Initial Decision of an SEC Administrative Law Judge
In the Matter of
In the Matter of
FEELEY AND WILLCOX ASSET
May 16, 2000
Robert Knuts and Jonathan L. Choslovsky for the Division of Enforcement, Securities and Exchange Commission
Lee D. Unterman and Cristin L. Flynn for Respondents Feeley and Willcox Asset Management Corporation and Michael J. Feeley
Brenda P. Murray, Chief Administrative Law Judge
The Securities and Exchange Commission ("Commission") initiated an informal inquiry into the business practices of Feeley and Willcox Asset Management Corporation ("F&WAM") on January 19, 1996, and it issued a Formal Order of Private Investigation on May 29, 1996. (Div. Exs. 76, 79.) On July 30, 1996, Judge John G. Koetl, U.S. District Court Southern District of New York, issued an Order to Show Cause why Respondents should not be held in contempt for failing to comply with a Commission subpoena for financial records. (Div. Ex. 79.) On August 20, 1996, the court ordered Respondents to produce documents and for Mr. Feeley to be deposed. (Div. Ex. 80.)
The Commission issued an Order Instituting Proceedings ("OIP") on March 27, 1998, pursuant to Section 8A of the Securities Act of 1933 ("Securities Act"); Section 15(b)(6) and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act"); and Section 203(e), Section 203(f), and Section 203(k) of the Investment Advisers Act of 1940 ("Advisers Act"). In February 1997, Mr. Feeley's attorney refused to produce any records voluntarily to the Division of Enforcement ("Division"). (Tr. 574; Div. Ex. 78.) On August 21, 1998, I issued a subpoena duces tecum to Mr. Feeley for the production of Feeley & Willcox, Inc. ("F&W Inc.") board of director minutes, shareholder meeting minutes, and federal tax returns for 1986-97; federal tax returns for F&WAM for 1994-97; Mr. Feeley's federal tax returns for 1993-97; and the original debentures issued by F&W Inc. in 1986. (Div. Ex. 109.)
On August 31 through September 3, 1998, I held a hearing in New York City. The Division presented seven witnesses and offered seventy-eight exhibits. Respondents presented four witnesses and offered twenty-three exhibits.1
Respondents failed to produce the following subpoenaed materials: F&W Inc. board of director minutes, shareholder meeting minutes, and federal tax returns for 1986-97; F&WAM federal income tax returns for 1994-97; Mr. Feeley's federal tax returns for 1993-97; and the original debentures issued by F&W Inc. in 1986. (Tr. 347-50.) Mr. Feeley claims that he could not locate many records of F&W Inc. in the 150 boxes in storage in Brooklyn, New York; that a former accounting firm will not release documents until its outstanding bill is paid; and that he cannot find copies of his personal income tax returns for the years 1993 through 1997. (Tr. 353-54, 572-74.)
I denied Respondents' Motion for a Directed Verdict made after the Division concluded its direct case. (Tr. 578, 580.)
The Division filed its Post-Hearing Memorandum on October 27, 1998. Respondents F&WAM and Michael J. Feeley filed their Post-Hearing Brief on December 16, 1998. The Division filed its Post-Hearing Reply Memorandum on December 23, 1998.2
Pursuant to 17 C.F.R. § 201.323, I take official notice of the fact that on January 31, 2000, the Commission cancelled the investment adviser registration of F&WAM based on a finding that the registrant no longer exists or is not engaged in business as an investment adviser. Order Cancelling Registration Pursuant to Section 203(h) of the Investment Advisers Act of 1940, File No. 80128021 (Jan. 31, 2000) ("Order Cancelling Registration").
- Did the Respondents willfully violate Section 17(a)(1), Section 17(a)(2), and Section 17(a)(3) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by representing to clients that the Series C Debentures were good investments and failing to disclose the poor financial condition of F&W Inc.?
- Did F&WAM willfully violate Section 206(1) and Section 206(2) of the Advisers Act by failing to disclose: (1) the poor financial condition of F&W Inc., and the conflicts of interests present in the transaction when it recommended that clients purchase the Series C Debentures or make a bridge loan; and (2) the financial arrangements between Mr. Feeley and Ernst & Co. when it recommended that F&WAM clients open brokerage accounts at Ernst & Co., and did Mr. Feeley cause and willfully aid and abet these violations by F&WAM?
- Did F&WAM willfully violate Section 204 of the Advisers Act and Rule 204-1 thereunder by failing to: (1) amend its Form ADV; (2) file audited balance sheets reflecting custody over client funds; and (3) file Forms ADV-S during the period January 1994 to December 1996, and did Mr. Feeley cause and willfully aid and abet these violations by F&WAM?
- Did F&WAM willfully violate Section 204 of the Advisers Act and Rule 204-2 thereunder by failing to properly maintain its books and records, and did Mr. Feeley cause and willfully aid and abet these violations by F&WAM?
- Did F&WAM willfully violate Section 204 of the Advisers Act by failing to provide Commission representatives with access to its books and records during the period from November 1995 through August 1996, and did Mr. Feeley cause and willfully aid and abet these violations by F&WAM?
II. FINDINGS OF FACT
My findings are based on the record and my observation of the witnesses' demeanor. I applied preponderance of the evidence as the applicable standard of proof. See Steadman v. SEC, 450 U.S. 91, 102 (1981). I have considered all posthearing submissions by the parties.
A. Respondents and Relevant Entities
1. Respondent Michael Feeley
Mr. Feeley earned a degree in economics from Georgetown University in 1966, a juris doctor degree from Fordham Law School in 1969, and a master of business administration degree from Harvard in 1971. From 1971 to 1975, he worked as a securities analyst, and in institutional sales and money management marketing with Mitchell Hutchins. Mr. Feeley joined Brown Brothers Harriman & Company as an institutional salesman in 1975, where he also worked in portfolio management and corporate finance. (Tr. 354-55.)
In 1986 Mr. Feeley and Peter Willcox began F&W Inc.3 The firm's letterhead advertised "[a] wholistic approach to people and finance." (Div. Ex. 8.) Mr. Feeley's public posture emphasized putting people, not money, first and that "people should always be treated as ends and never means and that money should always be thought of as means, never ends." (Tr. 729, 753.) F&W Inc. had two wholly owned subsidiaries: a broker-dealer, Feeley & Willcox Securities Corporation ("F&W Securities"), and a registered investment adviser, F&WAM, that provided clients with an integrated and cost-efficient approach to meet their investment needs. (Tr. 752; Resp. Br. at 4.)
2. Feeley & Willcox, Inc.
Mr. Feeley was president, director, and treasurer of F&W Inc. (Tr. 42, 220, 366.) Mr. Feeley was responsible for the firm's capitalization, corporate finance, and marketing. (Tr. 42.) Mr. Willcox was executive vice president of the firm, and he also served as a director of the firm from 1986 to the fall of 1992. (Tr. 45, 92.)
F&W Inc.'s initial capitalization came almost exclusively from a private offering to about twenty-eight people of units that consisted of 1,000 shares of stock at $5.00 per share and a 10-year convertible debenture at 10% per annum with interest paid semiannually in March and September. (Tr. 366-67, 608, 611.) The debentures were convertible at $10.00 a share. (Tr. 367.) The units were priced at $15,000 each, and sales took place from June through November 1986. (Tr. 366-67.) Mr. Feeley, an excellent salesperson, sold most of the units to his family, clients, and friends.4 (Tr. 226, 366-67.) Mr. Feeley and Mr. Willcox each contributed capital to F&W Inc. of $30,000 to $40,000. (Tr. 171-72.)
In 1988-89, Arthur Gray, Jr., a friend of Mr. Feeley and an adviser with over fifty years of experience, purchased about $2 million of the original 1986 debentures with the 1996 maturity date for some clients with large discretionary accounts.5 (Tr. 368-69, 379-81, 588-89, 596, 599, 617.)
F&W Inc. raised total revenues of about $3.3 million from sales of the original units from 1986-89. (Tr. 700; Resp. Ex. 8 at 9, Resp. Ex. 18 at 8.)
From its inception in 1986, F&W Inc. and its subsidiaries had increased revenues and acquired a favorable reputation, but it never operated at a profit over a 12-month period.6 (Tr. 221-22, 233, 594, 599; Resp. Ex. 8 at 8, Resp. Ex. 18 at 7.) Cash flow was a constant problem; the firm had difficulties paying its bills and the annual interest payments of $330,000. (Tr. 130, 221-24, 235-36, 608-11; Resp. Ex. 8 at 9, Resp. Ex. 18 at 8.)
In 1990, F&W Inc. had revenues of $2.5 million: $1.9 million from F&W Securities, $400,000 from corporate finance activities conducted by the holding company or by F&W Securities, and $200,000 from F&WAM. (Tr. 699.) The firm and its subsidiaries crested at thirty to forty employees in 1991 before its deteriorating financial situation caused a number of cut-backs. (Tr. 634, 754.) At the end of 1991, Mr. Willcox told Mr. Feeley that unless he received income from the firm in 1992 of at least $5,000 a month he would be forced to leave.7 (Tr. 374-75.)
Despite an equity offering in 1987 that raised only $200,000 to $300,000 of an expected $2 million, F&W Inc. planned a $3 million private equity offering for the fall of 1992, as a means of relieving the financial pressure on the firm. (Tr. 368, 380, 382, 700-01; Resp. Ex. 8 at 9, Resp. Ex. 18 at 8.) In anticipation of the offering, which was seen by some as necessary for the firm's survival, F&W Inc.'s twenty to thirty employees made a major effort, and the firm showed an operating profit for the first half of 1992. (Tr. 55-58, 94, 120-21, 375-77, 634, 701.) However, Mr. Feeley, against the advice of officers of the firm, decided in September 1992, to raise additional funds by offering additional debentures ("Series C debentures or bridge loans").8 (Tr. 79, 223, 402-03, 650-51.) A document inaccurately titled Unanimous Written Consent of Directors dated September 29, 1992, signed by Mr. Feeley, but not by the only other director, Mr. Willcox, authorized F&W Inc. to offer and sell up to $500,000 worth of 12% Series C debentures due June 30, 1993, together with warrants to purchase up to 25,000 shares of common stock at an exercise price of $10.00 per share. (Tr. 169-70, 408, 420-21, 423.) The Series C debentures were offered in two series; one took place from September 29 through October 13, 1992, and the second in March 1993. (Tr. 661.) Mr. Feeley raised about $300,000 by selling the Series C debentures to about ten or twelve F&WAM clients. (Tr. 408, 648, 651, 701.)
Mr. Feeley insists that "we were pretty excited about the firm" in late 1992 and early 1993. He was optimistic that F&W Inc. would repay the debentures, and there was a high probability that F&W Inc. would complete the equity financing. (Tr. 422, 523-26, 528, 536-39.) Mr. Feeley's recollection is that a computer glitch delayed the equity offering and the Series C debentures were to give the firm working capital to complete the equity offering. (Tr. 381-82, 402-03, 651.)
F&W Inc. made its last interest payment on the original debentures in September 1993. (Tr. 608.) It missed the interest payment due March 1994, but informed debenture holders that it hoped to get current by September 1994. (Tr. 611, 613.) Mr. Gray wrote the debentures off on September 30, 1994, when F&W Inc. fell a year behind in making payments, and he stopped doing business with Mr. Feeley and F&W Securities. (Tr. 614-15.)
In 1992 and 1993, Mr. Feeley saw China as a source of business opportunities, and he initiated the Chinese Initiative at F&W Inc. (Tr. 443-46.) In 1993 or earlier, he began associating with people in the Sino American Development Corporation ("Sino American"), a consulting organization. (Tr. 94-95, 442.) In September 1994, Mr. Feeley used the staff of F&W Inc. to organize a meeting with visiting Chinese dignitaries and several dozen American executives, hoping to form a China Business Roundtable ("Roundtable") which 200 or so American business executives would join at an annual cost of $30,000. (Tr. 228-29, 445.) Only three American companies signed up for the Roundtable. (Tr. 447.) Because he spent his time trying to develop business in China, Mr. Feeley spent less time generating brokerage revenues and promoting investment banking deals for F&W Inc. (Tr. 226.) Mr. Willcox, Mr. Kulp, and others at F&W Inc. were angry when they learned that Mr. Feeley, not F&W Inc., became an owner of Sino American.9 (Tr. 100-03, 227.) Mr. Feeley became chairman of Sino American in October 1993. (Tr. 808.) He was compensated for his work. (Tr. 808.) Mr. Feeley contends that Sino American paid F&W Inc. about $180,000, and that F&W Inc. profited from the relationship by $200,000 to $300,000; yet, he acknowledges that F&W Inc. has an unpaid $100,000 account receivable from Sino American. (Tr. 447, 668-69.)
F&W Securities ceased operations on March 31, 1995. (Tr. 103.) Mr. Feeley maintains that he decides on which creditors to pay using the guiding principle "to do what I think is most right, given . . . all the circumstances." (Tr. 775-76.) He has written clients that he will continue to work on repayment as long as he lives. (Tr. 776.) Mr. Feeley denies that the threat of a lawsuit caused him to pay one account in full, but the evidence is that the firm paid its debts applying the "squeaky wheel" principle. (Tr. 159, 776-77.)
3. F&W Securities
In 1986, Conklin Cahill, Incorporated, later Conklin, Cahill, & Feeley, Incorporated, became F&W Securities, a registered broker-dealer and member of the New York Stock Exchange ("NYSE") until June 29, 1995. (Tr. 356-57; Div. Ex. 63.) Mr. Feeley was president, secretary, and director of F&W Securities. (Tr. 220.)
Broker-dealers are required to submit Financial and Operational Combined Uniform Single ("FOCUS") reports that include a net capital calculation. See Rule 17a-5(a), 17 C.F.R. § 240.17a-5(a). In the fall of 1994, while preparing F&W Securities' FOCUS report, the firm's comptroller questioned whether the firm had sufficient capital because it appeared that a loan Mr. Feeley had negotiated from Sino American was not collateralized by dollars. (Tr. 226-28, 449-51.) Mr. Feeley insisted that the loan was collateralized. (Tr. 227-28.) The firm followed Mr. Feeley's opinion, and the result was that the NYSE forced it to voluntarily suspend operations on January 4, 1995, because of inaccurate records and capital compliance violations. (Tr. 252, 257, 263, 277, 459-60; Div. Exs. 63, 64, 116-20.)
In the fall of 1994, Mr. Feeley asked Ernst & Co. to take over the clearing activities for F&W Securities. (Tr. 248-49.) Ernst & Co. entered an agreement to clear transactions for F&W Securities on January 19, 1995. (Tr. 252; Div. Ex. 65.) Mr. Feeley did not tell Mr. Behrens, chair and chief executive officer of Ernst & Co., that the NYSE had in effect suspended F&W Securities about two weeks prior to the agreement. (Tr. 252, 257, 453, 459-60.) Ernst & Co. would have considered this information important in deciding whether to enter the clearing arrangement. (Tr. 255-56.)
Again, at Mr. Feeley's request, on January 31, 1995, Ernst & Co. entered into a $50,000 Cash Subordination Agreement and a $100,000 Secured Demand Note Collateral Agreement ("Secured Demand Note") maturing February 10, 1996, with F&W Securities. (Div. Exs. 66, 67.) Mr. Feeley told Mr. Behrens that F&W Securities needed additional capital because it had to restate its 1994 financials and could not obtain certified financial statements so that there was a possibility the NYSE might take action. (Tr. 257.) Mr. Feeley told Mr. Behrens that "he would make good if anything happened to the loans that Ernst & Co. made." (Tr. 265-66, 463-64.)
When F&W Securities closed its operations on March 31, 1995, the $50,000 cash was gone, but the $100,000 Secured Demand Note was still "standing" and became part of the capital account of F&W Securities.10 (Tr. 103, 264, 466, 560; Div. Exs. 24, 25, 28.) In late March or early April 1995, Mr. Feeley moved his licenses and brokerage business to Ernst & Co. (Tr. 265, 547; Div. Ex. 8.) By a Demand Note Collateral Agreement and a Promissory Note dated April 1, 1995, Mr. Feeley agreed that one-half of his commissions would go to repay Ernst & Co. on the $150,000 loan plus accrued interest. (Tr. 265, 555; Div. Ex. 68.)
Mr. Feeley sent a letter dated April 6, 1995, to F&W Securities clients, most of whom were also F&WAM clients, advising them that he had moved to Ernst & Co. and enclosing forms to transfer their brokerage accounts to Ernst & Co. (Tr. 548-50, 770; Div. Ex. 8.) In effect, when Mr. Feeley began working as a registered representative with Ernst & Co., his F&W Securities clients became Ernst & Co. clients. (Tr. 276, 465.) Mr. Feeley did not disclose to his clients that he was going to use one-half of the commissions to repay the $150,000 Ernst & Co. had loaned F&W Securities. (Tr. 200, 741; Div. Ex. 8, Div. Ex. 83 at 95-96, Div. Ex. 84 at 73-74.)
Ernst & Co. sent out a notice in September 1996 informing Mr. Feeley's brokerage and investment adviser clients that he had agreed to use one-half of his commissions to repay the loans. (Tr. 269-70; Div. Exs. 9, 122.) The delay was because Mr. Feeley wanted his attorney involved. (Tr. 270.) Mr. Feeley left Ernst & Co. in September/October 1997, by which time he had repaid Ernst & Co. $50,000 with interest. (Tr. 266-67.)
F&WAM is a New York corporation and a registered investment adviser.11 (Tr. 86.) F&WAM conducted its investment adviser activities using the instrumentalities of interstate commerce including the mails. In 1992, F&WAM had about fifty clients, including three limited partnerships, institutional clients, and individuals. (Tr. 48-49, 363, 632-34, 647.) Almost all F&WAM clients had accounts at F&W Securities. (Tr. 548-50, 770.) Mr. Feeley was chairman of the board, secretary, and compliance officer, and Mr. Willcox was a director and responsible for product development and managing portfolio assets. (Tr. 111-12, 115-16, 220.)
According to Mr. Feeley, "we restructured in March of 95, we basically wound everything down" and were "finally able to move the entity into a positive cash flow" situation by eliminating all costs except storage and legal fees. By running the adviser with part-time personnel Mr. Feeley was able to use advisory management fees to pay off creditors. (Tr. 430.) Subsequent to March 1995, there were less than twenty F&WAM clients. (Tr. 679.) In September 1998, Mr. Feeley was F&WAM's only employee, and the firm managed approximately $100 million for less than ten clients who cumulatively paid annual advisory fees of between $60,000 and $80,000. (Tr. 646, 715, 755-56, 760-63; Div. Ex. 114.)
5. F&WAM Clients
a. Sandra Feeley
Sandra Feeley, a self-employed hair stylist in Summit, New Jersey, is not related to Mr. Feeley. (Tr. 181-83, 713.) Ms. Feeley opened an account with F&WAM in August 1987 because she knew Mr. Feeley as one of her customers and she trusted him. (Tr. 182-83; Div. Ex. 82.) Ms. Feeley invested her total retirement savings with F&WAM and has added to the account. (Tr. 183, 213.) Ms. Feeley is not knowledgeable about investments. She explained to Mr. Feeley that because she did not participate in an employer pension plan, she wanted conservative investments so as not to risk her retirement funds. (Tr. 184; Div. Ex. 82 at 3.)
Ms. Feeley followed Mr. Feeley's recommendation and used the proceeds of a life insurance policy provided to her by her mother to purchase a 1-year, $25,000, Series C debenture at 12% issued by F&W Inc. and dated March 26, 1993. (Tr. 191-92, 213-14; Div. Ex. 56.) Mr. Feeley did not disclose the precarious financial condition of F&W Inc. to Ms. Feeley when he recommended that she purchase the Series C debenture. (Tr. 191-93, 199-200.) In 1995, when Ms. Feeley asked Mr. Feeley why he had transferred her account from F&WAM to Ernst & Co., he lied and said it was because the company was restructuring. (Tr. 200.) Mr. Feeley did not reveal his financial arrangements with Ernst & Co. to Ms. Feeley when he transferred the account. (Tr. 200.)
Ms. Feeley began receiving some return of principal in 1996, after Mr. Feeley represented he would begin to make quarterly payments to the best of his ability. (Tr. 196-97, 208-09; Resp. Ex. 1.) It has been necessary for Ms. Feeley to call Mr. Feeley's office each quarter and remind his secretary that a payment is due. (Tr. 197-98.) Ms. Feeley has never received any interest payments. On March 22, 1996, two years after the debenture matured in March 1994, Mr. Feeley sent Ms. Feeley a letter representing that interest was accruing at 12% in the account. The letter signed by Mr. Feeley as president of F&W, Inc., says "we will repay the [principal] first and then calculate the interest due." (Tr. 212; Resp. Ex. 1.) There is no evidence in the record as to where the account is, and no interest payments have been made. (Tr. 196.) The letter does not specify what figure the 12% will be applied to. (Tr. 207, 209-11; Resp. Ex. 1.) As of August 31, 1998, Ms. Feeley had recovered about $12,000 of her principal investment of $25,000.12 (Tr. 196.)
b. Simon B. Leventhal
Simon B. Leventhal is a dentist in Whippany, New Jersey. (Tr. 481.) Dr. Leventhal met Mr. Feeley in 1984 when they both served on the board of a small insurance company. (Tr. 481-82.) On September 8, 1987, Dr. Leventhal opened an account with F&WAM for the deposit of his retirement funds from his dental group.13 (Tr. 483-84, 486-88; Div. Ex. 40.)
In October 1992, Dr. Leventhal loaned F&W Inc. $25,000 from the retirement account for one month at at annualized interest rate of 12%. (Div. Exs. 41, 42.) Dr. Leventhal's account statement dated December 31, 1995, describes the loan as a bridge loan with a current yield of 12%. (Div. Ex. 46.) Mr. Feeley told Dr. Leventhal that the funds would be used to "capitalize" the firm and "put it on a more sound financial basis," and he recommended this short-term loan as a good investment that was not out of line with Dr. Leventhal's investment guidelines. (Tr. 489-91.) Dr. Leventhal followed Mr. Feeley's recommendation and extended the maturity date of the promissory note to December 31, 1992; then to December 31, 1993; and later to December 31, 1994. (Tr. 575-77; Div. Exs. 43-45.) As of September 2, 1998, Dr. Leventhal had not received any interest payments or return of principal. (Tr. 490.)
Dr. Leventhal transferred his account to Ernst & Co. in April 1995 at Mr. Feeley's request. Dr. Leventhal's quarterly statement dated December 31, 1995, shows 5,000 shares of "Feeley & Willcox common stock" with a market value of $25,000, a $10,000 "Feeley & Willcox" convertible debenture with a current yield of 10%, and the $25,000 "Feeley & Willcox" bridge loan with a current yield of 12%. (Div. Ex. 46.)
F&WAM's fee is based on assets in the account excluding the common stock of F&W Inc. which Mr. Feeley valued in the invoice he sent to Dr. Leventhal dated July 16, 1997, at $60,000. (Tr. 506; Resp. Ex. 4 at 7.)
c. James J. Donahue
James J. Donahue opened an account with Mr. Feeley while he was at Brown Brothers Harriman & Company. (Div. Ex. 84 at 14.) He met Mr. Feeley through an organization he joined following his retirement from Burlington Industries as vice president of marketing communications. (Div. Ex. 84 at 13, 98.) Mr. Donahue came to trust Mr. Feeley's judgment. (Div. Ex. 84 at 14.) Mr. Donahue transferred his account to F&WAM on May 28, 1986. (Div. Ex. 84 at 14, 16.) A long-time investor, Mr. Donahue has a master of business administration degree and a layman's understanding of finances. (Div. Ex. 84 at 10-11.) Mr. Feeley called Mr. Donahue around September 1992, and recommended that Mr. Donahue invest in F&W Inc. (Div. Ex. 84 at 32.) Mr. Donahue was reassured by Mr. Feeley's description that the bridge loan would allow him to participate in F&W Inc.'s expansion and receive a higher return than was available from a bank. (Div. Ex. 84 at 32-35, 96.) Mr. Donahue purchased a $20,000 Series C debenture at 12% on September 29, 1992. (Div. Ex. 13, Div. Ex. 84 at 39-40.) Mr. Feeley did not tell Mr. Donahue that F&W Inc. was in poor financial condition or that the loan involved any unusual risk. (Div. Ex. 84 at 35, 37, 40, 96.) Mr. Donahue ultimately invested a total of $60,000 in three Series C debentures at 12%. (Div. Ex. 84 at 43.) Mr. Donahue is angry with himself for agreeing to invest in the debentures. "I can hit myself for not . . . being sharper and harder on Mike than I was." (Div. Ex. 84 at 110.)
Mr. Feeley sent Mr. Donahue $2,500 in early 1998 indicating this was the first repayment. (Div. Ex. 84 at 43.) This check is the only repayment Mr. Donahue has received on the $60,000 worth of debentures he purchased from F&W Inc. in 1992. (Div. Ex. 84 at 40-44.) Mr. Feeley has given Mr. Donahue vague responses to repeated inquiries as to the status of the debentures. Despite what has happened, Mr. Donahue is depending on Mr. Feeley to carry through on his promise to pay back all the money "because that's the only thing that stands between me and a complete loss." (Div. Ex. 84 at 45-46, 93-95.)
F&WAM charged Mr. Donahue a quarterly management fee based on the value of assets in his account. (Div. Exs. 14, 15, Div. Ex. 84 at 50.) Mr. Donahue paid some of the bills until he determined that some of the assets, including the three F&W Inc. Series C debentures shown with positive values, were worthless. He then reduced the assets and submitted a lower payment. (Div. Ex. 84 at 50-52.) Mr. Feeley accepted Mr. Donahue's corrections. (Div. Ex. 84 at 50, 90-91.)
Mr. Feeley moved Mr. Donahue's brokerage account to Ernst & Co. without telling Mr. Donahue of his financial arrangements with Ernst & Co. (Div. Ex. 84 at 72.) At the time, Mr. Feeley explained to Mr. Donahue that "his company was going down the tubes" but that "all is not lost" and "we go on from here." (Div. Ex. 84 at 62, 94-95.) He did not tell Mr. Donahue that he had an agreement to share his commissions with Ernst & Co. to pay off the loans, but that information would not have made any difference to Mr. Donahue who reasoned that Ernst & Co. must have been receiving some financial benefit. (Div. Ex. 84 at 73-74, 76.)
d. Patrick Sean Murphy
Patrick Sean Murphy earned a master of fine arts degree from Yale in 1988 and is employed as an actor and college drama professor. (Div. Ex. 83 at 10-11.) Mr. Murphy is not interested in researching investments and relies on the advice of others. (Div. Ex. 83 at 14-15.) On the recommendation of Arthur Gray, Jr., Mr. Murphy opened an account with F&WAM in October 1988 and deposited approximately $150,000 that he had inherited from his parents. (Div. Ex. 83 at 13, 16, 21, 32, 43.) Mr. Murphy directed Mr. Feeley to invest his funds in conservative investments with low risk so that over the long-term he would be sure to have the money available to buy a home or for retirement. (Div. Ex. 83 at 14-15, 17, 20-24.) Mr. Murphy's low risk approach was caused in part by the "stock market crash" in October 1987, the previous year. (Div. Ex. 83 at 23-24.)
In the early 1990's, Mr. Murphy became uncomfortable at the increased level of commissions he was paying as a result of the increased number of transactions in his account. (Div. Ex. 83 at 26-27.)
In late September 1992, Mr. Feeley called Mr. Murphy and advised him to invest $25,000 in a Series C debenture at 12%, maturing June 30, 1993. (Div. Exs. 3-5, Div. Ex. 83 at 28-29, 31.) Mr. Feeley told Mr. Murphy it was a "wonderful opportunity" with a large return and that Mr. Murphy had to act quickly. (Div. Ex. 83 at 28-30, 38-39, 82.) Mr. Feeley did not provide Mr. Murphy with any information, financial or otherwise, about F&W Inc. (Div. Ex. 83 at 36-38.) About the same time, Mr. Murphy, at Mr. Feeley's recommendation, agreed to a second $25,000 loan. (Div. Ex. 83 at 39-40, 59-60, 84-85.) Mr. Murphy cannot find documentation for the second loan, and when he asked Mr. Feeley for copies, he was told that the materials were in storage. (Div. Ex. 83 at 39-40, 86-87.) In 1992, Mr. Murphy did not understand a bridge loan or a debenture. (Div. Ex. 83 at 29, 33, 80, 84.) Mr. Feeley did not mention risk, so that Mr. Murphy thought there was no risk involved when he agreed to the investments totaling $50,000. (Div. Ex. 83 at 34, 83.) If Mr. Murphy had known that the Series C debentures were risky investments, he would not have participated. (Div. Ex. 83 at 83.)
For several years, F&WAM's management fee included service on the bridge loans in Mr. Murphy's account. (Div. Ex. 83 at 47.) For example, for the fourth quarter of 1995, F&WAM charged Mr. Murphy a management fee of $531 or one quarter of 1% of the alleged account value of $212,000. This account value included $50,000 of bridge loans to F&W Inc. (Div. Ex. 7, Div. Ex. 83 at 45-47.) It was about this time that Mr. Murphy learned that the investments in his account were totally out of line with his investment objectives and that many of his assets were loans to F&W Inc. (Div. Ex. 83 at 43-44.)
F&WAM did not give Mr. Murphy timely notice of its change of address and phone number. Mr. Murphy tracked down Mr. Feeley at Ernst & Co. to inquire about his account, and Mr. Feeley told him "the company folded." (Div. Ex. 83 at 47, 95-96.) Mr. Feeley blamed "some man who had done something which caused this all to crumble. I asked him about the bridge loans and he said he would pay me back." (Div. Ex. 83 at 49.)
In April 1997, Mr. Murphy transferred the balance in his account, $117,000, and terminated his relationship with Mr. Feeley. (Div. Ex. 83 at 54, 58.) In the fall of 1997, Mr. Feeley calculated that he owed Mr. Murphy about $90,000 on the Series C debentures. (Div. Ex. 83 at 58.) Mr. Feeley has failed to keep his commitment to pay Mr. Murphy $1,000 a quarter on the debentures, and he refused to sign a document specifying the amount he owed Mr. Murphy and a repayment schedule. (Div. Ex. 83 at 56.) As of July 31, 1998, Mr. Feeley had repaid Mr. Murphy a total of $7,000. (Div. Ex. 83 at 56.)
e. Edward McDougal
Edward McDougal is a sophisticated securities investor who has been involved in the financial services industry for over twenty years. (Tr. 718-20, 743.) Mr. McDougal met Mr. Feeley through mutual acquaintances in early to mid-1992. (Tr. 720-21.) In December 1993, Mr. McDougal deposited $240,000, a portion of his portfolio holdings earmarked for retirement, at F&WAM in a discretionary account. (Tr. 724, 726, 728; Resp. Ex. 20.) Mr. McDougal's account objective was long-term growth that involved taking some risk. (Tr. 725.)
In 1994, Mr. McDougal purchased a $50,000 F&W Inc. debenture maturing in September of 1996 and paying 10% annually. (Tr. 731; Resp. Ex. 21.) Mr. McDougal knew from conversations with Mr. Feeley that the firm was struggling to become profitable. (Tr. 730-31.) Mr. McDougal considered the debenture to be high-risk because it was a private investment in a new firm that had not yet achieved profitability. (Tr. 730-33, 738-39.) As of September 3, 1998, Mr. McDougal had not received any interest or return of principal, and he considered the funds lost but believes Mr. Feeley will make good on his investment if he is ever able to do so. (Tr. 737, 746.)
In 1998, Mr. McDougal continued to have an account with F&WAM. (Tr. 741-42.) He was unaware, when his account was moved to Ernst & Co., of Mr. Feeley's financial arrangements with that firm. (Tr. 741.)
f. David Lewis Vienneau
David Vienneau has a bachelor of science degree in psychology and a master of science degree in industrial science. Mr. Vienneau is president of an insurance company and several human resource consulting companies and a partner in three other businesses. (Tr. 810-11.) Mr. Vienneau and his wife opened an account at F&WAM with between $30,000 and $50,000 on September 16, 1991, that they intended to be a retirement account with an emphasis on quality investments over the long-term. (Tr. 811-14; Resp. Ex. 22.)
In about 1993 or 1994, Mr. Vienneau invested roughly $20,000 in F&W Inc. Series C debentures that Mr. Feeley recommended to him in response to his request for higher growth investments for his account, even those that involved enhanced risk. (Tr. 815-16.) Mr. Feeley described the difficulties in growing a business, but provided no specifics about F&W Inc.'s financial condition. (Tr. 815-17.) Mr. Vienneau has received one interest payment, but no return of his $20,000 principal. (Tr. 822.)
As of October 31, 1998, Mr. Vienneau valued his account at F&WAM at $350,000. At least $250,000 represents his contributions to the account. (Tr. 822.) Mr. Vienneau has a similar amount at other brokerage firms. (Tr. 823.) Mr. Vienneau spends time considering investment opportunities and makes his own investment decisions. (Tr. 820, 823-24.) He reviews the status of his portfolios bimonthly. (Tr. 822.) Mr. Vienneau is pleased with Mr. Feeley's investment adviser services. (Tr. 824.)
III. CONCLUSIONS OF LAW
A. Did Respondents Violate Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5?
Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 prohibit fraud in the offer, sale, or in connection with the purchase of a security. The required elements are a misstatement or omission of a material fact by a person acting with scienter. To violate Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5, a person must be shown to have acted with scienter, defined as "a mental state embracing the intent to deceive, manipulate, or defraud."14 Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). A showing of recklessness is sufficient to satisfy the scienter requirement.15 See Hackbart v. Holmes, 675 F.2d 1114, 1117 (10th Cir. 1982); see, e.g., Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990) (en banc) (as amended). Scienter is not required for a violation of Section 17(a)(2) and Section 17(a)(3). See Aaron v. SEC, 446 U.S. 680, 697, 701-02 (1980).
The unanimous evidence is that the actions of F&WAM and Mr. Feeley are one and the same. Mr. Feeley owned the controlling interest in the holding company and made decisions for the firm that bore Mr. Willcox's name as well as his own. (Tr. 102, 139, 153-54.) The evidence is that Mr. Feeley attempted to make it appear that his unilateral actions had the support of others. For example, only Mr. Feeley's signature appears on the Unanimous Written Consent of Directors that authorized the sale of up to $500,000 principal amount 12% Series C debentures together with warrants dated September 29, 1992. (Div. Ex. 34.) Mr. Willcox, the only other director, refused to sign the document, but Mr. Feeley went ahead with the sale. (Tr. 68, 406; Div. Ex. 34.)
Mr. Feeley knew that F&W Inc. was in a very precarious financial situation when he sold Series C debentures to Ms. Feeley, Mr. Donahue, Mr. Murphy, and Dr. Leventhal, and he did not disclose this information to these investors. The record is replete with evidence that F&W Inc. was all but bankrupt in late 1992. For example, by letter dated July 16, 1992, the Commission informed F&WAM that "the staff's review of [F&W Inc.'s] unaudited consolidated balance sheet for fiscal year ended December 31, 1991 revealed that it may be insolvent" and noted that failure to disclose the firm's precarious financial condition was a violation of Rule 206(4)-4 of the Advisers Act. (Div. Ex. 32 at 2.) The letter stated that the firm had a retained earnings deficit of approximately $3.8 million. (Div. Ex. 32 at 2.) In September 1992, John McDonough, F&W Inc.'s chief financial officer, resigned due to frustration with the firm's financial position, and Mr. Willcox resigned as a director because he disagreed with Mr. Feeley that the firm should take on more debt when it was barely surviving because of interest payments on the original debentures. (Tr. 79, 223, 406-07.)16 The unrefuted testimony of Mr. Kulp and Mr. Willcox is that in 1992 people at the firm, many of whom had taken reduced salaries, knew that its survival was questionable. (Tr. 79, 223-24.) Mr. Feeley's assessment that the Series C debentures were a moderately risky investment is self-serving and unsupported considering that Mr. Feeley's knowledgeable investor friends characterized the original F&W Inc. debentures as speculative, high-risk investments. (Tr. 537, 596-97, 739; Resp. Ex. 23 at 22.) It is reasonable to assume that the Series C debentures issued in 1992 and 1993, after five unprofitable years, are riskier investments than the original debentures issued in 1986-89.
Mr. Feeley did not mention risk or F&W Inc.'s poor financial situation when he urged Ms. Feeley, Dr. Leventhal, Mr. Murphy, and Mr. Donahue to invest in the Series C debentures. (Tr. 191-92, 199-200, 483-84, 511; Div. Ex. 83 at 34, Div. Ex. 84 at 35, 37, 40, 96.) When recommending the Series C debentures to Mr. Donahue and Dr. Leventhal, Mr. Feeley falsely represented that the funds would be used to capitalize the firm or put it on a more sound financial basis and that the debentures would permit participation in the firm's growth. (Tr. 490-91; Div. Ex. 84 at 32-33.) Mr. Feeley made these representations in 1992 when he knew that the firm was contracting, not expanding. Respondents' implied assertion that Mr. Feeley gave these clients information about F&W Inc.'s financial condition is false.
There is no evidence to support Mr. Feeley's position that F&W Inc. had sufficient funds to pay the interest due the original debenture holders in September 1992 without receipts from purchasers of the Series C debentures. In 1991, Mr. Feeley and Mr. Willcox received compensation of $17,000 each, Mr. Kulp and others took salary cuts, and still F&W Inc. had an operating deficit of $5 million. (Tr. 25, 156, 224, 374-75, 655.) The persuasive evidence is that the funds raised by the sale of Series C debentures were used to pay the semiannual interest due September 30, 1993, on the original debentures. (Tr. 614-15.)
The facts that F&W Inc. was in a precarious financial situation and that the funds raised from the offering were used to pay interest on past debt are material because there is a substantial likelihood that a reasonable investor would considered them important as part of the "total mix" of information available in making an investment decision. Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988) (citing TSC Indus., Inc. v. Northway, Inc, 426 U.S. 438, 449 (1976)). Because a debenture is an unsecured promise to pay, backed only by the general credit of the issuer, the issuer's financial state is a serious consideration in deciding whether or not to purchase. See Barron's Dictionary of Banking Terms, 133 (3d ed. 1997). Mr. Feeley failed to disclose material information to these four investors, and he lied when he characterized the Series C debentures as a good investment and in describing how the funds raised by the offering would be used.
Mr. Feeley's conduct is reprehensible because these customers were unsophisticated investors who trusted him and allowed him to exercise discretion over money they had earmarked for retirement. Ms. Feeley signed what he gave her to sign and she "just followed whatever suggestions Mike made" for investments in her account. (Tr. 184-86, 198, 335-37.) Dr. Leventhal gave Mr. Feeley discretionary authority over his account because he was not knowledgeable about investments. (Tr. 511.) Mr. Murphy trusted Mr. Feeley to make investment decisions with his best interests in mind, and he gave Mr. Feeley discretion to act in the account. (Div. Ex. 83 at 25, 27, 70-71, 80-81, 83.) Mr. Donahue did not give Mr. Feeley formal discretionary authority but he followed his recommendations, "I figured if Mike said all was well or would be well . . . that was enough for me." (Div. Ex. 84 at 110.)
All four accounts were for retirement purposes. Mr. Donahue was retired when the events transpired. As a self-employed person, Ms. Feeley did not have a company pension plan available so she was adamant that this account be handled in a conservative manner to assure she would have funds available in retirement. (Tr. 184; Div. Ex. 82.) By reason of the low material returns offered by his chosen occupations as actor and teacher, Mr. Murphy was equally adamant that his account be handled in a conservative manner so that he would have funds when he wanted them. (Div. Ex. 83 at 14-15, 20-24.) Dr. Leventhal told Mr. Feeley that the investment objective of his retirement account was long-term growth and he directed that most of the funds should be invested in low risk investments, some at medium risk, and none at high risk. (Tr. 483-84, 508-09.) Mr. Donahue wanted to invest conservatively, without exposure to an inordinate amount of risk since he and his wife "look to our assets plus Social Security for our entire income" and "[s]afety of principal is a prime concern." (Div. Ex. 16, Div. Ex. 84 at 12, 22-23.) Mr. Feeley confirmed by letter to Mr. Donahue that "[w]e agreed on four components of a strategy that emphasizes safety of principal and moderate growth of income and principal."17 (Div. Ex. 16.)
Mr. Feeley maintains that it was sound for these people to invest in Series C debentures because F&W Inc. held valuable assets, the Series C debentures paid 12% interest when banks were paying only 4% interest, the Series C debentures came with 5-year warrants that provided the investor with an additional opportunity to make a profit, and he believed there was a very high probability that the debenture would be paid.18 (Tr. 418-21, 424.)
I felt that these Notes with their interest bearing component . . . that as the firm grew in profitability, we would then be able to convert [the 1986 debentures and Convertible Series C debentures] so the interest would no longer be part of the obligation. So three million dollars of debt would become three million dollars of equity as the firm moved into profitability and this whole . . . interest burden which was taking the operations for maybe $100,000, $150,000 of profit into a negative . . . . So at that time we had small operating profitability put into a loss position because of the interest so, overall, in 92 as I recall we had about $100,000, $150,000 of profit and then maybe $200,000 of loss after you took the net expenses of the holding company . . . . So that if you drove the firm to profitability in that year, not only would you get the benefit of the profitability in that year but then the investors who knew that we thought it would take us . . . less than ten years to get the firm in profitability they would convert from a debenture, a debt status to an equity status. So, that was always part of the plan and that's what we were all trying very, very hard to accomplish.
Mr. Feeley did not get an independent opinion as to the likelihood that F&W Inc. would repay the debentures before he recommended them to F&WAM's clients. (Tr. 528-29.) It is reasonable to assume that he did not seek such an opinion because he knew that one could not be obtained. Mr. Feeley's beliefs have no rational basis. His position that the Series C debentures were "a very attractive investment" is implausible, and it is disingenuous for someone with his education and experience to express such a position.19 (Tr. 711-12.) Moreover, however optimistic Mr. Feeley was about the firm's future, he knowingly or recklessly omitted material information and made material misrepresentations to investors in connection with the offer and sale of Series C debentures. 20
I find that Mr. Feeley acted with scienter in that he deliberately lied to people who he knew trusted him as part of a scheme to defraud to obtain funds needed to continue F&W Inc. For all these reasons, F&WAM and Mr. Feeley willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5. Willfulness does not require an intent to violate the law, nor does it require "deliberate or reckless disregard of a regulatory requirement." Jacob Wonsover, 69 SEC Docket 694, 711 (Mar. 1, 1999), aff'd Wonsover v. SEC, 205 F.3d 408 (D.C. Cir. 2000). To commit a willful violation, a Respondent need only have intentionally committed the act which constitutes the violation. See Arthur Lipper Corp., 547 F.2d 171, 180 (2d Cir. 1976); Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965); James E. Ryan, 47 S.E.C. 759, 761 n.9 (1982).
B. Did F&WAM Willfully Violate Section 206(1) and Section 206(2) of the Advisers Act and Did Mr. Feeley Cause and Willfully Aid and Abet the Violations?
Section 206(1) and Section 206(2) of the Advisers Act repeat the prohibitions set out in Section 17(a)(1) and Section 17(a)(3) of the Exchange Act. Section 206(1) makes it unlawful for any investment adviser, by use of the mails or any means or instrumentality of interstate commerce, directly or indirectly to "employ any device, scheme, or artifice to defraud any client or prospective client." Section 206(2) forbids, under the same conditions, any investment adviser to "engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client." The scienter requirement similarly follows the Exchange Act in that Section 206(1) requires a showing of scienter and Section 206(2) does not. See SEC v. Steadman, 967 F.2d 636, 642-43 (D.C. Cir. 1992); SEC v. Moran, 922 F.Supp. 867, 896 (S.D.N.Y. 1996).
Ms. Feeley, Mr. Donahue, Mr. Murphy, and Dr. Leventhal were all clients of F&WAM to whom the adviser owed a fiduciary duty. A fiduciary duty is a "duty to act for someone else's benefit, while subordinating one's personal interests to that of the other person. It is the highest standard of duty implied by law (e.g., trustee, guardian)." Black's Law Dictionary, 625 (6th ed. 1990). A fiduciary owes its client "an affirmative duty of utmost good faith, and full and fair disclosure of all material facts." SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963). Furthermore:
Fiduciaries should be loyal to their beneficiaries. The duty of loyalty is implicit in the nature of the relationship. The fiduciary acts for the benefit of the beneficiary, and the beneficiary must trust him and rely on him. If the fiduciary's interests conflict with his beneficiary's or if he has interests that might subvert the unbiased and loyal performance of his duties, he breaches his duty, unless he discloses the conflict to the beneficiary and obtains the beneficiary's consent. A fiduciary must therefore refrain from putting himself in a position of conflict of interest since it does not permit him "to retain the freedom of judgment and action" that he ought to have as manager of other people's money.
2 Tamar Frankel, The Regulation of Money Managers 371 (1978).
F&WAM breached its fiduciary duty to its clients, by not fully disclosing to them that it benefited if they: (1) invested in the Series C debentures, and (2) moved their accounts to Ernst & Co. Mr. Feeley refused to admit that recommending Series C debentures to F&WAM clients placed him in a conflict of interest. (Tr. 529-36.) Mr. Feeley repeatedly refused to acknowledge that he had a conflict of interest and attempted to obfuscate the issue:
A. Well, I believe if you try to do the right thing, taking the whole idea of the holistic approach was to try to integrate things and to come up with a point of view of the right course of action, and I tried to commit myself to actions when I felt it was the right thing to do. . . .
In this case, this was the right kind of instrument to grow the firm. I thought it was good for the firm. I thought it was good for the people who would purchase the instruments. I tried to structure it in a way that the . . . the risk and reward were in balance. . . .
So, the way you'd calculate the relationship of return to risk is to try to make an estimate of those returns vis-à-vis the risk that is being taken. And then you have to take a look at how does that fit into a person's portfolio. . . . when I make a recommendation, I have a conviction . . . that that is a very good investment for the client. . . .
Sure, I would have a benefit. The firm would have a benefit. And, I believe, the customers would have a benefit. I thought there was an alignment of interests . . . .
I'm trying to weigh in my own mind this notion of alignment of interest and conflict of interest. Can you have both at the same time?
I guess it is not crystal clear to me that it is a conflict . . .
Q. Am I correct that your testimony is that in seeking a bridge loans from . . . advisory clients, you did not see[ ] your situation involving a conflict of interest? This is what you just told me?
A. It certainly is a multiplicity of interest, and . . .
Q. Can you give me a yes or no answer to that question? If you can't, that's fine, too.
A. I certainly see areas of conflict . . . What I'm not settled in my own mind is - is the linkage between conflict and alignment to give you a complete judgment. I'm aware that there are some competing forces. The judgment approach I try to take is to integrate all of that and to come up with a sense of [what] is it right for both sides.
Mr. Feeley's attempt to rationalize his actions is unpersuasive. F&WAM violated the antifraud provisions by recommending the Series C debentures to its advisory clients as a good investment opportunity and by failing to disclose to its clients that F&WAM and Mr. Feeley benefited if the clients agreed to transfer their accounts to Ernst & Co. Information about both these subjects is material because it is reasonable to expect that an investor would have considered them significant as part of the "total mix" of information available in making an investment decision. Basic Inc. v. Levinson, 485 U.S. at 231-32 (citing TSC Indus., Inc. v. Northway, Inc, 426 U.S. at 449).
F&WAM and Mr. Feeley had a positive duty to clients to disclose conflicts of interest. In 1995, Ms. Feeley, Dr. Leventhal, Mr. McDougal, and Mr. Murphy transferred their accounts to Ernst & Co. and continued their advisory relationship with F&WAM based on false information and Mr. Feeley's failure to disclose material facts. Mr. Feeley told Ms. Feeley that her account was being transferred to Ernst & Co. because F&WAM was restructuring. He did not give Mr. Murphy a reason for the transfer, and Mr. Murphy first realized that Mr. Feeley was in financial difficulty when he learned from Ernst & Co. in September 1996 of its financial arrangement with Mr. Feeley. (Div. Ex. 83 at 51-54.) The evidence is persuasive that these investors would not have continued their relationship with F&WAM if Mr. Feeley had told them the truth about the firm's financial status and his arrangements with Ernst & Co.
F&WAM willfully violated Section 206(1) and Section 206(2) for all these reasons as well as the reasons stated previously to support my finding that Respondents violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5. See Frankel, supra at 373-74 (citing SEC v. Capital Gains Research Bureau, Inc., 375 U.S. at 187-92); 3 Louis Loss, Securities Regulation 1515 (2d ed. 1961). Mr. Feeley caused and aided and abetted the violations because Mr. Feeley knew that his activities were part of an overall fraudulent scheme and he knowingly and substantially assisted F&WAM's antifraud violations. See Investors Research Corp. v. SEC, 628 F.2d 168, 178 (D.C. Cir. 1980). At the time he engaged in these illegal activities, Mr. Feeley was associated with a broker-dealer.
C. Did F&WAM Willfully Violate Section 204 of the Advisers Act and Rules 204-1 and Did Mr. Feeley Cause and Aid and Abet the Violations?
Rule 204-1(b), promulgated pursuant to Section 204 requires, investment advisers to keep the information in their adviser registration application current by filing amendments to their Form ADV, Uniform Application for Investment Adviser Registration ("Form ADV"). See Electronic Filing by Investment Advisers, Proposed Amendments to Form ADV, 65 Fed. Reg. 20,523, 20,525 (2000) (to be codified at 17 C.F.R. pts. 200, 275, 279) (proposed Apr. 5, 2000) ("Proposed Rule"). Part I of Form ADV contains information about an adviser's business, the people who own or control the adviser, and whether the adviser or certain of its personnel have been sanctioned for violating the securities laws or other laws. Part II of Form ADV contains information about the adviser's business practices, fees, and conflicts of interest the adviser may have with its clients.21 See Proposed Rule at 20,525.
The OIP charges that F&WAM willfully violated Section 204 of the Advisers Act and Rule 204-1 because it failed to file with the Commission: (a) any amendments to F&WAM's Form ADV since January 27, 1994, despite significant changes at the firm since that date, and (b) any Forms ADV-S during the period January 1994 to December 1996. (OIP at 5.)
Respondents concede that "certain ADVs were not timely filed" after it terminated the services provided by an outside law firm and accountant because of cost constraints. (Resp. Br. at 20.) Respondents' counsel agreed that F&WAM did not file to amend its ADV in 1995 or 1996, but he does not concede that F&WAM did not make a filing in 1997. (Tr. 20-21.) Mr. Feeley claims he did not know it was necessary to amend the ADV when information became outdated, but admittedly made minimal attempts to find out what was required to comply with the federal securities laws and regulations. (Tr. 395-400.)
The allegations in the OIP that F&WAM did not file required amendments to its Form ADV are true for the following reasons:
1. The Commission received F&WAM's most recent ADV filing on January 27, 1994. (Div. Ex. 17.)
2. Sometime after January 27, 1994, F&WAM changed its principal place of business and did not amend its ADV to reflect the change. On November 27, 1995, two Commission examiners went to 2 World Financial Center in New York City, the address that F&WAM showed as its business address on the latest Form ADV on file with the Commission. F&WAM was not conducting business at this location. (Tr. 286; Div. Ex. 22.) On November 27, 1995, Mr. Feeley told the examiners that he was conducting most of F&WAM business from his apartment. (Tr. 287, 332-33.) On a Form ADV dated December 27, 1995, that was not filed with the Commission, F&WAM lists its principal place of business as 380 Rector Place, Suite 6A in New York City. (Resp. Ex. 17.)
3. F&WAM indicated on ADV Forms, signed by Mr. Feeley on October 30, 1992, and March 15, 1993, that it had custody of client funds or securities; however, it failed to submit a balance sheet for the most recent fiscal year as required for advisers in this situation. (Div. Ex. 20, Div. Ex. 21 at Part I, Item 13, and Part II, Item 14.) Rule 204-1(a)(2) of the Advisers Act requires advisers who maintain custody over client funds to file an audited balance sheet.
At the hearing, Mr. Feeley testified that F&WAM did not have custody of client funds and that the Form ADVs were wrong. (Tr. 683-84, 786-87.) This is but one example of where Mr. Feeley gave different answers on important issues. In his investigative testimony on April 30, 1997, Mr. Feeley stated that at all times he was responsible for preparing and filing F&WAM's Form ADVs. (Tr. 223, 805.) Yet, he testified in September 1998, that the law firm of Kelley Drye & Warren was responsible for filing the Form ADVs. (Tr. 804.) The persuasive evidence is that Mr. Feeley prepared and signed the two Form ADVs described above. Mr. Feeley's position is unpersuasive.
4. F&WAM's Form ADV dated March 15, 1993, lists Mr. Willcox as a "control person" with the titles of president, director, and treasurer (Div. Ex. 21 at Part I, Schedule A.) The same filing indicates that nine employees perform investment advisory functions and that F&WAM had between 51 to 100 clients. (Div. Ex. 21 at Part I, Item 17.)
Mr. Willcox's role at F&W Inc., and presumably at F&WAM, was reduced significantly in the fall of 1992, and his business relationship with F&WAM ended when he left F&W Inc. in March 1995. Beginning in March 1995, Mr. Feeley was F&WAM's only full-time employee. (Tr. 429-30.) F&WAM did not amend its ADV to reflect the change in Mr. Willcox's status and the substantial changes in its business operations.22 (Tr. 399.)
In addition, in 1995 and 1996, F&WAM did not comply with Rule 204-1(c) that required investment advisers to file Form ADV-S, the annual report required of all registered investment advisers. See Suspension of Form ADV-S, 63 SEC Docket 1513 (December 20, 1996). F&WAM did not file a Form ADV-S in 1995 and 1996. (Div. Ex. 17.)
For all the reasons stated, I find that F&WAM violated Section 204 of the Advisers Act and Rule 204-1 because it willfully failed to file the necessary forms and amendments for 1995 and 1996. See, e.g., Tager v. SEC, 344 F.2d at 8; Roman S. Gorski, 43 S.E.C. 618, 622 (1967). I find further that Mr. Feeley willfully caused and aided and abetted the primary violations because he was responsible for F&WAM's compliance with the federal securities laws, and he knowingly or recklessly substantially assisted in F&WAM's violations. (Tr. 236, 805.) See Investors Research Corp. v. SEC, 628 F.2d at 178.
D. Did F&WAM Willfully Violate Section 204 of the Advisers Act and Rule 204-2 and Did Mr. Feeley Cause and Aid and Abet The Violations?
After F&W Securities shut down on March 31, 1995, F&WAM's financial record-keeping was done exclusively in a check register; it kept no journals, ledgers, or financial statements. (Tr. 562-64, 678-79.) F&WAM characterized its record-keeping as "casual," and did not make any contemporaneous records or order memos of client transactions; the only records of the transactions were kept in the client files. (Tr. 32, 564.) F&WAM insists that it kept records of orders placed for clients, transaction slips, and quarterly appraisals in the clients' main file along with bills for advisory services. (Tr. 677-78.)
Commission examiners tried to conduct an on-site review of F&WAM's books and records on November 27, 1995, but could not find the firm at the address on F&WAM's most recent Form ADV, 2 World Financial Center in New York City. (Tr. 284-96.) The examiners located Mr. Feeley at Ernst & Co. from information in the Central Registration Depository of registered representatives. At his suggestion, they conducted an examination on November 28, 1995, at an apartment that Mr. Feeley claimed was his residence, but which Mr. Feeley later testified was the Sino American office. (Tr. 288-90, 325, 682.) When the field examination concluded on December 8, 1995, Mr. Feeley had not fulfilled promises he made to provide most of the F&WAM's records the examiners requested. (Tr. 291-96, 572-74, 806.) This information included financial statements including general and auxiliary ledgers; balance sheets and income statements; records of cash receipts and disbursements; trial balances of financial statements; order memorandum for client transactions; bills or statements relating to trial balances; and a complete list of Mr. Feeley's personal transactions for 1995 and several prior years.23 (Tr. 291-98, 307, 319, 324.) Mr. Feeley provided the examiners with some documents including the most recent six months of bank statements, the most recent three months of cancelled checks, and a list of advisory clients. (Tr. 297, 327.) As was noted, at the Commission's request, the U.S. District Court for the Southern District of New York ordered Respondents to produce documents and for Mr. Feeley to be deposed on August 20, 1996. (Div. Ex. 80.)
The persuasive evidence supports the OIP charges that from 1995 to the present F&WAM willfully violated Section 204 because it failed to: (1) grant Commission representatives access to its books and records from November 1995 through August 1996, and (2) maintain cash receipts and disbursement journals; general ledgers; order memoranda; bills or statements relating to advisory services; trial balances or financial statements; and records of Mr. Feeley's personal securities transactions. The latter failure also violated Rule 204-2(a). Mr. Feeley willfully caused and aided and abetted the primary violations because he was responsible for F&WAM's compliance with the federal securities laws, and he knowingly or recklessly substantially assisted in F&WAM's violations.
IV. PUBLIC INTEREST
The following considerations are applicable in determining what actions are appropriate in view of the legal conclusions:
the egregiousness of the defendant's actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant's assurances against future violations, the defendant's recognition of the wrongful nature of his conduct, and the likelihood that the defendant's occupation will present opportunities for future violations.
Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981). The severity of a sanction depends on the facts of each case and the value of the sanction in preventing a recurrence. See Berko v. SEC, 316 F.2d 137, 141-42 (2d Cir. 1963); Richard C. Spangler, Inc., 46 S.E.C. 238, 251-52 (1976); Leo Glassman, 46 S.E.C. 209, 211-12 (1975).
Respondents' actions were egregious in that the fraudulent activities took place over several years and involved the retirement funds of several unsophisticated investors. At the same time that he lied to unsophisticated clients to cause them to (1) invest funds in his highly risky business venture, (2) extend repayments dates on money his firm owed them, and (3) transfer their brokerage accounts to benefit his interests, Mr. Feeley portrayed himself publicly as a securities professional who put people before material success.24
Mr. Feeley's personal knowledge of F&W Inc.'s finances and his arrangement to pay back the $150,000 from the commissions he earned while acting as a registered representative at Ernst & Co., his education and securities experience, and the witnesses' testimony all demonstrate that Mr. Feeley had a high degree of scienter. Mr. Feeley does not acknowledge the wrongful nature of his conduct. Rather, Respondents' position is that "this is a case of bad business judgment of a failing business and that's all." (Tr. 33-34.)
There is a strong likelihood that Mr. Feeley will commit future violations if allowed to continue to participate in the securities industry because, among other things, Mr. Feeley cannot accept facts that do not suit his purposes. For example, Mr. Feeley's explanations of the events in dispute are brazen and unrealistic. He described Ms. Feeley's $25,000 investment of retirement funds in a Series C debenture that was over four years overdue, and where Ms. Feeley had received no interest and the return of about half of her principal, as follows:
The instrument is still good. She has already received half her principal back. I believe she will receive the entire amount of her principal back. I believe she will receive not only the entire amount of her principal back but the accumulated accrued interest. I believe that this investment that she made will prove to be a superior investment over the life of the instrument which will be a 12% annual rate of return which will come to her well before her retirement starts.
Another example of Mr. Feeley's tortured rationalizations is his explanation that from June 1992 on, "we were particularly optimistic about the equity offering," at a time when F&W Inc. was having trouble paying interest due and preserving working capital. (Tr. 767-68.) Mr. Feeley's optimism was because he was talking to people about infusing capital. (Tr. 768.) Mr. Feeley always thought someone was going to provide F&W Inc. with needed capital. (Tr. 613.) There is no support in the record for Mr. Feeley's representation to (1) Mr. Gray on October 19, 1994, that Sino American was in the market to raise $3 million and that it wanted to acquire 51% of F&W Inc. for $2.5 million payable over eighteen months, or (2) Ernst & Co. in late 1994 or early 1995 that a Chinese securities corporation might possibly buy 80% of F&W Securities. (Tr. 463-64. 623-24; Div. Ex. 111.)
It defies logic for Mr. Feeley to claim F&WAM clients benefited by extending the due dates for loans they made to F&W Inc. Mr. Feeley's position is absurd that his June 29, 1992 and November 4, 1992 letters asking/recommending Mr. Donahue to extend the maturity dates on a $15,000 note due June 30, 1992, and a $25,000 note due October 31, 1992, benefited Mr. Donahue in "two ways, from continued higher interest plus additional warrants." (Tr. 765.) The fact that the firm could not pay off the note when it matured indicates that the firm would likely not be able to pay the higher interest rate and the warrants would have no value. Similarly absurd is Mr. Feeley's position that he acted reasonably by urging Mr. Murphy, an investor who wanted to take no risks, to extend the maturity date on his $25,000 loan to F&W Inc. because the note had a high interest rate, additional warrants and "we" were optimistic about the equity offering. (Tr. 766-67.)
The record shows that Mr. Feely lies with respect to the duty he owed F&WAM's advisory clients. These antifraud violations occurred within five years of the OIP. His letters to F&WAM clients in April 1995, do not mention that in his signed agreement with Ernst & Co. dated April 1, 1995, he committed to using one-half of his commissions to repay Ernst & Co. $150,000 so that transferring their accounts to Ernst & Co. benefited Mr. Feeley. (Div. Exs. 8, 68.) Mr. Feeley's present position is that he did not mention the agreement in the letter he sent to clients because he had not agreed to repay the loan until after he sent the letter. (Tr. 772.) When challenged, Mr. Feeley's explanation was that "I think I had benefited from the discussion that we all had and as I focused more . . . I recall that [the agreement] was actually a pre-dating and that the conversations were actually in May" and the agreement "may not have been executed until May." (Tr. 769-70, 774.) Mr. Feeley's position ignores the fact that the agreement states:
The [Secured Demand Note Collateral] Agreement, SDN and Collateral and the Cash Subordination Agreement (collectively, the "F&W Agreements") were each entered into on reliance upon Feeley's personal guarantee of amounts due under the F&W Agreements.25
(Div. Ex. 68 at E.)
Also, Mr. Feeley claims that he took on the repayment obligation as the honorable thing to do. However, the Secured Demand Note agreement made on April 1, 1995, specifies that:
In order to forestall possible legal action by Ernst against him, Feeley has agreed to pay to Ernst the sum of One Hundred Fifty One Thousand ($151,000) Dollars which includes interest due from February 1, 1995 with respect to the Cash Subordination Agreement.
(Div. Ex. 68 at G.)
Mr. Feeley also lied to the NYSE. In response to a January 1, 1995 notice from the NYSE, Mr. Feeley's stated, "the corporate receivable [note from Sino American] was not collateralized which we did not realize was a requirement." (Tr. 457; Div. Ex. 64.) As an experienced securities executive, Mr. Feeley knew or was reckless in not knowing that a loan had to be collateralized to satisfy the net capital requirements, but in any event, the firm's comptroller told him that loan was not collateralized and Mr. Feeley represented that it was.26 (Tr. 227-28, 790-91; Div. Exs. 63, 64.) This evidence contradicts Mr. Feeley's representation to the NYSE that his "level of understanding" evolved because he first thought the issue was whether the note would be paid, but he later came to understand the issue was the nature of the collateral. (Tr. 458, 461.)
The Division recommends that the Commission bar Mr. Feeley from association with any investment adviser or broker-dealer. (Div. Br. at 2, 34-37.) Respondents argue that Mr. Feeley should not be barred from association with a broker-dealer and investment adviser because "under the totality of circumstances" there has been no showing of a reasonable likelihood of future violations. Respondents characterize the charges as "two isolated events involving four individuals totaling, at most, $90,000." (Resp. Br. at 21-26.)
The Commission cannot impose a penalty for illegal activities that occurred prior to March 27, 1993, because they occurred outside the five year statute of limitations. See Johnson v. SEC, 87 F.3d 484, 488 (D.C. Cir. 1996) (the court struck down a Commission ordered censure and six-month suspension from industry participation based on its finding that the term "penalty" used in 28 U.S.C. § 2462 "is a form of punishment imposed by the [Commission] for unlawful or proscribed conduct, which goes beyond remedying the damage caused to the harmed parties by the [Respondent's] action").27 F&WAM's violations of Section 206(1), Section 206(2), and Section 204 of the Advisers Act, and Rules 204-1 and 204-2, which Mr. Feeley caused aided and abetted, occurred within five years of the OIP. Based on those violations, pursuant to Section 15(b)(6) of the Exchange Act and Section 203(f) of the Advisers Act, I find it in the public interest to bar Mr. Feeley from association with a broker or dealer and association with an investment adviser with the right to reapply in a non-supervisory, non-proprietary capacity after two years. See 17 C.F.R. § 201.193(d)(2).
B. Cease and Desist
Section 8A of the Securities Act, Section 21C of the Exchange Act, and Section 203(k) of the Advisers Act provide that the Commission may order a person found to be violating, to have violated, or about to violate a provision of the securities statutes to cease and desist where the person knew or should have known that their actions caused or contributed to the violations.
An order to cease and desist is unnecessary as to F&WAM since it no longer exists or is not engaged in business as an investment adviser. See Order Cancelling Registration. A cease and desist order is appropriate to Mr. Feeley because he knowingly violated and caused and aided and abetted violations of the securities statutes. The Commission has not resolved the issue of whether a cease and desist order requires a finding that there be a likelihood of a future violation. See Warren G. Trepp, 70 SEC Docket 2037 (Sept. 24, 1999). In case the Commission interprets the applicable statutory provisions to require such a finding, I find Mr. Feeley will likely commit future violations if allowed to continue to participate in the securities industry. I base this conclusion on his inability to understand the concept of conflict of interest, his disingenuous testimony under oath, and his deliberate disregard for regulatory requirements.
C. Disgorgement With Reasonable Interest
Section 8A(e) of the Securities Act, Section 21C(e) of the Exchange Act, and Section 203(j) of the Advisers Act provide that "the Commission may enter an order requiring accounting and disgorgement, including reasonable interest."28 Disgorgement is a remedial measure equitable in nature. Its purpose is "to deprive a wrongdoer of his unjust enrichment and to deter others from violating the securities laws." SEC v. First City Fin. Corp., 890 F.2d 1215, 1230 (D.C. Cir. 1989).
The Division recommends that Respondents be ordered to disgorge a principal amount of $95,000, as the amount Mr. Feeley raised from Ms. Feeley, Mr. Murphy, Mr. Donahue and Dr. Leventhal by the sale of Series C debentures that have not been repaid. (Div. Reply at 14.) The Division has calculated interest at the promised 12% rate on the unpaid amounts through the end of 1998 to be $76,197.52. (Div. Reply at 15 n.15.)
Respondents argue that disgorgement is not justified because there is no evidence that either F&WAM or Mr. Feeley retained those funds or personally profited from them and Mr. Feeley is making every attempt to repay the amounts lost, even though he has no legal obligation to do so. (Resp. Br. at 27.) Respondents claim that the Division's calculation ignores Mr. Feeley's payments of $12,000 to Ms. Feeley and $7,000 to Mr. Murphy. (Resp. Br. at 27.) The Division disagrees that Mr. Feeley is making every effort to repay and it points to payments to Mr. Feeley and related persons of over $200,000 after F&W Inc. defaulted on its Series C debentures, to argue that even if some of this money was business expense reimbursement, Mr. Feeley had a duty to first reimburse F&WAM's clients. (Div. Reply at 14.)
I find that the government has shown that F&WAM and Mr. Feeley should disgorge the unpaid amounts owed to Ms. Feeley, Mr. Murphy, Mr. Donahue, and Dr. Leventhal from the sale to them of Series C debentures plus prejudgment interest because F&WAM and Mr. Feeley were unjustly enriched by the receipt of these monies. Respondents' use of the funds is irrelevant, and the claim that a disgorgement order is unnecessary because Mr. Feeley is voluntarily making repayments is suspect. Ms. Feeley has received only half her principal and no interest since her Series C debenture matured in March 1994. Ms. Feeley must call Mr. Feeley each quarter to obtain payment. (Tr. 196-98.) As of September 1998, Dr. Leventhal had not received the return of his $25,000 principal or any interest on the Series C debenture that matured in November 1992. (Tr. 490.) In 1998, Mr. Donahue had received a $2,500 repayment on the $60,000 worth of Series C debentures he purchased in 1992. (Div. Ex. 84 at 43-44.) Mr. Murphy believes he has $50,000 worth of Series C debentures and in 1998, had received the return of only $7,000. (Div. Ex. 5, Div. Ex. 83 at 56.) Mr. Feeley refused to sign a document that Mr. Murphy's lawyer prepared acknowledging the debt and agreeing to a repayment schedule. (Div. Ex. 83 at 56.)
Based on the evidence, including the amounts repaid, it appears that the principal amounts owed are as follows: Ms. Feeley $13,000; Dr. Leventhal $25,000; Mr. Donahue $57,500; and Mr. Murphy $43,000 for a total of $138,500. It seems, therefore, that the Division's recommendation that Respondents be ordered to disgorge $95,000 is conservative. It is well settled that once the government presumptively shows that its disgorgement figure reasonably approximates the amount of unjust enrichment, the burden shifts to the respondent to demonstrate that the disgorgement figure was not a reasonable approximation. See SEC v. Lorin, 76 F.3d 458, 462 (2d Cir. 1996); SEC v. Patel, 61 F.3d 137, 140 (2d Cir. 1995). Any risk of uncertainty as to the disgorgement amount "should fall on the wrongdoer whose illegal conduct created that uncertainty." SEC v. First City Fin. Corp., 890 F.2d at 1232 (citations omitted).
D. Civil Penalties
Section 21B of the Exchange Act and Sections 203(i) of the Advisers Act authorize the Commission to assess civil monetary penalties where it is in the public interest to do so against any person if it finds that person willfully violated or willfully aided and abetted a violation of the securities laws or rules thereunder, or has willfully made or caused to be made in any registration or report filed with the Commission a material false or misleading statement or has omitted to state a material fact. The statutes set out three tiers of penalties. The first tier maximum penalty for each occurrence is $5,000 per natural person or $50,000 for any other person. Second tier civil penalties are applicable if the illegal act or omission involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement. Maximum civil penalties at the second tier are $50,000 for each occurrence for a natural person or $250,000 for any other person. The third tier is applicable where second tier conditions are present, and in addition, the activities resulted in substantial loss or a significant risk of substantial loss or substantial pecuniary gain to the person engaged in the illegality.
The Division recommends that Respondents be assessed fines at the third tier for their antifraud violations and at the first tier for violating the Commission's regulatory requirements governing the operation of an investment adviser. The Division would require F&WAM and Mr. Feeley to pay civil penalties of $1,050,000 and $205,000, respectively. (Div. Br. at 27-28.) The Division does not explain how it arrived at these amounts.
Respondents argue that civil penalties are unwarranted or, at the very least, excessive because in their view there was no fraud, no unjust enrichment, and Mr. Feeley is voluntarily repaying investors. (Resp. Br. at 26-27.)
I find it to be in the public interest to assess a civil penalty on F&WAM as the primary violator and Mr. Feely as the person who caused and aided and abetted the violations for their willful violations of Section 206(1), Section 206(2), and Section 204 of the Advisers Act, and Rules 204-1 and 204-2. The efficacy of this nation's system of regulation depends on voluntary compliance and cooperation with regulatory authorities. Respondents' fraudulent conduct and disregard for the Commission's investment adviser regulations was blatant. In the course of formal and informal investigations by the Commission, they misled investigators with promises of compliance, they forced the Commission to initiate court action to obtain documents, and they failed to produce subpoenaed documents at the hearing. Accordingly, I assess penalties at the first tier of $15,000 against Mr. Feeley and $150,000 against F&WAM. I have treated the antifraud violation, the failure to file amendments to the Form ADV, and the failure to keep the prescribed books and records and grant access to the Commission investigators as three separate illegal acts and have assessed the maximum fine for each.
V. RECORD CERTIFICATION
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.351(b), I certify that the record includes the items described in the record index issued by the Secretary of the Commission on May 17, 1999.
Based on the findings and conclusions set forth above:
I ORDER that pursuant to Section 15(b)(6) of the Exchange Act and Section 203(f) of the Advisers Act, that Mr. Feeley is barred from association with a broker or dealer or investment adviser with the right to reapply in a non-supervisory, non-proprietary capacity after two years;
I FURTHER ORDER, pursuant to Section 8A of the Securities Act, Section 21C of the Exchange Act, and Section 203(k) of the Advisers Act, that Mr. Feeley shall cease and desist from committing or causing any violations or any future violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5; and that Mr. Feeley shall cease and desist from causing and aiding and abetting violations or any future violations of Section 206(1), Section 206(2), and Section 204 of the Advisers Act and Rules 204-1 and 204-2;
I FURTHER ORDER, pursuant to Section 8A(e) of the Securities Act, Sections 21C(e) of the Exchange Act, and Section 203(j) of the Advisers Act, that F&WAM and Mr. Feeley disgorge $95,000, and prejudgment interest as described at 17 C.F.R. § 201.600(b);
I FURTHER ORDER, pursuant to Section 21B of the Exchange Act, Section 203(i) of the Advisers Act, that civil penalties of $15,000 be assessed against Mr. Feeley and of $150,000 against F&WAM.
Payment of disgorgement and penalties, plus interest, shall be made on the first day following the day this decision becomes final by certified check, United States postal money order, bank cashier's check, or bank money order payable to the U.S. Securities and Exchange Commission. The check and a cover letter identifying F&WAM and Mr. Feeley as Respondents in Administrative Proceeding No. 3-9571, should be delivered by hand or courier to the Comptroller, Securities and Exchange Commission, Operations Center 6432 General Green Way, Stop 0-3, Alexandria, Virginia 22312. 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, 17 C.F.R. § 201.360 (1998). 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 such 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 timely files a petition for review, or the Commission acts to review as to a party, the initial decision shall not become final as to that party.
Brenda P. Murray
Chief Administrative Law Judge
1 "(Tr. __)" refers to the transcript of the hearing. I will refer to Division and Respondent exhibits as "(Div. Ex. __)," and "(Resp. Ex. __)," respectively. Three of the exhibits were sworn testimony of Patrick Murphy and James J. Donahue for the Division and Donald K. Clifford, Jr., for Respondents. (Div. Exs. 83, 84, Resp. Ex. 23.)
2 The Division's Post-Hearing Memorandum is referred to as "(Div. Br.__.)." The Respondents' Post-Hearing Brief is referred to as "(Resp. Br.__.)." The Division's Post-Hearing Reply Memorandum is referred to as "(Div. Reply __.)."
3 Peter Willcox earned a degree in economics from the University of New Hampshire in 1966. Subsequently, he held positions as an analyst with John Hancock Mutual Life Insurance Company, the John P. Chase Mutual Fund, and Connecticut General Life Insurance Company. (Tr. 35-36.) In 1978, Mr. Willcox earned a master of business administration degree and master of finance degree from the University of Hartford. (Tr. 35-36.) Mr. Willcox served as the portfolio manager for Luma Sales during 1980 and held a similar position with American International Group from 1981 until 1986. (Tr. 36-37.)
4 Mr. Feeley testified that approximately twenty-eight people invested $15,000, but that could not be true if the offering raised $3.3 million. (Tr. 367, 700; Resp. Ex. 8 at 9, Resp. Ex. 18 at 8.)
5 Mr. Gray met Mr. Feeley in 1974 and was impressed with him. (Tr. 588.) In 1985-86, Mr. Gray managed about $150 million in assets. (Tr. 589.) The accounts were discretionary accounts with a minimum account value of $1 million. (Tr. 589-96.) As a speculative investment, the debentures were outside Mr. Gray's normal conservative investing strategy, but he considered them a special situation because of the conversion feature. (Tr. 596.) None of Mr. Gray's clients invested more than $100,000 in F&W Inc.'s original debentures. (Tr. 589.)
6 Until 1994-95, Coopers & Lybrand, and Kelly Drye & Warren served, respectively, as its auditor, and outside counsel. (Tr. 677.)
7 Payroll for the several companies was issued from an account at F&W Securities. (Tr. 655-57.) In 1986 and 1987, Mr. Feeley and Mr. Willcox each received compensation of over $100,000. (Tr. 658.) Because the operations were unprofitable, in 1991 Mr. Feeley and Mr. Willcox each received $17,000. (Tr. 25, 156, 655-58.) Subsequent to 1991, neither man received more that $60,000 in compensation. (Tr. 658, 665.)
8 The evidence is unequivocal that these two terms were used to refer to the same security. (Tr. 650-51.)
9 Charles M. Kulp was employed by F&W Inc. from August 1, 1986, until the end of October 1994. (Tr. 217-18, 227.) Mr. Kulp served in various capacities: senior vice president of F&W Inc., treasurer and compliance officer of F&W Securities, and senior vice president and portfolio manager of F&WAM. (Tr. 219-22, 233). Mr. Kulp became the treasurer of F&W Securities in 1993. (Tr. 225.)
10 The $100,000 Secured Demand Note that Ernst & Co. gave to F&W Securities remains outstanding. (Tr. 264.) Regulators count secured notes as capital in calculating a broker-dealer's capital requirements. (Tr. 545.) Ernst & Co. collects the interest on the Treasury bills that are the collateral for the note, but cannot take the bills back while the note is outstanding. (Tr. 272, 546.) The possibility exists that someone could go against the secured demand note and, if all the assets of the broker-dealer are exhausted, force the sale of the Treasury bills that are the collateral for the note. (Tr. 545.) Ernst & Co. denied Mr. Feeley's request in February 1996 to receive money under the Secured Demand Note to pay debts of F&W Securities. (Tr. 560-62.)
11 The original Form ADV, Uniform Application for Investment Adviser Registration, filed on September 11, 1986, is in the name of Feeley Asset Management. (Tr. 363; Div. Ex. 18.)
12 Mr. Feeley claims to have repaid $12,500. (Tr. 652.)
13 The plan was opened in the name of Bush Fine Leventhal Profit Sharing Plan, Subplan "L" and later changed to Roxbury Hackettstown Dental Associates, PC, Subplan "L." (Tr. 485-87; Div. Ex. 42.) The "L" is for Dr. Leventhal. (Tr. 488.)
14 Section 17(a)(1) makes it unlawful to "employ any device, scheme, or artifice to defraud." Section 17(a)(2) prohibits the use of false statements or omissions of material fact to obtain money or property. Section 17(a)(3) forbids any person from engaging "in any transaction, practice, or course of business which operates, or would operate as a fraud or deceit upon" a purchaser of securities. Section 10(b) and Rule 10b-5 make it unlawful for any person, directly or indirectly, in connection with the purchase or sale of a security, to make an untrue statement or omission of a material fact; use any device, scheme or artifice to defraud; or engage in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person.
15 Recklessness 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 v. Titan Capital Corp., 914 F.2d 1564, 1569-70 (9th Cir. 1990) (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).
16 Mr. Willcox remained as executive vice president of F&W Inc. until 1995. (Tr. 92; Resp. Ex. 17.)
17 Mr. Donahue had two accounts with Mr. Feeley. The account at issue is an Individual Retirement Account. (Div. Ex. 84 at 77.)
18 The valuable assets Mr. Feeley referred to were warrants in Expedite Systems that he believed to worth about $400,000 to $500,000. (Tr. 419-20, 538.) These warrants were valued on F&W Inc.'s books at $50,000. Mr. Feeley points out that this type of asset is carried at cost until it is sold. (Tr. 420; Div. Ex. 52.) The warrants were sold for $200,000 to pay creditors. (Tr. 537.)
19 Mr. Willcox explained Mr. Feeley's views on recapitalizing the firm as an inability to admit that he failed. (Tr. 53-54.) On October 19, 1994, Mr. Feeley told Mr. Gray that Sino American was in the market to raise $3 million and that it wanted to acquire 51% of F&W Inc. for $2.5 million payable over eighteen months. (Tr. 623-24; Div. Ex. 111.) Mr. Gray saw Mr. Feeley as always projecting that someone was about to invest large amounts of capital into the firm. (Tr. 613.)
20 Mr. Feeley testified in August 1998, that he had repaid approximately $100,000 of the $300,000 principal due on the Series C debentures. (Tr. 775.)
21 Rule 204-1 mandates that an adviser promptly file an amendment if answers to specific items in Part I become inaccurate for any reason, or if answers to Items 9 and 10 of Part I and any item in Part II, except Item 14, become inaccurate in a material manner. The adviser must file amendments to the remaining items in Part I and non-material changes to items in Part II within ninety days of the end of its fiscal year.
22 F&WAM's Form ADV dated March 15, 1993, shows Mr. Kulp as a senior vice president. (Div. Ex. 21 Schedule A for Part I.) Along with Mr. Willcox, Mr. Kulp managed F&WAM's investment portfolio. (Tr. 219.) F&WAM did not amend its Form ADV to reflect Mr. Kulp's departure from F&W Inc. in October 1994. (Tr. 219-220, 222, 226-27.) The Division's brief also faults F&WAM for not filing to reflect a change in its practice concerning recommending brokers after F&W Securities terminated operations in March 1995, however, it provides insufficient details for me to determine whether the charge is valid. (Div. Br. at 21.)
23 Mr. Feeley did not maintain a list of his personal transactions, but he provided the examiners with a list he reconstructed. (Tr. 293-94, 333-35.) He also claimed there was no need to keep a contemporaneous log of his personal security transactions because there were none. (Tr. 563.)
24 Mr. Murphy provided a vivid description of the frustration and range of emotions experienced by someone in this situation. "I paid for someone to have my best interests in mind, to make sure that I had something for my future and I felt screwed, totally screwed. That is what I mean by nightmare." (Div. Ex. 83 at 55.)
25 Mr. Feeley's explanation is typical of his nonsensical answers at the hearing:
I'm looking at this phrase, entered into on reliance upon Feeley's personal guarantee. I'm now trying to connect the memory of when I'm sitting with [the president of Ernst & Co.] and his group after [it has] failed and the surprise on all of their faces that the solution here was going to be my coming over. So, how can there be surprises on their face if the major motivation for entering into the relationship at the time was in reliance on my guarantees. I think what might be more properly said was that the idea of going into the agreement was thought to be a win-win for both of us. I think [the president of Ernst & Co.] had the sense that I'm a stand up guy and, when, in fact, it came time to follow up on this, in fact, I did stand up and do it and I believe that I had a better recall of my voluntary comments than they did.
26 Mr. Feeley's claim that he brought the issue to the NYSE's attention has no support in the record. "[W]hen it became an issue, I think I initiated contact with the [NYSE]. I said, I may have a problem, I've learned this." (Tr. 459.)
27 Section 2462 provides that, "[e]xcept as otherwise provided by Act of Congress, an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued."
28 The Commission's Rules of Practice mandate the assessment of prejudgment interest "on any sum required to be paid pursuant to an order of disgorgement." 17 C.F.R. § 201.600(a).
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