Resp. Div. K117.)
Mr. Tullis sent the information reported by Mr. Kenny to the Erwins. The information indicated the amount cash and securities being held in the account. (Tr. 1704.) In January 1995, Bear Stearns issued the December invoice and a margin call, both indicating that the actual balance of the account at Pauli & Co. had a cash balance of approximately 1 million dollars. (Tr. 1706.) Mr. Tullis informed the Erwins, Mr. Wilson, and Mr. Kenny of the problems with the account balance and margin trading on the Pauli & Co. account. Mr. Tullis said that Mr. Wilson told him that there was a problem with the transfer of funds that he previously had promised. (Tr. 1705-1707.) Mr. Tullis no longer believed Mr. Kenny after the second instance in which Mr. Kenny made a false confirmation about the status of the NFC account at Pauli & Co.. (Tr. 1706-1707.) NFC made complaints, but never registered a written complaint with Pauli & Co., Bear Stearns, or the insurance regulators concerning the account. (Tr. 1745, 1778-1779, 1931.)
NFC went to NASD arbitration to recover funds used within the transactions mentioned above. NFC was awarded over 1.7 million dollars, to be paid by Mr. Kenny and the other respondents, including Bear Stearns and Pauli & Co., plus $550,000 in punitive damages to be paid by Mr. Kenny. (Tr 1127, Div. Ex. 1005.) The award was affirmed in Euro American Ins. et al. v. National Family Care et al., No. 95-11063 (District Court, 191st Judicial District, Dallas County, Texas) (June 2, 1999). The Division's motion to supplement the record by inclusion of the Court's order as Division Exhibit 1005A is hereby granted.
e. Respondent Kenny's and Nicholson/Kenny's Dealings
with U.S. Employer Consumer Fund of Florida
The United States Employer Consumer Fund of North Carolina (USEC-NC) and United States Employer Consumer Fund of Florida (USEC-FL) were organized in 1991 to offer workers' compensation insurance in North Carolina and Florida, respectively. (Tr. 466.) Each Fund had separate Boards of Trustees. The United States Employer Consumer Association (USECA), owned by Jack Zickafoose, was the managing arm of the Funds. (Tr. 502.) USECA did the billing, collection, paid out claims, and conducted the investments for the Funds. Thomas Beckett was the Chief Financial Officer of USECA. (Tr. 466.) The service agreement between the Funds and USECA did not require USECA to manage investments for the Funds. (Tr. 501.) In November 1994, the USEC-FL received a notice from the insurance regulators for the State of Florida, that USEC-FL would have to stop listing 4 million dollars to 5 million dollars in account receivables as an asset. (Tr. 489.) Without the accounts receivable being counted as a financial asset, USEC-FL was in a financial deficit, and the State regulators required USEC-FL to clear up the deficit balance within 60 days or shutdown. (Tr. 468, 489-90.) USEC-FL was eventually taken over by the state in 1995. (Tr. 466-467.)
In December 1994, Jeff Crowley, an associate of Mr. Wilson, introduced USECA to Mr. Wilson. (Tr. 492.) On December 16, 1994, the Board for USEC-FL, their attorneys Ted French and John Yanchek, and their investment advisor, Dr. Robert Owen, met with Mr. Wilson. (Tr. 493, 523.) Neither Mr. French, Mr. Yanchek, nor Dr. Owen objected to the Mr. Wilson's proposed agreements to resolve the Funds cash needs through margin trading. (Tr. 523, 526.) Mr. Wilson's proposal focused on enhancing USEC-FL and USEC-NC investments, and the purchase of the surplus debentures and outstanding receivables. (Tr. 469.) Mr. Wilson agreed to help the USECA in regard to the USEC-FL financial deficit. He committed to purchase the USEC-FL accounts receivable for 4 million dollars and the surplus debentures from the fund for 1 million dollars, for a total of 5 million dollars which would get USEC-FL out of a deficit position with the State regulators. (Tr. 468.) Mr. Wilson promised a return on investment of 9.35 percent. (Tr. 513.) As a condition of the purchase, Mr. Wilson requested that Mr. Zickafoose include 76 percent of Manatee Insurance, which he owned, as part of the sale. (Tr. 504.) Another condition was requiring that the bond investment be under taken by USECA as security for the purchase. Mr. Wilson also selected Riles, a former Georgia insurance commissioner, to become a Trustee with signature authority for the USEC-FL. Mr. Wilson recommended that USEC-FL and USEC-NC open accounts with Pauli & Co., with Mr. Kenny as the account manager. (Tr. 470.) Mr. Wilson further requested that the Funds enter into investment advisory agreements with Nicholson/Kenny, with Mr. Kenny as the investment advisor. (Tr. 392, 470.) Nicholson/Kenny received a fee of .30 percent. (Tr. 1537.) USECA entered into an Investment Advisory Agreement with Nicholson/Kenny in December 1994 and Mr. Kenny signed the agreements for Nicholson/Kenny. (Tr. 388, Div. Ex. 46.) Nicholson/Kenny was expected to keep track of the purchases, the sales, the gains, and the losses. (Tr. 1539.) Nicholson/Kenny provided no investment advisory advice to USEC-FL while the account was open. (Tr. 1537.) However, USEC-FL did pay the quarterly investment advisory fee of $2,420 to Nicholson/Kenny. (Tr. 1539-1540, Resp. Ex. K24.)
USECA deposited 3.4 million dollars for USEC-FL and 1.0 million dollars for USEC-NC into separate accounts at Pauli & Company. Mr. Beckett claimed that Debenture Guaranty Association, a Wilson company, committed to deposit another 3.4 million dollars to 5 million dollars into the USEC-FL account for the purchase of the surplus debentures and bad receivables. (Tr. 469.) However, nothing in the agreements between Mr. Wilson and the Funds indicated that any money would be transferred from any source other than the Funds. (Tr. 474.) The combination of the USEC-FL deposit and the Mr. Wilson deposit was to be used for the purchase of 7 million dollars in U.S. Treasury Bonds. (Tr. 472.) USEC-FL was to obtain profit payments over a ten year period, while DGA would acquire the bonds at the end of the ten year period. (Tr. 474, 522.) In addition to receiving a percentage of the return as investment advisor, Mr. Kenny, as account representative for USEC-FL at Pauli & Co., received commissions on all of USEC-FL's 7 million dollars worth of bond transactions. (Tr. 400, 513.)
On December 27, 1994, USEC-FL received the monthly transaction statement for the account with Pauli & Company and the confirmation of purchase indicated that 7 million dollars worth of securities had been purchased into the USEC-FL account. (Tr. 475-476.) Mr. Beckett said Mr. Wilson claimed that DGA had deposited 2.3 million dollars more than required into the USEC-FL account and DGA wanted the excess funds from the bond purchase. (Tr. 477.) Mr. Beckett contacted Mr. Kenny's office at Pauli & Co., to verify that there was $7,011,000 in securities in the account, and Mr. Kenny's assistant, Nicole Gilbert, verified that the statement amount was accurate, but did not state the bonds were margined. (Tr. 477.) Believing that securities were in a cash position and not on margin, Mr. Beckett requested that Mr. Kenny transfer what he believed was an excess 2.3 million dollars from the USEC-FL Pauli & Co. account to USECA' s bank in Florida for transfer to DGA. (Tr. 477-478.) Mr. Kenny did nothing to dispell Mr. Beckett's misunderstanding which was based on incomplete information provided by Mr. Kenny's assistant.
On January 6, 1995, USEC-FL received a margin call on the securities held by Pauli & Co., managed by Mr. Kenny. The margin call indicated that instead of the account having a cash value of 7 million dollars, the account had a cash value of only about $700,000. (Tr. 478-479.) On January 6th, Mr. Beckett attempted to contact, Mr. Kenny, Mr. Wilson, and Gary Long, who was President of DGA, without any success. (Tr. 479.) Mr. Wilson returned Mr. Beckett's call and explained that there was a mistake regarding the transfer of funds, by either an operator in Zurich or within Pauli & Co., informed Mr. Beckett that the confusion over the margin call would be resolved. (Tr. 479-480.) Mr. Kenny sent Mr. Beckett a letter, dated January 6, 1995, indicating that there were no margin positions in regard to the USEC-FL and USEC-NC accounts, and that there would be no margin trading related to either account. (Tr. 480-481, Div. Ex. 50.) Mr. Beckett spoke with Mr. Kenny informing him that Florida law prohibited the USEC-FL engaging in margin trading with Fund assets. Mr. Beckett said he told Kenny that under Florida law one can only count the equity not margin value for admitted assets. After Mr. Beckett's discussions with Mr. Kenny and Mr. Wilson, and in view of Mr. Kenny's letter, Mr. Beckett believed that the USEC accounts were in full cash/equity position of approximately 7 million dollars. (Tr. 481.)
Later in January 1995, Mr. Wilson again told USECA that DGA had again deposited excess funds into the Pauli & Co. account. (Tr. 480-485.) Mr. Beckett had Pauli & Co. withdraw $728,000 from the USEC-FL account to USECA's bank, those funds were eventually transferred to DGA. (Tr. 484.) In mid January, Mr. Wilson told USEC (Mr. Becket) that he had lost some confidence in Pauli & Co.'s ability to handle the account. (Tr. 532, 553-534.) Therefore, on Mr. Wilson's advice, Mr. Beckett agreed to transfer USEC-FL and USEC-NC accounts from Pauli & Co. into the DGA account at Cohig & Associates. (Tr. 558-559.)6 Mr. Wilson promised to provide, from the Cohig & Associates account, 8.4 million dollars to USEC-FL's Pauli & Co. account. Mr. Kenny sent USEC-FL a letter dated January 10, 1995 informing Mr. Beckett that there would be 8.4 million dollars of bond securities transferred into the USEC-FL account and that 1.0 million dollars of those securities would be transferred to the USEC-NC account. (Tr. 482.) No funds were ever transferred to the USEC-FL account at Pauli & Company. USECA as representative for the Funds did not file any complaints regarding the absent transaction or the margin transaction to Bear Stearns, or Pauli & Company. (Tr. 580.)
USEC-FL continued a relationship with Mr. Wilson until the Florida state regulators took over USEC-FL in late 1995. USEC-FL also sent Mr. Wilson 1.1 million dollars in securities to have Mr. Wilson pay the State of Florida 1.1 million dollars, in lieu of cashing in the securities and losing $100,000 on the investment by paying the State themselves. (Tr. 582-583.) Mr. Wilson did not pay the State of Florida, nor did USEC-FL receive these or any other funds back from Mr. Wilson. (Tr. 583, 485.)
III. Conclusions of Law
Section 17(a) of the Securities Act, Section 10 (b) of the Exchange Act, and Rule 10b-5 are meant to prevent fraud. Section 17(a) addresses those persons who offer or sale securities, while Rule 10b-5 addresses those who are involved in the purchase or sale of securities, but both go to prevent persons from (1) employing schemes to defraud; (2) making material misleading statements or omitting to state material facts; or 3) engaging in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person. The Division has the burden of demonstrating by a preponderance of evidence any wrongdoing by Respondents. Steadman v. SEC, 450 U.S. 91, 102 (1981). The Division must show a misrepresentation, or an omission (where there is a duty to speak), or other fraudulent device, in the offer or sale or in connection with the purchase or sale, of a security. SEC v. Hasho, 784 F. Supp. 1059, 1106 (S.D.N.Y. 1992). Additionally, in cases of misrepresentation or omission, materiality must be shown. Basic, Inc. v. Levinson, 485 U.S. 224, 231-232 (1988). The Division must show that Respondents had scienter, the "mental state embracing intent to deceive, manipulate or defraud," in order to maintain a cause of action under Section 17(a)(1) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Aaron v. SEC, 446 U.S. 680, 701-702 (1980) (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976)). Scienter can be shown without direct knowledge of the individuals state of mind by alleging facts establishing a motive to commit fraud and an opportunity to do so, or by alleging facts constituting either reckless or conscious behavior. In re Time Warner Inc. Securities Litigation, 9 F.3d 259, 268 (2d Cir. 1993).7 Finally, the Division must show that the Respondents used the auspices of the interstate commerce or of the mails, or any facility of any national securities exchange in committing the fraudulent activities. Mr. Kenny communicated with Mr. Kaufman, the Smiths, NFC and USEC by telephone and through the mail.
The securities laws are meant to build the public trust in the securities market by achieving a high standard of business ethics in the securities industry and to maintain safeguards against fraud.8 Another purpose of the securities laws and regulations is "to ensure that investors obtain disclosure of material facts in connection with their investment decisions regarding the purchase or sale of securities." SEC v. Hasho, 784 F. Supp. at 1106 (See Affiliated Ute Citizens v. United States, 406 U.S. 128, 151 (1972)). Breaches of business ethics and the public trust should and shall be looked upon harshly by the Commission.
a. Respondent Kenny Committed Fraud.
The findings of fact indicate that there were numerous misrepresentations and omissions, and other fraudulent devices used by Mr. Kenny. Mr. Kenny misled Mr. Kaufman by failing to disclose material information in his correspondence with him. Mr. Kenny made misleading statements to the Smiths, which lead to the loss of their funds. Mr. Kenny conducted unauthorized trading in the Smith accounts, accompanied by deception, misrepresentations, and omissions.
1. Mr. Kaufman.
Mr. Kenny intentionally omitted material information when he corresponded with Mr. Kaufman. Each time Mr. Kaufman sent Mr. Kenny money for deposit into the Euro Scotia Funding-AK account, he accompanied the funds with a letter requesting account information. Mr. Kenny limited his response to each of Mr. Kaufman's letters by only informing him of the deposits to date. (Tr. 1188, 1295.) None of Mr. Kenny's correspondence informed Mr. Kaufman that the available cash was being wired out of the account to North American Technologies. (Tr. 265, Div. Ex. 529, 530.) On November 16, Mr. Kenny sent Mr. Kaufman a letter indicating that the total deposits to the account totaled $205,000. (Tr. 271, Div. Ex. 530.) The net equity in the account, at the time of Mr. Kenny's letter, was only $137,132. (Tr. 272, Div. Ex. 529.) Mr. Kenny omitted informing Mr. Kaufman about the $36,000 taken from the Euro Scotia Funding-AK account and placed into Euro Scotia Funding-MAP. (Tr. 324, Div. Ex. 529.) Mr. Kenny knew when he sent the letters that the deposit total was no longer the account balance for Euro Scotia Funding-AK. (Tr. 264-265.) Mr. Kenny fueled Mr. Kaufman's beliefs that the account was his, he had control on the activities within the account, and the account was valued at $205,000.
Mr. Kenny's contention that he had no duty to Mr. Kaufman regarding the Euro Scotia Funding-AK account is untennable. Mr. Kenny admitted that the account was for the benefit of Mr. Kaufman. (Tr. 221, 223.) As the account broker, Mr. Kenny either was or should have been aware that Mr. Wilson was not maintaining the Euro Scotia Funding-AK account in a manner that would benefit Mr. Kaufman. Once Mr. Kenny began to correspond with Mr. Kaufman, regarding the account, he accepted the duty not to omit any material information that would negate the statements in his correspondence. Kline, et. at. v. First Western Government Securities, et. al., 24 F.3d 480, 491 (3rd Cir. 1994) (citing Rose v. Arkansas Valley Envtl. & Util. Auth., 562 F. Supp. 1180, 1206-08 (W.D. Mo. 1983).9 Mr. Kenny violated his duty. He misrepresented and omitted information in his correspondence with Mr. Kaufman.
2. Mr. and Mrs. Smith.
Mr. Kenny misled Mr. and Mrs. Smith in regard to Mr. Wilson's bond trading program. There was no evidence that Mr. Wilson's bond trading program was anything but fictitious. Mr. Kenny went through some detail in his testimony explaining how the bond trading program worked. (Tr. 976-984.) Neither Mr. Pauli nor Mr. Nicholson, both securities professionals with twenty years experience, understood how the program worked and found that descriptions of the program were evasive. (Tr. 446, 1380, 1384-1385.) None of the account statements provided indicate that the program Mr. Kenny described was ever implemented in regard to the Smith's account. (Resp. Ex. K199, K213.) Furthermore, in reviewing all of the account statements and account information provided within this litigation there is no evidence to support the bond trading program described by Mr. Kenny's testimony. Nonetheless, Mr. Kenny made recommendations to the Smiths that Wilson's bond trading program was a viable, worthwhile investment that could earn a rate of return between 10 percent to 33 percent. (Tr. 640-641.) In assessing the recommendation
[t]he standards by which [Mr. Kenny]... must be judged is strict. He cannot recommend securities [or investment programs] unless there is an adequate and reasonable basis for such recommendation. He must disclose facts which he knows and those which are reasonably ascertainable. By his recommendation he implies that a reasonable investigation has been made and that his recommendation rests on the conclusions based on such investigation.
Hanly v. SEC, 415 F.2d 589, 597 (2d Cir. 1969).
An opinion or recommendation made without a genuine belief or reasonable basis will be viewed as an "untrue" statement, and if it is made knowingly or recklessly will be viewed as an intentional material misrepresentation.10 Mr. Kenny suggests that he was a victim who was conned by Mr. Wilson along with the Smiths into believing that Mr. Wilson would follow through as he had promised. However, Mr. Kenny had no reasonable basis to believe in Mr. Wilson's ability to conduct bond trading program, yet he recommended the program to the Smiths and other investors. Mr. Kenny, as a senior employee of Pauli & Co., misrepresented Mr. Wilson as being trustworthy and credible when he allowed Mr. Wilson to present the bond trading program, to the Smiths in the offices of Pauli & Co.
Mr. Kenny conducted unauthorized purchases in the Smith accounts.11 During the initial meeting between the Smiths, Mr. Kenny, and Mr. Wilson, Mr. Smith stated that he wished to proceed with the bond trading program, and that any stock purchase would be handled as a separate transaction all together. (Tr. 648.) Mr. Wilson committed to sell Tensiodyne stock to the Smiths for $1.50 per share, and requested that the transaction be handled through his attorney Mr. Boyd. (Tr. 645,648.) Mr. Smith agreed to purchase $50,000 worth of shares and sent the funds to Mr. Boyd. (Tr. 652.) Mr. Smith did not authorize Mr. Kenny to purchase stock, yet Mr. Kenny purchased 30,000 shares of Tensiodyne in the Smith's account. Mr. Kenny did not inform the Smiths of the purchase. After the Smiths found out about the unauthorized transaction, Mr. Kenny deceived the Smiths when he promised to dispose of the Tensiodyne stock. (Tr. 683.) He further deceived the Smiths with his recommendation that the Smiths transfer all of their account assets to Mr. Boyd's account. (Tr. 678.) By convincing the Smiths to issue the letter authorizing the transfer, Mr. Kenny encouraged the Smiths to ratify his unauthorized trade. (Tr. 995-996, Div. Ex. 264.) Mr. Kenny deceived the Smiths when he informed them that a new brokerage in Florida was going to handle specifically the bond trading program. (Tr. 670-671.) Mr. Kenny as the account broker for the Smiths, Mr. Wilson, and Mr. Boyd's trust account could reasonably be expected to know that the Smiths access to the funds once transferred to the Mr. Boyd's trust would be nonexistent. (Tr. 694.) The unauthorized trading accompanied with deception and nondisclosure demonstrates fraudulent activity on the part of Mr. Kenny.
As a broker and investment adviser, Mr. Kenny is an individual to whom the securities laws are meant to apply. The Smiths and Mr. Kaufman believed that they were doing business with Mr. Kenny and Mr. Wilson. Mr. Kenny argues that the Smiths and Mr. Kaufman did not have a direct relationship with him and that he was obligated to follow Mr. Wilson's instructions because he was the account holder. Mr. Kenny argues that he was simply one of the pawns in Mr. Wilson's con game by hiding the money from broker to broker. Mr. Kenny argues that he did not become aware of Mr. Wilson's fraudulent behavior or question his integrity until November 1995. (Tr. 1987-88.) No matter how Mr. Kenny tries to portray himself, he is not a victim in this proceeding.
Even if Mr. Kenny's arguments were accepted he would still be in violation of securities laws. Mr. Kenny admits to having had direct contact and interaction with Mr. Kaufman and the Smiths. Both parties initially met with Mr. Kenny to establish personal accounts with Pauli & Co. Mr. Kenny was required to use due diligence to determine the essential facts about the customers and the transactions that occurred in customer accounts.12 The Smiths and Mr. Kaufman believed that Mr. Kenny was their representative at Pauli & Co. Mr. Kenny did nothing to dispel their beliefs. Mr. Kenny had financial and investment objective information which indicated that the transactions in Mr. Kaufman's and the Smiths' accounts were inconsistent with their investment objectives. Mr. Kenny should have informed, at a minimum, his supervisor and the compliance division of Pauli & Co. of the improprieties within the accounts. In the Matter of Merrill Lynch, Pierce, Fenner & Smith, Inc., Exchange Act Release No. 19070, 26 S.E.C. Docket 227, at 7 (Sept. 21, 1982). The last thing Mr. Kenny should have done under these circumstances was continue to follow instructions from Mr. Wilson that would continue the improprieties in the accounts. By continuing to execute transactions and not reporting the improprieties, Mr. Kenny aided and abetted violations of the securities laws by Mr. Wilson in regard to those transactions.13 While Mr. Kenny may be found liable for aiding and abetting, he has violated the securities laws and engaged in direct fraudulent and misleading activities with regard to the Smiths and Mr. Kaufman.
b. Respondent Kenny Aided and Abetted Mr. Wilson's Fraud
Liability as an aider and abettor is present when (1) there is a primary or independent securities law violation committed by some other party, i.e. Mr. Wilson, (2) there exist an awareness of knowledge by the aider and abettor, i.e. Mr. Kenny, that his role was part of an overall improper activity; and (3) the aider and abettor knowingly and substantially assists the conduct that constitutes a violation.14 Mr. Kenny was an aider and abettor to Mr. Wilson's violations of the securities laws in regard to NFC and USEC.
1. National Family Care Insurance Company.
Both the Division and Mr. Kenny agree that Mr. Wilson defrauded NFC. Mr. Wilson misrepresented the success of his bond trading program to NFC with fraudulent 10K forms. (Tr. 1633, Div. Ex. 112.) Mr. Wilson issued false account confirmations to NFC, which misled NFC into believing that there account was not on margin. (Tr. 1685-1686.) Mr. Wilson misappropriated in excess of $9 million of NFC funds meant for use in the bond trading program. Mr. Wilson was found liable by a NASD arbitration panel as defrauding NFC out of millions. (Div. Ex. 1005.) The arbitration decision was affirmed on judicial review. (Div. Ex. 1005A.)
Mr. Kenny was aware that his actions were part of an overall improper activity. Mr. Kenny admitted in correspondence with NFC that he had participated improperly in margin trading under the NFC account. (Div. Ex. 60.) Mr. Kenny acknowledged to his client, NFC, that he was directed to do so by Mr. Wilson. (Div. Ex. 60.) As a registered securities representative, Mr Kenny had a duty to determine if the recommendations and transactions conducted in the NFC account were suitable to the investment objectives.15 Mr. Kenny did not conduct the proper inquiries to determine NFC's investment objectives. Instead Mr. Kenny relied on Mr. Wilson's decision-making and influence.
Mr. Kenny participated substantially in Mr. Wilson's misrepresentation and fraud of NFC. Mr. Kenny's scienter in regard to his participation as an aider and abettor is evident in his behavior.16 Mr. Kenny was informed by the Directors of NFC not place margin orders. (Tr. 1937.) Mr. Kenny was aware of that NFC was using the account as an asset under state insurance regulations. Mr. Kenny knew that Mr. Wilson had given him improper instructions and information in regard to the NFC account prior to a November 15, 1994 letter in which he corrects some previous misrepresentations. (Resp. Ex. K78, Div. Ex. 64.) On December 30, 1994, Mr. Kenny sent NFC a letter confirming that Mr. Wilson had deposited 11.4 million dollars in securities into NFC's Pauli & Co. account. (Tr. 1696, Div. Ex. 3.) Mr. Wilson transferred only enough funds, 1 million dollars, to purchase securities on margin. Mr. Kenny relied on Mr. Wilson's statements in December 1994, after he had claimed Mr. Wilson had deceived him in November of 1994. (Tr. 1948-1952, Div. 60, Resp. Ex. K251.) Mr. Kenny had a duty to verify the information provided by Mr. Wilson, before he allowed NFC to rely on the opinion provided in the December 30, 1994 letter.17 Mr. Kenny engaged in reckless and conscious behavior, which equates to scienter. Mr. Kenny is liable as an aider and abettor to Mr. Wilson in regard to his violations of the securities laws.
2. United States Employer Consumer Fund of Florida.
Mr. Wilson admitted to having defrauded USEC-FL out of millions of dollars and admitted that he caused the confirmation that 7.011 million dollars in Treasury securities and cash was being held in USEC-FL account at Pauli & Co. (Div. Ex. 357.) USEC-FL was falsely lead to believe that the securities were purchased for cash, when, in fact, they were purchased on margin. Mr. Wilson admitted that others assisted him in his efforts to defraud USEC-FL. (Div. Ex. 357.) Although Mr. Wilson refused to confirm or deny Mr. Kenny's role, it is clear from Mr. Kenny's actions however, that he most certainly is one of those "others."
Mr. Kenny knowingly assisted Mr. Wilson in defrauding USEC-FL. USEC-FL was a client of Mr. Kenny in two respects, as broker representative with Pauli & Co. and with his company Nicholson/Kenny Capital Management in an investment advisory relationship. At Mr. Wilson's recommendation USEC-FL opened an account at Pauli & Co., with Mr. Kenny as the account representative. (Tr. 470.) Mr. Wilson insisted that USEC-FL enter into an investment advisory agreement with Mr. Kenny's firm, Nicholson/Kenny Capital Management, and required that .30 percent of the return on investment go to Nicholson/Kenny. (Tr. 392, 470, 513.) Mr. Kenny recognized that Mr. Wilson would take the lead in any investment advice given to USEC-FL and consistently went along with his actions and judgement. Mr. Kenny ignored these contracted relationships, and allowed Mr. Wilson to take the lead in all investment advice and decisions for USEC-FL. Mr. Kenny's and Nicholson/Kenny's roles should have been as fiduciaries with respect to the assets deposited by USEC-FL with Pauli & Co.18 USEC-FL did not expect any specific investment advice from Mr. Kenny or Nicholson/Kenny, nonetheless, Mr. Kenny and Nicholson/Kenny had a duty to determine the investment objectives of USEC-FL. (Tr. 606-607.) Mr. Kenny admitted that Nicholson/Kenny did not engage in any of the advisory activities for which they were paid $2,420 quarterly. (Tr. 1539-1540.)
Additional evidence indicates that Mr. Kenny assisted and was aware that the margin trading was improper. Mr. Kenny's January 6, 1995 letter to USEC-FL indicated that there were no margin positions in USEC-FL's account, and that there would be no margin trading allowed in the account. (Tr. 480-481, Div. Ex. 50.) However, the USEC-FL account had received a margin call on January 6, 1995. Shortly after the margin call on January 10, 1995, Mr. Kenny issued another letter to USEC-FL stating that $8.4 million in bond securities would be deposited into their accounts at Pauli & Co. Mr. Kenny again based his information to USEC-FL on Mr. Wilson's claims without substantiating his claims. (Tr. 577-579, Resp. Ex. 35.) Mr. Kenny consistently used Mr. Wilson's false information to assist in the deception of USEC-FL.
Here, as with a virtual litany of dealings with Mr. Wilson, Mr. Kenny ignored repeated red flags. Those flags not only were raised, but virtually waved in Mr. Kenny's face in instances, among others, of Mr. Wilson's (1) misuse of the Dean Witter letter, (2) unfulfilled commitments to invest in Pauli & Co., (3) recommendation of a non-performing buyer of stock sold by Pauli & Co. (Kenny) to First Boston and the subsequent court order freezing and liquidating Euro-Scotia's account at Pauli & Co., (4) unexplained conversion of NAT funds at Pauli, and (5) Mr. Wilson's failure to provide promised cash for the NFC account. Additionally, clear red flags with respect to Mr. Wilson's associate Mr. McClain were raised (and disregarded by Mr. Kenny) in connection Mr. McClain's default of Dean Witter purchase order and Mr. McClain's failure to make an expected deposit to Mr. Kaufman's account.
c. Violations under Section 206 of the Advisers Act
Sections 206(1) and 206(2) of the Advisers Act prohibit any investment adviser "to employ any device, scheme or artifice to defraud any client or prospective client" or "to engage in any transaction, practice or course of business which operates as a fraud or deceit upon any client or prospective client," respectively. Advisers have a fiduciary duty requiring them to exercise the utmost good faith in dealing with clients, to disclose all material facts, and to employ reasonable care to avoid misleading clients. SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191-192, 194 (1963). Scienter is an element of a Section 206(1) violation but not of a Section 206(2) violation.19 The legislative history indicates that there is a delicate fiduciary duty within an investment advisory relationship.20
As previously stated Mr. Kenny admitted that Nicholson/Kenny did not engage in any of the advisory activities for which they were paid $2,420 quarterly. (Tr. 1539-1540.) Nicholson/Kenny and Mr. Kenny had a duty to act as fiduciary for USEC-FL, regardless of the expectations of USEC-FL.21 Mr. Kenny, as the investment adviser for Nicholson/Kenny, had a duty to obtain and understand all documents that accompanied Investment Advisory Agreement, including the purchase agreement and irrevocable instructions. Mr. Kenny never initiated any conversations with USEC-FL. (Tr. 617-618.) Mr. Kenny could not have relied on USEC-FL non-expectation of receiving investment advice when he and Nicholson/Kenny ignored their fiduciary duty to USEC-FL. Mr. Kenny, as the investment adviser, and Nicholson/Kenny, as the advisory firm, did not exercise reasonable care in their respective roles.
An investment adviser has a duty to expose all conflicts of interest.22 Mr. Kenny did not expose his conflict of interest involving Mr. Wilson to USEC-FL. Mr. Wilson's loan of $913,000 to Mr. Kenny in November 1994, was information that should have been but was not disclosed to USEC-FL. (Tr. 384-385, 605.) USEC-FL, without the conflict of interest information, relied upon Mr. Kenny's recommendation of Mr. Wilson as having superior integrity. (Tr. 485.) The sum of Mr. Kenny's actions indicates that his interest was not impartial.
d. Violations under Section 207 of the Advisers Act
A violation of Section 203 of the Investment Advisers Act occurs if Respondents:
willfully made or caused to be made in any application for registration or report... any statement which was at the time and in the light of the circumstances under which it was made false or misleading with respect to any material fact, or has omitted to state in any such application or report any material fact which is required to be stated therein.
15 U.S.C. § 80b-3(i)(1)(c).
Section 207 of the Advisers Act prohibits any person from willfully filing any registration, application or report with the Commission pursuant to Section 204 that contains any materially false statement or omission. Filing a Form ADV that contains false statements or omissions violates Section 207. Matter of Stanley Peter Kerry, Investment Advisers Act Rel. No. 1550 (January 25, 1996).
From 1994 to 1997, Nicholson/Kenny and Mr. Kenny did not describe a financial relationship with Mr. Wilson under question 10B of Form ADV, Part I, which requires a registrant to state whether it was financed by a person other than its owners and executive officer. The Division argues that there was a financial relationship between Mr. Wilson and Nicholson/Kenny that required Nicholson/Kenny and Mr. Kenny as the owner to disclose the relationship. Mr. Kenny borrowed money from Mr. Wilson. (Tr. 384.) Mr. Kenny did use the proceeds of that loan to establish Kenny Capital Management, which became the holding company for Kenny Capital/Management. The loan was between Mr. Kenny and Mr. Wilson, and did not have any conditions for co-ownership or interest in subsequent ventures created with the funds. The Division has not demonstrated that by a preponderance of the evidence that the loan created a financial interest or management interest for Mr. Wilson in Nicholson/Kenny. Therefore, failure to disclosure Mr. Wilson's loan to Mr. Kenny was not a violation of Section 207.23
IV. Public Interest
Under Section 8A of the Securities Act, Sections 15(b)(6), 19(h), 21B, and 21C of the Exchange Act, the Securities Act, and Section 203 of the Advisers Act, the Commission is authorized to impose sanctions against Respondents including a bar, revocation of investment advisory registration, limitations on activities, disgorgement, and civil penalties for the fraudulent actions of Mr. Kenny and Nichols/Kenny. The starting point for assessing what sanction is appropriate in the public interest requires consideration of many factors, including:
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), aff'd on other grounds, 450 U.S. 91 (1981). The Commission should consider a full range of factors, in order to meet the very broad public interest standard. Blinder, Robinson & Co. v. SEC, 837 F.2d 1099, 1110 (D.C. Cir. 1988). Sanctions should demonstrate to the particular respondent, the industry, and the public generally that egregious conduct will merit a harsh response. Parnassus Investments, et. al., Admin. Proc. 3-9317 (Sep. 3, 1998) (citing Arthur Lipper Corp. v. SEC, 547 F.2d 171, 184 (2d Cir. 1976). The facts of each case and the possibility of recurrence determine the severity of a sanction. Berko v. SEC, 316 F2d 137, 141 (2d Cir. 1963); Richard C. Spangler, Inc., 46 S.E.C. 238, 254 n.67 (1976); Leo Glassman, 46 S.E.C. 209, 211-12 (1975).
The Division asks for cease and desist and disgorgement orders against each of the Respondents, as well as a ban against Mr. Kenny, and a registration revocation against Nicholson/Kenny. As concluded above, Mr. Kenny was involved in schemes to defraud Mr. Kaufman, the Smiths, USEC, and NFC, violating Sections 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder. Further, Nicholson/Kenny and Mr. Kenny breached their fiduciary duty to USEC by engaging in fraudulent actions and omissions in violation of Section 206 of the Advisers Act. Accordingly, it is appropriate to order Respondents to cease and desist from committing or causing any violations or future violations. Mr. Kenny should be barred from being associated with any broker, dealer or investment adviser, and Nicholson/Kenny's investment adviser registration should be revoked. Finally, Respondents should be required to pay disgorgement in the amount of $1,333,000.
Civil Money Penalty
Section 21B(a) of the Exchange Act authorizes the Commission to assess civil money penalties against any person, in any proceeding instituted pursuant to Sections 15(b)(6). Additionally, Section 203(i)(a) of the Advisers Act, also authorizes the Commission to assess civil money penalties against any person, in any proceeding instituted pursuant to Section 203 (e) or (f). After notice and an opportunity for a hearing, if the Commission finds that such person has willfully (1) violated the Securities Act, the Exchange Act, or the Advisers Act; (2) aided, abetted, and counseled such a violation by any other person; or (3) made or caused to be made in any application or report required to be filed with the Commission that was false or misleading with respect to any material fact or statements, or omitted any required statement, then an assessment of civil money penalties may be levied. Since Respondent Kenny willfully engaged in efforts to defraud Mr. Kaufman, Mr. and Mrs. Smith, USEC, and NFC, in violation of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder, and has aided, abetted, and counseled such violations by Mr. Wilson and his entities, then I may assess a civil money penalty against him if I find it is in the public interest.
Section 21B(b) of the Exchange Act and Section 203(i)(b) of the Advisers Act each specifies a three-tier system for assessing the maximum amount of a penalty. A third tier penalty is the highest civil penalty available under the respective sections. It allows a maximum amount for each act or omission to be $100,000 of a natural person or $500,000 for any other person if the act or omission (1) involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement, and (2) directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons or resulted in substantial pecuniary gain to the person who committed the act or omission.
The Division recommends that Respondent Kenny be required to pay a third tier penalty, in the amount of $1,333,000. The recommendation is based upon Respondent Kenny's numerous violations and acts of fraud and deceit which resulted in substantial losses to investors. Division argues, further, that because the funds used to purchase Nicholson/Kenny came from Mr. Wilson's investors, that a third tier penalty is justified. Respondents argue that a civil penalty would be futile and inappropriate, although they do not even suggest an alternative penalty that would be appropriate. Their position is, in essence, "we did nothing wrong, but if we did, no penalty should attach." This, clearly, is not a credible position.
The amount recommended by the Division is not based upon any a specific number of violations or acts to defraud. The statute is clear that the each act or omission shall be allotted a maximum amount. Therefore, I believe the assessment should be based on the following for Respondent Kenny, 1a) for misleading Mr. Kaufman, $100,000; 1b) for omitting material information to Mr. Kaufman, $100,000; 2a) for misleading Mr. Smith, $100,000; 2b) for omitting material information to the Smiths, $100,000; 3) for misleading USEC, $100,000; 4a) for misleading NFC, $100,000; and 4b) for omitting material information to NFC, $100,000. The assessment for Respondent Nicholson/Kenny should be $500,000 for omitting material information to USEC. The total assessment against Respondents should be $1,200,000.
V. Record Certification
Pursuant to Rule 351(b) of the Commission's Rules of practice, 17 C.F.R. § 201.351(b) (1997), I certify that the record includes the items set forth in the record index issued by the Secretary of the Commission on February 19, 1999, with the exhibit list modified on March 15, 1999, and further modified by receipt in this decision of Division Exhibit 1005A.
Note: See Erratum with reference to the first paragraph, below.