Initial Decision of an SEC Administrative Law Judge
In the Matter of
In the Matter of
KEVIN G. QUINN
|APPEARANCES:|| David L. Kornblau and Fredric D. Firestone for the Division of Enforcement, Securities and Exchange Commission.
Thomas J. McGonigle and Laura Hutchinson of McGuire, Woods, Battle & Booth, for Respondent Kevin G. Quinn.
|BEFORE:||Robert G. Mahony, Administrative Law Judge|
The Securities and Exchange Commission (Commission) initiated this proceeding by an Order Instituting Proceedings (OIP) on November 17, 1999, against Kevin G. Quinn (Quinn or Respondent) pursuant to Section 8A of the Securities Act of 1933 (Securities Act) and Sections 15(b)(6) and 21C of the Securities Exchange Act of 1934 (Exchange Act).
A hearing was held in Washington, D.C., May 16 through 19, 2000. Closing arguments were held on February 22, 2001. The Division of Enforcement (Division) called six witnesses, including Quinn. Respondent called one witness. The record includes seventy-nine exhibits in evidence from the Division and forty-nine from Respondent.1
The findings and conclusions herein are based on the record, my observation of the witnesses, all arguments and proposals of fact and law, as well as the relevant statutes and regulations. Preponderance of the evidence was applied as the standard of proof. See Steadman v. SEC, 450 U.S. 91 (1981). All arguments, proposed findings and conclusions put forth by the parties were considered and those consistent with this decision were accepted.
Allegations and Arguments
The OIP alleges that Quinn violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder, during a March advance refunding conducted in part by Quinn's employer, Alex. Brown & Sons, Inc. (Alex Brown) for the Commonwealth of Pennsylvania (Commonwealth or Pennsylvania). The allegedly fraudulent scheme consisted of the incomplete disclosure to the Commonwealth of a fee-splitting arrangement by which Alex Brown shared substantial revenue from the transaction with another securities firm, Arthurs Lestrange & Co., Inc. (Arthurs Lestrange), and by making false statements about the mark-up Alex Brown charged on the securities it sold to the Commonwealth in order to increase the mark-up from 4.5 basis points to 45 basis points.
Quinn contends that the evidence fails to support the allegations. Quinn argues that the fee-splitting arrangement was disclosed to the Treasurer's Office of the Commonwealth (Treasurer's Office) orally and in writing and that the undisclosed percentages of the fee split were immaterial. Furthermore, the mark-up was continuously contemplated to be in the millions of dollars, or 45 basis points, regardless of any confusion about how to express the calculation. Quinn also argues that the Treasurer's Office was provided all relevant information in a timely fashion regarding the amount of the mark-up. In addition, the decision-makers at the Treasurer's Office never objected to the price of the securities or the mark-up.
The Division seeks a civil penalty of at least $50,000, a censure and suspension from association with a broker or dealer for one year, and a cease and desist order. Quinn asserts that the proceeding should be dismissed.
II. SUMMARY OF THE EVIDENCE
Respondent Kevin G. Quinn
Quinn graduated from Lowell College in 1976. He attended the University of Maryland Law School and Business School, where he received a law degree and a master's degree in business administration in 1979. After passing the bar in 1979, Quinn accepted an associate's position with the law firm Miles & Stockbridge in Baltimore, Maryland. In October 1982, Quinn left Miles & Stockbridge to join Alex Brown in an investment banking capacity, where he worked in the public finance department from 1982 to 1994. In 1993, he became a managing director of Alex Brown and was in charge of its public finance department from 1990 to February 14, 1994. (Tr. 676-77; Amended Stip., ¶ 1.)
In February 1994, Quinn and Alex Brown had differences of opinion about the direction the public finance department would take. Quinn resigned on February 28, 1994, effective April 7, 1994. (Tr. 677, 680, 697, 752; Div. Exs. 37, 39.) On May 2, 1994, Quinn began work at A. Webster Dougherty (A. Webster), an investment firm, as its new president. (Tr. 138, 753-55.) A. Webster ceased operations in December 1994. (Tr. 781-82.)
Henry Sciortino (Sciortino) joined the Treasurer's Office in 1989. Sciortino's educational background includes a bachelor's degree in history from Niagara University, and a master's degree in urban studies, which included the study of finance, from Occidental College. Sciortino has other continuing education credits and licenses that include real estate, various types of insurance, and the necessary credentials for a Series 7 license in securities. (Tr. 242-43.)
After graduate school, Sciortino took positions as city manager and redevelopment authority director of Monessen, Pennsylvania. For seven years he ran the day-to-day business operations of these offices. He then spent two years as the chief investment officer for the City of Pittsburgh, Pennsylvania, followed by one and a half years as the assistant city treasurer and then city treasurer. Sciortino managed the day-to-day activity of all city tax collection efforts, and was treasurer of the school district and the water and sewer authority. He also had oversight responsibility of 5,000 city employees' benefits. Sciortino also sat on the pension board on behalf of the city and was responsible for $1.4 billion in combined budget and cash flow activities for the city, the school district, and the water and sewer authority. (Tr. 242-45.)
In December 1988, Sciortino received a call from Patrick McCarthy (McCarthy), who introduced himself as a lawyer heading up soon-to-be Pennsylvania Treasurer Catherine Knoll's (Knoll) transition team. McCarthy discussed the possibility of Sciortino becoming the deputy state treasurer for the administration and the chief financial officer for the Commonwealth. Subsequently, Sciortino accepted the position and moved to Harrisburg, Pennsylvania. (Tr. 245-46.)
In March 1991, Sciortino became the deputy treasurer for finance, and the chief investment officer for the Commonwealth. His financial responsibilities included managing the funds settlement division, which settled all trades of the pension funds, and any activity that involved the exchange of money for the Commonwealth, including clearing trades. The portfolio he managed ranged from $3 to $8 billion. Sciortino reported directly to Executive Deputy Treasurer Seymore Heyison (Heyison), and Knoll. Sciortino's tenure with the Treasurer's Office ended on May 31, 1995. (Tr. 246-47.)
Michael Arpey (Arpey) became assistant counsel to the Treasurer's Office in January 1990, and was subsequently promoted to general counsel. Arpey graduated from St. Lawrence University in 1985, and the Dickinson School of Law in 1988. (Tr. 99-101.) While serving as general counsel for the Treasurer's Office, Arpey's duties included managing the short term investment pool for the Commonwealth, a pool of liquid assets, which includes tax receipts, pension funds, and other assets. Arpey also supervised the contracts and legal issues pertaining to the investment activity, and reviewed all contracts as well as audit issues associated with those contracts. As general counsel, Arpey reported to Heyison. (Tr. 102, 104-05.)
Arthur Heilman (Heilman) has worked for the Commonwealth for thirty-three years. His educational background includes a bachelor's degree and post-graduate work at the University of Virginia in economics; post-graduate work at the University of Pennsylvania in public administration; and completion of the state and local government program for senior governmental managers at the John F. Kennedy School of Government at Harvard University. Heilman was the director of the bureau of revenue, cash flow and debt in the Governor's Office of the Commonwealth (Governor's Office) during the March advance refunding that is the subject of this proceeding. Heilman has reviewed at least seventy to seventy-five bond issues and 150 or more financing proposals, and made recommendations to his superiors. No state bond issues have been completed over his objection. Heilman reported to Budget Secretary Michael Hershock (Hershock), who in turn reported to the governor. (Tr. 183-85.)
Howard Corner (Corner) was the senior vice president and manager of the Philadelphia office of Arthurs Lestrange in March 1994. (Tr. 37, 42.) Corner attended Bethany College and Duquesne University. He served in the U.S. Marine Corps from 1968 to 1974. (Tr. 35-36.) Corner has over thirty years experience in public finance. (Tr. 36, 73.) Corner had participated in hundreds of municipal bond issues for Pennsylvanian issuers and dozens of advance refundings. (Tr. 36-39.) Corner proposed the advance refunding that is the subject of this proceeding.
Arthurs Lestrange, headquartered in Pittsburgh, Pennsylvania, was the financial advisor to the Governor's Office for the advance refunding. The Philadelphia office of Arthurs Lestrange was a banking office with the sole focus of originating, structuring, and underwriting municipal bond issues or acting as a financial advisor to government entities. Barbara Williams (Williams), an analyst, worked with Corner out of the Philadelphia office. Corner's superior, Michael Bova (Bova), worked out of the Pittsburgh office. (Tr. 42, 44.)
Michael Meteer (Meteer), a resident of New York City, worked at Alex Brown from June 1992 until July 1997. Meteer attended the University of Pennsylvania and received a bachelor's degree in economics with a major in finance and real estate. In early 1994, Meteer was a quantitative analyst in the public finance department headed by Quinn. He was responsible for sizing and calculating the numbers for bond issues. During his employment, Meteer worked on fifteen to twenty advance refundings. (Tr. 459-63.)
Heyison, the executive deputy treasurer, was considered a micro-manager and a tough negotiator. His style made the Treasurer's Office a difficult place to work. He was responsible for every activity in the Treasurer's Office. (Tr. 247-48, 339-40.) Heyison was in strict control of the information flow in and out of the Treasurer's Office. He reviewed all correspondences Sciortino received, except for junk mail. Most of the time, Sciortino had to clear "return calls" with Heyison before making them including routine business. (Tr. 341.)
McCarthy, a Philadelphia-based attorney, headed Knoll's transition team in 1988, and was Knoll's close political advisor. (Tr. 105, 245.) McCarthy's law firm had a contractual relationship with the Treasurer's Office to provide legal advice, as "outside general counsel," "on the broad array of matters that would come before the Treasurer's Office." (Tr. 181.) The contractual arrangement provided McCarthy access to the Treasurer's Office, but Arpey also believed that McCarthy's strong personal and political relationship with Knoll and Heyison gave him access as well. (Tr. 180-82.) McCarthy was considered to be the number two person in the Treasurer's Office, and he held himself out as such. (Tr. 110-11.) Even when contracts lapsed, McCarthy's activities were consistent with them. McCarthy and Heyison were the decision-makers for the office, and both Arpey and Sciortino recognized McCarthy to be their superior. (Tr. 110, 181, 250.) McCarthy was not an employee of the Commonwealth, but they understood that he was standing in the shoes of Heyison and was to be involved in every decision. (Tr. 106, 250.)
Arpey testified that McCarthy was in the office at least once a week and spoke with him and Heyison on a daily basis. (Tr. 106.) Their discussions covered all topics, including personnel matters, program development, and the selection of investment banking firms and other vendors to be used by the Treasurer's Office. (Tr. 109-10.) Arpey could not recall any instances in which information was not given to McCarthy for his personal review. (Tr. 109.) Sciortino viewed McCarthy similarly, and testified that:
Mr. McCarthy was a constant fixture at [the Treasurer's Office] either in person or on the telephone constantly working alongside of Mr. Heyison, asking questions, giving direction, wanting to know how things were working, what we could change, what policies we might implement . . . [in] an administrative standpoint and a political standpoint, [and] positive for . . . [Knoll's] reputation.
The Commonwealth of Pennsylvania
The Constitution of the Commonwealth gives joint authority to the governor, the treasurer, and the auditor general to issue Commonwealth debt. Each of the three officials is elected independently. (Tr. 126, 186, 260-61.)
The Governor's Office usually takes the lead in bond transactions, and entertains proposals for bond issues. (Tr. 186.) The Governor's Office determines whether there is an advantage to proceeding with an advance refunding and also determines what specific securities should be refunded. As part of this determination, the office looks at cash flow in relation to managing the budget of the Commonwealth. Heilman was the point person in the Governor's Office for an advance refunding. (Tr. 262.) Budget Secretary Hershock and the Governor's Chief of Staff James Brown (Brown) were his superiors. (Tr. 46, 184, 429.)
The Treasurer's Office, as the escrow agent of all the funds of the Commonwealth, holds the securities of any advance refundings conducted by the Commonwealth. (Tr. 126.) As custodian for the securities, the Treasurer's Office develops the process by which the securities are structured and purchased for the escrow side of an advance refunding. (Tr. 261-62.) Sciortino had primary responsibility for overseeing these activities. (Tr. 126.) Arpey, as general counsel, had a limited role of insuring that documents produced by bond counsel for issues were accurate and properly prepared for the treasurer's signature. (Tr. 102-03.)
Alex Brown Selected as Financial Advisor to Treasurer's Office
In June 1993, the Treasurer's Office decided to solicit for a financial consultant/investment advisor. (Div. Ex. 18 at PA 001562-63.) Three firms submitted responses to the Request For Proposal (RFP). McCarthy and Heyison chose Alex Brown in Baltimore, Maryland, because it had the greatest depth of organization and experience, and was already doing the same type of business for another governmental entity. (Tr. 119-20.) McCarthy favored Alex Brown because it was geographically close, and in the past, the Treasurer's Office had positive experiences with Quinn.4 (Tr. 120.)
Sciortino objected because Alex Brown was outside of Pennsylvania and other applicants had better credentials. However, Heyison and McCarthy's decision was submitted to the treasurer and approved. (Tr. 260.) On September 17, 1993, Quinn signed a $115,000 service purchase contract for Alex Brown to provide financial advisor services. (Tr. 117-18, 258-59, 520-21; Div. Ex. 18 at PA 001561.) Alex Brown was expected to provide reports associated with the short term investment pool, performance analyses, technical assistance for structuring of targeted investments, and structuring guidance on the debt issuances. (Tr. 122-23.) Exhibit B of the service purchase contract was titled "Contractor Integrity Provisions." It prohibited side arrangements to the service purchase contract. The service purchase contract also stated that, "the contractor shall maintain the highest standards of integrity in the performance of this agreement." (Tr. 124-25; Div. Ex. 18 at PA 001584.)
Quinn understood that Alex Brown was expected to maintain the highest standards of integrity in the performance of its duties for the Commonwealth, and that Alex Brown had a fiduciary duty to the Treasurer's Office. Thus, advice given to the Treasurer's Office would be based on the interests of the Commonwealth, not Alex Brown's interests or his own personal interests. Quinn also recognized that he had a duty to disclose all facts that would be material to the decisions that the Treasurer's Office made in relation to the engagements under the service purchase contract. However, Quinn believed that most of the functions performed under the service purchase contract did not include a fiduciary dimension. (Tr. 523-25.)
The March Advance Refunding
Corner, at Arthurs Lestrange, recommended the advance refunding.5 (Tr. 43, 189; Resp. Ex. 3.) He constantly monitored the Commonwealth's outstanding general obligation debt for advance refunding opportunities. (Tr. 43.) In early fall of 1993, Corner identified an opportunity for the Commonwealth to refund a significant amount of its outstanding debt. (Tr. 45.) Williams put together the technical and financial information. She analyzed the advance refunding plan and Corner oversaw and advised her on different ideas in terms of structure, options and sensitivity analyses. (Tr. 44-45.)
Corner then presented the potential advance refunding plan to Heilman. (Tr. 45, 189.) Up to this time, the Commonwealth had completed approximately five or six advance refundings, so Heilman was familiar with the process of the bond issuance and the creation of the escrow account. (Tr. 187-88.) Heilman liked the idea and Corner became the main contact at Arthurs Lestrange in proceeding with the advance refunding. (Tr. 45-47, 190.)
After considering different advance refunding scenarios, Heilman wrote to Hershock and recommended that the Commonwealth proceed with an advance refunding using Arthurs Lestrange as its financial advisor. (Tr. 46-47, 191; Resp. Ex. 26.) Heilman's recommendation was accepted and, in November, Arthurs Lestrange was appointed financial advisor for the advance refunding. (Tr. 47, 191.) Arthurs Lestrange would be paid a financial advisory fee of $210,000 as determined by a set fee schedule. (Tr. 49-50, 193; Amended Stip., ¶ 11.) Arthurs Lestrange's appointment as a financial advisor to the Governor's Office was unrelated to Alex Brown's financial advisor service purchase contract with the Treasurer's Office.
By letter dated January 5, 199, Bova suggested to Brown that the Commonwealth begin its search for an escrow agent for the advance refunding.6 (Div. Ex. 22.) Arthurs Lestrange believed "it would be less costly and more efficient" and would "enable the team (Arthurs Lestrange as Financial Advisor and the designated escrow agent) to have the advance refunding(s) structured and ready . . . in the position to enter the market at will." The following day, Bova sent an information copy to Heilman. The cover letter suggested that it would be prudent for the Commonwealth to appoint an escrow agent "now in the event that the market conditions change and permit more than the current refunding to be completed in the first phase." (Div. Ex. 22.)
Thereafter, during a telephone call with Quinn on January 27, 1994, McCarthy advised that the Commonwealth planned to commence an advance refunding of over $1 billion in general obligation debt and was in need of an escrow agent.7 (Tr. 379, 572-73.) McCarthy estimated that the escrow agent would receive a $0.70 per bond financial advisory fee and a 3 to 5 basis point escrow agent fee.8 (Tr. 644-45.) However, McCarthy advised Quinn that Alex Brown would have to split the escrow fee 60/40, with sixty percent going to Arthurs Lestrange. McCarthy also advised that Alex Brown would have to assume all risk on the transaction. (Tr. 591-92.) Quinn and McCarthy tentatively calculated that the escrow agent fee would be between $3,066,000 and $5,110,000. (Div. Ex. 28, Resp. Ex. 35.)
Quinn believed that the offer was on a "take-it-or-leave-it" basis and was not negotiable. (Tr. 592.) He discussed the offer with the president of Alex Brown, Mayo Shattuck (Shattuck), the following morning. (Tr. 563-64.) Without asking for a risk analysis, Shattuck approved the deal. (Tr. 564.) Quinn testified that Shattuck did not ask for a risk analysis because Alex Brown had done extensive analysis in relation to other advance refundings and was comfortable in making a decision. (Tr. 564-65, 569.) However, this was the first time Alex Brown shared fees when it was the firm selling the escrow securities. (Tr. 569, 595.) Nevertheless, Shattuck agreed that it looked like a good arrangement and that Quinn should accept the offer, although Alex Brown did not know what revenues Arthurs Lestrange would add to the fee split pool. (Tr. 563-65.) Quinn then contacted McCarthy, who instructed him to get in touch with Bova at Arthurs Lestrange and Sciortino at the Treasurer's Office.9 (Div. Ex. 79 at 564-65.)
When Sciortino learned that Heyison and McCarthy selected Alex Brown, he objected. Sciortino believed that the Commonwealth could effectively provide the same services. The Investment Center was a full-service center that was capable of buying the securities for the escrow account, and the Commonwealth would have the funds for the purchase because $1 billion in tax payments would be received between March 15 and March 30.10 (Tr. 129-30, 263-65, 334.) Sciortino could not understand why they were farming out the work. (Tr. 265.)
Sciortino testified about a variety of possible escrow options including state and local government series bonds (SLGs), which are specific securities issued by the U.S. Treasury Department. They are custom made to fit advance or current refunding situations that need escrow securities. Other options included open-market purchasing "in-house," open-market purchasing by competitive bid, and open-market purchasing by negotiated bid. If open markets were better than SLGs, then buying "in-house" was the option that the Treasurer's Office had through the Investment Center. In open-market purchasing by competitive bid, someone on behalf of the Treasurer's Office would seek competitive bids from other firms and take the best-priced bid. In open-market purchasing by negotiated bid, Alex Brown would go out as a principal, and negotiate and purchase the securities for a price, and then resell the securities to the Commonwealth for a predetermined mark-up.11 According to Sciortino, the first three options would have resulted in no more compensation to Alex Brown than that identified in the financial advisor service purchase contract. The fourth option, open-market purchasing by negotiated bid, which Heyison and McCarthy pursued, would pay Alex Brown a mark-up.12 (Tr. 272-74; Div. Ex. 80.)
Sciortino also believed that it was a conflict of interest for Alex Brown to act in the capacity of escrow agent while already under contract as the treasurer's financial advisor. (Tr. 264.) However, he agreed that the escrow agent activities were independent of the financial advisor services already being provided and not covered in the financial advisor service purchase contract.13 (Tr. 369.)
Knoll, Heyison, and McCarthy listened to Sciortino's arguments concerning the conflict of interest, but rejected them and proceeded with Alex Brown. (Tr. 370.) McCarthy and Heyison told Sciortino that Knoll felt comfortable with Alex Brown and that the decision was final. (Tr. 265.) Based on Quinn's advice, open-market purchasing by negotiated bid was chosen by McCarthy and Heyison because Quinn was a professional who, along with Alex Brown, had far more experience and understanding of the process than the Treasurer's Office. (Tr. 276.)
Quinn negotiated with the Treasurer's Office concerning the level of the mark-up on the escrow securities.14 (Tr. 285, 505.) Sciortino thought a fair mark-up for the escrow securities was 1/32, approximately 3 basis points or 0.0003125. (Tr. 281, 370-71.) He believed that the Commonwealth was prepared to buy the securities no matter what, so there was no abnormal risk involved in the transaction. (Tr. 281-82.)
During these negotiations, Quinn took notes. (Resp. Ex. 41A.) These notes indicated that on February 7, 1994, Quinn proposed a mark-up of "$5/bond" for the escrow securities and "5 BP" for the forward supply contract, and that Sciortino preferred "$4/bond" for the escrow securities, making no mention of the forward supply contract.15 His notes further indicated that on February 15 the mark-up negotiation was finalized at "$4.5/bond" for the escrow securities and "4.5 BP" for the forward supply contract. (Tr. 682-86; Resp. Ex. 41A.)
When Sciortino checked with McCarthy and Heyison, Sciortino expressed his view that 1/32, or approximately 3 basis points, was a fair mark-up. (Tr. 281.) McCarthy and Sciortino debated this and the fact that Quinn made a counteroffer at 5 basis points.16 (Tr. 281, 283.) McCarthy settled the debate at 4.5 basis points citing that Alex Brown and Quinn were the professionals who knew what they had to recover and what the risks were. (Tr. 285-86, 373.) Since McCarthy and Heyison were in agreement, and because Quinn already knew what the Treasurer's Office was going to accept, Sciortino thought it was best not to fight for a lower mark-up. (Tr. 285, 375-76.) It was McCarthy and Heyison's decision; Sciortino could not authorize or bind the Commonwealth. (Tr. 372-73.)
On February 18, 1994, Bova sent a letter to Brown advising of the pooling and apportioning of the fees. (Div. Ex. 34.) The letter states:
This is to inform you that Arthurs Lestrange as Financial Advisor, and Alex Brown, as Escrow Agent, intend to pool and then mutually apportion their respective compensation for serving as Financial Advisor and Escrow Agent on the upcoming refunding. The efforts so far by each firm have been so inextricably integrated with the other firm that we are, in effect, working as partners on a day-to-day basis.
On a deal this size, with its significant complexity and critical-timing issues, close professional cooperation by the entire Commonwealth team (the issuer's overall financial advisor and the issuer's technical support - the escrow agent) will only serve to maximize benefits for the issuer.
(Div. Ex. 34.) The letter was copied to Heilman, Sciortino, and Quinn. (Div. Ex. 34.)
Corner alerted Heilman that he would receive a copy of the Bova letter. Arthurs Lestrange's intention "puzzled" Heilman. The letter discussed the intention of Arthurs Lestrange and Alex Brown to pool their efforts and share fees. Heilman discussed the letter with Brown, but not with Sciortino. Brown said that he did not know anything about it and that Heilman should not do anything about it. (Tr. 200-02.) Heilman did not pursue it any further. (Tr. 202, 211.) However, in his investigative testimony of April 3, 1997, Heilman testified that he checked with Brown who told Heilman that he was aware of the fee split and approved it. (Tr. 212.)
Sciortino did not believe he received the letter although it was copied to him. (Tr. 269, 385.) He testified that he first learned of a fee split on June 13, 1994, in a conference call with Heyison and Doug Carter, Quinn's successor at Alex Brown, concerning a second advance refunding. (Tr. 269-70.) A copy of Sciortino's handwritten notes from the conference call reflects that the 60/40 fee split was discussed. Sciortino testified that, at that time, he did not understand the relevance of a 60/40 fee split as it related to the June advance refunding. (Tr. 270-71; Div. Ex. 53.) Previous to this, he only recalls Heilman mentioning a "joint venture" during the course of the March advance refunding. (Tr. 269, 386.)
Quinn received a copy of the letter disclosing the fee split arrangement. Quinn never provided additional information to the Governor's Office, or the Treasurer's Office. He believed that the Bova letter appropriately disclosed to the Governor's Office and the Treasurer's Office the fee arrangement between Alex Brown and Arthurs Lestrange. (Tr. 596-99; Div. Exs. 32, 33.)
As part of its escrow agent responsibilities, Alex Brown responded to questions that the Treasurer's Office had concerning the advance refunding. (Tr. 531-32; Div. Exs. 30, 35.) A memorandum dated February 7, 1994, from Quinn to Sciortino, reviewed "the relative advantages of structuring an escrow comprised of open-market U.S. Treasury obligations for the State's advance refunding issue on a `negotiated' versus `competitive' basis." Quinn identified Alex Brown "as the State's advisor and escrow structuring agent." (Div. Ex. 30.) Quinn testified that this memorandum should only be viewed as "some information on alternative ways in which the transaction could've been done." Quinn believed he was only providing information in writing that had already been agreed upon. Recommending an approach was not the purpose of the memorandum. (Tr. 533-34.)
A memorandum dated February 22, 1994, from Quinn to Sciortino, stated that Alex Brown as escrow agent to the Treasurer's Office believed that the risk of non-delivery of the securities would be reduced if the securities were purchased by Alex Brown and then re-sold to the Commonwealth. (Tr. 277-78.) The memorandum concluded that this was "the approach which [Alex Brown] recommend[ed] that the State adopt." (Div. Ex. 35.) Again, Quinn believed that this memorandum "confirm[ed] a decision that had already been made," because it articulated a position that was consistent with what the Commonwealth had done in other advance refundings since 1990. (Tr. 536.) This memorandum also disclosed that the escrow agent would secure a forward supply contract and the reasons therefor. (Div. Ex. 35.) See infra note 15.
Since Alex Brown was selling the open-market securities to the Commonwealth, Meteer took part in calculating the mark-up. Two or three weeks before the pricing of the escrow securities, Meteer, Dan Curry (Curry), and Quinn discussed the mark-up, and concluded that the mark-up would be 4.5 basis points.17 Meteer and Curry then began a preliminary run on the escrow securities. During this process of entering the securities into the computer model, Meteer was not clear on whether the mark-up was 4.5 basis points of the reduction in yield or 4.5 basis points on the purchase price of the securities. Quinn, however, stated that the mark-up was on the purchase price of the securities. Meteer and Quinn also discussed the dollar amount of the mark-up when Meteer advised that 4.5 basis points was not producing the million dollar amount that Quinn had contemplated. (Tr. 474-79.)
Quinn concluded that Meteer and Curry would use 0.0045 because that was Quinn's agreement with the Commonwealth. Meteer testified that when he mentioned to Quinn that 0.0045 was 45 basis points, Quinn did not react. Meteer was sent back to his desk with the instruction that 0.0045 was to be used, because the mathematical result of the mark-up was to be in the millions. When the preliminary bidding for the securities was done, Meteer marked up the purchase price by 0.0045, or 45 basis points. (Tr. 477-79.)
On March 16, 1994, the escrow securities pricing date, there was significant involvement among Alex Brown, Arthurs Lestrange, and the Commonwealth.18 On that day three bids for the refunding bond issue were received around 11:00 a.m. Arthurs Lestrange reviewed and tabulated the bids to make sure they were accurate. Around noon the winning bid figures were transferred to Alex Brown with the actual pricing and the arbitrage yield. Alex Brown then bid for the escrow securities and, based on the actual arbitrage yield of the successful bid, they structured the escrow account so that it did not exceed the arbitrage yield of the refunding bonds. Alex Brown then transferred back to Arthurs Lestrange an actual escrow price. Arthurs Lestrange fine-tuned the bond issue to an exact size with the amounts of the maturities. This information was then passed on to Peat Marwick in Texas for verification. Around 4:00 p.m., Arthurs Lestrange received verification and the successful bidder of the refunding bonds was contacted and awarded the bonds. (Tr. 64-65; Resp. Ex. 8.)
Also on March 16, 1994, Sciortino drove to the Alex Brown office in Baltimore, Maryland.19 (Tr. 286, 480.) Although he had wanted to arrive by 11:00 a.m., Sciortino got lost and called Quinn for directions. He arrived at 12:00 or 12:15 p.m. (Tr. 367, 392, 737; Resp. Ex. 10.) During his visit, Sciortino waited for the information from the refunding side of the transaction and observed some of the escrow securities purchases. (Tr. 287.) At Quinn's request, Meteer met with Sciortino to review the escrow securities before Alex Brown locked in the price.20 They were alone at the meeting. (Tr. 480-82.) The review included the portfolio that Alex Brown had purchased, the mark-up, and the resulting cost to the Commonwealth. (Tr. 482.)
Throughout this discussion, Meteer reviewed a two-page document with Sciortino. (Tr. 481-82; Resp. Ex. 1.) The first page of the document was printed at 2:12 p.m. and the second page was printed at 2:42 p.m. (Tr. 490-91.) The pages were numbered 1 and 2 by Meteer. (Tr. 491.) Meteer testified that he used the first sheet to show Sciortino the securities Alex Brown was buying, and to demonstrate that multiplying that amount by "1.0045," or 45 basis points, resulted in the upper limit of the mark-up that Alex Brown and the Commonwealth had agreed to. (Resp. Ex. 1.) Meteer wrote down the basis points and the resulting total. (Tr. 481, 483.) Meteer further testified that he reviewed the numbers with Sciortino and that Sciortino understood them. (Tr. 491.) Sciortino also wrote down the mark-up amount of $1,782,141, and the underwriter's discount of $4.00 per bond, or 40 basis points. (Tr. 742; Resp. Exs. 11 at PA 002057-59, 13.) In his investigative testimony, Sciortino stated that he wrote the amount on the day of the pricing, but at the hearing he stated that he wrote it sometime later. (Tr. 410-12.) Meteer received Sciortino's approval of the figures and the purchase was locked in. If Sciortino had withheld his permission, the transaction would not have occurred and "all hell would have broken loose."21 (Tr. 491-92.)
During the investigation and the hearing, Sciortino provided a variety of reasons for his presence at Alex Brown, none of which related to the mark-up. He stated that he was there as requested by McCarthy to represent the Commonwealth and oversee the bidding and structuring of the escrow securities. (Tr. 287, 393, 480.) It was standard practice for the Commonwealth to visit the offices of the companies with which it worked, as a form of due diligence. Having never been to Alex Brown's office, Sciortino thought this was a good opportunity. (Tr. 393-94.) Sciortino wanted to see the process of purchasing escrow securities. (Tr. 287.)
In his investigative testimony, Sciortino stated that he visited Alex Brown to make sure that it did the escrow securities purchase "right," because there were certain firms that the Commonwealth did not want to do business with, which the traders at Alex Brown would not have been aware of.22 (Tr. 394.) In investigative testimony taken on November 19, 1997, Sciortino stated that he was at Alex Brown to check on what it charged the Commonwealth for the escrow securities. (Tr. 395-96.) Then, in investigative testimony taken on March 13, 1998, Sciortino stated his purpose was to determine whether or not there was sufficient escrow securities to defease the issue and to obtain a verification report. However, that report was not ready until 6:00 p.m., well after the time Sciortino left. (Tr. 396.) Also, Sciortino was unable to clearly recall other events that day. He was unsure about whether he went trout fishing, to the office, or home upon leaving Alex Brown. (Tr. 397-99.)
On March 17, 1994, the day after the escrow securities pricing, Heilman sent a memorandum to Hershock in the Governor's Office and the auditor general summarizing the results of the bond issuance of the previous day. (Tr. 216; Resp. Ex. 12.) In the memorandum, Heilman stated that, "The sale . . . could not have gone much better than it did." (Tr. 216; Resp. Ex. 12.) The transaction was believed to have saved the Commonwealth over $10 million with a present value of $12.7 million. (Tr. 216-17.) Heilman's memorandum did not express a specific opinion on the mark-up fees because, at that time, he was unaware of them. (Tr. 229.)
The following day when Sciortino received the list of escrow securities that were purchased on behalf of the Commonwealth, he gave the list to an analyst in his office to examine the relative price and costs of purchasing them.23 (Tr. 289.) After making an initial examination, the analyst advised Sciortino that the price to be paid by the Commonwealth was "way out of line." (Tr. 289.) According to Sciortino, the analyst concluded that the mark-up was excessive at $1.8 million or about 45 basis points. When Sciortino was told that the mark-up was 45 basis points, he became "unhappy" and rechecked the numbers with the analyst to make sure they were accurate. (Tr. 291, 414.) Once Sciortino was comfortable with the conclusions, he notified Quinn that the securities had been marked up ten times the amount previously agreed to. Quinn replied that Sciortino's calculations were inaccurate because it was 4.5 basis points. (Tr. 292.)
Sciortino also reported the excessive mark-up to Heyison and McCarthy. (Tr. 293, 423.) Sciortino stated that based upon the spreadsheet from the analyst, they had evidence that the mark-up was 45 basis points instead of 4.5 basis points. (Tr. 293.) Heyison questioned the accuracy of Sciortino's numbers and asked him to check them again. Ultimately, Heyison agreed to look into the matter. (Tr. 293, 425.) McCarthy also questioned whether Sciortino had done the calculations correctly and suggested that the numbers did represent a mark-up of 4.5 basis points. McCarthy also agreed to look into the matter. (Tr. 293-94.)
Sciortino also personally notified Knoll, and explained to her the difference between 45 and 4.5 basis points by providing a numeric example of the difference between 179,000 and 1.79 million. Sciortino's action of notifying Knoll agitated Heyison and he forbade Sciortino to ride in the car alone with Knoll after this incident. (Tr. 423-26.)
On March 30, 1994, the advance refunding closed when the banking firms transferred the escrow securities to the Commonwealth. (Tr. 294-95.) Sciortino did not make an effort to stop the closing, even though the mark-up issue remained unsettled. (Tr. 295.) To stop the closing would have caused a significant negative impact on the Commonwealth's ability to borrow in the future. It would have also caused problems with the Commonwealth's credit rating, and decreased its credibility in the marketplace. (Tr. 296.) Comparatively, the risk in causing the transaction to fail and the fact that Sciortino had reported it, caused Sciortino to not attempt to stop the closing. Sciortino assumed that the overall transaction would be successful financially. (Tr. 296.)
Sciortino believed that he could pursue the possibility of getting a refund from Alex Brown for what he believed was an excessive mark-up. Sciortino wanted the difference between the actual mark-up and what he believed they had agreed to originally. He pursued it with Heyison, Arpey, and also McCarthy. Sciortino was told repeatedly that the Treasurer's Office, meaning Heyison, was considering the issue. Sciortino was to "get out of it, go back and do [his] job and [Heyison] would handle that aspect of the transaction." (Tr. 296-97.)
At the time of closing, Heilman was unaware of any dispute over the mark-up amount. (Tr. 205.) The following day, March 31, 1994, Heilman sent a memorandum to Hershock and Sciortino titled, "Summary of First Series of 1994 Refunding." (Resp. Ex. 17.) In the memorandum, Heilman stated that "[t]he sale went well for us and it also went well for the underwriters making the issue a win for all." (Resp. Ex. 17.) In general, Heilman had the same opinion on the advance refunding the day after the pricing and the day after the closing. (Tr. 217.) Heilman also mentioned in the memorandum that the market had been turbulent during the advance refunding, making the purchase much more difficult. He provided highlights of the purchase with final numbers prepared by Arthurs Lestrange. (Tr. 218; Resp. Ex. 17.)
On April 4, 1994, Heilman sent a memorandum titled, "Results of Negotiated Changes to Issuance Costs" to Brown and Hershock in the Governor's Office. (Resp. Ex. 29.) Heilman summarized the final negotiated issuance costs in the first series of 1994 advance refunding bonds. The last paragraph indicated that "[Alex Brown] was not paid a specified fee but apparently was allowed a mark-up on the escrow. I have not been able to find out that amount." (Resp. Ex. 29.)
The Amended Stipulation articulates the results of the March advance refunding:
Alex Brown paid a total of $396,562,554.88 for the Escrow Securities (including accrued interest). Alex Brown sold [them] to the Commonwealth at a total price of $398,344,695.52 (including accrued interest). Alex Brown's mark-up on its sale of the Escrow Securities to the Commonwealth was $1,782,140.70. Alex Brown's mark-up represents 0.0045 (rounded off to the nearest 0.0001) times the price it paid for the Escrow Securities.
Alex Brown also received a "Forward Supply Fee" of $194,000 as part of the March 1994 refunding. Alex Brown calculated the Forward Supply Fee as 4.5 basis points, or 0.00045, times certain cash flows totaling $431,335,000. The fee was then rounded down to the nearest $1,000.
In addition to the mark-up on the Escrow Securities and the Forward Supply Fee, Alex Brown received $418,316.40 (the "Repo Spread") in the March 1994 refunding as a result of a Treasury Repo transaction. (Alex Brown borrowed funds to purchase the Escrow Securities on March 14, 1994, which the firm owned until the refunding transaction closed on March 30, 1994. The Repo Spread represents the difference between the interest accrued on the Escrow Securities during the period and Alex Brown's borrowing costs during this period.)
As the [Governor's Office's] financial advisor in the March 1994 refunding, Arthurs Lestrange & Company, Inc., received a financial advisory fee of $210,000.
Pursuant to an agreement between the two firms, Alex Brown and Arthurs Lestrange pooled and split their fees on the transaction. Arthurs Lestrange received 60 percent, or $1,562,674.26, of the pooled fees, and Alex Brown received 40 percent, or $1,041,782.84.
(Amended Stip., ¶¶ 8-12.)
Aftermath of the March Advance Refunding
In June 1994, in preparation for the second part of the advance refunding, Arpey reviewed the forward supply contract from the March advance refunding which showed that the Commonwealth paid a fee in the March advance refunding for the forward supply contract. He called Sciortino, who was trout fishing, on his cell phone to determine if a similar arrangement had been made for the upcoming June advance refunding. (Tr. 135, 305-06, 356-59.)
Arpey asked Sciortino what Alex Brown was going to charge for the forward supply contract in the second advance refunding. Sciortino told him that there would not be a charge, because it was all-inclusive in the mark-up that was negotiated. (Tr. 307.) Sciortino believed that it would be exactly the same as the March advance refunding, a single charge of 4.5 basis points and the predetermined financial advisor service purchase contract fee. (Tr. 135, 307, 360.) Although stating that he was not aware that Alex Brown had received a fee, Sciortino did admit that he was aware that the forward supply contract was a separate fee not included in the mark-up. (Tr. 307, 360, 376-78.)
Quinn, who was no longer working for Alex Brown, was conferenced into the call. (Tr. 159, 307, 360.) Quinn, Sciortino, and Arpey became involved in a heated discussion. (Tr. 135-36.) Quinn stated that Sciortino was aware of the forward supply contract. (Tr. 307-08.) Sciortino said that he was not. (Tr. 308.) Quinn stated that he had sent a memorandum to Sciortino about the forward supply contract prior to the escrow securities pricing day. (Tr. 360-61.) When Sciortino denied seeing the memorandum, Arpey went into Sciortino's office and found it. (Tr. 361; Resp. Ex. 10.) Still Sciortino claimed to had never seen the memorandum because that was the day he was in Baltimore.24 (Tr. 361.) The memorandum discussed the forward supply contract, not the mark-up on the escrow securities. (Tr. 176.) Arpey described the memorandum's contents to Sciortino, and Sciortino concluded that the Commonwealth had been deceived. (Tr. 159.)
Although not fully appreciating the fact that there were separate fees for the forward supply contract and the escrow securities, Arpey brought the excessive mark-up issue to the attention of Heyison and McCarthy. (Tr. 137-38, 164, 177.) He asserted that the Treasurer's Office should recoup the money from Alex Brown. (Tr. 138.) McCarthy and Heyison decided that it would be best to recoup the money prospectively, from Alex Brown during future business transactions. (Tr. 138.) They also instructed Arpey not to pursue the issue; McCarthy and Heyison would take care of it. (Tr. 164.) There is no evidence that they ever did.
Thereafter, Quinn called McCarthy because he was concerned that the Treasurer's Office was not happy with the March advance refunding. (Tr. 767.) Arpey and Sciortino's telephone call was the first time that a possible problem was mentioned to Quinn. (Tr. 770.) Quinn requested that McCarthy call him if there was a problem. (Tr. 767-69.) McCarthy called sometime later and advised that since Alex Brown could not find the information on the March advance refunding, Quinn should prepare a memorandum and attach whatever documents he still had. (Tr. 769; Resp. Exs. 40, 40A.) Quinn went through some of his old material and found a final draft of the forward supply contract with the distribution list and a copy of the settlement page for the fees associated with the transaction. (Tr. 769.) He sent the material to McCarthy and further suggested that his assistant from Alex Brown would have diskettes with all of the other memoranda regarding the transaction. (Tr. 769; Resp. Ex. 40.)
The first time Heilman found out there was a disagreement with the March advance refunding was August 22, 1994. (Tr. 225.) At an August 22, 1994, meeting, attended by Heyison, Sciortino, and Heilman, a discussion was held regarding the difference between a 4.5 and a 45 basis point mark-up with the conclusion that the Treasurer's Office was charged an excessive mark-up on the escrow securities purchased in the March advance refunding. (Tr. 225-26.) Heyison and Sciortino did not explain to Heilman why it took them until August 22 to raise the issue or bring this mistake to Heilman's attention. They did not decide on any course of action. (Tr. 227-28.)
In late July or early August 1994, McCarthy mentioned to Quinn that Arpey was still "hung up" about the forward supply contract. (Tr. 772.) Quinn wanted to meet with Arpey, Sciortino, and Heyison to clear up the matter, with the hopes that he could offer the services of his new firm, A. Webster. (Tr. 773.) The meeting was arranged and then rescheduled for August 24, the day of Heyison's birthday party. (Tr. 773.)
After the party, Sciortino, Arpey, Heyison, McCarthy, and Quinn went to Heyison's office. (Tr. 312.) When the basis point dispute was raised, it was a rehashing of the two positions. (Tr. 145.) According to Sciortino, Quinn quietly and calmly argued that the Treasurer's Office miscalculated the mark-up and maintained that the escrow securities mark-up was intended to be 4.5 basis points. (Tr. 146, 318.) In contradiction, Quinn testified at the hearing that the meeting did not involve any discussion that included 45 basis points, dollar amounts, or escrow securities mark-ups, rather the conversation concerned the forward supply contract. (Tr. 778.) Quinn also testified that Sciortino did not speak at the meeting. (Tr. 778.) When the meeting ended Quinn had a sense that the issue had been smoothed over and any misunderstanding was now a closed matter. (Tr. 778-79.)
III. FINDINGS OF FACT AND CONCLUSIONS OF LAW
The Division alleges that Quinn violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder, collectively known as the antifraud provisions, because he failed to "fully and accurately" disclose to the Treasurer's Office the 60/40 fee split arrangement between Alex Brown and Arthurs Lestrange, and "looked the other way" when Arthurs Lestrange provided the Governor's Office with a description of the arrangement that the Division alleges is materially misleading. The Division also alleges that, in furtherance of the scheme, Quinn made materially false statements about the mark-up by continuing to affirm that the escrow securities mark-up was 4.5 basis points after having knowledge that it was closer to 45 basis points.
Section 17(a) of the Securities Act prohibits using the mails or instruments of interstate commerce in the offer or sale of securities to employ any device, scheme, or artifice to defraud; use false statements or omissions of material fact to obtain money or property; or engage in any transaction, practice or course of business which is or would operate as a fraud or deceit upon a purchaser.
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, make it unlawful for any person, directly or indirectly, in connection with the purchase or sale of any security to make an untrue statement or omission of 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.
For liability to attach under the antifraud provisions, omissions or misstatements must be material. The test for materiality is whether there is a substantial likelihood that a reasonable investor would consider the information important to the investment decision, and would view it as having significantly altered the total mix of available information. See Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). Materiality is a mixed question of law and fact, dependent on the circumstances at the time of the alleged misstatement. See Ganino v. Citizens Utils. Co., 228 F.3d 154, 162, 165 (2d Cir. 2000).
Scienter is a required element under Section 17(a)(1) of the Securities Act, Section 10(b), and Rule 10b-5 of the Exchange Act, but not Sections 17(a)(2) and 17(a)(3) of the Securities Act.25 See Aaron v. SEC, 446 U.S. 680, 697 (1980). The Supreme Court has defined scienter as "a mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). The scienter requirement is also satisfied by showing that the respondent acted recklessly, 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." Meyer Blinder, 50 S.E.C. 1215, 1229-30 (1992) (quoting Sunstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir. 1977)); see also Hollinger v. Tital Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990).
"Fraud or deceit presupposes the superior knowledge of one party over another." SEC v. Coffey, 493 F.2d 1304, 1313 (6th Cir. 1974) (citing Myzel v. Fields, 386 F.2d 718, 739 (8th Cir. 1967)); see also Chelsea Assocs. v. Rapanos, 376 F.Supp. 929, 939-40 (E.D. Mich. 1974) ("A fundamental purpose, common to securities regulation statutes, is to [establish] a philosophy of full disclosure . . . and to achieve a high standard of business ethics in the securities industry."). The antifraud provisions "make sure that buyers of securities get what they think they are getting and that sellers of securities are not tricked into parting with something for a price known to the buyer to be inadequate or for a consideration known to the buyer not to be what it purports to be." Chemical Bank v. Arthur Andersen & Co., 726 F.2d 930, 943 (2d Cir. 1984). "No doubt Congress meant to prohibit the full range of ingenious devices that might be used to manipulate securities prices." Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 477 (1977).
The Escrow Agreement and Fee Split
The OIP charges that Quinn engaged in a scheme to defraud by failing to "fully and accurately" disclose the 60/40 fee split to the "Commonwealth." It further charges that Quinn "looked the other way" when Bova wrote to the Governor's Office that Alex Brown and Arthurs Lestrange intended to pool and split their fees, because the letter did not specifically state the percentage of the fee split or that McCarthy required Alex Brown to split the fee as a condition of being named escrow agent.
The treasurer and the governor each has a role in advance refundings. The Governor's Office decides if it is advantageous to proceed with an advance refunding, and the Treasurer's Office, as escrow agent for the Commonwealth, holds the securities of any advance refunding conducted by the Commonwealth. (Tr. 186, 261-62.) In this case, the Governor's Office accepted Arthurs Lestrange's recommendation of conducting an advance refunding and looked to the Treasurer's Office to obtain the escrow securities. (Tr. 43, 47, 189, 191, 194-95; Div. Ex. 22.)
The evidence establishes that the Treasurer's Office had a long-standing relationship with McCarthy, and the staff at the Treasurer's Office relied on his direction and decisions. McCarthy was recognized as having authority "very similar to Mr. Heyison's which was everything from hiring and firing, to making decision on the smallest of items to the largest of items." (Tr. 109-10, 249-50.) On occasion, through a separate agreement between Alex Brown and McCarthy's law firms, Quinn received work from the Treasurer's Office through McCarthy. (Tr. 579; Div. Ex. 75; Amended Stip., ¶¶ 3-5.)
On January 27, 1994, McCarthy advised Quinn that the Commonwealth planned to commence an advance refunding of over $1 billion in general obligation debt and was in need of an escrow agent. (Tr. 379, 572-73.) In offering Alex Brown the position of escrow agent, McCarthy instructed Quinn that Alex Brown would have to split the escrow fee 60/40, with sixty percent going to Arthurs Lestrange, and assume all of the risk involved in the transaction. (Tr. 591-92.) McCarthy made the offer of a 60/40 fee split, as a "take-it-or-leave-it" proposition. (Tr. 592.) After discussions with the president of Alex Brown, Quinn accepted the offer from McCarthy. (Tr. 563-65; Div. Ex. 79 at 564-65.)
Since Quinn knew of the relationship between McCarthy and the Treasurer's Office and had previously received work from the Treasurer's Office through McCarthy, I find that it was reasonable for Quinn to believe that McCarthy was speaking on behalf of the Treasurer's Office in making the offer to be the escrow agent for the advance refunding. When the offer was made, it was reasonable for Quinn to believe that all of the terms related to him by McCarthy, including the requirement to split the fee with Arthurs Lestrange, were terms that the Treasurer's Office was well aware of.
The allegation of "look[ing] the other way" relates to the letter Bova wrote to the Governor's Office on February 18, 1994, advising that Alex Brown and Arthurs Lestrange would pool, and then apportion, their fees from the advance refunding. The letter did not mention the percentage of the apportionment or that McCarthy had conditioned the offer of escrow agent on the fee split. Quinn, along with Sciortino and Heilman, was copied on the letter. (Div. Ex. 34.) Quinn testified that he believed the letter was sufficient and I credit his testimony. (Tr. 596-99.) Further, while it is not clear what "look[ing] the other way" may mean as to Quinn in this proceeding, there is no evidence to support a finding that Quinn had an obligation to the Governor's Office to comment on the letter or add any additional detail.26
I conclude that there is no evidence that Quinn intentionally withheld any information about becoming the escrow agent from the Treasurer's Office or the Governor's Office, or that he did so recklessly or negligently. I further conclude that Quinn had no duty to disclose additional information to the Governor's Office.
Mark-Up of the Escrow and Forward Supply Contract
The OIP also charges that Quinn made materially false statements about the basis points used to compute the mark-up.
I find that the negotiations about the mark-up were to determine an agreed upon amount of money that Alex Brown would be paid for its services as escrow agent as well as an additional amount for the forward supply contract.
Quinn and McCarthy's initial discussion on January 27, 1994, contemplated a fee in the millions of dollars, as indicated by Quinn's notes. They estimated the escrow fee would be approximately between $3,066,000 and $5,110,000 on an advance refunding of approximately $1 billion. The fee for the escrow agreement was estimated to be 3 to 5 basis points. (Div. Ex. 28, Resp. Ex. 36.)
On February 5, 1994, Quinn spoke with Bova in an effort to ascertain the aggregate amount of their revenues and the potential fee split from the transaction. Using the range of figures from his conversation with McCarthy, Quinn's notes reflected a bond issue size of approximately $1 billion. He stated that the notation for the escrow mark-up "4.5 BD" referred to "per bond" rather than "4.5 BP" meaning basis points. The expected amount of the mark-up was in the millions, at $4,600,620. I find that this amount equals a mark-up of 45 basis points or $4.50 per bond. (Tr. 514-19; Div Ex. 29.)
Two days later, on February 7, 1994, Quinn spoke with Sciortino and discussed the mark-up on the securities escrow and the forward supply contract.27 Quinn's notes indicated that he proposed "$5/bond" for the escrow mark-up and "5 BP" for the forward supply contract. Sciortino proposed "$4/bond" but did not mention the forward supply contract. This calculation showed that Quinn expected the escrow mark-up to be in the millions. (Resp. Ex. 41A.) Quinn's notes reflect a subsequent conversation with Sciortino on February 15 that indicates "Henry [was] ok at 4.5 bond + 4.5 BP on [the forward supply contract]." (Resp. Ex. 41A.)
Two or three weeks before the pricing date of March 16, 1994, Meteer testified that Quinn told him that the escrow mark-up would be calculated by using 4.5 basis points. In doing a preliminary analysis, Meteer was unclear as to whether this was to be 4.5 basis points of the reduction in yield or on the purchase price of the securities. Meteer also advised that 4.5 basis points would not produce the million dollar mark-up amount that Quinn expected. Quinn responded that the mark-up would be based on the purchase price and further advised Meteer that the mark-up would be 0.0045 because that was the agreement with the Commonwealth. (Tr. 474-77.)
The evidence further demonstrates that over $1.7 million was calculated for the mark-up on the pricing date, March 16. Meteer reviewed a two-page document titled "Escrow Cost" showing Sciortino the securities to be purchased at a 0.0045 mark-up. (Resp. Ex. 1.) According to Meteer, Sciortino understood the mark-up and approved the transaction. (Tr. 491.) Sciortino also wrote down that the mark-up would be $1,782,141, either on the pricing date or sometime thereafter. (Resp. Ex. 11 at PA 002059.) Quinn did not participate in this conversation.
Moreover, Sciortino brought the million dollar mark-up to the attention of Heyison and Knoll the following day. (Tr. 293, 423-26.) Sciortino even used an example to demonstrate his concern. Although Heyison and McCarthy questioned Sciortino's accuracy, both agreed to look into the matter. (Tr. 293-94, 425.)
I conclude that Knoll and Heyison, who were the decision-makers for the Treasurer's Office, as well as McCarthy and Sciortino, knew the dollar amount of the mark-up, which was the material information, at least two weeks prior to the closing and that it was computed on 45 basis points. Therefore, the Treasurer's Office had two weeks to act on the information if it believed that the Commonwealth was being charged an excessive mark-up.
Through the course of the March advance refunding there was unquestionable miscommunication or lack of communication among the parties in two interrelated areas. First, Quinn continued to assert a 4.5 basis points mark-up although continuously calculating a fee in the millions of dollars. Second, the Treasurer's Office did not grasp the significance of two mark-ups, one for the forward supply contract and one for the escrow securities. The forward supply contract had a mark-up of 4.5 basis points. (Resp. Ex. 10 at PA 002018-32.) The escrow securities, the subject of this proceeding, had a mark-up of 45 basis points.
This interrelated confusion, however, does not disturb the legal conclusions contained herein. The intended result of the escrow securities mark-up was consistently and continuously in the millions of dollars, regardless of anyone's confusion about 4.5 or 45 basis points. Further, the Treasurer's Office's lack of awareness as to the 4.5 basis points mark-up in the forward supply contract raised an inference that the Treasurer's Office did not distinguish between the forward supply contract and the escrow securities mark-up. Wherever the confusion lay, it does not modify my conclusion that the Treasurer's Office was in possession of the material information concerning the March advance refunding.
Accordingly, there is no credible evidence that Quinn omitted or misrepresented any material information regarding the March advance refunding with the intent to defraud the Commonwealth, nor did he act recklessly or negligently within the meaning of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
IV. 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 set forth in the record index issued by the Secretary of the Commission on June 15, 2001.
IT IS ORDERED that the proceeding against Respondent Kevin G. Quinn is hereby DISMISSED.
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. Pursuant to that rule, a petition for review of this initial decision may be filed within 21 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 21 days after service of the initial decision upon him, 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.
Robert G. Mahony
Administrative Law Judge
|1 Citations to exhibits offered by the Division and Respondent, to the transcript of the hearing, and to the Amended Stipulation will be noted as "(Div. Ex. __.)," "(Resp. Ex. __.)," "(Tr. __.)," and "(Amended Stip., ¶ __.)" respectively.|
|2 Information concerning Heyison, now deceased (1996), was derived primarily from the testimony of Arpey and Sciortino.|
|3 McCarthy did not testify at the hearing. His involvement in the events in question was derived from witness testimony and exhibits.|
(Amended Stip., ¶¶ 3-5.) From 1991 through February 1994, McCarthy's law firms collectively received over $369,000 through this arrangement. (Tr. 579; Div. Ex. 75.)
(Amended Stip., ¶ 6.)
When an escrow is developed, it is typically made up of component pieces of various U.S. Treasury securities, varying in date and yield, making a complete package that will produce enough cash to defease the bonds when they are callable. (Tr. 195-96.) However, proceeds from the escrow are restricted to the arbitrage yield on the new issue so that the issuer cannot make money on the transaction. (Tr. 39-40, 196.) The maturing escrow securities and the interest earned thereon should be sufficient to pay the debt on the bonds when they are callable. (Tr. 40.)
|6 Although Heilman had expected Arthurs Lestrange to do the escrow work, he received a call from Heyison stating that the Treasurer's Office would take the responsibility for the escrow securities. (Tr. 194-95.) Arthurs Lestrange's analyses would provide the necessary information to the Treasurer's Office to pay off the bonds that were being advance refunded, but Arthurs Lestrange would not have any other interaction with the Treasurer's Office. (Tr. 51-52.)|
|7 As time went on, interest rates started to increase to where it was not financially beneficial to refund some of the bonds. (Tr. 379-80.) Furthermore, it was determined that the advance refunding should be broken into two parts. The first advance refunding in March 1994 was for approximately $300 million. (Tr. 380.) A second advance refunding would be conducted in June 1994.|
|8 A basis point is one one-hundredth of one percent, or 0.0001.|
|9 Neither party provided documentation memorializing the agreement between Alex Brown and the Commonwealth for the March advance refunding.|
|10 In 1989, the Treasurer's Office was ill equipped to handle all of the financial activities of a $3.5 to $4 billion portfolio of the Commonwealth. (Tr. 248.) With an Investment Center, the Commonwealth would not duplicate activities and, in turn, save taxpayers' money. (Tr. 249.) Knoll took on the mission of dedicating a portion of the finance building to finance activities. (Tr. 248.) The result was a high-tech, state-of-the-art, fully capable Investment Center with computer and telephone connections that could handle the Commonwealth's investment activities, clearing activities, banking activities, and the wiring of funds in and out of the Commonwealth. (Tr. 130, 248-49.) It brought all of the financial operations of the Treasurer's Office into one place. (Tr. 130-31.)|
|11 The mark-up is the revenue or commission a firm receives for handling the securities transaction. (Tr. 466.) A mark-up is added to the purchase price of the escrow securities prior to reselling the same securities to the user. (Tr. 466.) Meteer testified to two methods to derive the mark-up. With a reduction-in-the-yield method, the parties determine a number by which they want to reduce the yield and then adjust the purchase price of the securities such that it will accomplish the reduction in the yield. With a percentage-of-the-purchase-price method, the parties negotiate a percentage by which the purchase price for the escrows will be multiplied. The parties then "do the math" by applying that percentage to the purchase price of the securities. (Tr. 467.) In the latter method, the percentage could be indicated through the use of basis points or an amount per bond.|
|12 Sciortino sought information from Quinn on the relative advantages of structuring an escrow in a negotiated versus competitive basis and Quinn provided a letter, dated February 7, 1994, advising that the negotiated basis was the most advantageous. (Tr. 274-75; Div. Ex. 30.) The letter did not persuade Sciortino. (Tr. 275.)|
|13 Quinn testified that the escrow agent function undertaken by Alex Brown in the March advance refunding was neither pursuant to nor covered by the financial advisor service purchase contract. "It was an engagement to broker securities in connection with the transaction that already [had] been defined many months before I was contacted to become involved." The escrow agent activities were distinct from financial advisor duties. (Tr. 538.)
Quinn also testified that the relationship between Alex Brown and the Commonwealth concerning the advance refunding transaction was so obviously an isolated activity, that it would only insult the intelligence of the individuals in the Treasurer's Office to clarify it. (Tr. 542.) Accordingly, Quinn never explicitly stated that Alex Brown was working in two different capacities. (Tr. 543.) The Treasurer's Office knew it.
|14 On February 5, 1994, before discussing the mark-up of the escrow securities with Sciortino, Quinn spoke with Bova. (Tr. 514, 519.) Quinn testified that his notes, which incorporate information that McCarthy had provided previously, read "4.5 BD" referring to "per bond" rather than "4.5 BP" referring to "basis points." The fees written by Quinn while in conversation with Bova indicate a financial advisor fee of $817,888, or $0.80 per bond times the issue size, and a mark-up of $4,600,620, or $4.50 per bond times the issue size. (Div. Ex. 29.) The mark-up was based on an estimated cost of $1,022,360,000 for the securities. This fee is the result of using 45 basis points. (Tr. 517-20.)|
|15 The purpose of the forward supply contract is to "optimize the efficiency of the refunding escrow." This determined how the bond proceeds would be invested during the gaps between when the escrow securities matured and when the payments were due on the original bonds. (Tr. 599-600.) The Commonwealth intended to sell the right to invest the bond proceeds during the gaps to an investment firm through the forward supply contract. (Tr. 599-601.) On March 30, 1994, Quinn sent a letter to Knoll advising that it was prudent to enter into such an agreement. (Tr. 537; Div. Ex. 43.)|
|16 Quinn testified at the hearing that he negotiated a mark-up of $5 per bond, not 5 basis points. (Tr. 682-85.)|
|17 Meteer was responsible for the structuring of the securities for the escrow, and Curry was responsible for the bidding out of the forward supply contract. (Tr. 473-74.)|
|18 On the previous day, March 15, Sciortino received a document by facsimile with the subject title "Commonwealth of Pennsylvania Refunding - Escrow Obligations," which provided information on the forward supply contract fee, which was an additional fee to the mark-up on the escrow securities. (Resp. Ex. 10.) The document included a "Draft of Float Contract Bid Form," which stated under "Fee" that "[a] fee equal to 4.50 basis points will be delivered to Alex Brown upon closing. This amount is in addition to the target amount shown in Exhibit B." Exhibit B detailed the "Summary of Bonds Refunded and Escrow Requirements." (Resp. Ex. 10 at PA 002018-32.)|
|19 On March 15, the day before the pricing, Sciortino spoke to Quinn and stated that he wanted to come to Baltimore to observe and supervise the pricing process regarding the escrow securities and the awarding of the forward supply contract. Quinn thought it was a good idea for Sciortino to be there. (Tr. 734-35.)|
|20 Typically, Meteer did not meet with the client on the day of pricing on issues concerning the escrow side of the transaction. (Tr. 481.) He did not recall ever having a senior banker request him to have a meeting to go over the escrow securities. (Tr. 481.)|
|21 At the hearing, Sciortino did not recall meeting with Meteer separately, or discussing the mark-up with him. (Tr. 289, 399.) He testified that he met Meteer, spoke to him briefly, and otherwise observed Meteer going "in and out of the conference room." (Tr. 400, 405.) Sciortino did not recall receiving a two-page document on the mark-up from Meteer, nor did he believe that they discussed the mark-up. (Tr. 288-89.)|
|22 Sciortino had discussed with Quinn the people who were approved to do trades with the Commonwealth and Heyison had added and subtracted people. Sciortino provided a final list to Quinn. (Tr. 394-95.)|
|23 Because the Treasurer's Office is the custodian for the Commonwealth, it is standard practice to compare transaction results with analyses of hypothetical results as if the Treasurer's Office had conducted the transaction itself. Information databases can identify prices of other escrow securities purchased on the day Alex Brown purchased the escrow securities for the Commonwealth. (Tr. 290-91.) Although not precise, an analyst can calculate a price range, a high and a low, for the escrow securities purchased that day and compare it to the action that was taken by Alex Brown. (Tr. 291.)|
|24 There is no evidence to suggest that the memorandum was not facsimiled on March 15, 1994, the day before Sciortino went to Baltimore, as reflected by the facsimile date stamp. Sciortino's handwritten directions to Baltimore are on the first page of this memorandum. When presented with this evidence Sciortino stated that he only had the first sheet with him in Baltimore. (Tr. 367-68.)|
|25 A finding of negligence is adequate to establish a violation of Sections 17(a)(2) and 17(a)(3) of the Securities Act. See Jay Houston Meadows, 52 S.E.C. 778, 785 & n.16 (1996), aff'd, 119 F.3d 1219 (5th Cir. 1997); see also SEC v. Steadman, 967 F.2d 636, 643 & n.5 (D.C. Cir. 1992) (citing Aaron v. SEC, 446 U.S. 680, 701-02 (1980)); Newcome v. Esrey, 862 F.2d 1099, 1102 n.7 (4th Cir. 1988).|
|26 The Division contends that Quinn violated his fiduciary duty to fully disclose all material facts to the Treasurer's Office. This duty, according to the Division, arose under the financial advisor service purchase contract between Alex Brown and the Treasurer's Office. However, both Sciortino and Quinn testified that the escrow arrangement was separate from the financial advisor service purchase contract. (Tr. 369, 538-39.) This testimony is uncontradicted and I credit it to support my conclusion that the escrow agent relationship was separate and distinct from the financial advisor service purchase contract. Therefore, the agreement to apportion the escrow agent fees did not "trigger" any provision of the financial advisor service purchase contract. There is also no evidence that Alex Brown and Arthurs Lestrange did not complete all the work or not accept all the risk required of them as the Treasurer's Office's escrow agent and Governor's Office's financial advisor, respectively. Since Alex Brown was the only escrow agent, it was responsible for all the risk of the position.|
|27 Sciortino's testimony is not credible with respect to several important events. First, he did not recall getting a copy of the February 18, 1994, letter from Bova to the Governor's Office; then he denied getting the March 15, 1994, facsimile until it was found in his office and he was shown his handwriting on the first page. He also denied meeting alone with Meteer on the pricing date and he tried to explain his reasons for being at Alex Brown for reasons that had nothing to do with the mark-up. These were times at which important information was brought to his attention that he denies receiving. I do not credit his testimony on these matters. In contrast, Sciortino was quick to point out to the decision-makers in the Treasurer's Office that he received information about a possible mark-up overcharge the day after the pricing date.|
|Home | Previous Page||