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U.S. Securities and Exchange Commission

Initial Decision of an SEC Administrative Law Judge

In the Matter of
George J. Kolar

INITIAL DECISION RELEASE NO. 152
ADMINISTRATIVE PROCEEDING
FILE NO. 3-9570

UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.


______________________________
                              :
                              :
     In the Matter of         : INITIAL DECISION
                              : October 28, 1999
     GEORGE J. KOLAR          :
                              :
______________________________:

APPEARANCES: Mark R. Borrelli, Peter K.M. Chan, Jerrold H. Kohn, and David J. Medow for the Division of Enforcement, Securities and Exchange Commission.

H. Nicholas Berberian, Robert J. Kuker, and Scott A. Meyers for Respondent Kolar.

BEFORE: James T. Kelly, Administrative Law Judge

INTRODUCTION

The United States Securities and Exchange Commission (Commission) instituted these proceedings on March 27, 1998, pursuant to Sections 15(b), 19(h), and 21B of the Securities Exchange Act of 1934 (Exchange Act). The Order Instituting Proceedings (OIP) alleges that George J. Kolar, while employed at Dean Witter Reynolds, Inc. (Dean Witter), a registered broker-dealer, failed reasonably to supervise a registered representative subject to his supervision, within the meaning of Section 15(b)(4) of the Exchange Act. The registered representative is alleged to have committed willful violations of Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 (Securities Act) and Sections 10(b), 15(a)(1), and 15(c)(1) of the Exchange Act, as well as Commission Rules 10b-5 and 15c1-2.

The matter was initially assigned to Chief Administrative Law Judge Brenda P. Murray; it was reassigned to my docket on April 12, 1999. I held a public hearing on June 14-17, 1999, in Detroit, Michigan. The hearing record consists of 1,013 pages of transcript, including the testimony of twelve fact witnesses and two expert witnesses, as well as sixty-five exhibits from the Division of Enforcement (Division) and fourteen exhibits from Respondent Kolar.1 The Division filed its Post Hearing Brief, and Proposed Findings of Fact and Conclusions of Law on July 30, 1999. Respondent filed his Post Hearing Brief, and Proposed Findings of Fact and Conclusions of Law on September 7, 1999. The Division filed its Reply Brief on October 5, 1999.2

The OIP alleges that, from approximately January 1992 through June 1995, Mr. Kolar was the manager of Dean Witter's branch office at Southfield, Michigan, and also supervised the branch manager of Dean Witter's Troy, Michigan, branch office and the registered representatives in the Troy office. It further alleges that Mr. Kolar failed reasonably to supervise Dean C. Turner, a registered representative in the Troy branch office, with a view toward preventing Mr. Turner's violations of the federal securities laws.

The OIP charges that Mr. Turner sold approximately $13.6 million in promissory notes issued by Lease Equities Fund, Inc. (LEF) to the customers of Dean Witter, and that the notes were not registered with the Commission and were not approved by Dean Witter for sale to its customers.3 It also maintains that the notes were part of a "Ponzi" scheme,4 that Mr. Turner offered and sold the notes without conducting any due diligence inquiry, and that he made misrepresentations of, and omitted to state, material facts to investors concerning the use of investor funds, the source of funds to be repaid to investors, the risks associated with the securities, the collateral for the securities, and the returns to be realized. The OIP further alleges that Mr. Turner's customers lost at least $10 million due to the fraudulent nature of the notes.

The OIP asserts that, beginning in August 1992, Respondent Kolar received a "red flag" in the form of a complaint made to him by an individual who provided certain financial services to clients of Dean Witter. According to the OIP, the complainant told Mr. Kolar that Dean Turner had been selling LEF securities to his customers at Dean Witter. After receiving the "red flag," the OIP asserts, Mr. Kolar did not take any steps to investigate the complaint, other than relying on Mr. Turner's unverified representation that he did not solicit or sell LEF securities to his customers.

As sanctions, the Division seeks to suspend Mr. Kolar from association with any broker or dealer for a period of nine months and from such association as a supervisor for an additional twelve months. It also requests imposition of a civil penalty of $20,000.5

Mr. Kolar maintains that his involvement with Mr. Turner and the events at issue are limited to one isolated incident in August 1992. At that time, Mr. Kolar, who was not even located in the same branch office as Mr. Turner, immediately reacted to information about Mr. Turner that he received from a person unknown to him by reporting that information to his own supervisor. Respondent asserts that he then made the inquiries of Mr. Turner that he was directed to make by his supervisor, after that supervisor had consulted with Dean Witter's Law Department. Those inquiries involved an interview of Mr. Turner and review of corroborative income tax documentation from him. Mr. Kolar then reported the results of these inquiries to his supervisor, and was not told to do anything further. Respondent contends that the charges should be dismissed.

Related Litigation

In addition to the present proceeding, the December 1995 collapse of LEF has generated several other criminal, civil, and administrative cases. The principal ones are summarized here:

United States v. William H. Malek, Crim. No. 96-80603, E.D. Mich. In August 1996, the former president and co-owner of LEF and its affiliate, National Business Funding, Inc. (NBF), pled guilty to a six-count information charging mail fraud. In April 1997, Judge Avern Cohn sentenced Mr. Malek to a forty-two month prison term, and ordered him to pay restitution of $11.4 million. Mr. Malek served twenty-seven months in prison and a halfway house, and was released on July 10, 1999 (Div. Ex. 68-32; Tr. 481-85).

William H. Malek, 65 SEC Docket 1556 (Sept. 30, 1997). For his role in the offer and sale of LEF notes, and the guilty plea described above, and without admitting or denying the Commission's allegations, Mr. Malek consented to a lifetime bar from association with a broker, dealer, or investment adviser.

Michael L. Cooperstock, 65 SEC Docket 1560 (Sept. 30, 1997). For his role in the offer and sale of LEF notes, and without admitting or denying the Commission's allegations, Mr. Cooperstock consented to a bar from association with a broker, dealer, or investment adviser, with a right to reapply for association after five years.

United States v. Dean C. Turner, Crim. No. 96-80603, E.D. Mich. Mr. Turner was indicted in November 1997, then re-indicted in May 1998, in connection with the offer and sale of LEF notes. The charges included nineteen counts of mail fraud, securities fraud, making a false statement, and conspiracy. A jury trial commenced on May 3, 1999, before Judge Cohn, and a verdict was returned on June 16, 1999. Mr. Turner was found guilty on two counts of mail fraud and one count of making a false statement and is awaiting sentencing (Resp. Exs. 12, 13). He was acquitted on the other sixteen counts.

SEC v. Malek, Turner, and Cooperstock, Civ. No. 97-74810, E.D. Mich. In this civil action, filed September 18, 1997, the Commission alleged violation of the antifraud, securities registration, and broker-dealer registration provisions of the securities laws. It sought permanent injunctions, disgorgement, and civil penalties. On September 26, 1997, without admitting or denying the charges, Mr. Malek and Mr. Cooperstock consented to a final judgment and order of permanent injunction. On December 10, 1997, Judge John Feickens stayed the proceedings against Mr. Turner, pending a verdict in the Turner criminal trial.

Raymond A. Basile, 67 SEC Docket 72 (April 29, 1998). The former manager of Dean Witter's Troy branch office settled charges that he had failed reasonably to supervise Mr. Turner. Without admitting or denying the allegations, Mr. Basile agreed to a suspension from association for three months with any broker or dealer, from association in a supervisory capacity for another nine months with any broker or dealer, and a civil penalty of $5,000.

Customer litigation. Several securities fraud cases, filed in December 1995 and later, seek recovery of monetary damages. As here relevant, the cases assert derivative liability against Dean Witter, as the employer of Mr. Turner. See, e.g., Benedict v. Cooperstock, 23 F. Supp. 2d 754 n.1 (E.D. Mich. 1998) and Krear v. Malek, 961 F. Supp. 1065 (E.D. Mich. 1997). The consolidated cases have been assigned to Judge Paul V. Gadola.

Delay In Commencing Hearing

There was a fourteen month gap between issuance of the OIP (March 27, 1998) and commencement of the hearing (June 14, 1999). The delay had several causes.

After filing his answer to the charges on April 18, 1998, Mr. Kolar asked for extra time to review the Division's investigative file. He later asked for more time to recuperate from injuries he sustained in a bicycle accident. Chief Judge Murray granted both requests.6

As a separate matter, the United States Attorney for the Eastern District of Michigan asked to postpone the hearing in this case until after the Turner criminal trial. The U.S. Attorney noted that several of the Division's proposed witnesses against Mr. Kolar would also be witnesses in the criminal prosecution against Mr. Turner. He explained that allowing the administrative proceeding to go first "could seriously prejudice the government's case by creating multiple prior sworn testimonies on the part of many of the witnesses" which, in turn, "will allow the creation of impeachment material on the government's witnesses." Chief Judge Murray granted this request, as well.7

Thereafter, the criminal trial encountered delays of its own, as Mr. Turner obtained additional time to recuperate from back surgery, and to consider the advisability of a possible guilty plea. This, in turn, prompted the U.S. Attorney to seek further delays in the administrative hearing. These requests were not opposed by the Division or by the Respondent, and they were granted.8 When the case was reassigned to me, the hearing date of June 14, 1999, had already been set.

Denial of Kolar's Request For Further Delay

The Turner criminal trial finally commenced on May 3, 1999, and the prosecution rested by late May. Before the defense could complete its case, however, Mr. Turner's attorney was injured in a serious automobile accident. The criminal trial was suspended until June 10, 1999, while counsel recuperated.

At this juncture, Mr. Kolar renewed his request for postponement of the administrative hearing. He argued that Mr. Turner would be an essential witness, and that fundamental fairness required that the administrative proceeding not go forward until Mr. Turner was no longer in a position to assert a Fifth Amendment right against self-incrimination. The Division opposed a postponement. I denied Mr. Kolar's request, after finding that there would be no prejudice to going forward in the administrative hearing as to witnesses who had already testified for the prosecution in the criminal case, who were not expected to testify again for the defense in the criminal case, and as to whom Mr. Kolar had an opportunity to obtain a transcript of their criminal trial testimony.9 I offered Mr. Kolar the option of revisiting the issue of a continued administrative hearing as to Dean Turner and any other defense witnesses as to whom he needed more time.

The Turner criminal trial resumed on June 10. After Mr. Turner testified, the defense rested on June 11. Closing arguments were presented on the morning of June 14, and the case went to the jury at mid-day (Tr. 141). The jury returned its verdict by mid-afternoon on June 16 (Tr. 797-98). As noted above, the administrative hearing also started on June 14 (in the same federal courthouse as the Turner criminal trial). When the jury returned its verdict in the Turner criminal case, the Division had not yet rested its administrative case against Mr. Kolar (Tr. 797-98, 863).

Mr. Kolar obtained the criminal trial transcripts of eight Division witnesses, and used that material at the administrative hearing in an effort to impeach the Division's witnesses and/or refresh their recollections.10 In this manner, he obtained discovery well beyond that contemplated by the Commission's Rules of Practice. Accordingly, I find that Mr. Kolar suffered no prejudice from the fact that the Turner criminal trial had not ended, and a verdict had not yet been returned, before the administrative hearing began. Both the Division and the Respondent identified Mr. Turner on their prehearing witness lists and, at Mr. Kolar's request, I signed a subpoena requiring Mr. Turner's appearance. Neither side elected to call Mr. Turner as a witness. A verdict was returned in Mr. Turner's criminal case before the Division had rested in the administrative proceeding. After that, both sides could have called Mr. Turner to testify (without raising any Fifth Amendment concerns) if they wanted to do so. Before Respondent rested his case, he confirmed that his decision not to call Mr. Turner as a witness was purely tactical, and was not based on insufficient opportunity to prepare (Tr. 945-46).

FINDINGS OF FACT

I base the findings and conclusions herein on the entire record and on the demeanor of the witnesses who testified at the hearing. I applied "preponderance of the evidence" as the applicable standard of proof. Steadman v. SEC, 450 U.S. 91, 97-104 (1981). I have considered and rejected all arguments and proposed findings and conclusions that are inconsistent with this decision.

Respondent Kolar

Respondent George J. Kolar is forty-nine years old and resides in Lakewood, Ohio. He earned a B.B.A. degree, with a major in accounting, from Pace University. Before entering the securities industry, Mr. Kolar was employed for several years as an auditor, accounting analyst, and controller (Tr. 741-43).

Mr. Kolar has been affiliated with Dean Witter since 1981. From March 1984 to January 1992, he managed Dean Witter's branch office at Cape Coral, Florida. At the same time, he also supervised three other Florida branch offices, with about thirty brokers. Each of the other branches had only part-time resident managers (Tr. 744-46, 833-34).

Dean Witter reassigned Mr. Kolar to Detroit from February 1992 through June 1995 (Tr. 746, 831, 833, 853). At all times relevant to this case, he held the title of Detroit metropolitan area manager (Tr. 747), and wore three hats: first, he supervised the firm's focus market program in the Detroit area; second, he managed Dean Witter's Southfield, Michigan, branch office, with twenty-five brokers (Tr. 213, 236, 444, 749, 830-31); third, he supervised other branch offices at Troy, Dearborn, and downtown Detroit. Each of these three offices also had its own on-site branch manager; collectively, the four Detroit-area offices had 120 registered representatives (Tr. 830-31). During this period, Mr. Kolar was a full-time manager; he had very few customers of his own, and did not earn commission income (Tr. 855).

The focus market program, one of seven conducted nationwide, was a multi-pronged marketing initiative. It was designed to raise Dean Witter's market share and the level of public awareness of the firm in an area that management considered under-penetrated (Tr. 234, 286-87, 442-43, 746-50). Mr. Kolar coordinated resources and cost efficiency among the four branch offices reporting to him. He also organized client seminars, increased brokers' knowledge of the firm's products, ran charity fund raisers, and planned programs to improve employee morale, such as company-sponsored summer picnics.

From February 1992 through June 1995, Mr. Kolar also supervised, on an overall basis, the branch office managers at Dearborn, Detroit, and Troy. During this period, the Troy branch office manager reported directly to Mr. Kolar (Tr. 213, 215-16, 443-45, 475, 476, 750). Mr. Kolar visited the Troy branch office every six to eight weeks, and spoke by telephone with the Troy branch office manager as frequently as business required--sometimes two or three times per day, sometimes only once a week (Tr. 751-52). Such conversations involved sales and marketing issues (frequently) and operations and compliance issues (occasionally) (Tr. 752-53). On his visits to the Troy branch, Mr. Kolar also talked to the brokers and reviewed the office ledgers (Tr. 214, 854).

During this period, Mr. Kolar participated in hiring, disciplinary, and firing decisions as to registered representatives at the Troy branch (Tr. 214-15, 243, 275-76, 445-46, 758). He did not have the last word in such matters, but did have input, and his views carried weight with Dean Witter's midwest regional director in Chicago (Tr. 448).11 Mr. Kolar was not simply a messenger between the Troy branch manager and the midwest regional director (Tr. 446).

In June 1995, Dean Witter reassigned Respondent Kolar from Detroit to Cleveland, Ohio. From that time to the present, he has supervised four branch offices in the Cleveland area (Tr. 264, 457-58, 831, 833). Apart from this case, Mr. Kolar has not been the subject of any disciplinary action or customer complaints.

Dean Turner

From August 1990 to December 1995, Dean C. Turner was a registered representative and vice president of Dean Witter at the firm's Troy branch office. Well before gaining infamy in the present dispute, Mr. Turner was a minor celebrity in the Detroit area. He had played college-level ice hockey for the University of Michigan, then signed a professional ice hockey contract (Tr. 94, 221, 257, 448).12 He is also the son of a popular Detroit television personality, Marilyn Turner. His background was well known to both his customers and his supervisors (Tr. 11-12, 37, 150, 257, 575, 785-86, 854).

Before joining Dean Witter, Mr. Turner was a registered representative at another broker-dealer. He informed one customer that he was switching firms because "he had an arrangement with Dean Witter by which he didn't have to push conventional products" but "was free to seek good solid investments on his own" (Tr. 147, 174). He told another customer that, at Dean Witter, he would have "special situations that weren't available to everybody" (Tr. 578). He advised clients and associates that Dean Witter had "bought him out . . . because they wanted him and his portfolio," that he had received a "very very good offer," and a "signing bonus" (Tr. 12, 489, 578). The Troy branch manager told Dean Witter's Compliance Department that he was "very excited" about recruiting Mr. Turner "and the potential business [he] can bring to Dean Witter" (Resp. Ex. 4-4).

While at Dean Witter, Mr. Turner declined to execute stock market transactions for a customer, explaining that he was not a stock broker, but instead focused on managed accounts and LEF notes (Tr. 589). Mr. Turner was never registered as a broker or dealer (Div. Ex. 67).

Roz Suwinski was Mr. Turner's sales assistant/secretary at the Troy branch office. She dealt with Dean Witter customers who invested in LEF notes and with LEF's clerical assistant (Tr. 167, 185, 348, 538, 564-65).

Mr. Turner's supervisors at Dean Witter characterized him as no more than an average revenue producer (Tr. 242, 256, 848).13 He carried the title of "vice president," not the more prestigious titles of "first vice president" or "senior vice president," and he occupied one of the smaller exterior window offices at the Troy branch (Tr. 241-42, 274, 285-86).

Thomas O'Neil, Raymond Basile

At all relevant times, Thomas C. O'Neil was Dean Witter's midwest regional director, with an office in Chicago, Illinois. He exercised overall supervisory responsibility for the operation of sixty to seventy branch offices in an eleven state area (Tr. 440-41). He described his management style as one of collectively drawing conclusions and reaching consensus, not as one of giving direct orders to his subordinates (Tr. 447-48, 479). In thirty-seven years of professional experience, Mr. O'Neil has encountered approximately six cases of "selling away" (Tr. 467). In most such episodes, the matter came to the firm's attention by customer complaint, after the investments in question had proven unsuccessful. Management then confronted the offending brokers, who confessed, and were terminated (Tr. 468).

Raymond A. Basile managed Dean Witter's Troy branch office from August 1990 to February 1996 (Tr. 210, 232, 287). In this capacity, he was Dean Turner's immediate day-to-day supervisor. At all relevant times, there were fifty to sixty brokers in the Troy office (Tr. 232). Mr. O'Neil removed Mr. Basile from this position as a result of the LEF matter (Tr. 471-72). From February 1996 through the date of hearing, Mr. Basile has been central division manager for Dean Witter's Mutual Fund Division (Tr. 209).

Before Mr. Kolar arrived in Detroit in February 1992, and after Mr. Kolar left Detroit in June 1995, Mr. Basile reported directly to Mr. O'Neil (Tr. 215, 475-76).

Mr. Basile hired Dean Turner early in his tenure as Troy branch manager, with input from and approval by Mr. O'Neil (Tr. 215, 242-43, 287-88, 448, 476). During the interview process, Mr. Turner told Mr. Basile that he was an investor in LEF notes and that he had friends and associates who were also investors in LEF notes. He was advised by Mr. Basile that he could not offer or sell those instruments to Dean Witter customers (Tr. 215-16, 244). Although Mr. Turner later requested and received Dean Witter's approval for certain of his outside investments, including T. P. Investment Corporation and Genesis Secured Prime Plus Limited Partnership, there is no documentary evidence that he sought the required approval to invest in or hold LEF notes (Resp. Ex. 4-4; Tr. 247-48).

LEF Notes

LEF was a Michigan corporation, organized in 1988, with its office in Milford, Michigan (Div. Ex. 28-37). Its stock was owned by NBF. William Malek was president of both corporations (Tr. 485-86). LEF was liquidated in February 1996, after several creditors filed an involuntary bankruptcy petition (Tr. 486).

LEF leased equipment to small and medium size businesses that could not get conventional financing. An investor would loan money to LEF in exchange for a promissory note from LEF to the investor, requiring LEF to pay back the principal and interest at a fixed rate over a period of time (Tr. 95, 97, 343, 486-87, 655-56).

To illustrate how a long-term collateralized transaction was structured, LEF would finance leased equipment to a computer company, using the investor's money to purchase the equipment to be leased. The computer company would then owe LEF lease payments at a certain rate and LEF would use the stream of lease payments to pay back the investor. LEF told investors that its promissory notes were backed by collateral in the form of LEF's rights to payments under the equipment leases held by LEF or assigned to LEF (Tr. 487-88). In fact, only some LEF notes were backed by collateral; many others were not (Tr. 349-50, 353, 493, 580-81, 655-56).

Most notes were for terms of twenty to sixty months. Face value of the notes ranged from $10,000 to $500,000. From 1991 to 1995, fixed interest rates ranged from seven percent to fifteen percent. In one case, the return was twenty-four percent, which the investor described as a gift from Mr. Turner (Tr. 608-09).

Some notes were for terms of three to six months (Div. Exs. 43-4H, 49-4N, 57-4V), and others were for terms of under thirty days (Tr. 400-01; Div. Exs. 47-4L, 48-4M, 58-4W). With respect to the very short term notes, Mr. Malek explained: "[W]e had investors who essentially figured out [in 1993-94] that I was having cash flow problems and they were tagging me for a point a week on their investments" (Tr. 493). There was no collateral for such notes, and the transaction involved a simultaneous exchange of checks. Annualized rates of return were as high as thirty-five percent and fifty-two percent (Tr. 616-19). One investor described the short term loans as "a favor" to Mr. Malek. Mr. Turner was not shown to be involved in such transactions.

LEF notes were sold between 1989 and 1995 by several individuals, including Joseph Cole and Michael Czerny, in addition to Messrs. Malek, Turner, and Cooperstock. At no time did NBF or LEF file a securities registration statement with the Commission (Div. Exs. 65-33, 66-34).

LEF viewed its note holders as "investors" (Tr. 360, 362, 487, 514, 649) and the note holders viewed themselves as "investors," as well (Tr. 19, 148, 580). Some note holders believed they could get a better rate of return than was available in the stock market, while others thought LEF notes were safer than the stock market (Tr. 15, 19, 68-69, 151-52, 580-81). One note holder financed office equipment for his endodontics practice and funneled payments through LEF for tax purposes (Tr. 625-26).

Interest income earned by LEF note holders was reported to the Internal Revenue Service on IRS Form 1099-INT for the years 1992-94 (Resp. Ex. 1-77).

LEF was profitable for its first two years and Mr. Malek believed that "things were going along fine" (Tr. 486; Div. Ex. 68-32 at 14). As early as 1991, however, LEF experienced problems providing on-time payments to several note holders (Tr. 544-45, 656-57, 659). In some instances, security interests were not perfected by making the necessary Uniform Commercial Code (UCC) filings with the State of Michigan (Tr. 478, 549, 661, 674). I find that LEF was operating as a "Ponzi" scheme by late 1992, when Michael Czerny persuaded one elderly individual to invest $250,000 in LEF notes so that five of Mr. Czerny's other investors could get their money out (Tr. 722-26).14

By October 1995, over 100 investors had purchased LEF notes, many of them on more than one occasion. At that time, LEF owed investors in its notes approximately $11 to $14 million (Div. Exs. 27-16, 31-14; Tr. 360-63, 510-11, 563-64, 649-51).

Turner's Sale of LEF Notes

Mr. Turner sold LEF promissory notes from 1990 through 1995 (Tr. 150-51, 360-63, 488, 649-50). For a brief time in 1993, he was also vice president and secretary of LEF (Tr. 503-04; Div. Ex. 35-13). He knew before starting his employment at Dean Witter that Dean Witter had not approved the LEF notes and would not authorize him to sell them (Tr. 216-17).

Over this six year period, Mr. Turner solicited approximately thirty to fifty investors for LEF notes (Tr. 373-74, 421-22).15 Four of these investors testified at the hearing. Each was a customer of Mr. Turner at Dean Witter, and each was a friend, neighbor, or social acquaintance of Mr. Turner from a wealthy Detroit suburb. Each was a college graduate, and two held advanced professional degrees. Two had extensive prior investment experience with securities (Tr. 116-17, 600-07), and two did not (Tr. 9-10, 145-46). Two customers acknowledged that some of their LEF investments had absolutely nothing to do with Dean Witter (Tr. 178-79, 201, 605).

After a successful solicitation, Mr. Turner either would accept investor funds and forward them to LEF, or would direct his customers to send their funds directly to LEF (Tr. 184-85). He would then receive a copy of the note and all related documents from LEF (Tr. 186, 346-50). Mr. Turner would communicate on a regular basis with Mr. Malek at LEF. As LEF made its monthly payments on the notes that Mr. Turner had sold, Mr. Turner would receive the LEF payment checks for his customers at his Dean Witter office, or at his home, and the checks would then be deposited into Mr. Turner's customers' accounts at Dean Witter (Tr. 165). NBF had its own account at Dean Witter's Troy office (Tr. 346).

Dean Witter's monthly account statements and its internal Troy branch records show frequent transfers of funds from customer accounts at Dean Witter to NBF and LEF, and from NBF and LEF to the customers' accounts at Dean Witter from 1990 to 1995 (Div. Exs. 14-RX48; 22-RX47; 62-24; 70-26). Such records show transfers to and from the accounts of customers Don Dixon, Dr. Bruce Abbott, Dr. Melvyn Eder, and Robert Bacon, among others, prior to August 1992.

Mr. Turner told prospective investors that LEF notes were risk free and safe; that they were backed by the State of Michigan; that there was collateral behind every note (compare Tr. 16 with Tr. 496, 517-18, 548); and that there was a guaranteed rate of return (Tr. 16, 95-97, 122, 135, 148, 151, 580). Mr. Malek could not recall Mr. Turner's ever asking for LEF's financial statement, for copies of UCC filings of security interests, or for any information about the lessees on leases assigned to notes he had sold (Tr. 548-49).

By 1993, documents available to Mr. Turner regarding the LEF notes sold to his customers indicated that the notes were not secured, were secured with leases that had been fully assigned to other LEF notes, or were secured by nonexistent or unconsummated leases.16

From 1990 through 1995, Mr. Turner received compensation from NBF or LEF in the form of commissions, salary, a credit card for his expenses, a leased luxury automobile, and insurance payments for two automobiles (Tr. 489-90; Div. Ex. 33-39). In 1991, NBF paid Mr. Turner wages of $34,282 and miscellaneous income of $57,033 (Div. Ex. 30-40; Tr. 371-73). In 1994, through mid-September, LEF paid Mr. Turner sales compensation of $76,527, or approximately $8,500 per month (Div. Ex. 29-38). Mr. Malek estimated Mr. Turner's total compensation from LEF over the six year period at $500,000 to $700,000 (Tr. 511-12).

In the summer of 1992, Mr. Turner asked that he no longer receive wages from LEF, reportable on IRS Form W-2. He told Mr. Malek that he wanted to switch from payroll income to investment income, reportable on IRS Form 1099, because he did not want Dean Witter to know he was receiving compensation from another source. Mr. Malek, himself then licensed as a securities industry professional, realized on his own that, if Dean Witter learned of Mr. Turner's moonlighting, he could be fired. LEF therefore complied with Mr. Turner's request (Tr. 385-86, 436-38, 520-24, 534-36). In an FBI interview conducted before the hearing, Mr. Malek had stated that, in 1995, Mr. Turner had asked him to tell anyone who inquired that the checks he received from LEF were interest income or return on principal. At the hearing, however, Mr. Malek could not recall telling this to the FBI (Tr. 523-24).

Interest income reported to the Internal Revenue Service for LEF notes held by Mr. Turner was $4,068 in 1992, $400 in 1993, and $43,600 in 1994 (Resp. Ex. 1-77). When LEF collapsed in late 1995, the unpaid principal on Mr. Turner's own notes exceeded $480,742 (Div. Exs. 27-16 and 31-14). According to Mr. Malek's calculations, however, Mr. Turner still came out ahead by a six-figure sum (Tr. 539, 552-53).

August 1992

At all relevant times, Michael Czerny was a representative of CIGNA Financial Advisors, Inc. (CIGNA), one of several companies that marketed estate planning and insurance products to Dean Witter customers (Tr. 652, 664, 763-64). In the late 1980s and early 1990s, Mr. Czerny, like Dean Turner, was moonlighting in the offer and sale of NBF and LEF notes.

In 1991, about ten or twelve investors to whom Mr. Czerny had sold NBF notes were not receiving timely payments from LEF (Tr. 656-57). In response to complaints, Mr. Czerny tried several self-help measures on behalf of these investors: he talked with Mr. Malek about these cash flow problems, made UCC filings with the State of Michigan on his own initiative, warned that he would report Mr. Malek to the Michigan Better Business Bureau, and even threatened physical violence (Tr. 544-45, 658-61, 674). Mr. Czerny believed that Mr. Malek was paying off investors brought to NBF and LEF by Dean Turner, in preference to paying off those introduced by Mr. Czerny (Tr. 672, 709-10). In addition, there had been bad blood between Mr. Czerny and Mr. Turner, stemming from an incident several months earlier in which Mr. Turner had accused Mr. Czerny of stealing his clients (Tr. 666-67, 721). That allegation had been relayed to Mr. Czerny through an unidentified Dean Witter regional vice president in Chicago (Tr. 667-78, 706-07, 721-22). The episode had effectively ended Mr. Czerny's ability (and desire) to gain referrals under the Dean Witter-CIGNA business arrangement (Tr. 714-15).

As a part of his self-help program to recover delinquent payments to investors he had introduced to LEF, Mr. Czerny called a friend who was a registered representative at Dean Witter's Southfield, Michigan, branch office. He explained that he was having a problem with a broker in the firm's Troy branch office, and asked his friend "who [he] could talk to in the organization with some authority that could help [him] out." The friend recommended Respondent Kolar (Tr. 675, 708).17

Mr. Czerny then contacted Mr. Kolar and identified himself as a CIGNA representative. The two men disagree on just about everything that happened next. Mr. Kolar testified that they had a five minute telephone conversation, but never met in person; and that Mr. Czerny's accusations against Mr. Turner were strictly limited to "selling away" (Tr. 763-65, 837-39, 855). For his part, Mr. Czerny testified that the initial five minute telephone conversation was followed by a face-to-face meeting in Mr. Kolar's office, lasting forty-five to sixty minutes. At this in-person meeting, Mr. Czerny testified that he laid out not only his "selling away" allegations, but also informed Mr. Kolar about the cash flow difficulties at LEF and his suspicions that Dean Turner controlled the payments to LEF investors (Tr. 675-78, 689-92, 699-703, 711, 715-18, 720-21). Mr. Czerny could not recall if he then knew that LEF notes were securities (Tr. 669-70, 683, 699). At this time, Mr. Kolar did not have any concerns about Mr. Czerny's credibility (Tr. 764-65).

Mr. Kolar took notes of his conversation with Mr. Czerny, and recorded them on his day timer for August 14, 1992 (Resp. Ex. 11-DX 29; Tr. 837-38). The notes read as follows:

Got a call from Mike Czerny of CIGNA. Client that Dean Turner recommended to Mike said he got some private equipment leases from Dean Turner. The partnerships were put into a pension account. The clients involved are Don Dixon, Melvyn Eder, Dr. Abbott. The company that Dean got them through is named National Business Funding--SEC registered as Lease Equities Fund. Mike says he has a copy of a 1099 made out to Dean for the calendar year 1991 for $57,000. Mike says he will make copies of everything and drop it off at the office early next week. Also in Dixon's account is insurance policy issued by Mass General.

Mr. Kolar told Mr. Czerny that he would handle the situation. He further stated that he would call the Troy branch manager that day (Tr. 678). Mr. Kolar did try to inform Mr. Basile that afternoon, but he was out of town. Mr. Basile promptly learned of the allegations from Mr. Kolar when he returned to the office the following Monday.

At the same time, Mr. Kolar also sought the advice of Mr. O'Neil in Chicago. Although Mr. Kolar testified that he briefed both Mr. O'Neil and Mr. Basile by reading his notes of the Czerny conversation "verbatim," neither Mr. O'Neil nor Mr. Basile could recall Mr. Kolar's making specific identification of Mr. Czerny as the complaining outside vendor. Nor could either man recall Mr. Kolar naming any of the three customers whom Mr. Czerny had identified (compare Tr. 218, 249, 251, 451 with Tr. 766, 768, 840).

After consulting with Dean Witter's Law Department, Mr. O'Neil told Mr. Kolar that he and Mr. Basile should interview Mr. Turner. He left it to Messrs. Kolar and Basile to formulate the questions they would put to Mr. Turner (Tr. 472-73).18 He further stated that "a very productive avenue" of inquiry would be to question Mr. Turner about LEF and to have him bring his personal income tax returns to the meeting. In this way, Mr. O'Neil said, the Law Department believed they could determine if he was being paid to "sell away" from the firm.19 The Law Department never told Mr. O'Neil that checking the tax return would be legally sufficient, and that nothing beyond that needed to be done (Tr. 453).

Mr. Basile contacted Mr. Turner that same day, Monday, August 17, 1992, and set up an interview at the Troy office for the next day. He did not tell Mr. Turner the purpose of the meeting, but did ask Mr. Turner to bring his 1991 income tax return (Tr. 217-19, 249-53, 451-53, 766-67, 776).

According to both Messrs. Kolar and Basile, their meeting with Dean Turner took place on August 18, 1992, and lasted two to three hours. Mr. Turner brought his 1991 income tax return, as requested. Mr. Kolar chaired the meeting, which was confrontational and abrasive from the start. Both managers asked Mr. Turner personal questions about his background, where (other than at Dean Witter) he made his money, and what his wife did for a living (Tr. 220-21, 224, 253, 782-83).

Mr. Turner acknowledged that he was an investor in LEF notes, and that fellow members of his country club (who were Dean Witter customers) were also LEF investors. He denied selling LEF notes to anyone (Tr. 221-22, 776-77, 809). He explained that he had earned money playing professional ice hockey, that he came from a socially prominent family, and that his wife had a substantial income of her own (Tr. 256-57, 782, 785). Messrs. Kolar and Basile did not ask Mr. Turner for the names of specific Dean Witter customers who were investing in LEF notes (Tr. 777-78).

Messrs. Kolar and Basile testified that they also reviewed the 1991 joint federal income tax return of Mr. Turner and his spouse. The described the tax return and the accompanying schedules as thirty to forty pages in length. They did not find a Schedule C, reflecting profit and loss from business activities (Tr. 780). They also did not find W-2 wage income reflecting earned income from NBF or LEF. They did find numbers on Schedule B of the return that "matched perfectly" what they were looking for--interest or dividend income from NBF in the approximate amount of $57,000 (Tr. 254, 778, 780, 784). The two supervisors did not photocopy the tax return they reviewed (Tr. 289, 794). Mr. Kolar could not remember if the tax return had been signed by Mr. Turner and his wife, or by a paid preparer (Tr. 855).

Messrs. Kolar and Basile did not interview Mr. Turner's sales assistant, Roz Suwinski (Tr. 799-800). Nor did they check Dean Witter's internal records to see if Mr. Turner had reported his status as an investor in LEF notes, as he was required to do when hired and each year thereafter (Tr. 226, 810-13).

Mr. Basile prepared summary notes at the close of the meeting; Mr. Kolar did not make notes during or after the meeting (Tr. 258-60, 794; Resp. Ex. 5-81). Mr. Basile's notes state:

Ray Basile, George Kolar and Dean Turner in my office discussed outside interests, outside CIGNA rep advised. He has not solicited any outside limited partnerships since joining Dean Witter. The 1099 information was his interest earned, not commissions. Discussed with Tom O'Neil, George and Ray. Dean stated that he had no involvement in Lease Equities other than as an investor.

There are several different sorts of IRS Forms 1099 (compare Div. Ex. 30-40 with Resp. Ex. 1-77). One is used to report interest income (IRS Form 1099-INT); another, to report dividend income (IRS Form 1099-DIV); and a third, to report miscellaneous income, including commission income (IRS Form 1099-MISC). During the investigation that preceded this case, Messrs. Kolar and Basile testified that they were not sure if they knew of the different sorts of Forms 1099 when they interviewed Mr. Turner (Tr. 222-24, 254-56, 778-82). At the hearing, however, both supervisors testified that they were quite sure when they interviewed Mr. Turner that the Form 1099 they saw on August 18, 1992, was either for interest or dividends, but not for miscellaneous income (Tr. 222, 778-82). But see Div. Ex. 30-40 (1991 IRS Form 1099-MISC from NBF to Mr. Turner in the amount of $57,033.69).

David Disner is a certified public accountant from West Bloomfield, Michigan. He has prepared the tax returns of Dean Turner for ten years. He provided a copy of the federal income tax return he prepared for Mr. Turner and his spouse for calendar year 1991 (Tr. 816-29; Div. Ex. 64-30A).20 Among other things, that return shows that Mr. Turner did not file his 1991 tax return on April 15, 1992, but sought an automatic four-month extension that allowed him to file as late as August 17, 1992 (Tr. 826)--one day before the Kolar-Basile-Turner meeting. Additionally, the tax return prepared by Mr. Disner shows that Mr. Turner had reportable 1991 wage income from NBF of $34,282. This amount was posted to line 7 of IRS Form 1040 (see page ENF 023 of Div. Ex. 64-30A), and is consistent with the Form W-2 issued by NBF's bookkeeper (Div. Ex. 30-40). The tax return provided by Mr. Disner also shows on Schedule B, Interest and Dividend Income, that the combined interest and dividend income of Mr. Turner and his wife for 1991 was far less than the $57,533.69 that Mr. Kolar and Mr. Basile state they saw in their review of the return on August 18. Finally, Mr. Disner posted the 1099-MISC income of $57,533.69 to Mr. Kolar's tax return on Schedule C, Profit and Loss from Business, as part of the gross receipts or sales (Tr. 819-20).

After Mr. Kolar and Mr. Basile had interviewed Mr. Turner, they dismissed him from the room. The two managers then held a fifteen to twenty minute telephone conversation with Mr. O'Neil, summarizing their meeting. They told Mr. O'Neil they had examined Mr. Turner's 1991 income tax return and found evidence of investment income from LEF, but no sign of earned income from LEF. Mr. O'Neil and Mr. Basile testified that Mr. Kolar never recommended contacting the Dean Witter customers named by Mr. Czerny; in contrast, Mr. Kolar testified that the subject was discussed at this time (Tr. 226, 456, 793). The three managers collectively concluded that Mr. Turner was not selling LEF notes, but was an investor in LEF notes. Based on Mr. Turner's cooperation and explanations, his demeanor at the meeting, the absence of prior discipline or customer complaints, and their examination of his income tax return, they concluded that he was not "selling away." They jointly decided not to proceed further.

Some time thereafter, Mr. O'Neil had a "very short" conversation with an unidentified individual in Dean Witter's Law Department, to inform that office of the results, thus "closing the loop" (Tr. 478-80, 795-97).

1993 and 1994: LEF's Cash Flow Difficulties Get Worse

In 1993, LEF loaned $500,000 to a start-up company named "JET-U.S." Shortly thereafter, JET-U.S. failed, and the company ceased operations. LEF lost not only its $500,000 loan, but also an additional $500,000 in legal fees in connection with the transaction (Tr. 491-93).

At about the same time, Mr. Turner and Mr. Malek started their own cable television service company, NBF Cable Systems, Inc. (NBF Cable), in Ft. Lauderdale, Florida. LEF loaned over $2 million to NBF Cable to cover high capitalization costs and litigation expenses incurred by NBF Cable (Tr. 491-93).

In a separate transaction, Joseph Cole, another Dean Witter broker in the Troy office, and Derrick Suciu, who was then a trust investment officer at the First National Bank of Pittsburgh (First National), discussed LEF promissory notes as an investment for the bank. Eventually, Mr. Suciu purchased about $8 million in LEF promissory notes for the bank's account (Tr. 496-500).

In mid-1994, after a bank audit, officials at First National notified Mr. Malek that the LEF notes were inappropriate investments. The bank demanded immediate repayment. Mr. Malek negotiated with the bank officials, and reached an agreement to repay approximately $4.8 million (Tr. 496-500, 545). LEF acquired the funds to repay the bank by soliciting individual investors.

From August through November 1994, Mr. Turner solicited at least three such investors, and raised at least $1.4 million, to pay LEF's debt to First National (Tr. 17-21, 104-06, 585-86, 608-09). Among other things, Mr. Turner told these prospective investors that LEF had the opportunity to buy back some leases from the bank at a discount, without telling them that LEF was actually indebted to the bank for nearly $4.8 million and that the bank was demanding immediate repayment. He said that the investment was a "really sweet deal," a "slam dunk, no brainer," and that the investors "cannot lose"; that the loans were backed by the State of Michigan and therefore were guaranteed; that Dean Witter's accounting staff had told him that it was allowable for an individual investor to margin his pension account to enter the transaction; and that the leases could be obtained at a good rate if they were purchased quickly.

At this juncture, Mr. Malek began to falsify documents, issue leases without collateral, and use the same collateral for different leases (Tr. 400, 493, 499-500; Div. Ex. 68-32 at 14).

1995: The "Ponzi" Scheme Collapses

In the Spring and Summer of 1995, LEF began failing to meet its payment obligations on many of the notes to investors (Tr. 106-08, 160, 354, 357-59, 505, 551, 608). During this time, Mr. Turner was frequently in contact with Mr. Malek or his office assistants to determine whether LEF had sufficient funds available so he could decide which customers' checks from LEF he could deposit into their bank accounts (Tr. 356, 506). If investors inquired of Mr. Turner about the late payments, he would offer excuses, such as telling them the payments were merely delayed because a storm had disabled LEF's computers, or because his own assistant at Dean Witter was out sick (Tr. 29, 106-07, 358, 506-07). In some cases, Mr. Turner tried to convince investors that LEF was still a sound company (Tr. 30, 160). He continued to sell LEF promissory notes to investors through August 1995 (Tr. 359, 507).

In late August 1995, Mr. Basile learned that the back office staff at the Troy branch office had been experiencing difficulties in clearing several LEF and NBF checks (Tr. 227-28). On August 25, 1995, the Compliance Department, which had been auditing the Troy branch, requested Mr. Basile to obtain additional information from Mr. Turner about his outside financial interests, including LEF. Mr. Basile interviewed Mr. Turner, who again denied that he had any affiliation with LEF, and also denied that he had solicited Dean Witter clients to invest in LEF. With respect to the large number of checks going to LEF from Dean Witter, and coming from LEF to Dean Witter, Mr. Turner explained that LEF was run by a friend who referred clients to him. The branch manager reported these denials and explanations to Dean Witter's Compliance Department in a memorandum dated September 18, 1995 (Tr. 264-69; Resp. Ex. 4-4).

In the Autumn of 1995, after LEF had failed to meet its payment obligations, Mr. Turner attempted to convince his major customers to surrender their LEF notes, so that a new company could be formed which would be given a lien on the assets of LEF (Tr. 35-37, 110-11). While attempting to persuade investors to accept this agreement, Mr. Turner falsely told one investor that other investors had signed on to the plan, in order to convince her to follow suit (Tr. 39-40). The reorganization plan did not take place.

Several creditors filed an involuntary bankruptcy petition against LEF on December 15, 1995 (Tr. 486). After a hearing, the corporation was liquidated. The earliest customer lawsuits were also filed in December 1995, amid considerable publicity in the local press (Tr. 229).

Fact Witness Credibility

The Division contends that its customer witnesses were truthful, that Mr. Kolar was untruthful, and that Messrs. O'Neil and Basile were biased against its case because of the pending customer litigation against Dean Witter. The Division cannot quite bring itself to claim that Mr. Czerny is credible, but instead argues that Mr. Czerny's credibility should not be an issue. For his part, Respondent attacks the bias of the customer witnesses and the truthfulness of Mr. Czerny.

There is little question that the pending customer litigation against Dean Witter looms large. I find that certain testimony by both customer witnesses and Dean Witter employees was slanted, and should be discounted as a result. As illustrations, I have given little weight to one customer's efforts to portray himself as one of the "little people," because he acknowledged that his 1990 net worth was $800,000 and his annual income exceeded $200,000 (Tr. 150, 177). Indeed, the customer witnesses were far more experienced and sophisticated than they attempted to portray themselves at the hearing. One customer witness who made unsecured short-term loans to Mr. Malek at arguably usurious interest rates at times sounded more like a predator himself than the innocent victim of LEF's fraud (Tr. 616-19). Likewise, I consider highly implausible the testimony of Mr. Basile that, in December 1995, as the public was first learning of the collapse of LEF, some seven to eight customers specifically volunteered to him that they knew that LEF notes were not a Dean Witter product (Tr. 269-71).

The four customer witnesses were generally truthful in describing their dealings with Dean Turner and William Malek, and those parts of their testimony are fully credited. Aspects of their testimony confirming their lack of contact with Dean Witter's supervisors were also truthful, but troubling. For example, after the customers became exasperated with Mr. Turner, they never complained to any higher officials of the firm (Tr. 48, 50, 66-67, 89-90, 118, 137, 172-75). One customer threatened to blow the whistle on Mr. Turner by complaining to a local politician, whom she knew only slightly, instead of bringing her legitimate concerns directly to a supervisor at Dean Witter (Tr. 34-35, 71, 89-90). The witness's explanation that she "assumed that the company was involved in this whole thing and there was no one that was going to help me" is rejected as incredible (Tr. 90).

While Mr. Czerny has never been convicted of a crime or disciplined by any regulatory authorities (Tr. 662-63), his record as a securities industry professional is not free from blemish. In 1994, he and his employer settled a securities arbitration case for $300,000, without admitting liability. The claimant there had alleged fraudulent misrepresentations (Resp. Ex. 8-17). In 1995, Mr. Czerny and his employer settled civil litigation brought by the U.S. Department of Labor for $35,000, also without admitting liability. The Department had alleged violations of ERISA with regard to Mr. Czerny's sale of limited partnerships to a pension account (Resp. Ex. 9-18; Tr. 670-72, 731-36).21 He was also deeply involved in the sale of LEF notes, "selling away" from his own employer. In one particularly disturbing episode, Mr. Czerny acknowledged that he persuaded an elderly investor to put $250,000 into an LEF note so that he could take five other investors out. At the hearing, Mr. Czerny chillingly characterized this as a "judgment call" and a "trade off" (Tr. 722-26). Mr. Malek, who has known Mr. Czerny for twenty-two years, opined that "he's a bigger criminal than me and Turner put together" (Tr. 556-57, 562; see also Tr. 632-33). Although the Division interviewed Mr. Czerny several times before the hearing, it did so in a fashion that did not create Jencks Act statements, releasable to Mr. Kolar under Rule 231(a) (Tr. 683-88).22 These are illustrations, not an exhaustive catalog, of the difficulties presented by Mr. Czerny.

For present purposes, however, Respondent's character attacks on Mr. Czerny are immaterial. Mr. Kolar said that Mr. Czerny's credibility was not an issue in his mind before the August 18, 1992, meeting (Tr. 767, 770). Likewise, Messrs. O'Neil and Basile could not recall if Mr. Kolar identified Mr. Czerny to them by name as Dean Turner's accuser (Tr. 218, 249, 449-51). Finally, both Mr. Kolar and Mr. Basile described the August 18 meeting as limited to probing the conduct and examining the tax return of Mr. Turner. Mr. Czerny's motives and reputation for truthfulness were not on the agenda. There is no evidence that any of the three Dean Witter supervisors discounted the accusations against Mr. Turner because Mr. Czerny, the messenger, was himself deemed untrustworthy. I find this to be so both before and after the August 18, 1992, meeting.23

It is unnecessary to address the conflict between the accounts of Messrs. Czerny and Kolar as to whether they met in person and how long they spoke. First, the Division does not press either point. Second, the case can be resolved by accepting Mr. Kolar's version of events, as memorialized in the notes he wrote on his August 14, 1992, day timer.

Mr. Kolar's testimony at the hearing is given limited weight in view of significant conflicts with his own prior investigative testimony and with the hearing testimony of the other witnesses from Dean Witter. With his career on the line, he has an obvious motive for minimizing his own supervisory role and in weaving a scenario in which he bucks responsibility for every significant decision up to Mr. O'Neil in Chicago, or down to Mr. Basile in Troy.

The discrepancies between his investigative and hearing testimony are plain. Mr. Kolar's efforts at the hearing to get out from under earlier admissions that he played a role in disciplining Troy branch broker Michael Alito, and that he did not know in August 1992 that there were different types of IRS Forms 1099, are rejected as self-serving (Tr. 756-62, 778-82).

Likewise, I reject Mr. Kolar's efforts to portray himself as nothing more than a fact finder in August 1992, who passed the "hot potato" to Mr. O'Neil and received in return a strictly-limited mandate, and who would be deemed in violation of corporate protocol if he did any more than Mr. O'Neil had specifically directed. If credited, this testimony would require a fact finder to accept the notion that Mr. O'Neil was a martinet who barked out orders that subordinates were to follow without question. It would also require a finding that Mr. Kolar's job title, Detroit metropolitan area manager, was utterly meaningless insofar as his overall supervisory responsibilities for the Troy branch brokers' compliance was concerned. Finally, it would require one to find that Mr. Kolar was a timid soul, with a literalist's approach to his duties, who lacked the slightest spark of initiative when presented with a direct accusation of wrongdoing by a subordinate.24 Based on my observation of Mr. O'Neil's and Mr. Kolar's demeanors, none of these notions is tenable.

In fact, Mr. O'Neil gave Mr. Kolar's recommendations a lot of weight (Tr. 475), would not have considered further action by Mr. Kolar as usurping his own authority (Tr. 457), did not view Mr. Kolar as merely a messenger between the Troy branch and the Chicago regional office (Tr. 448), rarely gave direct orders to subordinates, and favored a collegial decision making style (Tr. 447-48, 479). When Mr. Czerny asked a friend at Dean Witter for the name of someone in authority to speak with about difficulties he was having with a Troy branch registered representative, the friend did not refer Mr. Czerny to the Troy branch manager, but rather to Mr. Kolar (Tr. 675, 708). Finally, it was disingenuous for Mr. Kolar to testify that the tax return he reviewed was reliable because it was "prepared" under penalty of perjury. Signature, not preparation, is the key factor in any perjury inquiry, and Mr. Kolar, with a strong background in accounting, surely appreciated that. Moreover, Respondent could not remember if the return he purportedly examined had been signed by Mr. Turner and his wife or by a paid preparer (Tr. 789, 855).25

The single most credible witness to testify was David Disner, the certified public accountant who prepared Dean Turner's income tax returns. Mr. Disner has no stake in the outcome of this proceeding, and his testimony was backed by highly probative documentary evidence.

Expert Witness Credibility

John D. Maine testified for Respondent as an expert witness. He has extensive experience at a major broker-dealer, including service as a branch office manager, responsible for sixty-five registered representatives; a regional director, responsible for twenty branch offices; and a member of the firm's board of directors. Following his retirement, he has been a self-employed consultant and expert witness in cases involving brokerage firm management and compliance issues (Resp. Ex. 14; Tr. 878-944).

Mr. Maine opined that Mr. Kolar turned over the investigation of Dean Turner to Mr. O'Neil and was thereafter simply a resource that Mr. O'Neil could tap. Once Mr. Kolar had done so, he was no longer a central figure. In Mr. Maine's view, Mr. Kolar's conduct was more than reasonable (Tr. 889, 893, 898, 904, 909, 939). Mr. Maine disputed the opinion of the Division's expert witness that Mr. Kolar should have contacted Dean Witter customers about their investments in LEF notes away from the firm. He urged that such an inquiry would have been inappropriate. In contrast, he acknowledged that a broker-dealer has a right and duty to ask a customer about anything that appears on the firm's own books and records (Tr. 899).

On cross-examination, the Division established that, in seventy-five percent of the cases in which Mr. Maine has testified as an expert, he has been a witness on behalf of a defending broker-dealer and against a complaining customer (Tr. 916-20); he has not read any case law on the topic of failure to supervise (Tr. 935); and his written expert testimony was prepared in large part by Mr. Kolar's attorneys and tracked the language used in earlier filings by counsel (Tr. 923-29). His testimony has been evaluated with these factors in mind.

John E. Parkes, Jr., President of Compliance Associates, testified for the Division as an expert witness in rebuttal. Before starting his own independent consulting business, Mr. Parkes served as compliance officer for a registered broker-dealer with four branch offices and eighty-five to 100 registered representatives. He has testified as an expert witness in approximately five other cases involving allegations of "selling away" (Tr. 950, 956, 963). Mr. Parkes acknowledged that, in the great majority of the cases where a registered representative is involved in inappropriate activity, confrontation by management will force a disclosure. He opined that this case, in which Mr. Turner was "able to face two managers and not cave in," was "very unique" (Tr. 981-82, 1009).

Mr. Parkes opined that Mr. Kolar's conduct should not be evaluated as if nothing were done, but rather as a situation where more should have been done. In his written testimony, Mr. Parkes identified several additional avenues of investigation that Mr. Kolar could have undertaken to confirm or disprove the allegations made to him about Mr. Turner. He stated that Mr. Kolar was not required to take all the extra steps he had identified, but should have at least taken one or more of them (Div. Ex. 71).

On cross-examination, however, Mr. Parkes acknowledged that several of the additional steps he had identified would not have been helpful in the circumstances of this case. These included his recommendation for contacting the Central Registration Directory to determine the individuals paid by LEF, checking with the State of Michigan, and searching for publicly-available information about distributions by LEF. Mr. Parkes also conceded that his recommendation to hire an investigative agency ordinarily would be handled by a broker-dealer's legal or compliance departments, and not by branch or area supervisory officials (Tr. 998-1006). These aspects of Mr. Parkes report are not pressed in the Division's posthearing pleadings, and will be given little weight.

CONCLUSIONS OF LAW

Section 15(b)(6) of the Exchange Act, in conjunction with Section 15(b)(4), provides that the Commission may sanction a supervisor for failure reasonably to supervise a person subject to his supervision, with a view to preventing violations of the Securities Act, the Exchange Act, or the Commission's implementing rules and regulations. In order to sanction Mr. Kolar in this case, the Division must prove that Mr. Turner violated at least one of the statutory provisions or regulations identified in the OIP, that he was subject to Mr. Kolar's supervision, and that Mr. Kolar failed reasonably to supervise Mr. Turner with a view to preventing the violations.

The fact that Mr. Turner has been acquitted in a jury trial of sixteen counts of mail fraud and securities fraud is not dispositive here on the issue of his underlying violations. The allegations of willful violations by Mr. Turner in this proceeding need only be proven by a preponderance of the evidence, and not beyond a reasonable doubt, as in a criminal case. See Sidney Leavitt, 45 S.E.C. 206, 209 n.9 (1973); A.J. White & Co., 45 S.E.C. 459, 460-61 (1974).

In addition, while Mr. Turner's "selling away" strongly suggests that he violated Dean Witter policies and the rules of various self-regulatory organizations, the OIP does not identify specific rules or require me to draw conclusions as to any such rule violations.26 See Michael E. Tennenbaum, 47 S.E.C. 703, 712 n.25 (1982). "Selling away," by itself, has not been shown to be a per se violation of any of the Securities Act or Exchange Act provisions or Commission rules identified in the OIP, and suggestions to the contrary by the Division and its expert witness remain unproved.27

Self-regulatory organization rules are an integral part of the federal regulatory scheme, but they are not always co-extensive with federal law or capable of universal application. Cf. Conrad C. Lysiak, 51 S.E.C. 841, 844 n.13 (1993), aff'd, 47 F.3d 1175 (9th Cir. 1995). When a duty (here, the duty not to "sell away") arises only as a result of such a supplementary self-regulatory organization rule or internal broker-dealer policy, as opposed to a Congressional or Commission policy determination, conduct violative of such a duty falls outside of the jurisdiction of a Section 15(b) proceeding. Of course, self-regulatory organization duties and federal duties may coincide in some instances, but ultimately the proper frame of reference in setting the standard of conduct to be applied will be Congressional enactments and the Commission's regulations. Cf. Graves v. Shearson Hayden Stone, Inc., [1980-1982 Transfer Binder] Comm. Fut. L. Rep. (CCH) 21,301 (CFTC, 1981). Thus, the allegations in OIP I.P and I.Q, standing alone, do not support a finding of liability in this proceeding.

LEF's Long-Term Promissory Notes Were Securities

As a threshold matter, Mr. Kolar argues that this case is not within the purview of the Commission because the LEF notes in question--or at least the few notes shown on this record to have been sold before August 18, 1992--were not "securities" within the meaning of the federal securities laws (Resp. Br. at 32-33). The Division argues that they were (Div. Reply Br. at 23-25).

The definition of "security" in Section 3(a)(10) of the Exchange Act includes a long list of financial instruments, beginning with "any note" and ending with "but shall not include . . . any note . . . which has a maturity at the time of issuance of not exceeding nine months . . . ."

LEF's unsecured short-term notes, with maturities of six months or less, do not warrant extended consideration here. Such notes were negotiated directly between Mr. Malek and individual investors. As Dean Turner was not shown to be involved in their offer or sale, they are irrelevant to Mr. Kolar's potential liability for failure to supervise. I therefore decline to address the issue of whether these short-term notes were or were not securities.

LEF's long-term notes cannot be so easily sidestepped, because Dean Turner did offer and sell scores of them. See note 15, supra. The notes matured in twenty to sixty months, had face values ranging from $10,000 to $500,000, and carried interest rates between seven and fifteen percent. Some were backed by collateral, and some were not.

In Reves v. Ernst & Young, 494 U.S. 56, 61-67 (1990), the Supreme Court stated that the statutory phrase "any note" should not be interpreted literally, but must be understood against Congress' purpose, which "was to regulate investments, in whatever form they are made and by whatever name they are called" (emphasis in original). Under the Reves "family resemblance test," every note is first presumed to be a security, but the presumption may fall away under either step of a two-tiered analysis. Id. at 67.

In the first step, the notes under review are compared to several types of notes the Supreme Court specifically said are not securities. The comparison between the notes in question and the excluded notes is to be made by considering four factors: (1) the motivations that would prompt a reasonable seller and buyer to enter into the transaction; (2) the plan of distribution of the instrument; (3) the reasonable expectations of the investing public; and (4) whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the investment, thereby rendering the application of the federal securities laws unnecessary.

The notes are not securities if this four-factor comparison reveals a "strong resemblance" to one of the enumerated types of notes. None of the four factors is crucial, and the failure of one will not automatically result in a determination that the notes are not securities. All four factors must be balanced in order to determine whether, on the whole, the notes look more like securities than not. In re NBW Commercial Paper Litigation, 813 F. Supp. 7, 12 (D.D.C. 1992).

If a strong resemblance is not found, the second step of the analysis requires a determination as to whether another category should be added to the judicially-crafted list of exceptions. This decision is to be made by examining the same four factors. Whether a note is a security is a question of law. See Stoiber v. SEC, 161 F.3d 745, 749 n.7 (D.C. Cir. 1998) ("[T]he presumption is only rebutted when the two-step, four-factor analysis based on all the evidence leads to the conclusion that the note is not a security"). This reflects Congress' intent to define the term "security" with sufficient breadth to encompass virtually any instrument that might be sold as an investment. Trust Co. of Louisiana v. N.N.P., Inc., 104 F.3d 1478, 1489 (5th Cir. 1997).

In this case, the customer witnesses were primarily motivated to obtain LEF notes by the opportunity to earn a profit on their money. They viewed the long-term LEF notes as a stock market substitute, and the funds came from their various investment accounts. When these factors are added to the favorable interest rates offered by LEF, the first Reves factor points in the direction of the long-term LEF notes being securities.

In contrast, the weight of the evidence shows that the long-term LEF notes were not offered and sold to a broad segment of the public. Dean Turner sold LEF notes to a rather narrow circle of friends, neighbors, and social acquaintances from a wealthy Detroit suburb. Testimony from one such customer, attributing to Mr. Turner a desire to make the opportunity to purchase LEF notes available to "the little people," is not dispositive, because the witness' understanding of "the little people" is over-inclusive. Paul Czerny sold an LEF note to a customer with a net worth of about $2 million (Tr. 722-26). Joseph Cole sold LEF notes to the trust department of a Pennsylvania bank. The record contains no other evidence about the financial profile or geographic distribution of LEF note holders. Thus, the second Reves factor suggests that the notes may not be securities.

The third Reves factor examines the reasonable expectations of the investing public. When a note seller calls a note an investment, in the absence of contrary indications, it is reasonable for a prospective purchaser to take the offeror at its word. Reves, 494 U.S. at 69. Here, there is ample evidence that Mr. Malek and his office assistants, as well as Mr. Turner and Mr. Czerny, all viewed the note holders as "investors." This factor favors a finding that the LEF notes were securities.

The fourth and final inquiry looks to the adequacy of regulatory schemes other than the federal securities laws in reducing risks to lenders. Such risk-reducing factors operate either to prevent investors from harm in the first place or to make recovery more likely after injury. Mr. Kolar points specifically to the collateral backing the long-term LEF notes, the protections of the UCC and ERISA, and unidentified consumer protection statutes. Respondent basically argues that the state courts are open for business and that injured note holders can bring lawsuits.28 I find the additional protection of the federal securities laws to be necessary in this case.

Based on the four Reves factors, I conclude that the long-term LEF promissory notes were securities. They do not bear a strong resemblance to the category of notes the Supreme Court has declared to be outside the definition of securities and the four factors do not suggest that the notes should be treated as a new non-security category. The plan of distribution signals that the notes might not be securities, but that factor by itself is not dispositive.

Turner Willfully Violated Sections 5(a) and 5(c) of the Securities Act

Section 5(a) of the Securities Act provides that, unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly, to sell the security through the use of any means or instrumentality of transportation or communication in interstate commerce or of the mails. Section 5(c) of the Securities Act provides a similar prohibition as to offers to sell a security unless a registration statement has been filed. A prima facie case for a violation of Section 5 of the Securities Act is established by showing that: (1) no registration statement was in effect or filed as to the securities; (2) a person, directly or indirectly, sold or offered to sell the securities; and (3) the sale was made through the use of interstate facilities or the mails. SEC v. Continental Tobacco Co., 463 F.2d 137, 155 (5th Cir. 1972). Willfullness is shown where a person intends to commit an act which constitutes a violation. There is no requirement that the actor also be aware that he is violating any Acts or Rules. Arthur Lipper Corp. v. SEC, 547 F.2d 171, 180 (2d Cir. 1976).

No registration statement for LEF notes was ever filed with the Commission (Div. Exs. 65-33, 66-34). Mr. Turner offered and sold LEF notes to various investors through the use of the mails and the telephone. He certainly intended to do so. The Division has thus established a prima facie case.

Respondent claims--for the first time in his posthearing brief--that the LEF notes should be deemed exempt from registration under Section 5 because they did not involve a "public offering" within the meaning of Section 4(2) of the Securities Act. This untimely argument has been waived.

The "private offering" exemption is an affirmative defense that must be proved by the person claiming the exemption. Swenson v. Englestad, 626 F.2d 421, 425 (5th Cir. 1980); Lively v. Hirschfeld, 440 F.2d 631, 632 (10th Cir. 1971). Affirmative defenses must be pled in an answer, see Rule 220(c); cf. Fed. R. Civ. Pro. 8(c), or they are waived. Crowe v. Cherokee Wonderland, Inc., 379 F.2d 51, 54 (4th Cir. 1967); Glens Falls Ins. Co. v. Newton Lumber & Mfg. Co., 388 F.2d 66, 70-71 (10th Cir. 1967); Baker v. Chicago Fire & Burglary Detection, Inc., 489 F.2d 953, 955 (7th Cir. 1973); Funding Systems Leasing Corp. v. Pugh, 530 F.2d 91, 96 (5th Cir. 1976).29 Respondent failed to meet these requirements here. The weight of the evidence thus establishes that Mr. Turner willfully violated Sections 5(a) and 5(c) of the Securities Act.

Turner Willfully Violated Section 15(a)(1) of the Exchange Act

It is undisputed that Mr. Turner was not registered as a broker or dealer at any time relevant to this case (Div. Ex. 67-35). Because Mr. Turner sold LEF notes privately, only to Michigan residents, and only on behalf of LEF, a Michigan issuer, Respondent argues in his posthearing brief that Mr. Turner's activities were "exclusively intrastate," and that he was therefore not required to register as a broker or dealer. Respondent also contends that Mr. Turner need not have registered independently, because he was already a person associated with Dean Witter, itself a registered broker-dealer, and he was acting within the scope of his employment in the sale of LEF notes.

Once the Division proves that an individual is unregistered, the burden of proving an exemption from registration is on the party claiming the exemption. A claim of exemption from registration is an affirmative defense. Western Federal Corp. v. Erickson, 739 F.2d 1439, 1442 (9th Cir. 1984); Parker v. Broom, 820 F.2d 966, 968 (8th Cir. 1987); Birnholz v. 44 Wall St. Fund, Inc., 904 F.2d 567, 569 (11th Cir. 1990).

As above, the exemption arguments under Section 15(a)(1) have been waived because they were not among the affirmative defenses raised in Mr. Kolar's answer to the OIP, see Rule 220(c), and because he never sought to amend his answer to include such defenses, see Rule 220(e). His prehearing brief and his hearing presentation were also silent on these issues. Such arguments may not be raised for the first time in his posthearing brief.30

The Division has shown that Mr. Turner violated Section 15(a)(1). However, the parties have not cited, and I have not found, any contested cases in which the Commission has sanctioned a supervisor for failing to supervise where the underlying violation by the registered representative is the failure to register as a broker or dealer under Section 15(a)(1). (Mr. Basile's settlement so provides, but it is not binding precedent). Cf. SECO Sec., Inc., 49 S.E.C. 873, 875 n.3 (1988). Such a holding would be counter-intuitive, as the stated need for the individual to register is grounded in the lack of opportunity to supervise. If there is a lack of opportunity to supervise, as in Sodorff and Roth, it is not clear how there can also be a failure reasonably to supervise. For these reasons, Mr. Kolar's liability for failure to supervise will not be based on Mr. Turner's underlying violation of Section 15(a)(1).

Turner Willfully Violated the Anti-Fraud Provisions of the Securities Laws

The OIP alleges that Mr. Turner violated Section 17(a) of the Securities Act, Sections 10(b) and 15(c)(1) of the Exchange Act, and Rules 10b-5 and 15c1-2, through a series of misrepresentations and omissions.

To prevail under Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5, the Division must show: (1) misstatements or omissions to state material facts; (2) made in connection with the offer, sale or purchase of securities; and (3) that Mr. Turner acted with scienter. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). No scienter requirement exists for violations of Section 17(a)(2) or Section 17(a)(3) of the Securities Act. Aaron v. SEC, 446 U.S. 680, 701-02 (1980).

A fact is material if there is a substantial likelihood that a reasonable investor would consider the fact important in making his investment decision and that disclosure of the omitted fact would have significantly altered the total mix of information made available. Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). Scienter may be established by a showing of recklessness. Mansbach v. Prescott, Ball & Turben, 598 F.2d 1017, 1023 (6th Cir. 1979). The Sixth Circuit has described recklessness as "highly unreasonable conduct which is an extreme departure from the standards of ordinary care." Id. at 1025.

With respect to material misrepresentations, the Division need not prove detrimental reliance by customers. SEC v. Blavin, 760 F.2d 706, 711 (6th Cir. 1985); SEC v. Rana Research, Inc., 8 F.3d 1358, 1364 (9th Cir. 1993). With respect to material omissions, reliance is presumed. Affiliated Ute Citizens v. United States, 406 U.S. 128, 153 (1972); Wright v. Heizer Corp., 560 F.2d 236, 249 (7th Cir. 1977); Schwarz v. Folloder, 767 F.2d 125, 132 (5th Cir. 1985). A respondent may prevail by rebutting the presumption--i.e.,--proving that customers did not rely on the omitted information, or were aware of the risk, or would have been indifferent to the omitted information, if it had been disclosed. But this is a formidable burden, not often satisfied.

Section 15(c)(1) of the Exchange Act expressly prohibits a broker or a dealer from employing any manipulative, deceptive or other fraudulent device, as defined in Rule 15c1-2 thereunder, to induce or attempt to induce the purchase or sale of any security. The elements of a cause of action under Section 15(c)(1) are the same as for Section 17(a), Section 10(b), and Rule 10b-5, except that Rule 15c1-2 requires that a statement or omission be made only with knowledge or reasonable grounds to believe that it is untrue and misleading. SEC v. Great Lakes Equities Co., Fed. Sec. L. Rep. (CCH) 95,685 (E.D. Mich. 1990); SEC v. Wexler, Fed. Sec. L. Rep. (CCH) 97,758 (S.D.N.Y. 1993).

As found above, there is no evidence that LEF had become a "Ponzi" scheme, that Mr. Turner knew it to be a "Ponzi" scheme, or that Mr. Malek was overcollateralizing notes as of August 18, 1992. See notes 14, 16, 17, supra. Nonetheless, there is evidence of Mr. Turner's fraud before that date. Three customers testified that, as early as 1990, Mr. Turner minimized the risk of loss and stressed the "guaranteed" return on LEF notes he was selling (Tr. 95-97, 101-02, 148-51, 580-82). He omitted to tell these customers that such notes were not a Dean Witter product and that he had been forbidden to sell them. I find these misrepresentations and omissions to be material.

Evidence of fraud by Mr. Turner after August 18, 1992, is considerably more extensive. Four customer witnesses testified that Mr. Turner repeatedly minimized the risk of loss. He also told them LEF notes were backed by collateral, when many were not. With respect to the resale of LEF notes held by a Pennsylvania bank, he told at least one customer a blatant falsehood (that Dean Witter's accounting department had authorized margining the customer's retirement account to purchase the notes). As to other customers, he omitted mention of the fact that LEF was indebted to the bank and that the bank had demanded immediate repayment. He engaged in high-pressure sales tactics, to induce his customers to act swiftly.

Mr. Kolar does not seriously dispute that some of Mr. Turner's misrepresentations and omissions were material, such as the failure to disclose to his customers that LEF securities were actually not approved by Dean Witter, or that, contrary to Mr. Turner's assurances about collateral behind LEF notes, certain of the leases were forged, altered, or overcollateralized. He does dispute the materiality of other misrepresentations and omissions, arguing that some of Mr. Turner's statements were "mere puffery," that written disclosure always trumps oral misrepresentations, and that any post-sale misrepresentations are not actionable.

Viewing Mr. Turner's solicitation statements in the context of the entire record, it is impossible to dismiss them as "mere puffery." 31 It is unnecessary to consider whether full written disclosure renders verbal misrepresentations irrelevant because it is unclear what written disclosure Mr. Kolar would rely upon. Mr. Turner gave his customers no LEF prospectus or offering statements; the leases themselves were complex documents; and some of the underlying lease equipment agreements were printed in a microscopic typeface, making them all but impossible to read, much less comprehend.

Mr. Turner's scienter is clearly established on this record. He knew from the start of his employment with Dean Witter that he was not permitted to sell LEF notes to Dean Witter customers (Tr. 215-16). His failure to exercise due diligence in investigating LEF before recommending its notes to his customers was reckless. In 1995, as the LEF "Ponzi" scheme was in danger of collapse, he lied repeatedly to customers (assuring them that LEF was still a sound company, telling them their checks from LEF were overdue because a storm had damaged LEF's computers, and misleading them about how many other customers had signed on to his plan to have a new company assume the debts of LEF). He did so while he was holding their LEF checks in his desk and awaiting word from Mr. Malek as to when it would be safe to let the customers cash them. Mr. Kolar argues that such post-sale evidence of fraud is not probative. Lulling customers into a false sense of security, and leading them to believe that their funds were safe and that they would soon be paid according to the terms of their notes, was simply a device to avoid detection for an additional period of time. Such lulling conduct, in furtherance of a pre-existing fraudulent scheme, is itself actionable fraud.

Mr. Kolar also argues that Dean Turner's lack of scienter is established by the fact that he continued to invest his own funds in LEF notes through mid-1995, and that a rational person would not have done so if he were truly aware of the relevant facts. The evidence supports an inference that Mr. Turner put some of his own money--but not too much of it--back into LEF in an attempt to forestall the firm's inevitable collapse. As Mr. Malek's testimony and the documentary evidence show, Mr. Turner's belated contributions were less than his earlier withdrawals and compensation, and Mr. Turner still came out ahead by a six-figure sum.

Turner Was "Subject To" Kolar's Supervision

While the law governing alleged failure to supervise by a branch office manager is fairly settled, it has been evolving with respect to broker-dealer employees who are line supervisors above the branch office manager level, or who are staff officials within a firm, such as heads of functional areas, compliance officers, and general counsel. The Division argues that the case law defining a supervisor under the federal securities laws is extremely broad, and that its proper application here should reach beyond Mr. Basile, the Troy branch office manager, to Mr. Kolar, the metropolitan area manager. Citing the Commission's Settlement Order and Report of Investigation in John H. Gutfreund, 51 S.E.C. 93, 113 (1992), it contends that a supervisor is anyone who "has a requisite degree of responsibility, ability or authority to affect the conduct of the employee whose behavior is at issue" (Div. Br. at 12-15; Div. Reply Br. at 4-10).

Mr. Kolar contends that Dean Turner was never "subject to his supervision" within the meaning of Section 15(b)(4)(E) of the Exchange Act. Pointing to the concurring views of two Commissioners in Arthur James Huff, 50 S.E.C. 524, 530-37 (1991), Respondent argues that "control" is the essence of supervision, and that he lacked control over Mr. Turner because he never had the power to hire, fire, reward, or punish him.32 Pointing to Louis R. Trujillo, 49 S.E.C. 1106, 1110 (1989), Respondent also maintains that he had only limited advisory authority with respect to Mr. Turner's supervision.33 He urges me to hold that his "participation" in group managerial decisions and the fact that Mr. O'Neil had "high regard" for his opinions are insufficient as a matter of law to confer supervisory responsibility. Finally, Mr. Kolar argues that Gutfreund should not be used to evaluate his supervisory authority here because: (1) it represents a settlement, as opposed to a litigated case; and (2) "if" it imposes a new standard of supervisory responsibility, due process prohibits its retroactive application to conduct occurring in August 1992, four months before that Settlement Order and Report of Investigation were issued (Resp. Br. at 5-16).

The Commission has been careful to identify Gutfreund as a settlement in its adjudicatory opinions.34 However, the Gutfreund settlement order makes findings; it is also accompanied by a report of investigation issued under Section 21(a) of the Exchange Act.35 Cf. Carl L. Shipley, 45 S.E.C. 589, 591-92 n.6 (1974) (settlement orders, when accompanied by findings and an opinion stating the Commission's views on the issues raised, "are written only after deliberation and analysis akin to that reflected in [its] opinions in contested causes. Hence they are as authoritative as opinions in those cases"). Of course, the "report of investigation" accompanying the Gutfreund settlement order is not precisely the same as the "opinion" contemplated by Shipley. The Gutfreund "report of investigation" evaluates the conduct of an individual who was not a respondent, who was not sanctioned, and who had no intention of being employed in the securities industry in the future. That individual's interest in contesting the wording of the "report of investigation" was somewhat less than that of a respondent facing sanctions yet eager to remain in the industry. Unlike a Commission opinion in a contested case, the "report of investigation" was not drafted by the adjudicatory staff in the Office of the General Counsel, but rather, by the Division itself. Nonetheless, the Commission subsequently confirmed in Lysiak, 51 S.E.C. at 844 n.13, that the report of investigation in Gutfreund "properly states [its] opinion" on supervisory issues.

An additional question is whether Gutfreund's "report of investigation" was designed only to have prospective application--a warning shot across the bow, to inform legal and compliance officials without line responsibilities what level of supervisory care would be expected of them in the future--or whether it was also intended to govern conduct that occurred before its issuance. The Commission stated in Gutfreund that it was not changing the law with respect to the scope of a legal or compliance officer's duty to supervise. See 51 S.E.C. at 113 n.24 (emphasizing that the supervisory principle amplified in Gutfreund was consistent with Part VI of the concurring views expressed in Huff). In Lysiak, the Commission then applied Gutfreund to evaluate supervisory conduct by a part-time compliance officer for underlying violations that took place in a remote branch office in 1988-89. It is not clear how the Gutfreund standard might have been properly applied in that situation if a retroactive application of new law were truly at issue. However, the Commission's explanation, harmonizing Gutfreund with Part VI of the Huff concurrence, has not met with universal acceptance outside the agency.36

The Commission has not specifically addressed whether other aspects of the Huff concurrence, beyond Part VI, are consistent with Gutfreund. Part III of the Huff concurrence, on which Mr. Kolar relies, expresses the "power to control" in varying terms. At one point, it references the line manager's "power to hire or fire, and to reward or punish." 50 S.E.C. at 532 (emphasis added). Shortly thereafter, it identifies supervisors as presumptively those who have "the authority and the responsibility to hire and fire and reward and punish." Id. (emphasis added).37 In contrast, Lysiak, citing Gutfreund, states that the lack of authority to hire and fire is "far from dispositive." 51 S.E.C. at 844.

It is now settled that judicial decisions in civil cases, when issued by the Supreme Court and lower federal courts, are fully retroactive. Harper v. Virginia Dept. of Taxation, 509 U.S. 86, 96-97 (1993); Landgraf v. USI Film Products, 511 U.S. 244, 278 n.32 (1994); Crawford v. Falcon Drilling Co., 131 F.3d 1120, 1123-24 (5th Cir. 1998). However, the same is not true as to the adjudicatory decisions of administrative agencies. ARA Services, Inc. v. NLRB, 71 F.3d 129, 135 (4th Cir. 1995); Laborers Intl. Union of North America v. Foster Wheeler Energy, 26 F.3d 375, 386 n.8 (3d Cir. 1994). Respondent's brief leaves it to me to speculate how much (if any) the report of investigation in Gutfreund may have changed the Commission's prior jurisprudence on the scope of supervision, and whether the Commission intended such changes to apply retroactively. If adopted, Respondent's argument against the retroactive application of Gutfreund would essentially create a "grandfather" status for supervisory conduct occurring prior to December 1992. Such matters should not be decided in the abstract, and are more properly addressed to the Commission.

Neither Huff nor Gutfreund is on point here. Both decisions discussed situations in which individuals who were clearly not line managers could nevertheless be found to have supervisory responsibilities. It is inappropriate to twist that analysis here to hold that those who are obviously line supervisors--branch managers (Mr. Basile), metropolitan area managers (Mr. Kolar), and regional directors (Mr. O'Neil)--need not be deemed supervisors.

Using pre-Huff case law as a point of reference, Mr. Turner was subject to Mr. Kolar's control because Mr. Kolar was his second-level line supervisor. Using the Huff concurrence as a point of reference, Mr. Kolar had the authority to control Mr. Turner. Using the Gutfreund report of investigation as a point of reference, Mr. Kolar had significant ability to affect Mr. Turner's conduct. Mr. Kolar was the Detroit metropolitan area manager, with overall supervisory responsibility for the operation of four branch offices, including Troy, and their registered representatives, including Mr. Turner. His regular visits and telephone calls to these branch offices, along with his review of paper work and his contact with the registered representatives at the branches, confirms his own recognition of the breadth of his supervisory duties. He was considered a supervisor with a full range of authority, and not a mere messenger, by Mr. O'Neil. There is no ambiguity in Mr. O'Neil's testimony about the four Detroit area branch managers: "They reported to George . . . Period" (Tr. 445). Mr. Kolar was also recognized as a supervisor with full authority to control, by the Dean Witter staff. When Mr. Czerny asked for the name of an official "with some authority" to discuss his concerns about Dean Turner and LEF, he was referred to Respondent. Mr. Kolar participated in the decision to discipline Troy branch representatives, including Mr. Alito. He was simply not credible in minimizing his own supervisory role over all aspects of the four Detroit area branch offices. The fact that he could not hire, fire, reward, or discipline "on his own," but shared such responsibilities with other supervisors, is not dispositive. It has long been the Commission's view that a Respondent is not relieved of his supervisory obligations just because other officials at a registered broker-dealer firm share responsibility for supervising the firm's sales agents. Robert J. Check, 49 S.E.C. 1004, 1008 (1988). Likewise, the notion that an individual can successfully defend against failure to supervise liability on the grounds that the firm lacked clear lines of responsibility for its officers was discredited in Patrick v. SEC, 19 F.3d 66, 68 (2d Cir. 1994) (NYSE hearing panel conclusion to that effect reversed by NYSE Board of Directors).38 I therefore conclude that Mr. Turner was "subject to" Mr. Kolar's supervision from February 1992 through June 1995. Mr. Basile, the Troy branch office manager, was also "subject to" Mr. Kolar's supervision during this same period, as alleged in the OIP, I.A.

Kolar Failed Reasonably To Supervise Turner

Failure to supervise has been described as being inattentive to supervisory responsibilities, and failing to learn of improprieties when diligent application of supervisory procedures would have uncovered them. Amato, 45 S.E.C. at 286. "Red flags" and suggestions of irregularities demand inquiry as well as adequate follow-up and review. When indications of impropriety reach the attention of those in authority, they must act decisively to detect and prevent violations of the federal securities laws. Wedbush Sec., Inc., 48 S.E.C. 963, 967 (1988). At the same time, however, the Commission's prior decisions have been careful not to substitute the knowledge, gleaned with hindsight, of actual wrongdoing by someone under a supervisor's control for an assessment of whether the supervisor's conduct was proper under the circumstances. Instead, it has applied the standard that a manager must respond reasonably when confronted with indications of wrongdoing. James Harvey Thornton, 69 SEC Docket 49, 57-58 (Feb. 1, 1999) (concurring views of Commissioner Unger), appeal filed, 5th Cir., No. 99-60201. The ultimate issue is not whether Mr. Kolar was "a model supervisor," but whether his supervision was reasonable under all the attendant circumstances. Huff, 50 S.E.C. at 529 n.7.

I agree with the Division's expert, John Parkes, that the highly unusual and specific character of Mr. Czerny's "selling away" allegations to Mr. Kolar required a response that independently disproved and set aside the allegations or, in the alternative, found evidence that independently corroborated them. If immediate confirmation or refutation of the allegations was not possible, Mr. Kolar was obligated to continue to investigate (see Div. Ex. 71 at 6-8; Tr. 977, 984).

Respondent relies heavily on his review of Mr. Turner's income tax return as corroboration of Mr. Turner's statements at the August 18, 1992, meeting. His expert witness, Mr. Maine, opined that such an examination would be "really a deep strike . . . a very strong measure" (Tr. 907).39 The Division characterizes it as "the crown jewel of his defense" (Div. Reply Br. at 2).

Unfortunately, no one who testified, other than Messrs. Kolar and Basile, has ever seen this allegedly corroborative return. Mr. Kolar did not order that a photocopy be made. He did not even establish that he inquired if Mr. Turner objected to a copy being made. Mr. Kolar could not recall if the tax return he reviewed was signed by Mr. Turner and his wife, if a paid preparer had been involved, or if the attached Forms 1099 reflected outside income. To erode this defense further, the tax return that Mr. Kolar described in his testimony was quite different from the only tax return in the record--the return that was offered by David Disner, the certified public accountant who had prepared Mr. Turner's tax returns for a decade. Respondent is left with two possibilities, neither of which helps his case: (1) Mr. Turner was able to alter the tax return prepared by Mr. Disner in advance of his meeting with Mr. Kolar; or (2) the tax return Mr. Kolar reviewed reflected outside income, but Mr. Kolar simply missed it.40 If Mr. Kolar believed himself unqualified to review the tax return, or if he believed he needed additional time to conduct a proper review, he was obliged to inform Mr. O'Neil of such concerns in clear and unambiguous language.

Mr. Kolar never satisfactorily explained why he and his supervisory colleagues collectively decided to close down their investigation of Mr. Turner right after the August 18, 1992, interview, without pursuing several other avenues of independent corroboration that were readily available to them. These additional avenues could have been explored swiftly, inexpensively, and discretely. I have phrased each of the five items below as something that Mr. Kolar could have "ordered" Mr. Basile to do. I recognize that the defense characterizes Dean Witter's midwest region as a place where superiors did not give "orders" to subordinates, but rather, where managerial consensus was reached after discussion. Analyzing Respondent's duties in those terms, Mr. Kolar's supervision was deficient because he failed to tell Mr. O'Neil and Mr. Basile that he considered these follow-up steps important in verifying Mr. Turner's statements of August 18, 1992, and that meaningful consensus could be not reached in the absence of such corroboration.

First, Mr. Turner admitted to Messrs. Kolar and Basile that he was an active investor in LEF notes. Mr. Kolar never directed Mr. Basile to retrieve Mr. Turner's annual disclosure reports of outside activities, so that Mr. Turner's verbal admission could be compared with his prior written disclosure to the firm. Such a review would have shown that Mr. Turner's investment in LEF notes had not been properly disclosed (Resp. Ex. 4-4), and would have been grounds for a second interview, at the least.

Second, Mr. Kolar's day timer note recorded Mr. Czerny's tip that NBF was "SEC registered" as LEF. Although the notes were securities and should have been registered, Mr. Kolar never communicated with the Commission, or required Mr. Basile to do so. Contact with the Commission would have disclosed that LEF notes were not registered securities (Div. Exs. 65-33, 66-34). That, in turn, would have alerted Mr. Kolar to the fact that Mr. Turner and at least three Dean Witter customers were investing in unregistered securities. That information also would have warranted further inquiry.

Third, Mr. Kolar did not order an interview of Roz Suwinski, Mr. Turner's sales assistant, who had numerous contacts with LEF personnel. Mr. Kolar explained that Mr. O'Neil never explicitly told him to conduct such an interview and that, once the Turner interview was completed, it would have been up to Mr. Basile to interview Ms. Suwinski (Tr. 799-800). Properly understood, Mr. O'Neil's instructions were simply for Mr. Kolar to get to the bottom of the Czerny allegations. Respondent cannot properly wash his hands of that responsibility by arguing that Mr. O'Neil never commanded him as to each step that was required to be taken along the way. Respondent's expert, John Maine, suggested that such an interview would have been bad for branch office morale, because "word will get around" and "major producers would depart" (Tr. 891-92). This suggestion is rejected. While sales assistants initially may be uncomfortable discussing the activities of the registered representatives they work with, tactful managers can obtain cooperation by emphasizing that the sales assistants work for the firm, not the individual representative.

Fourth, Mr. Kolar could have required Mr. Basile to commence an examination of the Troy branch's books and records. Although Respondent's note of his conversation with Mr. Czerny identified three of Mr. Turner's customers by name, there is no credible evidence that Mr. Kolar shared those names with Mr. O'Neil or Mr. Basile. It would have been a relatively simple matter for Mr. Kolar to instruct Mr. Basile to pull the three customers' files for a detailed review of the correspondence, and the frequency of fund transfers to and from NBF or LEF. The same type of examination should have been undertaken as to NBF's own account at the Troy branch. Once the firm's books and records had confirmed or contradicted what Mr. Turner had told Mr. Kolar at the interview, an informed decision could have been made whether to contact the three customers in writing or by telephone. Even Mr. Maine conceded that a broker-dealer firm has a right to contact customers about matters appearing on its own books and records (Tr. 899).

Finally, nothing prevented Mr. Kolar from re-contacting Mr. Czerny for clarification of any discrepancies after the August 18, 1992, interview of Mr. Turner.

Kolar Does Not Qualify For The "Safe Harbor" Of Section 15(b)(4)(E)

Section 15(b)(4)(E) of the Exchange Act provides in part that no person may be deemed to have failed reasonably to supervise any other person if:

(i) there have been established procedures, and a system for applying such procedures, which would reasonably be expected to prevent and detect, insofar as practicable, any such violation by such other person, and

(ii) such person has reasonably discharged the duties and obligations incumbent upon him by reason of such procedures and system without reasonable cause to believe that such procedures and system were not being complied with.

Respondent argues that Dean Witter had established procedures for preventing and detecting Mr. Turner's "selling away" and the violations of the federal securities laws at issue here. Those procedures included educating registered representatives, reviewing their incoming and outgoing mail, sending customers trade confirmations and monthly statements of transactions done through the firm, and requiring registered representatives periodically to fill out questionnaires disclosing any outside activities (Div. Ex. 63-21; Resp. Ex. 14 at 6-8). The Division's expert witness acknowledged that these Dean Witter procedures were among the most prominent procedures that would detect "selling away" activity, and were in accordance with the industry standard at the time (Tr. 952-54). Dean Witter is not a party to this proceeding. Under the circumstances, the Division does not challenge the adequacy of Dean Witter's supervisory procedures (Div. Reply Br. at 17 n.23).

Mr. Kolar also contends that he had no supervisory duties or obligations with respect to the above-described procedures, as they related to Mr. Turner, and that all such responsibilities belonged to Mr. Basile. He maintains that he did not have reasonable cause to believe that there was a lack of compliance with Dean Witter's procedures and systems at the Troy branch office, or to believe that Mr. Basile was not discharging his compliance obligations at Troy (Resp. Br. at 31-32). The Division strongly disagrees with this contention.

Certainly, the branch office manager in a large firm is the first line of defense against misconduct by a registered representative, as the Dean Witter Branch Manager's Manual makes clear (Div. Ex. 63-21). However, there is a wide range of supervisory issues and problems on which the branch manager consults with his regional director, and/or the firm's compliance or law departments. The case law makes clear that such line and staff officials have supervisory obligations, as well. La Jolla Capital Corporation, 70 SEC Docket 1101, 1109 & n.21 (Aug. 18, 1999). The Manual in evidence assumes that there was no middle-level line manager between the branch manager and the regional director. This is consistent with the testimony that the focus market initiative, which created a metropolitan area manager, was new to Dean Witter when Mr. Kolar assumed his position in February 1992. The lack of mention of such an intermediate supervisor in the Manual suggests only that the Manual had not been updated. It is not proof that Mr. Kolar had no supervisory duties or obligations under the Dean Witter system. Respondent's own testimony establishes that he had at least "occasional" compliance discussions with the four branch managers who reported to him (Tr. 753). The remainder of the record supports a finding that he had a full range of compliance oversight responsibilities at the Troy branch. His failure reasonably to discharge such duties and obligations with respect to overseeing Mr. Basile precludes his reliance on the "safe harbor" defense here.41

SANCTIONS

Sections 15(b) and 19(h) of the Exchange Act empower the Commission to impose administrative sanctions against a person associated with, respectively, a broker-dealer and a member of a self regulatory organization. Specifically, the Commission may censure, place limitations on the activities or functions of such a person, suspend him for a period not exceeding twelve months, or bar such a person from being associated with a broker or dealer if the Commission finds that, on the record after notice and opportunity for hearing, that such censure, placing of limitations, suspension, or bar is in the public interest.

The public interest analysis requires that several factors be considered, including: (1) the egregiousness of the respondent's actions; (2) the isolated or recurrent nature of the infraction; (3) the degree of scienter involved; (4) the sincerity of the respondent's assurances against future violations; (5) the respondent's recognition of the wrongful nature of his conduct; and (6) the likelihood that his 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 severity of sanctions depends on the facts of each case and the value of the sanctions in preventing a recurrence of the violative conduct. Berko v. SEC, 316 F.2d 137, 141 (2d Cir. 1963). Sanctions should demonstrate to the particular respondent, the industry, and the public generally that egregious conduct will elicit a harsh response. Arthur Lipper, 547 F.2d at 184. Sanctions are not intended to punish a respondent, but to protect the public from future harm. Leo Glassman, 46 S.E.C. 209, 211-12 (1975).

Despite personal knowledge of a "red flag" communicated to him by Mr. Czerny, Respondent did far less than his supervisory position demanded of him. As a result, the offer and sale of unregistered securities by his subordinate, Dean Turner, continued for another three years. It evolved into a "Ponzi" scheme and the investing public eventually lost $10-14 million. Reasonable supervision by Mr. Kolar could have nipped Mr. Turner's misconduct in the bud in August 1992. Had he followed up on that "red flag" at any time during his supervision of Mr. Turner through June 1995, he could have discovered the ongoing misconduct. Mr. Kolar has not provided any assurances against future supervisory violations. He refuses to recognize that his supervisory conduct was deficient. Since he now supervises four Dean Witter offices in Cleveland, Ohio, opportunities for future supervisory failures exist.

Respondent argues that he did not act intentionally to further Mr. Malek's or Mr. Turner's underlying misconduct, and did not profit from their scheme. This is true, but irrelevant. Had he done so, he would have been charged not only as a deficient supervisor, but also as a principal, or perhaps an aider and abettor.

Respondent also claims that any suspension at all would end his management career in the securities industry (Resp. Br. at 2, 44; Tr. 849-50; see also Tr. 906-08). The import of this argument is unclear. If it is intended to suggest that the Commission need not take any remedial action because the industry will respond sufficiently on its own, such speculation finds no record support. If it is intended to request that I impose only token sanctions unless I am "really, really sure" about Respondent's liability, it appears to suggest that the Division must prove its case by something more than a preponderance of the evidence. That suggestion is also rejected. Moreover, this argument ignores the fact that the Commission's imposition of a supervisory suspension did not end the career of Mr. Basile. While he is no longer a manager in Dean Witter's broker-dealer subsidiary, Mr. Basile is still employed by the firm's mutual fund division, and he still identifies himself as a manager (Tr. 209). If Mr. Basile has missed a single pay check since being removed as Troy branch office manager in February 1996, there is no evidence of it on this record. As long as Dean Witter faces financial exposure to customer claims arising out of the LEF matter, and as long as it needs Mr. Kolar's and Mr. Basile's cooperation to defend against such claims, it is reasonable to anticipate that the firm will not be too provocative in its treatment of either individual.

Nonetheless, I agree with Respondent that he should not face the full measure of sanctions sought by the Division. Apart from his involvement in this proceeding, Mr. Kolar has enjoyed a lengthy tenure in the industry, free from discipline or customer complaint. The Division's expert witness acknowledged that this case was "very unique." In addition, Mr. Turner stands convicted of lying to Dean Witter about his involvement in LEF.

Taking all these factors into consideration, I conclude that Mr. Kolar should be suspended from acting in a supervisory capacity with a registered broker or dealer for a term of six months.

I further conclude that it is not appropriate to suspend Mr. Kolar from association with a broker or dealer in a non-supervisory capacity. The record shows that he has done very little as a non-supervisory registered representative since 1984. For fifteen years, he has been a full-time manager. He has not earned commission income. He has no more than twelve customers, all of whom have been with him since the early 1980s. His shortcomings in this proceeding were wholly supervisory.

Under Section 21B(a) of the Exchange Act, the Commission may assess a civil monetary penalty against a person in a proceeding instituted pursuant to Section 15(b)(6) of the Exchange Act. As here relevant, the Commission must find that such a person has failed reasonably to supervise within the meaning of Section 15(b)(4)(E) of the Exchange Act. It must also find that such a penalty is in the public interest, see Section 21B(c) of the Exchange Act. In its discretion, the Commission may consider evidence of the Respondent's ability to pay, see Section 21B(d) of the Exchange Act.

Section 21B(b) of the Exchange Act specifies a three-tier system identifying the maximum amount of a penalty. For each "act or omission" by a natural person, the maximum amount of a penalty in the first tier is $5,000; in the second tier, it is $50,000; in the third tier, it is $100,000. As here relevant, a second-tier penalty must have "involved fraud," while a third-tier penalty must have not only "involved fraud," but also must have "directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons."

Assuming, without deciding, that Mr. Kolar's failure to supervise constitutes a single "act or omission," I conclude that it "involved fraud"--specifically, fraud committed by non-party Dean Turner--and that a tier-two penalty is allowable under Section 21B(b)(2). See Consolidated Inv. Serv., 52 S.E.C. at 590 ("applicants' failures allowed and were responsible, in part, for the success and duration of [the non-party registered representative's underlying] fraudulent misconduct. We thus conclude that their activities involved fraud and that a second-tier civil penalty is appropriate"). Because the Division seeks only a $20,000 penalty against Mr. Kolar, it is unnecessary to decide whether a tier-three penalty might also be allowable on the present record.

At first glance, the guidance provided by Consolidated is at odds with the Commission's subsequent opinion in Thornton, 69 SEC Docket at 57. Thornton also involved findings of failure to supervise by a registered broker-dealer firm and its president, and the underlying misconduct also involved fraud by a non-party registered representative. The Commission nonetheless imposed only first-tier civil penalties against each respondent. The underlying fraud in Consolidated lasted far longer than the fraud in Thornton (five years versus four months). In addition, care must be taken to distinguish between the maximum permissible penalty--an issue under Section 21B(b)--and the "appropriate" penalty in the facts and circumstances of a given case. I read Thornton as addressing only the latter issue, not the former. I do not understand it to overturn the analysis in Consolidated.

Based on the public interest discussion above, including the underlying sale of unregistered securities and fraud, the harm to Dean Witter customers, and Mr. Kolar's otherwise clean record, I conclude that a civil penalty of $20,000 is appropriate. There is no issue as to Mr. Kolar's ability to pay.42

RECORD CERTIFICATION

Pursuant to Rule 351(b) of the Commission's Rules of Practice, I certify that the record includes the items set forth in the record index issued by the Secretary of the Commission on October 8, 1999, as amended on October 26, 1999.

ORDER

Based on the findings and conclusions set forth above, and pursuant to Sections 15(b), 19(h), and 21B of the Exchange Act, I order that Respondent George J. Kolar be suspended from acting in a supervisory capacity with a registered broker or dealer for six months and that he pay a civil penalty of $20,000.

Payment of the civil penalty shall be made on the first day following the day this initial decision becomes final. Payment shall be made by certified check, United States Postal money order, bank cashier's check, or bank money order, payable to the Securities and Exchange Commission. The check, and a cover letter identifying the Respondent and the proceeding designation, should be delivered to the Office of the Secretary, Securities and Exchange Commission, 450 Fifth St., N.W., Washington, D.C. 20549. A copy of the cover letter should be sent to the Commission's Division of Enforcement.

This order shall become effective in accordance with and subject to the provisions of Rule 360 of the Commission's Rules of Practice. Pursuant to that Rule, a petition for review of this initial decision may be filed within twenty-one days after service of the initial 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 twenty-one days after service of the initial decision upon that party, unless the Commission, pursuant to Rule 360(b)(1), determines on its own initiative to review this initial decision as to that party. If a party timely files a petition for review, or the Commission acts to review on its own motion, the initial decision shall not become final as to that party.

_______________________________

James T. Kelly
Administrative Law Judge

 


Footnotes

1 Citations to the prehearing transcript, transcript, and to exhibits offered by the Division and by Respondent, will be noted as "PH Tr. ___," "Tr. ___," "Div. Ex. ___," and "Resp. Ex. ___," respectively. I have not considered the testimony of Division witness Scott Hlavacek (Tr. 297-340) or the four exhibits he sponsored (Div. Exs. 23-7, 24-6, 25-8, 26-9), because the Division withdrew them (see Tr. 409-17). The Division also withdrew its Exhibits 9-25 (Tr. 81-85) and 34-12 (Tr. 500-03).

2 Citations to the posthearing pleadings will be noted as "Div. Br. ___," "Div. Prop. Find. ___," Resp. Br. ___," "Resp. Prop. Find. ___," and "Div. Reply Br. ___," respectively.

3 When a registered representative receives selling compensation from a third party for a securities transaction done outside of the firm at which the registered representative is employed, the practice is called "selling away" (Div. Ex. 71 at 4-5; Resp. Ex. 14 at 4-6). "Selling away" violates the rules of various self-regulatory organizations; the issue to be considered here is whether it independently violates any provision of the Securities Act or the Exchange Act.

4 A "Ponzi" scheme is one in which returns are paid to initial investors from funds supplied by later investors, rather than from the profits of the underlying venture. See United States v. Cook, 573 F.2d 281, 282 n.3 (5th Cir. 1978). It is named after the Boston swindler who was convicted, imprisoned, and later deported to Italy, where he found new employment in Mussolini's finance ministry. See United States v. Masden, 170 F.3d 790, 797 n.9 (7th Cir. 1994).

5 Prehearing Conference of May 14, 1999, PH Tr. 8-10; Div. Prop. Find. at 17.

6 Orders of April 27, 1998, and June 2, 1998.

7 U.S. Attorney's Motion of July 6, 1998, 3, 4; Order of July 13, 1998. This Order predated the December 14, 1998, effective date of Rule 210(c)(3), but it was fully consistent with the spirit of that Rule. As a result, the Division's witnesses in the administrative proceeding faced impeachment by Respondent Kolar, based on their testimony in the Turner criminal trial.

8 U.S. Attorney's Motions of Sept. 3, 1998, and Dec. 11, 1998; Orders of Sept. 14, 1998, and Feb. 4, 1999. By letter of April 15, 1999, the U.S. Attorney predicted that the criminal trial would last three to four weeks and should end prior to the scheduled commencement of the administrative hearing.

9 Prehearing Conference of June 7, 1999, PH Tr. 3-18. Chief Judge Murray had also denied Mr. Kolar's request for a postponement tied to Mr. Turner's expected invocation of the Fifth Amendment. See Order of May 21, 1998.

10 Witness Malek testified in the Turner criminal trial on May 10; witness Reed testified on May 11; witnesses Cracchiolo, Abbott, and Bacon testified on May 12-13; witness Czerny testified on May 17; and witnesses Eder and Basile testified on May 18. See Tr. 87, 138, 207, 208-09, 404, 530, 602, 725. Mr. Kolar had an opportunity to observe these witnesses at the criminal trial and to review the transcripts of their testimony thereafter.

11 Mr. Kolar emphasized that he did not hire, fire, or discipline Detroit-area brokers "on his own." This is correct, as the evidence shows that such decisions were collegial. Mr. Kolar also minimized his role in such joint decisions (Tr. 754-62). This aspect of his testimony is rejected on credibility grounds, discussed below.

12 Most of Mr. Turner's professional career was spent in the minor leagues; he played in thirty-five games over four years in the National Hockey League. J. Naughton, Rangers Trade Four for Beck, Rockies' Star Defenseman, N.Y. Times, Nov. 3, 1979, at 15; The Hockey Encyclopedia 370 (Stan Fischler and Shirley Walton Fischler, eds., 1983).

13 This assessment is supported by the IRS Form 1040 for calendar year 1991, prepared by Mr. Turner's accountant (Div. Ex. 64-30A). Item 7, schedule #1, of the return shows gross wages of $46,713 paid to Mr. Turner by Dean Witter in 1991.

14 The OIP, I.C, alleges that "beginning in or about 1990" LEF operated as a "Ponzi" scheme in which part of the proceeds from the sale of new LEF notes were used to make principal and interest payments to LEF's earlier investors. There is no question that LEF ended up as a "Ponzi" scheme, from at least 1993 through 1995 (see Tr. 504-06; Div. Ex. 68-32). Michael Czerny's testimony about engineering a one-customer-for-five-customers "trade off" demonstrates that LEF was a "Ponzi" scheme in late 1992, as well (Tr. 722-26). However, the weight of the evidence does not sustain the "Ponzi" scheme charge as to LEF before August 18, 1992.

15 The OIP, I.D, alleges that Mr. Turner offered and sold "at least" 161 LEF notes to investors, and that his investors lost at least $10 million. The principal support for these figures was to be the testimony and exhibits of Scott Hlavacek, which were withdrawn by the Division. See note 1, supra. The remaining evidence on this issue is quite soft, and I have little confidence in it. Div. Exs. 27-16 and 31-14 are not reliable insofar as they seek to attribute sales of specific LEF notes to Mr. Turner. The record shows that Mr. Turner bought many such notes himself (Tr. 538-40, 550, 552). As for third party note holders, some dealt directly with Mr. Malek on their subsequent transactions, after an introductory sale by Mr. Turner (Tr. 365-68, 536). The exhibits erroneously attribute all such sales to Mr. Turner.

16 See Div. Prop. Find. at Appendices A, B, and C. The OIP, I.H.5, alleges that "from in or about 1992" through 1995, Mr. Turner failed to disclose to investors in LEF notes that Mr. Malek was using the funds raised from new LEF investors to pay previous note purchasers. The weight of the evidence does not show that Mr. Turner knew or should have known that LEF was operating as a "Ponzi" scheme before 1993 (Tr. 377, 512-19, 542, 545-48, 550). I decline to draw an inference of such early knowledge on his part.

17 Mr. Czerny said these events occurred in the Summer of 1991 (Tr. 675, 678, 691). This is at odds with other testimony and documentary evidence that puts them in the Summer of 1992. The latter year is accepted as the correct one. I do not find that Mr. Czerny was lying, but simply that he was mistaken. Mr. Czerny's shakiness about dates precludes reliance on his testimony to establish the existence of a "Ponzi" scheme before late 1992. See notes 14 and 16, supra.

18 I reject as incredible the self-serving testimony of Messrs. Kolar and Basile that Mr. O'Neil "set forth the ground rules" for the interview and "told us . . . the questions that we should ask" (Tr. 288, 811).

19 There are no written records to memorialize Mr. O'Neil's communications with Dean Witter's Law Department, and Mr. O'Neil could not identify the attorney with whom he spoke (Tr. 476-78, 480-81).

20 The tax return in question is a copy from Mr. Disner's files. It is not signed by Dean Turner or his wife. It identifies Kaufman & Disner, P.C., as the paid preparers, but it is not signed by Mr. Disner, either. Mr. Disner characterized the return as "fairly complicated" and opined that Mr. Turner was "probably not able to prepare it himself" (Tr. 824).

Respondent argues that there is no proof that the return provided by Mr. Disner is the income tax return that Mr. Turner and his wife actually filed with the IRS for 1991 (Tr. 824-25). Respondent intimates that the return provided by Mr. Disner at the hearing is not the one that Dean Turner showed him on August 18, 1992 (Tr. 841-43).

21 I have given no weight to state court litigation brought against Mr. Czerny by Dr. Robert J. Galacz in 1994 (Resp. Ex. 10-19), as Respondent failed to show that the matter was resolved adversely to Mr. Czerny. In fact, that proceeding was removed to federal court and eventually dismissed with prejudice. Galacz v. CIGNA Securities, Inc., 1995 U.S. Dist. LEXIS 1863 (N.D. Ill. 1995).

22 Although sometimes challenged as controlling the "creation" of discoverable material, this practice is perfectly permissible. United States v. Lieberman, 608 F.2d 889, 897 (1st Cir. 1979) (no duty to create Jencks Act material by recording everything a potential witness says).

23 Respondent could hardly argue otherwise, because Mr. Czerny's charges turned out to be substantially correct. In reaching this determination, I have considered Mr. Kolar's sole post-meeting reference to Mr. Czerny's credibility (Tr. 790). Fairly read, that passage suggests only Mr. Kolar's post-meeting conclusion that the allegations made by Mr. Czerny lacked merit.

Based on the testimony of Messrs. Kolar and Basile, one would infer that, during an acrimonious two to three hour meeting, Mr. Turner never asked about or learned the identity of his accuser, never mentioned the incident several months earlier when he had charged Mr. Czerny with stealing his customers, and never suggested that Mr. Czerny might have been motivated by spite and seeking his revenge.

If one accepts Mr. Kolar's testimony that Mr. O'Neil did not know Mr. Czerny (Tr. 767), one would infer that Mr. O'Neil had no reason to recall the earlier episode in which an unidentified Dean Witter regional vice president in Chicago had transmitted Mr. Turner's complaints about Mr. Czerny to CIGNA. Dean Witter's three supervisors may well have taken the high road and avoided ad hominem reaction to Mr. Czerny's allegations (viz., "consider the source"). However, there is a whiff of implausibility about their accounts.

24 Given the very high expectations at Dean Witter when Mr. Turner was hired in 1990 (Resp. Ex. 4-4), and given Mr. Kolar's client development/marketing mission in the Detroit focus market, one would expect that Mr. Kolar would have given his special attention to an under-producing registered representative whose many hours on the golf links (see Tr. 33, 92, 620) were not generating proportionate rewards for Dean Witter. In addition, low commission income is itself indicative of possible "selling away." In such circumstances, Mr. Kolar's forbearance for Mr. Turner's modest productivity is striking.

25 See In re Lee, 186 B.R. 539, 540; 1995 U.S. Dist. LEXIS 13231 (S.D. Fla. 1995) ("The U.S. Tax Courts have consistently held that an unsigned tax return is no return at all, because an unsigned tax return would be insufficient to support a perjury charge based on a false return") (collecting cases).

26 See OIP, I.P and I.Q and note 3, supra. Both expert witnesses identified National Association of Securities Dealers (NASD) Rules 3030 and 3040 and New York Stock Exchange Rule 346 as relevant.

27 Tr. 971; Div. Br. at 19. That the NASD "deems" transactions by registered representatives, concealed from their employers, "fraudulent," is not dispositive, absent proof of all the elements of a fraud violation under the securities laws. Cf. Anthony J. Amato, 45 S.E.C. 282, 284 (1973).

28 When analyzing the "securities" status of the notes, I have looked at what the notes would have been but for the fraud. Singer v. Livoti, 741 F. Supp. 1040, 1050 (S.D.N.Y. 1990); Prochaska & Assoc. v. Merrill Lynch, 798 F. Supp. 1427, 1430 n.2 (D. Neb. 1992).

29 Such exemptions are construed strictly against the claimant. Quinn & Co. v. SEC, 452 F.2d 943, 945-46 (10th Cir. 1971). Moreover, as the Division points out, the applicability of a Section 4(2) exemption turns on whether the particular class of persons affected needs the protection of the Securities Act. Whether investors need the protection of registration depends on whether they had access to the type of information that registration provides. Doran v. Petroleum Management Corp., 545 F.2d 893, 899-904 (5th Cir. 1977). LEF note holders had no access to LEF's financial statements or other registration or equivalent information. In these circumstances, the "private offering" exemption was not available.

30 In addition, both arguments lack merit. Such exemptions are construed narrowly. SEC v. Blazon Corp., 609 F.2d 960, 968 (9th Cir. 1979); Pharo v. Smith, 621 F.2d 656, 665 n.3 (5th Cir. 1980); Van Dyke v. Coburn Ent., 873 F.2d 1094, 1097 (8th Cir. 1989). A broker or dealer cannot qualify for the "exclusively intrastate" exemption from registration under Section 15(a)(1) if he sells the securities of an entity that does business in another state. See Professional Investors, Inc., 37 S.E.C. 173, 175-76 (1956); Peoples Securities Co., 39 S.E.C. 641, 652-53 (1960); Eugene T. Ichinose, Jr., 47 S.E.C. 393, 397 (1980).

The LEF note that Mr. Turner sold to one investor assigned to that investor an equipment lease with Nova Enterprises, Inc., a corporation domiciled in Washington State. The leased equipment was located in Las Vegas, Nevada. (Div. Ex. 1-5A). The LEF note that Mr. Turner sold to another investor assigned to that investor, through NBF Cable, the right to provide satellite and/or cable television programs to residents of a Hollywood, Florida, condominium owned by Sea Air Towers, Ltd. Disputes under the agreement were to be resolved under the laws of the State of Florida, and the venue of any litigation was to be in Broward County, Florida (Div. Ex. 61-42). Finally, Mr. Turner was actively involved in the resale to Michigan residents of LEF notes held by a Pennsylvania bank. Mr. Turner's activities were not shown to be "exclusively intrastate."

Respondent also argues that Mr. Turner was exempt from registration as a broker or dealer in his individual capacity because he was already associated with Dean Witter. He contends that Mr. Turner was acting within the scope of his employment at Dean Witter when selling LEF notes. In contrast, the Division maintains that Mr. Turner was acting outside the scope of his association with Dean Witter. See OIP I.M; Div. Br. at 10-11; Resp. Br. at 40-41; Div. Reply Br. at 25-26.

The exemption for natural persons associated with a broker or dealer is not available where the securities transactions conducted by an associated person are not within the scope of his employment at the registered firm or where the registered broker or dealer is unaware of the associated person's involvement in the transactions. Gordon Wesley Sodorff, Jr., 50 S.E.C. 1249, 1255 n.19 (1992); Charles A. Roth, 50 S.E.C. 1147, 1152 (1992), aff'd, 22 F.3d 1108 (D.C. Cir. 1994). "Selling away" is, by its very nature, beyond the scope of a registered representative's employment and Mr. Turner's sale of LEF notes cannot be said to be in furtherance of his agency with Dean Witter.

31 The Commission has not generally been hospitable to claims that statements made by a registered representative in the course of customer solicitation are "mere puffery." Cortlandt Investing Corp., 44 S.E.C. 45, 50 & n.9 (1969) (collecting cases); John R. Brick, 46 S.E.C. 43, 52 n.23 (1975). Respondent relies on several more recent pronouncements by the Courts of Appeals, holding that "puffery"--statements on which no reasonable investor would rely--is not actionable fraud. See, e.g., Howard v. Haddad, 962 F.2d 328, 331 (4th Cir. 1992); Raab v. General Physics Corp., 4 F.3d 286, 289-90 (4th Cir. 1993); Continental Bank, N.A. v. Meyer, 10 F.3d 1293, 1299 (7th Cir. 1993); San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Co., 75 F.3d 801, 811 (2d Cir. 1996). The Commission considers such cases "extreme." Safe Harbor for Forward Looking Statements, 57 SEC Docket 2292, 2297 & n.61 (Oct. 19, 1994).

32 Mr. Huff was senior registered options principal in the New York compliance department of a nationwide broker-dealer. The misconduct at issue took place in the firm's Miami, Florida, branch office. Two Commissioners found that Mr. Huff had exercised reasonable supervision; two other Commissioners found that the registered representative who committed the underlying violations was not subject to Mr. Huff's supervision.

33 Mr. Trujillo was an assistant to a branch office manager, responsible for administrative and compliance matters. The Commission assumed that he was a supervisor, but ruled that his attempts to discipline a registered representative, despite the opposition of the branch manager, constituted reasonable supervision.

34 Steven P. Sanders, 68 SEC Docket 982, 997 n.30 (Oct. 26, 1998); James J. Pasztor, 1999 SEC LEXIS 2193, at *19 n.27 (Oct. 14, 1999).

35 As the Commission explained in Gutfreund: "[W]e believe this is an appropriate opportunity to amplify our views on the supervisory responsibilities of legal and compliance officers . . . ." 51 S.E.C. at 112-13.

36 See Lewis D. Lowenfels and Alan R. Bromberg, Broker-Dealer Supervision: A Troublesome Area, 25 Seton Hall L. Rev. 527, 541-57 (1994). "It seems at best unclear how to reconcile the `authority . . . to control' language of the concurring opinion in Huff with the `requisite degree of responsibility, ability or authority to affect the conduct of the employee' language of Gutfreund." Id. at 551. The authors conclude that Gutfreund is somewhat broader than prior Commission cases. Id. at 551 n.61.

37 Other regulatory schemes are not nearly so demanding. For example, the National Labor Relations Act (NLRA), which excludes supervisors from the protections of collective bargaining, defines a "supervisor" as one who exercises authority in any one of twelve listed areas, who exercises that authority in the interest of the employer, and who uses independent judgment. See Section 2(11) of the NLRA, 29 U.S.C. 152(11). If the individual can hire, transfer, suspend, lay off, recall, promote, discharge, assign, reward or discipline other employees or responsibly direct them or adjust their grievances or effectively recommend such actions, he is deemed a supervisor. The "effective recommendation" language of the NLRA's supervisory definition is particularly relevant to Mr. Kolar's defense here. See Caremore, Inc. v. NLRB, 129 F.3d 365, 369-70 (6th Cir. 1997).

38 I have considered the dictum in the concurring views in Huff, 50 S.E.C. at 535 n.14, suggesting that, if a broker-dealer firm fails clearly to assign supervisory authority and responsibility to specific individuals, then "theoretically" no individual in such a circumstance could be charged with a failure to supervise, although the firm itself would have committed such a violation. However, Mr. Kolar has not defended on the grounds that he should be absolved of liability because Dean Witter and/or Mr. O'Neil are liable.

39 Mr. Maine never saw Dean Turner's tax return; he relied on Mr. Kolar's statement that Mr. Kolar saw it (Tr. 930-31).

40 Cf. Republic Bank v. Fineberg (In re Fineberg), 1992 Bankr. LEXIS 1982 (U.S. Bankr. Ct., E.D. Pa. 1992) (criticizing a bank creditor for presenting "a weak case" when it failed to verify the accuracy of the debtor's unsigned tax return from independent sources).

41 Such a holding does not conflict with the views expressed by two Commissioners in Huff, 50 S.E.C. at 529, that deficient supervision by a subordinate is not a "violation" on the basis of which the subordinate's supervisor can be disciplined. Compare OIP I.A and I.P. Rather, it is used here as grounds for rejecting Mr. Kolar's affirmative defense that he reasonably discharged the duties and obligations incumbent on him by reason of Dean Witter's procedures and systems. A Commission opinion issued after Huff has implicitly recognized this distinction. Cf. Consolidated Inv. Serv., Inc., 52 S.E.C. 582, 589-90 (1996).

42 Prehearing Conference of May 18, 1999, PH Tr. 10-11.

http://www.sec.gov/litigation/aljdec/id152jtk.htm


Modified:11/01/1999