Initial Decision of an SEC Administrative Law Judge
In the Matter of
In the Matter of
Euro-Atlantic Securities, Inc.
February 25, 2000
|APPEARANCES:|| Christian R. Bartholomew for the Division of Enforcement,
Securities and Exchange Commission
|Erwin Cohn for Respondent Brian A. Schmidt|
| Respondents William Avent, John A. Dilworth II, and Darlan E.|
Gordon appeared pro se
|BEFORE:||Robert G. Mahony, Administrative Law Judge|
The Securities and Exchange Commission (Commission) instituted public administrative and cease-and-desist proceedings pursuant to Section 8A of the Securities Act of 1933 (Securities Act), and Sections 15(b) and 21C of the Securities Exchange Act of 1934 (Exchange Act) in this matter on September 10, 1997. The Order Instituting Public Administrative Proceedings (OIP) alleges that from about February 1995 through about October 1995, the above named Respondents violated several federal securities laws.
Respondents William Avent (Avent), John A. Dilworth II (Dilworth), Darlan E. Gordon (Gordon), and Brian A. Schmidt (Schmidt) allegedly violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder (antifraud provisions), in that they contributed, by way of material omissions, misstatements, and other acts, to a fraudulent scheme or device involving a purported lease of U.S. Treasury Bills (T-Bills) and a related "high yield trading program." (OIP ¶¶ II.F - II.G.) Respondent John T. Madden (Madden) allegedly failed reasonably to supervise Schmidt within the meaning of Section 15(b)(6) of the Exchange Act, in that Madden failed adequately to perform delegated supervisory procedures and failed reasonably to respond to indications of wrongdoing by Schmidt.1 (OIP ¶ II.H.) Respondent Euro-Atlantic Securities, Inc. (Euro-Atlantic) allegedly failed reasonably to supervise Schmidt within the meaning of Section 15(b)(4)(E) of the Exchange Act, in that it failed to have in place written supervisory procedures for registered representatives who shared accounts with branch managers and it failed reasonably to respond to indications of wrongdoing by Schmidt. (OIP ¶ II.I.)
A hearing was held on June 2, 3, 4, 5, and 9, 1998, in Chicago, Illinois. Respondents Dilworth, Gordon, and Schmidt have filed posthearing briefs. The Division of Enforcement (Division) has filed a posthearing brief and a reply brief.2
II. FINDINGS OF FACT
My findings and conclusions are based upon the record and my observation of the witnesses that testified at the hearing, the arguments and proposals of fact and law, and the relevant statutes and regulations. I applied preponderance of the evidence as the applicable standard of proof. See Steadman v. SEC, 450 U.S. 91 (1981). I have considered all contentions of the parties, and accept those that are consistent with this decision.
1. Respondent Euro-Atlantic Securities, Inc.
Euro-Atlantic, based in Boca Raton, Florida, has been registered with the Commission as a broker-dealer since 1987. Respondent Madden was the branch manager of the Chicago office of Euro-Atlantic for most of the time period in question. Respondent Schmidt was a registered representative with the Chicago office for the time period in question.
2. Respondent John T. Madden
Madden has an undergraduate degree in accounting from Florida State University. After graduation, he became a tax auditor for the state of Florida. (Tr. 280.)3 He passed the Series 7 exam in 1987 and joined J.W. Gant, a registered broker-dealer. After J.W. Gant went out of business in 1991, Madden joined Euro-Atlantic.
In March 1995, Madden became the Series 24 principal and branch manager of the Chicago office of Euro-Atlantic. (Tr. 282.) After assuming these new duties, Madden was concerned that he would not be able to adequately service his clients. He approached Schmidt, and they agreed to pool a portion of their clients under a joint representation and share commissions on these clients. Schmidt performed the routine servicing of these clients, freeing Madden to perform his management duties. Madden chose Schmidt because Schmidt was the senior broker in the Chicago office and had an excellent production record. (Tr. 284.)
3. Respondent Brian A. Schmidt
Schmidt received a bachelor of arts degree from Quinnipiac College in 1975 and conducted graduate studies in hotel management at Cornell University. (Tr. 936.) Schmidt worked for Marriot Corporation for a number of years. In late 1992, he joined Chatfield Dean & Co. (Chatfield Dean), a registered broker-dealer. (Tr. 937.) He passed his Series 7 exam in February 1993 and joined Joseph Roberts & Co. In January 1994, Schmidt joined Euro-Atlantic. (Tr. 937.) In the three month period prior to Madden's arrival at the Chicago office, Schmidt served as acting branch manager. (Tr. 526-27.)
4. Respondent Darlan E. Gordon
Gordon completed three years of undergraduate studies at Florida A&M University. (Tr. 836.) After college, he joined the U.S. Marines and left military service at the rank of E3. He entered the securities industry in 1991 and has a Series 7 license and a Series 63 license. (Tr. 838.) Gordon worked at a number of brokerage houses, including Chatfield Dean; Gordon's period of employment with Chatfield Dean coincided with Schmidt's employment at that firm. He worked at Euro-Atlantic's Chicago office from January 1994 to May 1995. Gordon was terminated due to poor production and client complaints. (Tr. 289-90.) He subsequently went to La Jolla Capital Corporation (La Jolla)4 and was employed there from May 1995 to July 1995. (Tr. 785.)
5. Respondent William Avent
Avent completed three years of undergraduate studies at Strayer Business College. In the past ten years, Avent derived most of his income from a part-time job at a clothing store. (Tr. 926.) He also worked with Flenoid Haywood at Northern Industries, Inc. (Northern Industries), a Bahamian corporation in which Avent has a one-third ownership interest. (Tr. 891, 926; Div. Exs. 59-62.)5 The primary business of Northern Industries is the construction of runways and air strips. As a workplace, Avent utilized the offices and facilities of N & J Industries, Inc., (N & J Industries), a construction company owned by Avent's friend and associate, Marshall J. Wade. (Tr. 891.)
In March 1995, Avent opened four brokerage accounts for Northern Industries at Euro-Atlantic. (Tr. 291-93, 974; Div. Exs. 59-62.) Avent opened these accounts with the stated intention of funding them through the proceeds of a transaction involving billions of dollars in foreign securities.6 Schmidt was the broker of record for these accounts. (Div. Exs. 59-62.) These accounts remained unfunded, and were completely inactive, until the Stoutt transaction described below. (Tr. 872-73.)
6. Respondent John A. Dilworth II
Dilworth completed coursework at Chicago State University and the Illinois Institute of Technology. (Tr. 717-18.) His business interests centered on not-for-profit ventures and the development of mortgage pools for low income families. (Tr. 717-19.)
B. Palmer P. Stoutt
Palmer P. Stoutt (Stoutt) is the president of Rancal International, and its subsidiary Rancal Puerto Rico. He is a resident of the British Virgin Islands. Stoutt completed his undergraduate studies in Canada, earning a bachelor of science degree in computer science in 1982. (Tr. 29.) Stoutt was awarded a masters degree from the London School of Economics in 1983. (Tr. 29.) After completing his graduate studies, he remained in the United Kingdom for a few years, and performed research consulting for a number of companies including Citicorp and IBM Deutchland. (Tr. 30.)
Stoutt started a car rental business called Rancal Corporation in 1985. (Tr. 30.) In partnership with his brother, Stoutt started a construction company called Rancal Development in 1987. In 1989, Stoutt also started an information technology consulting firm called Rancal Information Systems Limited. At the end of 1990, Stoutt and his brother ended their business relationship. Stoutt retained the car rental and information technology divisions of the business under the name Rancal International. (Tr. 31.) In 1994, Rancal Puerto Rico began negotiations with a Puerto Rican telephone company for a large-scale information technology contract. Due to the size of the contract, Stoutt approached Banco Popular for project financing. (Tr. 32.) Banco Popular had provided project financing to Rancal International in the past. On previous contracts, Banco Popular had financed 75% of Rancal International's project costs with short-term unsecured loans. (Tr. 32.) However, due to the nature of this contract, Rancal Puerto Rico required a long-term loan. Banco Popular agreed to make a five year long-term loan of $1.5 million, provided that it was collateralized with T-Bills.7 (Tr. 32-33.) Stoutt did not have $1.5 million in T-Bills.
C. Stoutt Transaction
1. Stoutt Meets Schmidt
In an effort to obtain the $1.5 million in T-Bills, Stoutt utilized a subscription service and found an advertisement promising "unlimited [ ] financing." Interested persons were encouraged to contact Heddy Y. Hetherington (Hetherington).8 (Tr. 34, 491-92; Div. Ex. 7.) Stoutt called Hetherington on July 14, 1995. He told her that he wanted $2 million in T-Bills to collateralize a loan of $1.5 million by his bank. At Hetherington's request, Stoutt sent information about his company, along with a letter reiterating his desire for $2 million in collateral. (Tr. 35-36; Div. Ex. 9.) Hetherington called Stoutt a week later and suggested that T-Bill leasing would meet his needs. Hetherington said that she had a contact who was knowledgeable about T-Bill leasing and that she would put Stoutt in touch with him. (Tr. 36.)
On July 20, 1995, Hetherington initiated a conference call with Stoutt and Schmidt. (Tr. 37, 492-94.) Schmidt introduced himself as a licensed stock broker working with Euro-Atlantic. (Tr. 37-38.) Schmidt informed Stoutt that T-Bill leases were only available at a minimum denomination of $10 million, and this would cost $300,000 a month. Stoutt replied that he only needed $2 million, and could not possibly afford the monthly payments. (Tr. 37-38.)
Schmidt told Stoutt that this was not a problem, provided that Stoutt could come up with the lease payment for the first month. Stoutt could retain $2 million worth of T-Bills to collateralize his loan from Banco Popular and house the other $8 million worth of T-Bills in an account at a brokerage house. Once these T-Bills were housed, they could be margined at approximately 90% of their face value, and the margin utilized to fund a high yield trading program. (Tr. 38-39.) Schmidt said that this trading program would easily cover the cost of future lease payments and generate substantial profits for Stoutt.
Schmidt instructed Stoutt to send to him a Letter of Intent to lease $10 million in T-Bills. (Tr. 40-41.) Schmidt also requested written proof that Stoutt had received a loan offer from Banco Popular, and that Stoutt had the means to make the first month's $300,000 lease payment. (Tr. 42-43.) Stoutt assembled and mailed a packet to Schmidt containing the Letter of Intent and other requested materials. (Div. Ex. 103(a).) The Letter of Intent contained the terms under which Banco Popular would accept securities as collateral and approve Stoutt's loan. Specifically, the securities would have to originate from an acceptable securities firm in the United States, so that their value and authenticity could be verified. (Tr. 41-42; Div. Ex. 103(a).)
Schmidt called Stoutt after receiving the package, and told him that the two letters evidencing Stoutt's loan offer, and his ability to make the first lease payment, were unsatisfactory. Schmidt requested certain modifications to these letters, and requested that Banco Popular send these materials directly. (Tr. 45-46.) Upon Stoutt's request, Banco Popular sent Schmidt two letters, one verifying the loan offer to Rancal International, and the other verifying Rancal International's credit line. (Tr. 45-46, 1004-06; Div. Exs. 104, 105.)
Hetherington also introduced Stoutt to William Dedman (Dedman), an attorney. Dedman represented that he was knowledgeable about complex financial transactions. (Tr. 47.) Stoutt hired Dedman to draft and review legal documents in connection with this transaction. (Tr. 47-48; Resp. Ex. 2.) Dedman did not bill Stoutt an hourly fee for his services, but expected to split fees with Hetherington and Schmidt upon completion of the transaction. (Tr. 100; Div. Exs. 14, 15, 17.)
Hetherington and Schmidt both testified that it was Stoutt who came to them with the idea of leasing T-Bills. (Tr. 492, 982.) They then did their best to meet Stoutt's needs. However, Hetherington and Schmidt proposed another T-Bill leasing scheme to Excalibur USA (Excalibur), prior to meeting Stoutt.9 There is also evidence that Schmidt employed similar formulae in T-Bill leasing transactions with Richard Andron (Andron)10, Don Hough (Hough),11 and Wesley Taylor (Taylor).12
Schmidt denied requesting a package of information from Stoutt, including a letter of intent, bank records, and a business plan. (Tr. 992-93; Div. Ex. 103(a).) However, the package was addressed to Schmidt, and in the cover letter, Stoutt enumerated the contents of the package. The cover letter stated that the enumerated items had been included according to Schmidt's instructions. (Div. Ex. 103(a).) Although Schmidt denied receiving the other materials in this package, he admitted to receiving the cover letter. (Tr. 993.) Schmidt's testimony that he did not request or receive this package is not credible, and I accord it no weight.
2. Schmidt Introduces Stoutt to Dilworth
Schmidt originally suggested Bill West (West), a representative at Burns & Gimble13 as a source of T-Bills. (Tr. 49; Resp. Ex. 7.) Schmidt and Stoutt spoke to West in the first week of August, and West told them that Burns & Gimble would not be able to provide the T-Bills until August 21, 1995. (Tr. 49.)
Schmidt told Stoutt that there was no reason for delay because he had another source for T-Bills. Schmidt initiated a conference call with Stoutt and Dilworth. (Tr. 49, 639.) Dilworth introduced himself as an agent of Equity Enhancement and Guarantee (EEG), a private bank headquartered in London.14 Dilworth said that EEG had over $10 billion in assets in a trust in Ireland, and that he had the legal right to assign to Stoutt $10 million worth of the EEG trust's T-Bills. (Tr. 640-43, 690.) Dilworth sent the Contract For Assignment (Contract) to Schmidt, and Schmidt faxed it to Stoutt. (Tr. 50-51, 652; Div. Exs. 10, 106.) After receiving the Contract, Stoutt contacted Schmidt and told him that it was not acceptable because it did not include two items that were agreed upon in their conversation with Dilworth: 1) after the first month's payment, Stoutt would not be responsible for making subsequent payments and 2) the T-Bills would be housed and traded at La Jolla. (Tr. 52.) Dedman subsequently revised the Contract to Stoutt's satisfaction. (Tr. 57.)
The cover page for the Contract was addressed to Stoutt in Schmidt's handwriting, although Schmidt denied sending it. (Tr. 1007; Div. Exs. 10, 106.) Schmidt explained that although he wrote the cover page, it must have been attached to some other document that was faxed to Stoutt. (Tr. 1011.) Schmidt could not identify this other document. (Tr. 1011.) However, Dilworth testified that he gave the contract to Schmidt and that Schmidt forwarded it to Stoutt. (Tr. 652.)
3. Stoutt Receives Verification from La Jolla
Schmidt also told Stoutt that he would get a letter from La Jolla confirming that it was involved in the transaction and that a trading program would be available. (Tr. 53.) On August 8, 1995, Stoutt received a faxed memorandum signed by Gordon. (Div. Ex. 18.) In this document Gordon represented that he was familiar with the background of the "issued Contract, Deed of Assignment, and Safekeeping Receipt."15 (Div. Ex. 18.) The memorandum further read that Gordon was:
personally knowledgeable of the circumstances that [ ] structure Mr. Dilworth's relationship with the trust and ha[s] submitted this paperwork for review to [La Jolla]. After careful review, the agreement was made to Mr. Dilworth that [Gordon's] [c]ompany will margin these instruments and trade the cash value of the margin. The weekly interest on this program will be 3% to 5% net.
(Div. Ex. 18).
Upon reviewing this memorandum, Stoutt contacted Schmidt and expressed his concern that the memorandum did not state that the trading program would pay the $300,000 a month lease payments for the T-Bills. Stoutt wanted confirmation that he would not remain liable for this amount. (Tr. 54.) Schmidt agreed to go back to La Jolla and get this confirmation. Stoutt received another fax on August 9, 1995. (Div. Ex. 19.) The first page of the fax was a handwritten cover page addressed to Stoutt and Dedman from Schmidt. The second page of the fax was another memorandum from Gordon. The memorandum was entitled "PRE-TRADING CLIENT ADVISEMENT." It was nearly identical to Gordon's August 8 memorandum with the following additional paragraph:
Upon Mr. Dilworth's written [acknowledgment] to La Jolla, your assigned Ten Million U.S.D. US Treasury Bills will immediately be margined and traded. You will not be liable to return the Deed of Assignment to the trust. You will be given transactional reports of every trade. [Y]ield weekly for the one year term will be at least 3%. [You] will not have any liability to the trust for La Jolla's administration of the program. Upon opening your account, I anticipate engaging your business.
(Div. Ex. 19.)
Although both memoranda appeared to be on La Jolla letterhead, the stationery was not genuine. (Tr. 729-30; compare Div. Exs. 18 and 19 with Div. Ex. 101.) Gordon denied fabricating the La Jolla stationery and authoring and sending the memoranda. (Tr. 771-72, 777-78.) He testified that his signature was forged. (Tr. 775-77.) Avent, however, testified that he and Schmidt directed Gordon to write these memoranda, and that Gordon authored both of them. (Tr. 850-52.)
Schmidt testified that he had nothing to do with the August 8 memorandum. (Tr. 1014-16.) Schmidt denied asking Gordon to write this memorandum and send it to Stoutt. Schmidt said that the only reason that he had a copy of this document in his possession was because Stoutt sent a copy to him sometime in August. (Tr. 1015-16.) Schmidt likewise denied having any involvement with the August 9 memorandum. Schmidt admitted that the cover page was in his handwriting, but opined that some other document must have been attached to it. (Tr. 1024-25.)
After receiving these memoranda, Stoutt was satisfied that La Jolla would accept the leased T-Bills. However, Stoutt asked Schmidt for more information about La Jolla itself. On August 18, 1995, Schmidt faxed a La Jolla promotional brochure to Stoutt. (Tr. 1028; Div. Ex. 12.) The brochure was appended to a cover page on Euro-Atlantic letterhead with a handwritten note addressed to Stoutt and signed by Schmidt. The note said, "here is the info[rmation] on La Jolla. [The] rest will be forthcoming. I will call." (Div. Ex. 12.)
Schmidt admitted sending this La Jolla promotional material to Stoutt but stated that it was not his intention to commend La Jolla to Stoutt. Schmidt said that one day, Avent and Dilworth came to the Euro-Atlantic office and had a closed-door meeting with Madden. At the end of the meeting, Dilworth purportedly gave the promotional brochure to Schmidt and asked him to fax it to Stoutt. Schmidt complied with this request. (Tr. 1027-28.)
4. Stoutt Seeks Proof of Assets from EEG Trust
During the week of August 21, 1995, Stoutt asked Schmidt to give him additional information about T-Bill leasing and further confirmation that these instruments actually existed. In response, Schmidt faxed an unexecuted Deed of Assignment to Stoutt. (Div. Ex. 24(a).) Stoutt told Schmidt that the Deed of Assignment did not demonstrate that the T-Bills actually existed.
On August 21, 1995, Stoutt faxed Schmidt a letter in which he stated that he refused to execute the contract and wire his funds until an attached Proof of Assets letter was completed. (Tr. 69-70; Div. Ex. 23.) After completion, the Proof of Assets letter was to be sent directly from the bank or brokerage firm where the T-Bills were physically housed, so that the relevant financial institution could confirm that the trust actually had $10 million in T-Bills in an account. (Tr. 71.)
A few days later, Schmidt initiated a conference call in which he introduced Stoutt to Avent. Avent told Stoutt that he was knowledgeable about the EEG trust, that it had been in existence for over fifty years, and that it had the requisite assets. (Tr. 71-72.) However, for confidentiality reasons, the trust would not complete the Proof of Assets letter. (Tr. 72, 657.) In order for Stoutt to get the Proof of Assets executed by the trust, he would be required to demonstrate his "good faith," by proving that he had $300,000. Stoutt offered to get a standby letter of credit, but was told that the trust required evidence of liquid funds. Schmidt then suggested that Stoutt wire his money into a Euro-Atlantic account where it would be held in safekeeping. According to Schmidt, this would allow the EEG trust to verify that the funds were available and then complete the Proof of Assets letter. Once the Proof of Assets letter was completed, Euro-Atlantic would release Stoutt's funds from the "safekeeping" account. Stoutt agreed to this plan, but first required written confirmation that his money would be held in safekeeping. Neither Avent nor Schmidt mentioned that, in reality, Stoutt would be wiring his money into one of Northern Industries' accounts and that the account would be under the control of Avent. (Tr. 72-75).
On August 28, 1995, Schmidt faxed three letters to Stoutt. The first letter was printed on Euro-Atlantic letterhead and signed by Schmidt. It informed Stoutt that the clearing firm for Euro-Atlantic had changed to Wertheim Schroder and Company (Wertheim Schroder). (Div. Ex. 27.) The second letter was printed on Euro-Atlantic letterhead and requested that Stoutt wire his money into the Wertheim Schroder account number that Schmidt had provided. (Div. Ex. 29.) The second letter warranted that Stoutt's money would "be held in safekeeping and not released to the trust until [he] received the letter from [EEG] as requested." (Div. Ex. 29.) The third letter contained wire instructions which only listed the account number to which the money would be wired but did not state that the account belonged to Northern Industries. (Div. Ex. 28.)
At the hearing, Schmidt denied that he verbally assured Stoutt that his funds would be held in a safekeeping account but admitted that he sent Stoutt a memorandum representing that Stoutt's money would be held in safekeeping. (Tr. 1031; Div. Ex. 29.) However, Schmidt stated that this was not in response to any conversation with or request of Stoutt. (Tr. 1033.) Rather, Schmidt chose to write that memorandum as a courtesy. (Tr. 1033, 1145-46.) Schmidt testified that the usage of the word "safekeeping" was not meant as a term of art for an escrow account. He testified that when he used the word "safekeeping," he meant that the money would be held safely in an account at Wertheim Schroder. (Tr. 1145-47.) However, this testimony is not credible, and I accord it no weight. Schmidt sent the "safekeeping" letter to induce Stoutt to wire his money with the understanding that Euro-Atlantic would safeguard it until Stoutt received the proof he required. Then, under the pretense of giving Stoutt wire instructions to a "safekeeping" account, Schmidt sent Stoutt wire instructions to the very same Northern Industries account that Stoutt had refused to wire his money to in the first place. (Compare Div. Ex. 10 with Div. Ex. 28.)
Stoutt testified that when he sent the $300,000 to a "safekeeping" account at Euro-Atlantic, he believed that the funds would be held in an escrow account and would not be released until Stoutt received a Proof of Assets letter. (Tr. 74). The plain language of the "safekeeping" letter from Schmidt to Stoutt supports this interpretation. (Div. Ex. 29.) Avent also shared this interpretation. (Tr. 854-57.)
Also, on August 28, 1995, Stoutt sent a notarized and executed copy of the Contract to Dilworth. (Tr. 80; Div. Ex. 25.) The Contract was copied to Schmidt. Attached to the Contract was another copy of the Proof of Assets letter, and an addendum page which read:
this addendum is to that contract for assignment of U.S. Treasury bills dated August 28, 1995 and said contract was amended as follows: The contract is conditioned upon [Dilworth] providing the confirmation of proof of ownership of U.S. Treasury Bills held by EEG to be provided in the format as attached not later than August 28, 1995.
(Div. Ex. 25.)
That same day, Stoutt also wired $300,000 to Northern Industries' account at Euro-Atlantic according to Schmidt's wiring instructions. (Div. Ex. 30.) On August 30, 1995, unbeknownst to Stoutt, Avent wired $44,900 from the Northern Industries account to the N & J Industries account, and this money was immediately divided by Avent and Dilworth. (Tr. 662-64; Div. Exs. 32, 33.) On August 31, 1995, Avent wired $250,000 from the Northern Industries account to Thomas Ross (Ross). 16 (Tr. 664-65; Div. Exs. 34-36.)
5. The Memorandum of Understanding and the Master Pay Order
On August 29, 1995, Stoutt executed and faxed to Schmidt, a Memorandum of Understanding (MOU) and an Irrevocable Master Pay Order (MPO).17 (Div. Exs. 14-17, 31.) Schmidt had previously told Stoutt that once Stoutt executed the MOU and sent it back to him, it would be executed by EEG, and the transaction could be completed. EEG never executed the MOU. (Tr. 98.)
6. Stoutt Attempts to Open an Account at La Jolla
During the week of August 21, 1995, Avent told Stoutt that he would arrange to have La Jolla account-opening forms faxed to him. (Tr. 85-87.) Avent mentioned William Schumaker (Schumaker) as the La Jolla broker who would open Stoutt's account. (Tr. 85-86; Resp. Ex. 6.) Stoutt received La Jolla account-opening forms via fax. He completed them and faxed them back. (Tr. 88.)
On September 5, 1995, Schmidt called Stoutt and told him that there was a delay in opening the account because Stoutt faxed the account-opening documents to the wrong La Jolla office. In order to correct this error, Stoutt was instructed to fax a letter to the San Diego headquarters of La Jolla, designating Bruce Straughn (Straughn) as Stoutt's broker of record. (Tr. 89-90, 169.) On September 6, 1995, Stoutt faxed a letter to La Jolla headquarters designating Straughn as his broker of record. (Div. Ex. 115.) At the hearing, Schmidt denied sending account-opening documents to Stoutt and inducing Stoutt to change his broker of record from Schumaker to Straughn. (Tr. 1027, 1030.) I credit Stoutt's testimony and I reject Schmidt's testimony on this issue.
7. Stoutt is Lulled
On September 6, 1995, Stoutt still believed that the La Jolla account was not opened because he sent the account-opening paperwork to the wrong office. He remedied this problem, per Schmidt's instructions, but remained concerned about the status of his money. (Tr. 91-92.) He had wired his money on August 28, 1995, and still did not have an open account at La Jolla containing $10 million in T-Bills, and the accompanying margin trading in a high yield trading program. Stoutt told Schmidt that he wanted confirmation that his money was still being held in the Euro-Atlantic safekeeping account, and Schmidt promised to provide such confirmation. (Tr. 92.)
Shortly after their conversation, Schmidt faxed a three page document to Stoutt. (Tr. 1042; Div. Ex. 42.) The cover sheet was on Euro-Atlantic stationery, and two letters were attached to it. The first letter was dated September 6, 1995, and read:
I confirm that on August 30, 1995 we received from you $300,000 U.S.D. at Schroder [Wertheim], account #614014603. This was wired out in your behalf on August 31, 1995 per the instruction of William Avent and John Dilworth, the holders of the account. Sincerely, Brian Schmidt.
(Div. Ex. 42.) This letter contained the misrepresentation that both Dilworth and Avent were holders of the account and that the money was wired out at their instruction. In reality, Dilworth had no control over the account. Only Avent controlled the account, and the money was wired out at his direction. (Tr. 1043-44.) Schmidt testified that this misstatement was an innocent mistake. (Tr. 1044.) However, Schmidt was the registered representative on the Northern Industries accounts. He opened these accounts, and knew or should have known who the account holders were. Dilworth was never an account holder at Euro-Atlantic. (Tr. 1085.)
Upon receiving this letter, Stoutt learned for the first time that account number 614014603 was not really a safekeeping account at Euro-Atlantic, but rather, an account under the control of a third party. (Tr. 94.) The second letter attached to Schmidt's September 6 fax was on the letterhead of "N & J Industries, Commercial Food Service Equipment." The letter read:
This letter will confirm to you that we have received from Euro-Atlantic $300,000 USD to commence your treasury bill lease agreement. Currently John Dilworth will be traveling to Texas to complete finalization of your lease. We expect to have all affairs in order by or on Friday September 08, 1995. [Signed] William Avent [and] John Dilworth.
(Div. Ex. 42.)
After receiving these letters, Stoutt called Schmidt and expressed a number of concerns. Stoutt noted that he did not have an executed Proof of Assets letter as he had been promised. Stoutt further noted that the terms and conditions of the MOU had not been met, and he could not understand how the money was released from the safekeeping account to Avent and Dilworth. Schmidt told Stoutt that he should not worry and that he would receive all that was promised. (Tr. 97.)
On September 7, 1995, Stoutt faxed to Schmidt a letter which read:
Further to our telephone conversation earlier regarding the above captioned transaction, I require for my files a letter from [La Jolla] stating the reasons for the delay in opening the account since all the account documents were received by fax on August 28, 1995 and the originals on August 31, 1995. In addition, the letter from [N & J Industries], does not state the date that they received the $300,000 USD from Euro-Atlantic [S]ecurities. Can you also have them revise this letter and also, they should state the reasons for the delay in transferring the treasury bills to the account at [La Jolla].
(Div. Ex. 116.) There was no formal reply or explanation from Schmidt in response to this letter. Stoutt called Schmidt several times, and each time, Schmidt assured him that the T-Bills were forthcoming. (Tr. 101-02.)
On September 7, 1995, Stoutt called Avent to inquire about the T-Bills. Avent told him that the deal was going to be done by September 8, 1995, and that Dilworth was going to Texas to conclude the transaction. (Tr. 103.) No one contacted Stoutt on September 8, 1995, and Stoutt tried in vain to reach Avent and Dilworth to verify that the transaction had been consummated. (Tr. 103-05).
On September 14, 1995, Stoutt sent a letter to Avent and Dilworth memorializing the September 7 telephone conversation. The letter further informed them that Stoutt urgently needed documentation to substantiate the status of the transaction before an upcoming Rancal International board of directors meeting. Stoutt wanted all original documents including the date of assignment, safekeeping receipts, and other supporting confirmations for the leased $10 million in T-Bills, and the account number of the Rancal International account at La Jolla where the T-Bills were housed. Stoutt also wanted confirmation that 90% of this amount could be margined for the trading program. (Tr. 105-06; Div. Ex. 113.)
Stoutt subsequently called Straughn at the Chicago office of La Jolla to inquire why an account had not yet been opened. Straughn told Stoutt that La Jolla would not open the account because there was a problem with either the margin department or the compliance department. (Tr. 114-15; Div. Ex. 20 at 77-78.) Stoutt also called Avent, who confirmed Straughn's representations, and added that there was an additional problem with opening the account because La Jolla did not have the requisite insurance for the size of Stoutt's proposed account. (Tr. 115.) Stoutt told both Avent and Straughn that it was very important that La Jolla put the basis of its refusal to open the account in writing, so that Stoutt could justify his failure to consummate the transaction to his board of directors. Straughn refused to put anything in writing, citing liability concerns. (Div. Ex. 20 at 104-09.)
On September 20, 1995, Gordon faxed a letter to Stoutt informing him that "because of the size of this transaction [La Jolla] does not have the insurance to facilitate your T-Bill transaction. Sorry for the inconvenience." (Div. Ex. 22.) The letter was on fake La Jolla letterhead. (Compare Div. Ex. 22 with Div. Ex. 101.) This letterhead is exactly the same stationery that was used for Gordon's August 8 and 9 memoranda to Stoutt. (Compare Div. Exs. 18 and 19 with Div. Ex. 22.) Gordon was not affiliated with La Jolla when this letter was written. (Tr. 788.)
Gordon testified that he did not write this letter and that his signature was a forgery. (Tr. 787.) Gordon further testified that Stoutt's account was not rejected for insurance reasons at all. (Tr. 787.) He stated that Stoutt's transaction was rejected because La Jolla became suspicious of it. (Tr. 788-89.) However, in his investigative testimony, Gordon said that La Jolla did not open the account for insurance reasons. (Div. Ex. 5 at 200.) Gordon also made the same representation in his Wells statement. (Div. Ex. 111.) When confronted with this discrepancy, Gordon testified that his Wells statement was simply wrong. (Tr. 786-87.) By contrast, Avent testified that Gordon did write the letter. He said that Gordon told him that Stoutt's transaction had been turned down because La Jolla did not have the insurance coverage to open it. (Tr. 847.) Avent was aware that Gordon was not affiliated with La Jolla, but he still directed Gordon to write this letter, and Gordon complied. (Tr. 847; Div. Ex. 20 at 111-15.)
Stoutt spoke with Avent after receiving this letter. Avent expressed his concern about La Jolla's failure to open an account, and said that he would open an account on Stoutt's behalf at Prudential Bache Securities (Prudential Bache). (Tr. 117; Div. Ex. 20 at 6-21.) In the meantime, Avent offered to margin $2 million of his own securities, and lend this sum to Stoutt to meet Stoutt's interim funding needs until Stoutt's transaction was consummated. (Tr. 117; Div. Ex. 8 at 452, Div. Ex. 20 at 11-13.) Once the account at Prudential Bache was opened and Stoutt's T-Bills were margined, Stoutt would then return the $2 million to Avent. On September 25, 1995, Avent sent Stoutt a letter memorializing their conversation and confirming his intention to wire $2 million to Stoutt within forty-eight hours. (Div. Ex. 43.) Stoutt never received these funds, and an account was never opened at Prudential Bache. Stoutt was given vague excuses as to why the account at Prudential Bache could not be opened. (Tr. 118-19.)
8. Stoutt Hires an Attorney to Recover His Money
On September 26, 1995, Stoutt sent a letter to Avent, Dedman, Dilworth, Hetherington, and Schmidt, because he realized that the transaction was not being consummated as promised. (Tr. 119-20; Div. Ex. 47.) This letter summarized the sequence of events starting from July 20, 1995, and made a formal request for the return of his money. In a series of telephone conversations, Avent, Dilworth, Gordon, and Schmidt told Stoutt that an account had in fact been opened for him, the T-Bills had been margined, and a cash margin would be wired to his bank very soon. (Tr. 119; Div. Ex. 20 at 190-361, Div. Ex. 21 at 431-42 & 505-10.) When asked where the T-Bills had been housed and margined, the Respondents would not give Stoutt a firm answer and vacillated between Lexington Securities and Dean Witter. (Tr. 119; Div. Exs. 20, 44.) For several days they continued to ply Stoutt with excuses, but the promised wire transfer was not made. In response, Stoutt hired Robert Mandell (Mandell), a Chicago attorney, to secure the return of his $300,000. (Tr. 606.)
On October 5, 1995, Mandell sent Avent, Dilworth, Gordon, and Schmidt a letter demanding that Stoutt's $300,000 be returned. (Tr. 607; Div. Ex. 48, 49.) On the same day, Mandell called Madden to complain about Stoutt's missing money. At Madden's insistence, Schmidt contacted Avent, Dilworth, and Gordon, and joined them in a conference call so that the matter could be resolved. During the call, Stoutt asked for his money back. Schmidt replied that he did not have the money and that Stoutt should focus on Avent and Dilworth. Avent and Dilworth promised to return Stoutt's money. (Tr. 124, 318-19, 608-09; Div. Exs. 50, 51.)
On the morning of October 6, 1995, Dilworth faxed Mandell a note in which he promised to send the following items to Mandell by October 9, 1995: 1) proof of the immediate availability of a trading program at a European "prime bank" that could be funded by EEG's leased T-Bills, 2) proof of the availability of $10 million in T-Bills that Stoutt had contracted to lease, and 3) a copy of the wire order in which $300,000 would be sent back to Stoutt. (Div. Ex. 52.) Dilworth also wrote that although Stoutt's money would be returned, Dilworth felt that Stoutt was "legally not entitled to one dime." (Div. Ex. 52.) After receiving this fax, Mandell and Stoutt initiated another conference call with Dilworth, Madden, and Schmidt in which Mandell told the Respondents that Stoutt was not interested in any proof of a trading program or the existence of T-Bills. His only interest was a prompt return of the money. Dilworth reiterated his intention to wire the funds on October 9, 1995. (Div. Ex. 53.)
On October 9, 1995, Dilworth faxed Mandell and Stoutt a note in which he informed them that his bank was closed due to the observance of Columbus Day, and that he would call Mandell's office by 10:00 a.m. on October 10, 1995, to arrange payment of the money owed. (Div. Ex. 54.) When Dilworth did not contact Mandell by 10:00 a.m. on October 10, 1995, Mandell faxed Dilworth a note demanding that the $300,000 be wired by 2:30 p.m. that day. (Div. Ex. 55.) Dilworth did not wire the money. Instead, he faxed Mandell another note in which he stated that the money would not be sent after all because he was having difficulty cashing out securities with which to make the payment. Dilworth promised to make payment by October 11 or 12. (Div. Ex. 56.) No payment was ever made.
9. The Correspondence Policy at Euro-Atlantic
Euro-Atlantic had policies and procedures in place regarding outgoing and incoming correspondence. All incoming correspondence would be received and classified by the operations department. Anything, other than "junk mail," would be passed to Madden for review prior to distribution to any brokers. All outgoing correspondence would be reviewed by Madden before it was sent. No employee was authorized to send or receive mail, courier packages, or faxes without prior substantive review by Madden. (Tr. 285-86, 520-21, 595-97.)
The correspondence policy is found in Euro-Atlantic's compliance manual. (Tr. 345-47; Div. Ex. 94.) Compliance bulletins were distributed, and office meetings conducted to remind employees of the policy. (Tr. 287-88, 521-22; Div. Ex. 96.) When James St. Clair (St. Clair), Euro-Atlantic's compliance officer, conducted his annual audits, he would verify the mechanics of the compliance policy and hold meetings to educate employees about how the policy functioned. (Tr. 521-25.)
The office fax machine was kept in a separate room, in the operations department, next to the desk of Beth Minser (Minser), the operations manager. On one occasion, Minser saw Schmidt near the fax machine, apparently waiting for a fax. She informed Madden, and Madden reminded Schmidt that he was not allowed to receive faxes directly and that they had to go through the operations department first. (Tr. 288, 598.) Schmidt admitted that during the Stoutt transaction he sent and received faxes directly. (Tr. 944-45.)
10. Madden and St. Clair Investigate Schmidt
On August 29, 1995, when the wire request came in to send $44,900 from the Northern Industries account to the N & J Industries account, Madden and St. Clair first became aware that there might be a problem. This was a "red flag" to Wertheim Schroder, because $300,000 had been wired into the account only the day before, and money was being wired back out without any transactions having occurred. (Tr. 305-06, 528-29.) Wertheim Schroder called St. Clair and alerted him to this anomaly. (Tr. 528.) St. Clair called Madden and asked him to investigate.
Madden asked Schmidt to explain the transaction, and Schmidt said that he had merely introduced some parties for a transaction that occurred at La Jolla. Schmidt said that Euro-Atlantic was not involved in any way and that he was entitled to a finder's fee. (Tr. 305-06, 530-33.) St. Clair could not think of any legal basis to stop the wire, and the wire transfer was honored. (Tr. 312-13, 529.)
Madden and St. Clair began an investigation, and they asked Schmidt to surrender all documents relating to the transaction. (Tr. 303-04, 530.) On August 31, 1995, a second wire request transferred $250,000 from the Northern Industries account to an account at Fidelity South Bank, in Fort Worth, Texas, belonging to Ross. (Div. Ex. 34.) This almost emptied the Northern Industries account without any trades having occurred and within days of any money having been put into the account.
St. Clair called the National Association of Securities Dealers (NASD), who said that, in principle, it was acceptable for Schmidt to receive a finder's fee for a transaction as long as Euro-Atlantic received written authorization from the account holder to make payment. (Tr. 307-08, 534-36.) Madden told Schmidt that before the $5,100 remaining in the Northern Industries account could be released to him as a finder's fee, Avent and Dilworth had to write a letter explaining the transaction in detail. (Tr. 1048.) Madden also told Schmidt that Euro-Atlantic needed written authorization before the finder's fee could be released to him. (Tr. 532-35.) Schmidt relayed this request to Avent; Avent then directed Dilworth to write a letter of explanation and fax it to Schmidt. (Tr. 1048-49.) Schmidt received the letter on September 6, 1995, and gave it to Madden. The letter read:
On 08/30/95 $300,000 was wired into the [Northern Industries], account number #614014603. Which were proceeds from a transaction performed at [La Jolla] (clearing through Paine Webber) between Rancal De Puerto Rico and [Northern Industries] reference to a $10,000,000.00 lease assessment of treasury bills.
All transactions are performed at [La Jolla] of which Euro-Atlantic is not liable for or part of. All funds wired to Euro-Atlantic are settled funds and not part of the actual transaction mentioned above at [La Jolla].
$5,000.00 of the funds goes to Brian Schmidt of Euro-Atlantic for bringing parties to the table that resulted in the above mentioned transaction in effect a "finder's fee".
(Div. Ex. 41.) The letter is signed by "John Dilworth, Northern Industries," and "Bill Avent, Northern Industries." (Div. Ex. 41.)
Several representations in this letter were false and misleading. The $300,000 wired into the Northern Industries account came directly from Stoutt, and these funds were wired with the understanding that they would be held in safekeeping until Stoutt received assurances that the EEG trust was a legitimate organization which possessed $10 million in T-Bills. Therefore, the letter's representation that the $300,000 was the proceeds of a transaction performed at La Jolla between Stoutt's company and Northern Industries was false. There was no transaction performed at La Jolla, and the $300,000 was not the proceeds of any transaction performed between Stoutt's company and Northern Industries. Schmidt reviewed the letter written by Avent and Dilworth, and handed it to Madden without disclosing the misrepresentations. Schmidt testified that he was not aware that the letter contained any misrepresentations when he handed it to Madden. (Tr. 1049-50.)
Then, on October 5, 1995, Avent, Dilworth, Gordon, Madden, Mandell, and Schmidt participated in a conference call in which Avent and Dilworth promised to return Stoutt's money. (Tr. 124, 318-19, 608-09.) Mandell subsequently sent St. Clair documents that Madden and St. Clair had never seen before, particularly a letter in which Schmidt represented that money sent to Euro-Atlantic would be held in safekeeping. (Tr. 542-43; Div. Ex. 29.)
In mid-September, $250,000 was wired in and out of another account at Euro-Atlantic in another T-Bill leasing transaction. (Tr. 537-41, 1062-63.) This time the money came in and out of the Tacoma account.18 (Tr. 539.) Madden and St. Clair were further alarmed by this development, particularly because Schmidt was the broker of record in the Tacoma account. (Tr. 566-67, 1060.)
Subsequently, Madden entered Schmidt's office and looked through his files seeking other documents related to the Stoutt transaction. (Tr. 550-51.) Schmidt was suspended from employment at Euro-Atlantic in mid-October and terminated shortly thereafter. (Tr. 551-52.)
On October 15, 1995, St. Clair received an unsolicited letter from Avent and Dilworth. (Tr. 551; Div. Ex. 107.) The letter stated that Schmidt acted strictly on Avent's instructions, and did not solicit any transaction with Stoutt. The letter also stated that Northern Industries' role in the contract between Dilworth and Stoutt was to act as an "escrow agent." Actually, Northern Industries was never an escrow agent. (Tr. 683, 1058-59). Schmidt testified that he did not warn Madden and St. Clair of this misrepresentation because, in mid-October, Schmidt believed that Northern Industries might have acted as an escrow agent. (Tr. 1054.) Such an explanation is at variance with Schmidt's investigative testimony before the Commission staff, in which he admitted that on October 15, 1995, he was aware that Northern Industries had never been an escrow agent. (Tr. 1055.)
11. Schmidt's Defense
Schmidt's testimony in support of his defense described a very different picture of his role. According to Schmidt, he was merely a "go-fer." (Tr. 1001.) He had only the faintest knowledge of the details of the transaction and merely brought the parties together. He did not act as a focal point for the interactions of the other co-schemers, and he did not accept documents from Avent, Dilworth, or Gordon and forward them to Stoutt. (Tr. 1006-07.) The only reason, Schmidt explained, that he possessed documents central to the transaction, was because Madden asked him to obtain as much documentation as possible. (Tr. 1003.) Schmidt testified that he obtained copies of these documents from Stoutt; Stoutt dealt with Avent and Dilworth directly. Schmidt could not credibly explain why numerous documents central to this transaction were either sent by him, addressed to him, or copied to him, and why all of the other parties appeared to go out of their way to keep him informed of the transaction. (See Div. Exs. 10, 12-17, 19, 23, 23A, 25, 27, 29, 30, 31, 33, 34, 42, 47, 49, 102, 103-05, 115, 116.) Schmidt also could not explain why, in addition to the $5,000 "finder's fee," his services entitled him to another $25,000 of Stoutt's money upon completion of the transaction and a commission of one-third of 1.5% of every trade that occurred in the high yield trading program. (Tr. 1002; Div. Exs. 14-17.)
I do not credit Schmidt's testimony about his role in the events at issue in this proceeding. The evidence supports my finding that Schmidt played a central role in furtherance of this scheme. Schmidt acted as the conduit, through which Avent, Dilworth, and Gordon sent documents to Stoutt. (Tr. 651-52.) Schmidt used his association with Euro-Atlantic and his access to Euro-Atlantic letterhead to put the imprimatur of a registered broker-dealer on this transaction. Schmidt persuaded Stoutt to send $300,000 to Euro-Atlantic by misrepresenting that the money was going into an escrow account, when, in reality, it was going into an account under the control of Avent. Likewise, Avent, Dilworth, and Gordon have not offered any credible evidence to exculpate themselves from their roles in this scheme.
D. Treasury Bill Leasing
John Smith (Smith) testified as an expert witness for the Division. He holds the following securities licenses: Series 7, Series 24, Series 63, Municipal Securities Principal, and Options. He has been testifying as an expert witness for approximately twenty-five years. (Tr. 360; Div. Ex. 117).
Smith was awarded a bachelor of science degree from Florida State University, and entered the securities industry in 1967 as a stock broker for Merrill Lynch. While at Merrill Lynch, Smith also carried the title of product manager, and trained and educated other representatives on securities products. After ten years of employment, Smith left Merrill Lynch to found a series of other financial corporations. He founded Lowry Financial Services, a stock brokerage company, and Lowry Management Corporation, a registered investment advisory company. He created two mutual funds and served as portfolio advisor for three others. Smith also created a stock market and bond market research company. (Tr. 358-59; Div. Ex. 117).
At Lowry Financial Services, Smith wrote the compliance manuals, created the due diligence department, hired and supervised all of the branch managers for sixty to sixty-five branches, and served as a branch manager himself. Smith has acted as an independent consultant to brokerage firms that have been sanctioned by regulatory agencies and required to bring in outside assistance. Smith worked on a task force that rewrote substantial portions of the Florida state securities laws and currently teaches at the Florida Securities Examiner School. Over the past fifteen years, Smith has been involved in a dozen national and district committees for the NASD. (Tr. 359-60; Div. Ex. 117.)
Smith performed a study of T-Bill leasing that formed the basis of his testimony in this case. Prior to this case, Smith had never before heard of T-Bill leasing. Smith opined that although the leasing of T-Bills was theoretically possible, T-Bill leasing schemes were almost certainly illegitimate. (Tr. 380.)
T-Bills may be purchased or sold, but not leased, because they are not printed in tangible certificate form. They are computerized records of the U.S. Treasury Department and exist only in electronic book entry form at financial institutions. The transfer of ownership through electronic book entries is the only T-Bill transaction that has economic substance.19 Any representation that an investor can lease a quantity of T-Bills, house them at a brokerage house, and obtain a margin, is fraudulent. (Tr. 405-06, 411, 416; Div. Ex. 114.)
Another fraudulent element of this scheme was the representations about prime bank guarantees and prime bank securities.20 Prime banks are supposedly European "top 100" banks. In this case, Respondents represented that prime banks would guarantee 108% of the face value of a Deed of Assignment to a T-Bill lessor. (Tr. 722-24; Resp. Ex. 7.) This would ostensibly reassure the lessor and induce him to lease his T-Bills to the lessee. The lessee could then freely encumber or margin the leased T-Bills. The lessee could house the T-Bills in a brokerage firm, and the brokerage firm would margin the T-Bills at approximately 90% of their face value. Through this process the lessee could fund a high yield trading program. This trading program, through the purchase and sale of prime bank securities, would generate returns of 3-5% a week.
III. CONCLUSIONS OF LAW
Section 17(a) of the Securities Act makes it unlawful in the offer or sale of securities, by jurisdictional means, to: 1) employ any device, scheme, or artifice to defraud; or 2) obtain money or property by any untrue statement of or omission of a material fact necessary to make the statement not misleading; or 3) engage in any transaction, practice, or business which is or would be a fraud on the purchaser.
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder make it unlawful for any person, directly or indirectly, 1) in connection with the purchase or sale of a security, to make an untrue statement of material fact; 2) omit to state a material fact; 3) use any device, scheme or artifice to defraud; or 4) engage in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person.
A threshold question in finding a violation of Sections 17(a) of the Securities Act, and/or Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, is whether the instruments allegedly offered, purchased, or sold, are securities within the meaning of the federal securities laws.
The Respondents offered Stoutt a lease interest in T-Bills. T-Bills are securities, and subject to the antifraud provisions. See Sections 3(a)(2) and 17(c) of the Securities Act, and Section 3(a)(12)(A) of the Exchange Act; Fisher v. Dean Witter Reynolds, Inc., 526 F. Supp. 558, 559 (E.D. Pa. 1981); Paine, Webber, Jackson & Curtis, Inc. v. Conaway, 515 F. Supp. 202, 210 (N.D. Ala. 1981); see also First Nat'l Bank v. Estate of Russell, 657 F.2d 668, 672 n.14 (5th Cir. 1981) (government securities are subject to the antifraud provisions).
There is no evidence in the record that the T-Bills offered to Stoutt actually exist. However, a financial instrument which is non-existent may still be a security for purposes of the antifraud provisions. See Seeman v. United States, 90 F.2d 88, 89 (5th Cir. 1937); Mishkin v. Peat, Marwick, Mitchell & Co., 744 F. Supp. 531, 533 n. 10 (S.D.N.Y. 1990) (citing cases). The characteristics of a financial instrument, as presented by the promoters, are evaluated to determine whether the instrument is a security. See SEC v. Lauer, 52 F.3d 667, 670 (7th Cir. 1995); Martin R. Kaiden, 70 SEC Docket 439, 443 (July 20, 1999); see also SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 353 (1943) ("in the enforcement of an act such as this it is not inappropriate that promoters' offerings be judged as being what they were represented to be"). The Respondents represented that they were offering T-Bills. Therefore I conclude that the instruments offered were securities within the meaning of the federal securities laws.
B. Sale of an Interest in a Security
Under Section 17(a) of the Securities Act, the fraud or misrepresentation must occur "in the offer or sale" of a security. Section 2(a)(3) of the Securities Act defines a "sale" as "every contract of sale or disposition of a security or interest in a security, for value" (emphasis added).
Stoutt paid $300,000 to lease $10 million in T-Bills under the terms of the Contract and the MOU. Stoutt was told that these leased T-Bills could be used to collateralize a loan and that they could be used for margin and trading. Stoutt never intended to purchase the T-Bills, and title never passed to him. However, for purposes of Section 17(a) of the Securities Act, an offer and/or sale can occur even if an interest less than title has been transferred to the purchaser. See Rubin v. United States, 449 U.S. 424, 429-30 (1981). This lease was a disposition of an interest in a security, and I therefore conclude that a "sale" has occurred for purposes of Section 17(a) of the Securities Act.
C. In Connection with the Purchase or Sale of a Security
Under Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder, the fraud or misrepresentation must occur "in connection with" the purchase or sale of a security. Section 3(a)(14) of the Exchange Act defines "sale" as including "any contract to sell or otherwise dispose of" a security. The "in connection with" requirement is to be construed broadly. See Superintendent of Ins. v. Bankers Life & Cas. Co., 404 U.S. 6, 12-13 (1971). However, there must be a nexus between the fraud and the purchase or sale of a security. See Chemical Bank v. Arthur Andersen & Co., 726 F.2d 930, 942-43 (2d Cir. 1984); Tully v. Mott Supermarkets, Inc., 540 F.2d 187, 194 (3d Cir. 1976).
In this case, the T-Bills were never purchased or sold. I therefore conclude that this scheme was not "in connection with" the purchase or sale of a security, within the meaning of Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder.
The test for materiality is whether there is a substantial likelihood that under all the circumstances, a reasonable person would consider the omitted or misstated information significant in making an investment decision. See Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988) (citing TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)).
In furtherance of the scheme, Respondents told Stoutt that his $300,000 payment would give him a lease interest in $10 million in T-Bills and that his lease interest would be margined to fund a high yield trading program in prime bank instruments, generating a rate of return of 3-5% a week. Respondents did not disclose to Stoutt that T-Bills cannot be leased.
It was also in furtherance of the scheme that Respondents told Stoutt that he was wiring $300,000 into a safekeeping account at Euro-Atlantic and that his money would not be released or disbursed until he received a Proof of Assets letter. In fact, Stoutt was given wiring instructions to an account under the control of Avent, and the money was disbursed without receipt of a Proof of Assets letter. All of these misrepresentations were material.
The Division must establish scienter for a finding of violations of Section 17(a)(1) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; it does not need to establish scienter for violations Section 17(a)(2) and (a)(3) of the Securities Act. See Aaron v. SEC, 446 U.S. 680, 697 (1980). Scienter is "a mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12 (1976). Reckless conduct can satisfy the scienter requirement. See SEC v. Steadman, 967 F.2d 636, 641-42 (D.C. Cir. 1992); Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 & n.6 (9th Cir. 1990) (collecting cases); David Disner, 52 S.E.C. 1217, 1222 (1997). Reckless conduct is defined as "an extreme departure from the standards of ordinary care . . . which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it." Hollinger, 914 F.2d at 1569-70 (quoting Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir. 1977)); see also Meyer Blinder, 50 S.E.C. 1215, 1229-30 (1992). Scienter may be inferred from circumstantial evidence. See Herman & Maclean v. Huddleston, 459 U.S. 375, 390 n. 30 (1983); Pagel, Inc. v. SEC, 803 F.2d 942, 946 (1986); Meyer Blinder, 50 S.E.C. at 1230.
I conclude that the Respondents acted with scienter in the execution of this scheme and/or device to defraud. The record is replete with evidence that each of the Respondents, individually and collectively, intentionally or recklessly, acted in furtherance of this scheme.
Schmidt initially solicited Stoutt and introduced Stoutt to the other Respondents. Schmidt routed correspondence back and forth between Stoutt and the other Respondents. Schmidt convinced Stoutt to wire his money to an account at his brokerage firm with promises of "safekeeping." Gordon acted with apparent authority for La Jolla and helped convince Stoutt that the scheme was legitimate, that La Jolla would house the leased T-Bills, and that Stoutt would earn high rates of interest in a trading program. Avent and Dilworth both deceived Stoutt with the details of the scheme. They generated and sent fraudulent documents to add legitimacy to their representations. They convinced Stoutt to wire his money into an account under Avent's control and then disbursed Stoutt's funds, retaining a portion of the proceeds for themselves. All of the Respondents lulled Stoutt for as long as possible in furtherance of their scheme.
The jurisdictional requirements of the antifraud provisions are interpreted broadly. SEC v. Softpoint, Inc., 958 F. Supp. 846, 865 (S.D.N.Y. 1997). The Respondents consummated this scheme by way of mail, telephone, and bank wire. These acts meet the jurisdictional requirements.
Based upon the findings of fact as set out herein, I conclude that Respondents Avent, Dilworth, Gordon, and Schmidt, individually and collectively, knowingly participated in a scheme to defraud involving the offer and sale of securities, in willful violation of Section 17(a) of the Securities Act.
I further conclude that the OIP, in so far as it alleges a violation of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, be DISMISSED.
A. Public Interest
The imposition of administrative sanctions requires consideration of:
the egregiousness of the defendant's actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant's assurances against future violations, the defendant's recognition of the wrongful nature of his conduct, and the likelihood that the defendant's occupation will present opportunities for future violations.
Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979) (quoting SEC v. Blatt, 583 F.2d 1325, 1334 n. 29 (5th Cir. 1978)), aff'd on other grounds, 450 U.S. 91 (1981). The severity of a sanction depends on the facts of each case and the value of the sanction in preventing a recurrence. Berko v. SEC, 316 F.2d 137, 141 (2d Cir. 1963); Richard C. Spangler, Inc., 46 S.E.C. 238, 254 n. 67 (1976); Leo Glassman, 46 S.E.C. 209, 211-12 (1975). Sanctions should demonstrate to the particular respondent, the industry, and the public generally, that egregious conduct will elicit a harsh response. Arthur Lipper Corp. v. SEC, 547 F.2d 171, 184 (2d Cir. 1976).
Respondents Avent, Dilworth, Gordon, and Schmidt collaborated in furtherance of a fraudulent scheme. They fabricated an investment opportunity, and bolstered it with oral misrepresentations and deceptive documents. Gordon used his prior association with La Jolla to convince Stoutt that the T-Bills would be margined in an account. After Stoutt wired his money, the Respondents lulled Stoutt for as long as possible. There is evidence in the record that the Respondents' acts were not an isolated incident, but rather, a pattern of solicitations of fraudulent T-Bill leasing schemes and related schemes. At the hearing, the Respondents neither expressed remorse, nor admitted to the wrongful nature of their conduct. Respondent Schmidt's behavior was particularly egregious because he used his status as an associated person at a registered broker-dealer as a means of perpetrating this fraud.
B. Cease and Desist
The Division seeks cease and desist orders as to all Respondents. (OIP ¶ III.D; Div. Br. at 35.) The Commission may impose a cease and desist order pursuant to Section 8A(a) of the Securities Act and Section 21C(a) of the Exchange Act if the Commission finds that any person is violating, has violated, or is about to violate any rule or regulation. An order may issue absent a finding that a Respondent is apt to commit violations in the future, though evidence suggesting the probability of prospective violations may be relevant in deciding whether to issue an order.
Based on the public interest considerations explored above, the Respondents shall be ordered to cease and desist from committing any violations or future violations of Section 17(a) of the Securities Act.
C. Accounting and Disgorgement
The Division requests that an accounting and disgorgement, including reasonable interest, be ordered against Respondents Avent, Dilworth, and Gordon, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act. (OIP ¶ III.D; Div. Br. at 35).
Section 8A(e) of the Securities Act and Section 21C(e) of the Exchange Act provide that the Commission may enter an order requiring accounting and disgorgement, including reasonable interest. Disgorgement seeks solely to deprive the wrongdoer of his or her ill-gotten gains. See Hibbard, Brown & Co., 52 S.E.C. 170, 183 & n.64 (1995) (citing Hately v. SEC, 8 F.3d 653 (9th Cir. 1993)), aff'd 92 F.3d 1172 (3d Cir. 1996) (unpublished table decision); Toney L. Reed, 51 S.E.C. 1009, 1013 (1994) (same); Kenneth L. Lucas, 51 S.E.C. 1041, 1046 (1994) (citing SEC v. First City Fin. Corp., 890 F.2d 1215, 1230 (D.C. Cir. 1989)).
Any risk of uncertainty as to the disgorgement amount "should fall on the wrongdoer whose illegal conduct created that uncertainty." First City Fin. Corp., 890 F.2d at 1232 (citations omitted). Joint-and-several liability is appropriate in cases where two or more individuals collaborate or have close relationships in engaging in the illegal conduct. See SEC v. Hughes Capital Corp., 124 F.3d 449, 455 (3rd Cir. 1997).
Respondents Avent, Dilworth, and Gordon are jointly and severally liable for a disgorgement amount of $300,000, plus prejudgment interest from August 28, 1995.
D. Civil Penalties
The Division seeks the imposition of a monetary penalty of $100,000 against Respondent Schmidt pursuant to Exchange Act 21B(a). (OIP ¶ III.E; Div. Br. at 34). Schmidt will be ordered to pay a third-tier civil monetary penalty in the amount of $100,000. This amount is supported by the public interest analysis set forth above, and my finding that Schmidt's violations involved fraud and resulted in substantial losses or created the risk of substantial losses to other persons.
E. Bar and Suspension
Section 15(b) of the Exchange Act authorizes the Commission to order a wide range of sanctions restricting the ability of brokers, dealers, and those persons associated with, or seeking to become associated with brokers or dealers, to serve in the securities industry if the Commission determines that person has committed certain wrongful acts.
Schmidt used his registered status as a vehicle to perpetrate securities fraud. The severest sanction is warranted in this case. Schmidt will be barred from association with any broker or dealer.
Euro-Atlantic has not appeared or defended in this matter, and the Division recommends that its registration be revoked. Euro-Atlantic's registration as a broker-dealer is hereby revoked.
V. RECORD CERTIFICATION
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.351(b), I hereby certify that the record includes the items set forth in the record index issued by the Secretary of the Commission on March 18, 1999.
Based on the findings and conclusions set forth above, pursuant to Section 8A of the Securities Act and Sections 15(b), 21B, and 21C of the Exchange Act, I ORDER that:
(1) Respondents William Avent, John A. Dilworth II, Darlan E. Gordon, and Brian A. Schmidt shall cease and desist from committing any violations or future violations of Section 17(a) of the Securities Act.
(2) Respondents William Avent, John A. Dilworth II, and Darlan E. Gordon shall jointly and severally disgorge $300,000, plus prejudgment interest from August 28, 1995, through the last day of the month preceding the month in which payment of disgorgement is made. The rate of interest shall be that established under Section 6621(a)(2) of the Internal Revenue Code, 28 U.S.C. § 6621(a)(2), compounded quarterly, pursuant to Rule 600, 17 C.F.R. § 201.600 of the Commission's Rules of Practice.
(3) Respondent Brian A. Schmidt shall pay a civil penalty of $100,000.
(4) Respondent Brian A. Schmidt is barred from association with any broker or dealer.
(5) The registration of Euro-Atlantic Securities, Inc., is revoked.
(6) The OIP, in so far as it alleges a violation of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, is DISMISSED.
The payment of penalty, disgorgement, and interest shall be made on the first day after this decision becomes final. Such payment shall be: (1) made by United States postal money order, certified check, bank cashier's check, or bank money order; (2) made payable to the Securities and Exchange Commission; (3) delivered by hand or courier to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, Virginia 22312; and (4) submitted under cover letter which identifies the Respondents, and the file number of the proceeding. A copy of the cover letter should also be delivered to the Commission's Division of Enforcement.
This order shall become effective in accordance with and subject to the provisions of Rule 360, 17 C.F.R. § 201.360 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 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 the party, unless the Commission, pursuant to Rule 360(b)(1), determines on its own initiative to review this initial decision as to any party. If a party files a timely petition for review, or the Commission acts to review as to a party, the initial decision shall not become final as to that party.
Robert G. Mahony
Administrative Law Judge
1 Madden reached a settlement with the Commission and, without admitting or denying liability, agreed to a three month suspension from serving as a registered representative, a twelve month suspension from a supervisory capacity, and a $5,000 fine. John T. Madden, 68 SEC Docket 2788 (January 7, 1999).
2 The Respondents' posthearing briefs are referred to as "([Respondent] Br. __.)," respectively; the Division's posthearing brief is referred to as "(Div. Br. __.)," and the Division's reply brief is referred to as "(Div. Reply __.)."
3 Citations to the hearing transcript are designated "(Tr. __.)"
4 La Jolla is a registered broker-dealer based in San Diego, California.
5 Each Division exhibit is referred to by number as "(Div. Ex.__.)"; each Respondent exhibit is referred to by number as "(Resp. Ex.__.)."
6 In January 1995, Avent approached Gordon and Schmidt with letters of credit purportedly issued by the Republic of Georgia and certificates of deposit purportedly issued by Mexican banks. (Tr. 949-50.) These foreign notes bore a face value of $5 billion to $8 billion. (Tr. 955.) From January to approximately March 1995, Avent, Gordon, and Schmidt, worked together to authenticate these notes, and house and margin these notes at a brokerage house. (756-57, 949-53.) They were ultimately unsuccessful. (Tr. 758, 972.)
7 T-Bills are short-term obligations of the U.S. Government. They have maturities of one year or less, and are issued at a discount from face value. See BLACK'S LAW DICTIONARY 1501-02 (6th ed. 1990.)
8 Hetherington owned and operated Cal-West International, a company that brokered commercial loans. (Tr. 491-92.)
9 In the spring of 1995, Hetherington and Schmidt solicited Gary Goodman and Arthur Thayer, the principles of Excalibur, a Colorado company, to lease T-Bills. These T-Bills would be margined, and the proceeds placed in a high yield trading program, with returns of 1-3% a week in interest. (Tr. 980-81, 1111-12.)
10 In March 1995, Andron, Avent, and Schmidt were parties to a proposed T-Bill leasing transaction. (Tr. 418-41.) In the course of negotiations, Avent misrepresented to Andron that Northern Industries had $25.5 million in an account at Euro-Atlantic. (Tr. 335-36, 420, 872-77.) Schmidt bolstered this misrepresentation in a telephone conversation with Andron, and in a letter to Andron on Euro-Atlantic letterhead. (Tr. 421-23; Div. Exs. 70, 73.) The Division stipulated that Respondent Schmidt's witness, James L. Hayes (Hayes), a handwriting expert, if called to testify, would opine that he was not certain whether Schmidt's signature on the letter to Andron was genuine or whether it was superimposed from another document. (Tr. 1159-61; Resp. Ex. 15.) I have considered this stipulation and assign it no weight.
11 At approximately the same time as Schmidt offered the T-Bill leasing plan to Stoutt, Schmidt offered a similar plan to Hough. Hough needed to raise capital for his company, Milwaukee Tel-com Partners. (Tr. 1018.) Schmidt and Hough spoke on the phone on July 26, 1995, and Schmidt offered Hough a T-Bill lease of $5 million. (Div. Exs. 108-10.)
Schmidt sent Hough a letter on Euro-Atlantic letterhead, in which Schmidt requested a number of items of information that Hough needed to submit prior to consummation of the T-Bill lease. (Tr. 1019-23; Div. Exs. 108, 109.) These items included a business plan, a bank reference, and a letter of intent. (Tr. 1021-22; Div. Exs. 108, 109.) The letter also stated that $5 million was the minimum denomination available, and that these T-Bills could be leveraged and the proceeds from trading could be utilized to meet Hough's lease payment obligations. (Tr. 1022; Div. Ex. 108.)
12 In May 1995, Gordon and Schmidt met with Taylor in a private conference room at Euro-Atlantic. (Tr. 760, 768.) Taylor needed a loan to purchase a business, and sought methods of obtaining collateral. (Tr. 250-78.) Gordon and Schmidt proposed a T-Bill lease. (Tr. 254-56, 760-67.) They subsequently sent a letter to Taylor, on Euro-Atlantic letterhead, containing the terms of the proposed T-Bill lease. (Div. Ex. 77.) The Division stipulated that Hayes, Schmidt's handwriting expert, if called upon to testify, would opine that he was not certain whether Schmidt's signature on the letter to Taylor was genuine or whether it was superimposed from another document. (Tr. 1159-61; Resp. Ex. 15.) I have considered this stipulation and assign it no weight.
13 Burns & Gimble is a New York investment firm that purportedly leases T-Bills through a source in Switzerland. (Tr. 61.)
14 Dilworth testified that he first heard about EEG while investigating not-for-profit companies involved in mortgage pools. EEG struck Dilworth as more knowledgeable about complex financial matters than the local entities he was familiar with. According to Dilworth, EEG has a large quantity of T-Bills in a trust, and it is willing to lease them to others under a contract called a Deed of Assignment. Dilworth testified that he obtained a Deed of Assignment for $20 million in T-Bills, for which he paid $500,000 a month, and that he was going to assign one-half of his rights under the Deed of Assignment to Stoutt. (Tr. 643, 687.)
15 Gordon testified that he knew about the relationship between Dilworth and the EEG trust because, in June 1995, he and Dilworth had attempted to house and margin Dilworth's Deed of Assignment for $20 million in T-Bills at La Jolla. (Tr. 644, 768.) Gordon was employed with La Jolla at the time. Dilworth and Gordon told La Jolla that they had gone to Texas and visited the mandate of the EEG trust, and they were convinced of the authenticity of the trust and the Deed of Assignment. (Tr. 649-50, 768, 776.) There is no evidence in the record that La Jolla housed and margined the leased T-Bills.
16 Ross is purportedly an attorney in Dallas, Texas. Ross has been alternatively described as a representative, mandate, or escrow agent for EEG.
17 The MPO actually consisted of two separate pay orders. The first pay order provided commissions to be paid to Dedman, Hetherington, and Schmidt, on the trading program at La Jolla. (Tr. 99-100; Div. Exs. 14, 15, 17.) They were entitled to split equally a commission of 1.5% per trade on Stoutt's trading program. The second pay order provided a commission of $25,000 to compensate Hetherington and Schmidt for arranging the $10 million T-Bill lease. (Tr. 100-01; Div. Ex. 16.)
18 The Tacoma account was controlled by Dr. Rasheed. The money transferred was the first month's lease payment, and future payments would be made from the proceeds of a high yield trading program. (Tr. 1060-63.) Both Avent and Gordon participated in this transaction, although the record is unclear as to their exact roles. (Tr. 1061; Div. Ex. 101 at 16.)
19 T-Bills may be assigned if deposited at an intermediary institution which would act as a custodian. There must still be an electronic transfer of the T-Bills from the assignor to the intermediary institution. A paper agreement will not suffice. (Tr. 402.)
20 Prime bank instruments are nonexistent and fraudulent. See, e.g., SEC v. Lauer, 52 F.3d 667, 670 (7th Cir. 1995); SEC v. Bremont, 954 F. Supp. 726, 730-31 (S.D.N.Y. 1997); Martin R. Kaiden, 70 SEC Docket 439, 447-49 (July 20, 1999).
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