Initial Decision of an SEC
Administrative Law Judge
In the Matter of
George J. Kolar
INITIAL DECISION RELEASE NO. 152
FILE NO. 3-9570
UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
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
BEFORE: James T. Kelly, Administrative Law Judge
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
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 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
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
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
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
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.
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,
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 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.
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,
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,
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,
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.
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.
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.
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
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,
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
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
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
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
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,
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
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
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
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.
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
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
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
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
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.
Finally, nothing prevented Mr. Kolar from re-contacting Mr. Czerny for
clarification of any discrepancies after the August 18, 1992, interview of Mr.
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
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,
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
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
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
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.
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
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
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
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,
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,
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
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
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
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
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.
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
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
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
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.