Initial Decision of an SEC Administrative Law Judge
In the Matter of
In the Matter of
CHARLES K. SEAVEY
February 20, 2002
|APPEARANCES:|| John S. Yun and Kashya K. Shei for the Division of Enforcement, Securities and Exchange Commission
W. Reece Bader and Thomas J. Gray of Orrick, Herrington & Sutcliffe LLP for Respondent Charles K. Seavey
|BEFORE:||Carol Fox Foelak, Administrative Law Judge|
This Initial Decision sanctions Charles K. Seavey for his role in a misleading performance report to investors in a hedge fund. Seavey was employed by the fund's investment adviser to manage its investments. After incurring steep losses, the fund purchased shares of a Lithuanian bank in a transaction arranged by one of the investment adviser's owners; he never delivered the shares and kept the purchase price, thus defrauding the fund's investors and his business partners. At the time of the performance report, five months had elapsed without the transaction's settling, despite diligent efforts by Seavey, with various excuses being provided by individuals in Lithuania. Seavey suspected fraud and urged the investment adviser to disclose it to investors, report it to authorities, and take legal action against the perpetrators. Nonetheless, the investment adviser sent investors a performance report, prepared and signed by Seavey, that included the Lithuanian bank stock, causing the fund's performance to appear vastly more favorable than reality. Thus, the investment adviser violated the antifraud provisions, and Seavey aided and abetted the violations through his role in the report. The Initial Decision fines Seavey $10,000, and also imposes a censure, thirty-day suspension, and cease-and-desist order.
A. Procedural Background
The Securities and Exchange Commission (Commission) initiated this proceeding on September 29, 2000, by an Order Instituting Proceedings, as amended February 20, 2001 (OIP).1 The proceeding was authorized pursuant to Sections 203(f) and 203(k) of the Investment Advisers Act of 1940 (Advisers Act).
The undersigned held a hearing in San Francisco, California, on February 13 through 15, 2001, as to Respondent Charles K. Seavey. The Division of Enforcement (Division) called four witnesses, including Seavey, from whom testimony was taken, and Seavey called one additional witness. Eighty-two exhibits were admitted into evidence.2
The findings and conclusions in this Initial Decision are based on the record. Preponderance of the evidence was applied as the standard of proof. See Steadman v. SEC, 450 U.S. 91 (1981). Pursuant to the Administrative Procedure Act,3 the following post-hearing pleadings were considered: (1) the Division's April 5, 2001, Findings of Fact and Conclusions of Law and Post-Hearing Brief; (2) Seavey's May 21, 2001, Findings of Fact and Conclusions of Law and Post-Hearing Brief; and (3) the Division's June 4, 2001, Reply Brief. All arguments, proposed findings, and conclusions that are inconsistent with this Initial Decision were considered and rejected.
B. Allegations and Arguments of the Parties
The OIP alleges that Seavey willfully aided and abetted and caused violations of Sections 206(1) and 206(2) of the Advisers Act by making material misstatements and omissions in letters sent by Morgan Fuller Capital Management, LLC (Morgan Fuller), an investment adviser, to investors in a hedge fund regarding a transaction involving the stock of a Lithuanian bank, AB Bankas Hermis (Bankas Hermis). The Division requests a cease-and-desist order, a censure, a thirty-day suspension, and a $10,000 civil money penalty.
Seavey contends that he did not aid and abet or cause an underlying violation of Sections 206(1) or 206(2) of the Advisers Act. He argues that there were no material misstatements in the letters, and the investors had additional information that made the letters not misleading. Seavey also argues that he lacked the requisite intent for the violations because he believed his superiors were responsible for the transaction, made good faith efforts to effect the transaction and recover the shares, and relied on the advice of an attorney. Alternatively, he argues that if violations are found, sanctions are not warranted.
II. FINDINGS OF FACT
A. Morgan Fuller and Respondent
During the time at issue, Morgan Fuller employed Seavey to manage its hedge fund, the Paradigm Capital Fund, LP (the Fund).
1. Morgan Fuller and its Owners
Morgan Fuller was a California limited liability company and investment adviser registered in the state of California.4 It organized the Fund as a California limited partnership.5 Morgan Fuller was the sole general partner and investment adviser to the Fund. Tr. 26; Div. Ex. 6. Its three owners, James W. Fuller, Gordon Taubenheim, and Alexander Lushtak, formed it in 1996; they were the firm's directors and managed it as a board of managers.6 Tr. 24; Div. Ex. 6 at 1, 5. Fuller was predominantly responsible for the management of the Fund, and Taubenheim, for Morgan Fuller's investment banking activities. Tr. 338-39.
Fuller has been in the securities business for about thirty years; his career included working in New York Stock Exchange (NYSE) management from 1978 to 1981, after which he served on President Reagan's transition team. Tr. 16-21, 103; Div. Ex. 6 at 12. Later he gained experience dealing with Eastern European countries. Tr. 107-08. Fuller had dealings with Bankas Hermis prior to the events at issue, and, with Lushtak, had met with top officials of the bank. Tr. 51-52, 103-06. Fuller was on the bank's supervisory council; in his testimony he was vague as to the duties and responsibilities of that position. Tr. 51, 106, 110-11, 336. Taubenheim, after military service in the early 1960s, had worked in computer systems and banking. He first worked in the securities industry in 1993; he met Fuller and Lushtak when they were negotiating to buy the firm with which he was associated, L. H. Alton & Co.7 Tr. 303-06. Lushtak appeared to be an investor who dealt in Eastern Europe when Fuller met him in the spring of 1995. Tr. 25, 112. Shortly after meeting him, Fuller accompanied Lushtak to Russia in connection with setting up a trading operation at a bank in Moscow. Tr. 112-13.
Lushtak is serving a seventy-one month sentence for money laundering in violation of 18 U.S.C. § 1956(a)(1)(B)(i). According to the transcript of his January 24, 2001, sentencing, of which official notice is taken, his wrongdoing included affinity fraud that targeted immigrants from Russia and neighboring countries. Lushtak defaulted in this proceeding. See Charles K. Seavey, 75 SEC Docket 1879 (A.L.J. Aug. 16, 2001). Fuller and Taubenheim entered settlements arising out of the facts at issue in this proceeding. See James William Fuller, 70 SEC Docket 2461 (Oct. 4, 1999); Gordon Richard Taubenheim, 70 SEC Docket 2467 (Oct. 4, 1999).
Fuller, Taubenheim, and Lushtak also formed a now-defunct broker-dealer, Morgan Fuller Capital Group (MFCG) in January 1996. Tr. 21, 23, 25. They hoped to act as a conduit for investors from Eastern Europe to invest in the United States, among other things. Tr. 25-26. In 1996, MFCG raised about $3 million in capital for Bankas Hermis in a private placement of its stock in the United States. Tr. 51-52, 103-04. Bankas Hermis participated in other private placements that involved MFCG and maintained a brokerage account at the firm. Tr. 107.
Seavey questions the credibility of Fuller's testimony. Much of Fuller's testimony concerned the Bankas Hermis transaction that is the background to the issues in this proceeding - alleged material misrepresentations and omissions in April and July 1997 letters to investors signed by Seavey. The testimony is not completely reliable. Fuller waffled, was vague, minimized his role, and maximized Seavey's role regarding Bankas Hermis. Tr. 26-27, 29-30, 39-43, 50-52, 54, 61-69, 74-81, 83-85, 88-91, 95-98, 122, 129-30, 137-44, 148-49, 151-56, 162, 164-68, 170, 179-80. For example, he testified that Seavey informed him of the opportunity to buy the Bankas Hermis shares and that the decision to buy was Seavey's. Tr. 52, 54. Fuller's version of events is not entirely credible in view of the difference in age, experience, and authority at Morgan Fuller and Fuller's previous history with Bankas Hermis and Lushtak. However, his spin does not affect facts that are material to this proceeding against Seavey, which pertain to Seavey's involvement in the April and July letters.
2. Respondent Charles K. Seavey
Seavey received a B.A. in English from Stanford University in 1988 and an M.B.A. from the University of Chicago Graduate School of Business in 1996. Tr. 187-88. Prior to attending graduate school, Seavey was employed in various occupations including jazz musician, bookkeeper, commodities broker, and real estate consultant. Tr. 188.
In the summer of 1993, after his first year of graduate school, Seavey began work as an analyst, assigned to a portfolio manager, at Soros Fund Management (Soros), which had over $10 billion under management. Seavey started as an emerging markets equities analyst, and eventually became a European equities analyst.8 Tr. 190-92, 194. He was also an assistant to the managing directors responsible for emerging markets and European equities. Tr. 415. At Soros, Seavey invested in futures and equities around the world and did currency trading. Tr. 415. After a year at Soros, Seavey, who had taken a leave of absence from graduate school, became a portfolio manager at Teleos Asset Management, which had about $300 million under management. There he was responsible for Japanese derivatives, as well as over $5 million in equities invested worldwide. Tr. 190-91, 194-95, 197.
After graduating from business school, Seavey joined a small start-up fund that specialized in emerging market debt, especially Russian and Eastern European debt; investment decisions were made by consensus. Tr. 197-98; Div. Ex. 6 at 12. Seavey left after six months because of a conflict over compensation, and joined Morgan Fuller as the portfolio manager for the Fund.9 Tr. 199-200, 419.
At the time they hired him, Seavey told Morgan Fuller's owners that he was bearish - he believed that the G7 markets, especially the U.S. stock market, would decline in the short-term - and contrarian - he believed that it would be profitable to take long positions in out-of-favor assets and short positions in in-favor assets. Tr. 27, 29, 126, 203-05.
Seavey was a full-time employee of Morgan Fuller from January 1, 1997, until he resigned on October 13, 1997. Div. Exs. 4, 36. He was given principal responsibility for the Fund's investments but was required to report to an investment committee for review of investment strategies and tactics. Div. Ex. 4, Div. Ex. 6 at 12. The investment committee consisted of Fuller and Taubenheim. Tr. 37. Seavey's compensation was to be half of Morgan Fuller's 20% share of any profits, allocated at the end of each year. Div. Ex. 4 at 1, Div. Ex. 6 at 14-15. During the first quarter of 1997 Seavey also ran his own hedge fund, Synergy Capital Fund I, LP (Synergy Fund), parallel to the Fund, until the Bankas Hermis transaction; the Synergy Fund ceased operations as of April 1, 1997, and returned a profit. Tr. 297, 409-12.
Seavey has no previous disciplinary history. Tr. 519. He has let his securities licenses lapse and has not engaged in money management activities since he resigned from Morgan Fuller. Tr. 95, 297-98, 519. He intends never again to manage anyone else's money. Tr. 518-519. Because of his age, education, and experience, however, he could return to managing funds. Tr. 540-41. Seavey consults and writes business plans, and is the chief financial officer of a start-up, internet-based, reseller of office furniture. Tr. 298-99, 407-10.
3. The Paradigm Capital Fund
Fuller and Lushtak decided to form a hedge fund in early 1996. Tr. 122-23, 212, 322. Their idea crystallized at the end of the year after Fuller met Seavey. Tr. 202-03. After Fuller, Lushtak, and Taubenheim interviewed Seavey, Morgan Fuller reached agreement with Seavey in November for Seavey to manage the Fund's investments as of January 1, 1997. Tr. 207; Div. Ex. 4. Their agreement called for Morgan Fuller to raise at least $2 million in initial capital and an additional $3 million by the end of 1997. Div. Ex. 4 at 2. The Fund began operations in January 1997. Tr. 36-37, 213; Div. Ex. 6. Morgan Fuller had raised only about $825,000 from seven investors, including Fuller. Tr. 214, 216, 422-23.
The Fund's investments were to include long and short positions in equity and debt securities of corporations and governments. Tr. 27, 465; Div. Ex. 6 at 8. The Fund's Offering Circular disclosed a bearish and contrarian investment strategy in accord with Morgan Fuller's decision to endorse Seavey's predilection. Tr. 27; Div. Ex. 6 at 9-11. The Offering Circular detailed risk factors, including information regarding the risks inherent in investments in foreign securities, such as difficulties in enforcing contractual obligations not present in the United States. Tr. 394-96; Div. Ex. 6 at 21. Morgan Fuller, the general partner, could change the strategy of the Fund without the consent of the limited partners - the investors. Div. Ex. 6 at 6. Morgan Fuller was required to report annually to each limited partner on the Fund's financial condition. Div. Ex. 6 at 19. Investors could contribute additional capital at any time, with the consent of Morgan Fuller. Div. Ex. 6 at 18. Investors had limited power to withdraw capital after a year passed. Tr. 355, 358-59, 391-92; Div. Ex. 6 at 6, 18. Morgan Fuller was to receive a management fee, amounting to 1% per year of net capital, for expenses, and incentive compensation of 20% of any profits, allocated at the end of each year. Div. Ex. 6 at 14-15.
Partnership interests were offered only to accredited investors. Tr. 132, 421-22, 450-51; Div. Ex. 6. The limited partners had significant long investments in Standard & Poor's 500 (S&P 500) type stocks and invested in the Fund as a hedge against the rest of their portfolios.10 Tr. 449-50. Of the seven original investors, three were friends of Seavey and his family, and three others were brought in by finders hired to solicit accredited investors. Tr. 214, 421-22. An eighth investor was originally an investor in the Synergy Fund. Tr. 412. When it ceased operating in April 1997, he moved his money into the Fund. Tr. 409, 412, 423.
B. The Fund's Losses
The Fund acquired a large short position in Hutchinson Technology and a number of put positions in the S&P 100 in accord with its bearish investment strategy.11 Hutchinson Technology rose, however, by 50%, and the S&P 500, by 10%. Tr. 135, 223, 229-30, 424, 451-53. By February 1997, the Fund had suffered precipitous losses.12 Tr. 46, 49, 132-33; Resp. Ex. 72. Fuller, Taubenheim, and Lushtak were dismayed. Tr. 46-50, 230-31.
Seavey informed Fuller and the limited partners, or their finders, about the losses. Tr. 132-33, 461. The finders also communicated their displeasure to Fuller. Tr. 133-36, 456-57. Soon after, Fuller told Seavey to alter his investment strategy and reduce his concentration in short positions. Tr. 135-36, 243-44, 294, 412-13, 454-57.
C. The Bankas Hermis Transaction
In late February 1997, Fuller and Lushtak presented Seavey with a deal to restore the Fund's losses - to purchase from Lushtak's girlfriend, Tanya Khabay, 15,000 shares in Bankas Hermis, the second largest bank in Lithuania, in a private transaction.13 Tr. 52-56, 111, 232-38, 268, 457.
The Fund's price was $250,000, while the market price for 15,000 shares was about $746,000. Tr. 235, 241. It was necessary to liquidate almost all the Fund's investments to pay for the transaction. Tr. 243-44. The benefit to Khabay was immediate liquidity, while the Fund could make up its losses by reselling the shares on the market in an orderly manner over a period of time. Tr. 138, 144-45, 236, 238-39. Fuller was pleased with the coup and even sought out Seavey's father to boast that he had solved a problem Seavey had created. Tr. 312-13, 338, 430-31.
Drawing on his prior relationship with Bankas Hermis, Fuller spoke with Ludmila Kirkiliene, head of Bankas Hermis's stock transfer department, and learned that Khabay had to send written instructions to Bankas Hermis to transfer the shares to the Fund. Tr. 142-44. In a letter dated February 21, 1997, Khabay memorialized the terms of the agreement and agreed to instruct Bankas Hermis to re-register her 15,000 shares in the Fund's name. Tr. 57, 239; Div. Ex. 16. Accordingly, Fuller and Seavey understood that Khabay would instruct Bankas Hermis to transfer the shares. Tr. 141-42, 242, 272.
Fuller also called Steponas Jurna, the bank's first deputy chairman, to confirm that Khabay owned the shares.14 Tr. 54-56; Resp. Ex. 70 at 19. Shortly thereafter, Morgan Fuller received, via facsimile (fax) dated February 27, a Bankas Hermis account statement purporting to show that Khabay owned 26,320 shares, purchased on July 9, 1996. Tr. 139-41; Div. Exs. 17, 18. In fact, Khabay's account had disposed of 16,000 shares in January 1997 and had only 10,320 shares in February 1997. Div. Ex. 43, Div. Ex. 45 at 1, 3.
Lushtak provided Seavey with wire transfer instructions and watched him input them into the computer. Tr. 242-43. In late February and early March 1997, Seavey wire-transferred a total of $239,000 to an account at Bank Frunzensky, as directed by Lushtak.15 Tr. 242-44; Div. Ex. 19. Fuller told Seavey to withhold the last installment of the purchase price, $11,000, until they received documentation that the Fund owned the Bankas Hermis shares. Tr. 58-59, 146, 161-62, 244-45. In March, Fuller asked Jurna and Kirkiliene at Bankas Hermis about the ownership documentation, which Morgan Fuller had not yet received. They did not give any indication that there was a problem. Tr. 151. Fuller also spoke with Lushtak, who falsely assured him that there was no problem with the transaction and it was only a matter of time. Tr. 152. In fact, the remaining 10,320 shares were sold by Khabay on March 4, along with 41,200 additional shares sold by Lushtak, in his own name and in the name of Rocney Corporation. Tr. 88-89, 278-84, 339, 508-10; Div. Ex. 42 at 1, 5-10, Div. Ex. 44, Div. Ex. 45 at 1, 3. Seavey also was unaware during the time at issue of Khabay's and Lushtak's March 4 disposition of Bankas Hermis shares. Tr. 513-16.
The Fund was not required to make quarterly performance reports, but in April 1997 Morgan Fuller sent a letter signed by Seavey to the limited partners (April letter). Div. Ex. 21. The April letter was a performance report for the Fund for the first quarter of 1997, January through March. Seavey drafted the April letter, and Fuller reviewed it. It included the Bankas Hermis shares as assets of the Fund's portfolio, marked to market. Tr. 65-69, 147-49, 249-53, 461-66; Div. Exs. 21, 22; Resp. Ex. 12.
The letter stated that the Fund had generated positive returns of 6%. Div. Ex. 21. Without the Bankas Hermis shares, or the $239,000 paid for the shares, the Fund would have had a negative return for the quarter of about 85% to 90%.16 Tr. 70, 254-55. The letter referred to the shares as the Fund's largest long position, purchased at an attractive price. Div. Ex. 21. At the time, the Fund had not received any confirmation that ownership of the shares had been transferred to the Fund. Fuller was not concerned, based on his experience that it took an inordinate amount of time to receive responses in dealings with countries in Eastern Europe; he believed that the Fund would receive the shares and told Seavey so. Tr. 64-65, 150-51, 254. Thus, at the time of the April letter Seavey also believed the transaction would settle. Tr. 466, 522.
Prior to the April letter, Seavey had talked to some of the limited partners or the finders, on their behalf, about the Fund's January and February losses and the Bankas Hermis transaction. Tr. 132-33, 456-57, 461.
By May, Morgan Fuller still had not received confirmation that the Fund owned the shares. By letter dated May 2, 1997, Seavey asked Khabay why they had not received any indication that the shares had been re-registered. Khabay indicated that she had requested re-registration of the shares and was surprised that it had not happened. Tr. 256-57; Div. Ex. 23.
On June 16 Seavey faxed a letter to Bankas Hermis demanding that the shares be re-registered by June 30, 2001. Div. Ex. 26. The bank's response, dated June 19, was that they had never received any documents confirming a sales transaction between Khabay and the Fund. Div. Ex. 28. Fuller inferred from the letter that the shares were still in Khabay's name, and that she simply had not done what was necessary to re-register the shares. Tr. 77, 154. Morgan Fuller had Khabay send another letter to Bankas Hermis requesting re-registration. On June 20 Seavey faxed a separate letter to Bankas Hermis to confirm its receipt of Khabay's latest request, and asked for verification of the re-registration. Tr. 81, 155; Div. Ex. 27, Resp. Ex. 20. He followed up with several telephone calls to Bankas Hermis and spoke to Kirkiliene; Alexander Federas, another officer; and an individual in the office of Nadiezda Novickiene, the chief executive officer. They all promised that confirmation would come by June 27. Tr. 472; Resp. Ex. 21. It did not, and Seavey faxed yet another letter demanding confirmation. Resp. Ex. 21. By fax dated June 30, 1997, Bankas Hermis informed Seavey that the shares could not be re-registered because Khabay did not own any Bankas Hermis shares. Div. Ex. 29. Seavey theorized that Bankas Hermis had seized Khabay's shares to satisfy a debt owed to Bankas Hermis by Lushtak. Tr. 162.
Around this time Taubenheim also became suspicious of Lushtak and he and Fuller became aware that Lushtak had financial problems. Tr. 315-16. Lushtak told Fuller that he would help to get the shares, but because of his financial situation, he was not in a position to repay the purchase price. Tr. 85.
To Fuller, the June 30 fax was the first real indication of a problem. Tr. 85. He had not been concerned previously because, from his experience, such delay was to be expected when doing business with foreign entities. Tr. 65, 73. Fuller confronted Lushtak, who denied that Bankas Hermis had seized the shares or that there was any problem; Lushtak said that there must be some mistake and that he would take care of it. Tr. 158, 161-62. Khabay continued to represent that she owned the shares and had a right to sell them. Tr. 161.
Fuller advised Seavey to contact Ivo Gueorguiev or Roberto Marzanati at the European Bank for Reconstruction and Development (EBRD). The EBRD was the largest shareholder of Bankas Hermis, and Fuller thought that Gueorguiev or Marzanati might be able to obtain additional information about the Bankas Hermis transaction. Tr. 88, 278-79. Seavey spoke with Gueorguiev, on June 30 and July 1, 1997. Tr. 279. On June 30, Gueorguiev said that the shareholder registry listed Khabay as owning 10,000 Bankas Hermis shares as of the end of April 1997. Seavey faxed Gueorguiev the document purporting to show Khabay owned 26,320 shares at the time of purchase, so Gueorguiev could follow up with Novickiene. Tr. 279-80, 474-75; Div. Exs. 17-18; Resp. Ex. 22. On the morning of July 1, Gueorguiev told Seavey that Khabay had ordered the sale of her shares on the open market in March 1997. Gueorguiev had asked the bank for documentation for the sale to send to Seavey, but received none. Tr. 279, 281, 486, 494, 504; Resp. Ex. 43. Fuller also spoke to Gueorguiev, who said that Novickiene sent him only a letter stating that Bankas Hermis acted in good faith, that Khabay had sold her shares in March, and everything was in order. Tr. 486.
Seavey was upset and obsessed with the problem. Tr. 91, 163, 276-83, 314, 327-29. He concluded that Lushtak had defrauded Morgan Fuller and the investors. He recorded his concerns in a draft memorandum and consulted his father, who recommended he consult a securities lawyer as to whether he himself had a duty to report this to regulatory and enforcement authorities. Tr. 282-87, 433-34, 476-78; Div. Ex. 31. The securities lawyer advised him to collect more solid evidence and to discuss his concerns with Fuller and Taubenheim, who were in charge of the situation. The lawyer advised that as things stood, Seavey had no duty or right to disclose his suspicions to the investors or report them to the authorities. Tr. 478-80. Seavey understood, however, that he could not make affirmative misrepresentations to the investors. Tr. 531-32.
Seavey met with Fuller and Taubenheim in the afternoon of July 1. Tr. 159, 287, 331. Seavey discussed the facts as articulated in the draft - that Khabay had sold her Bankas Hermis shares on the open market in March 1997 and that the account at Bank Frunzensky, where the consideration for the shares was wired, was owned or controlled by Lushtak - and concluded that Lushtak had defrauded Morgan Fuller and the limited partners. Tr. 278, 476, 480-81; Div. Ex. 31. Seavey suggested that they notify the Commission and the Federal Bureau of Investigation; hire counsel in the United States and Lithuania to go after Khabay, Lushtak, and Bankas Hermis; and meet with the investors to tell them about the situation. Tr. 159, 331, 480-81.
Fuller rejected the suggestions: there was no need to hire lawyers or to disclose or report anything because the situation was not serious; this was the way things were done in Lithuania. He thought Bankas Hermis was lying and the matter could be resolved informally. Tr. 164, 333-34, 481-83, 531. Throughout the summer Fuller continued to emphasize that he had a long relationship with Novickiene and her husband, that they do things like this in Lithuania, and that he could go there and straighten things out if necessary. Tr. 335, 482-83, 531. Before resigning in October 1997, Taubenheim again suggested meeting with the investors to discuss the Bankas Hermis transaction, but Fuller did not act on the suggestion. Tr. 332-33, 335; Div. Ex. 35.
Seavey drafted a letter, dated July 3, 1997, from Khabay to Bankas Hermis requesting documentation reflecting the March 1997 disposition of her shares and requesting the bank's full cooperation with the Fund in investigating the matter. Div. Ex. 32. Bankas Hermis did not respond, and Seavey sent the bank a letter, dated July 15, threatening to involve Lithuanian, United States, and international oversight agencies.17 Resp. Ex. 27. The bank's July 22 reply indicated that it was no longer willing to correspond because the Fund's claims were groundless; if Seavey persisted, Bankas Hermis would sue the Fund for damages. Resp. Ex. 30. Marzanati sent Seavey a memorandum, dated July 25, which reported that the management of the bank had assured him that they had acted in good faith and had done nothing wrong. Resp. Ex. 34. Marzanati also withdrew his help in the matter. Resp. Ex. 34.
On July 29, 1997, Morgan Fuller sent a letter signed by Seavey to the limited partners (July letter). Div. Ex. 33. The July letter was a performance report for April through June, the second quarter of 1997. Seavey drafted, and Fuller reviewed, the July letter. It included the Bankas Hermis shares as assets of the Fund's portfolio, marked to market.18 Tr. 91, 93-94, 287; Div. Ex. 33.
The letter stated that the Fund had a negative return of 4% for the year. The Bankas Hermis shares were included in this calculation. Tr. 92. If the Bankas Hermis shares and $239,000 paid for them were excluded the Fund would have had a negative return of about 70%.19 Tr. 290. Fuller believed that the Fund would ultimately get ownership of the shares. Tr. 165. Seavey believed that the Fund was entitled to the Bankas Hermis shares and would ultimately obtain them. Tr. 500, 522.
The July letter referred to the problems with the Bankas Hermis transaction but did not disclose that the shares had been included in the portfolio and calculation of the 4% negative return:
On an administrative level, you should be aware that a company in a less-developed country failed to deliver shares in the company purchased by the Fund in a related-party transaction. Based on the facts currently known to us, the company apparently seized the shares purchased by the Fund in satisfaction of a loan taken out from the bank by an acquaintance of the seller of the shares. If so, the company's actions are in contravention of securities laws internationally as well as in the country in question. We are taking vigorous action to investigate the situation further and enforce our interests through local regulators and the supervisory council of the company, as well as through the United States State Department and Treasury.
Div. Ex. 33. Seavey had previously discussed the situation with the investors or the finders, on their behalf. Tr. 165, 488-89, 500.
Seavey continued to try to obtain the shares. Tr. 168-69. On August 7 he faxed a letter to Marzanati asking whom else he could consult for help. Resp. Ex. 36. In late August, Seavey also appealed to Bankas Hermis's supervisory council for assistance, but was told that, after review of all the documents related to the Khabay issue, there were no contradictions to answers previously provided. Resp. Ex. 43. The Lithuanian Securities Commission notified Seavey by letter dated September 11, 1997, that it had opened an investigation into the matter. Resp. Ex. 44. On September 30, Khabay confessed to Seavey that Lushtak "might" have pledged the shares as security for a loan from the bank. Tr. 508-10. Seavey told Fuller and Taubenheim and reiterated his recommendations to hire lawyers, disclose to the limited partners, and complain to the regulatory authorities. Tr. 509-10. On October 13, 1997, Seavey resigned from Morgan Fuller. Tr. 95, 511-12; Div. Ex. 36. In June 2000, the Fund went into involuntary receivership and had no assets. The limited partners received nothing from their original investment. Tr. 99.
D. Expert Testimony
Donald J. Hardy testified as an expert witness for the Division and was accepted as an expert on hedge funds. Tr. 341-53 (qualifications), 354-406 (opinion). To the extent that his evidence does not lead to findings of fact, it will be summarized here and referred to as appropriate in the Conclusions of Law section of this Initial Decision.
Hedge funds mark positions in their portfolios to market daily, as of the trade date. Tr. 398. In the United States, there is a reliable settlement process in which settlement occurs three business days after the trade date through a central clearinghouse. Tr. 364. Hardy opined that a subsequent settlement problem does not make the valuation on the trade date improper, and in some instances, trades are even reversed. Tr. 398-99. Even in the United States, this can occur over a long period if there is a dispute. Tr. 398-99. Hardy opined that the key issue is whether there is a reliable settlement process that is being implemented. Tr. 398.
The Bankas Hermis transaction was to be settled through a murky settlement process in Lithuania, not a central clearinghouse. Tr. 365. Hardy opined that this was cause for caution. Tr. 365-66. He opined that it was improper to include the Bankas Hermis shares in the Fund's performance calculations contained in the April and July letters because of the uncertainty regarding settlement and the subsequent dispute over ownership. Tr. 367-72, 375-76.
III. CONCLUSIONS OF LAW
In this section it is concluded that Seavey willfully aided and abetted and caused Morgan Fuller's violations of Sections 206(1) and 206(2) of the Advisers Act. Seavey's secondary liability is based on conclusions that he knew that his role in the July letter was part of an overall activity that was improper and that he substantially assisted Morgan Fuller's violative conduct.
A. Advisers Act Antifraud Provisions
Seavey is charged with aiding and abetting and causing violations of the antifraud provisions of the Advisers Act, Sections 206(1) and 206(2), which make it unlawful for any investment adviser, by jurisdictional means, to directly or indirectly:20
1) employ any device, scheme, or artifice to defraud any client or prospective client, or
2) engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon any client or prospective client.
Scienter is required to establish violations of Section 206(1) of the Advisers Act. It is "a mental state embracing intent to deceive, manipulate, or defraud." Aaron v. SEC, 446 U.S. 680, 686 n.5, 695-97 (1980); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976); SEC v. Steadman, 967 F.2d 636, 641 (D.C. Cir. 1992). Recklessness can satisfy the scienter requirement. See David Disner, 52 S.E.C. 1217, 1222 & n.20 (1997); see also SEC v. Steadman, 967 F.2d at 641-42; Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990). Reckless conduct is conduct which is "`highly unreasonable' and represents `an extreme departure from the standards of ordinary care . . . to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it.'" Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 47 (2d Cir. 1978) (quoting Sanders v. John Nuveen & Co., 554 F.2d 790, 793 (7th Cir. 1977)).
Scienter is not required to establish a violation of Section 206(2) of the Advisers Act; a showing of negligence is adequate. See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 195 (1963); SEC v. Steadman, 967 F.2d at 643 & n.5; Steadman v. SEC, 603 F.2d 1126, 1132-34 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981).
Material misrepresentations and omissions violate Advisers Act Sections 206(1) and 206(2). The standard of materiality is whether or not a reasonable investor or prospective investor would have considered the information important in deciding whether or not to invest. See SEC v. Steadman, 967 F.2d at 643; see also Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 240 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). Investment advisers are fiduciaries and have an affirmative duty of utmost good faith and full and fair disclosure of all material facts. See Capital Gains Research Bureau, 375 U.S. at 191-92, 194, 201.
Morgan Fuller is accountable for the actions of its responsible officers, including Fuller, Taubenheim, and Lushtak. See C.E. Carlson, Inc. v. SEC, 859 F.2d 1429, 1435 (10th Cir. 1988); A.J. White & Co. v. SEC, 556 F.2d 619, 624 (1st Cir. 1977). A company's scienter may be imputed from that of the individuals controlling it. See SEC v. Blinder, Robinson & Co., 542 F. Supp. 468, 476 n.3 (D. Colo. 1982) (citing SEC v. Manor Nursing Ctrs., Inc., 458 F.2d 1082, 1096-97 nn.16-18 (2d Cir. 1972)). As an associated person of Morgan Fuller, Seavey's conduct and scienter are also attributed to the firm. See Section 203(e) of the Advisers Act.
1. Aiding and Abetting; Causing
For aiding and abetting liability under the federal securities laws, three elements must be established: (1) a primary or independent securities law violation committed by another party; (2) awareness or knowledge by the aider and abettor that his or her role was part of an overall activity that was improper; also conceptualized as scienter in aiding and abetting antifraud violations; and (3) that the aider and abettor knowingly and substantially assisted the conduct that constitutes the violation. See Graham v. SEC, 222 F.3d 994, 1000 (D.C. Cir. 2000); Woods v. Barnett Bank, 765 F.2d 1004, 1009 (11th Cir. 1985); Investors Research Corp. v. SEC, 628 F.2d 168, 178 (D.C. Cir. 1980); IIT v. Cornfield, 619 F.2d 909, 922 (2d Cir. 1980); Woodward v. Metro Bank, 522 F.2d 84, 94-97 (5th Cir. 1975); SEC v. Coffey, 493 F.2d 1304, 1316-17 (6th Cir. 1974); Russo Sec. Inc., 53 S.E.C. 271, 278 & n.16 (1997); Donald T. Sheldon, 51 S.E.C. 59, 66 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995); William R. Carter, 47 S.E.C. 471, 502-03 (1981). A person cannot escape aiding and abetting liability by claiming he was ignorant of the securities laws. See Sharon M. Graham, 53 S.E.C. 1072, 1084 n.33 (1998), aff'd, 222 F.3d 994 (D.C. Cir. 2000). The knowledge or awareness requirement can be satisfied by recklessness when the alleged aider and abettor is a fiduciary or active participant. See Ross v. Bolton, 904 F.2d 819, 824 (2d Cir. 1990); Cornfield, 619 F.2d at 923, 925; Rolf v. Blythe, Eastman Dillon & Co. Inc., 570 F.2d 38, 47-48 (2d Cir. 1978); Woodward, 522 F.2d at 97.
A respondent who aids and abets a violation also is a cause of the violation, within the meaning of Section 203(k) of the Advisers Act. See Sharon M. Graham, 53 S.E.C. at 1085 n.35. Negligence is sufficient to establish liability for causing a primary violation that does not require scienter. See KPMG Peat Marwick LLP, 74 SEC Docket 384, 421 (Jan. 19, 2001), recon. denied, 74 SEC Docket 1351 (Mar. 8, 2001), appeal pending, No. 01-1131 (D.C. Cir.).
The Division requests sanctions pursuant to Sections 203(f), 203(k), and 203(i) of the Advisers Act. The Commission must find willful violations to impose sanctions under Sections 203(f) and 203(i) of the Advisers Act. A finding of willfulness does not require an intent to violate, but merely an intent to do the act which constitutes a violation. See Wonsover v. SEC, 205 F.3d 408, 413-15 (D.C. Cir. 2000); see also Steadman v. SEC, 603 F.2d at 1135; Arthur Lipper Corp. v. SEC, 547 F.2d 171, 180 (2d Cir. 1976); Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965).
1. Primary Violations by Morgan Fuller
Morgan Fuller violated Sections 206(1) and 206(2) of the Advisers Act when it distributed the April and July letters to investors.
a. Scheme to Defraud
The letters were part of a scheme to defraud. They included the Bankas Hermis stock in the Fund's portfolio and calculation of returns when, in fact, the Fund had received nothing in return for paying out much of its capital. The April letter reported a positive return of 6%; in reality the Fund had lost 85% to 90%. The July letter reported a negative return of 4%; in reality the Fund had lost 70%. The July letter described the Bankas Hermis problem in a manner that not only fell short of full disclosure but also misled the reader into believing that the shares were not included in the Fund's performance. The record shows Lushtak's scienter, which is attributed to Morgan Fuller. His intent was to deceive and defraud. The $239,000 that he obtained was the purpose of his scheme. Lushtak had no intent to deliver the shares. Khabay did not have 15,000 shares at the time of the transaction, and her remaining shares, along with additional shares Lushtak owned or controlled, were sold a few days later, on March 4. By April, Khabay had no shares.
Additionally, by the time of the July letter, both Fuller and Seavey were at least reckless in not knowing that the letter was misleading concerning the Bankas Hermis transaction. The state of mind of each of them is attributed to Morgan Fuller.
b. Material Misrepresentations and Omissions
The letters also contained material misrepresentations and omissions. The letters included the Bankas Hermis stock in the Fund's portfolio and returns. They did not disclose the problems with the transaction, and the July letter described the Bankas Hermis situation in a misleading way. The misrepresentations and omissions were willful and made with scienter. The omitted and misrepresented information was clearly material.
Seavey argues that he or others had informally apprised investors of the Fund's losses and of the Bankas Hermis transaction and when the letters are seen in the context of the total mix of information there was no material misrepresentation. This argument is unavailing - in effect it is an argument that the investors would realize that the returns reported in the letters were meaningless and disregard the misrepresentations. The Fund's Offering Circular permitted investors to contribute additional capital at the discretion of Morgan Fuller, which had intended to raise $2 to $5 million - far more than the limited partners actually invested. Morgan Fuller had also hoped to raise capital from additional investors. An existing or would-be investor who was considering investing additional capital would have considered the Fund's actual return, as well as the fact that it had paid out almost all its capital in return for nothing, to be important.
The first element of aiding and abetting, primary violations by Morgan Fuller of Sections 206(1) and 206(2) has been established. The remaining elements - substantial assistance and awareness - are present as well.
2. Substantial Assistance
Knowing and substantial assistance to the conduct that constituted Morgan Fuller's violations is clearly present. Seavey signed both the April and July letters and participated in drafting them as well.
3. Awareness or Knowledge
Seavey was aware that his role in sending the July letter to investors was part of an overall activity that was improper. The performance returns included in the July letter included the positive effect of the Bankas Hermis shares, marked to market, and disclosed the problem with the transaction in a misleading manner. Five months had elapsed during which Seavey diligently attempted to obtain the shares. Not only had the transaction not settled, but Bankas Hermis had informed him that Khabay did not own shares, and the $239,000 purchase price could not be recovered from Lushtak. Seavey suspected Lushtak of fraud. He had urged Fuller to inform the investors and to retain attorneys to take legal action against Bankas Hermis, Lushtak, and Khabay. He even consulted a securities lawyer to ascertain whether he had a right or duty to report the situation to regulatory and enforcement authorities. Thus, he knew that the July letter gave a falsely optimistic picture of the Fund's returns and assets. Whatever the extent of Fuller's direction or editing of the contents of the letter, Seavey signed it and participated in drafting it. In the alternative, Seavey was reckless in sending such a letter. The awareness or knowledge requirement can be satisfied by recklessness when the alleged aider and abettor is a fiduciary or an active participant. As an associated person of an investment adviser, Seavey was a fiduciary, and he was an active participant in that he drafted and signed the letter.
Seavey raises reliance on counsel as a defense. This defense is unavailing. The four elements of a reliance on counsel defense are that a person made a complete disclosure to counsel of the intended action; requested counsel's advice as to the legality of the intended action; received counsel's advice that the conduct was legal; and relied in good faith on that advice. See Gallagher & Co., 50 S.E.C. 557, 563, n.15 (1991) (citations omitted); Markowski v. SEC, 34 F.3d 99, 104-05 (2d Cir. 1994); C.E. Carlson, Inc., 859 F.2d at 1436. Seavey consulted counsel on whether he had a duty to report his suspicions of fraud to the investors and to regulatory and enforcement authorities. He was advised that he had no such duty or right but should discuss his concerns with Morgan Fuller's owners and gather more information. Seavey did not consult counsel on the representations that were made in the July letter, and he understood that could not make affirmative misrepresentations to the investors.
Seavey argues generally that he relied on Fuller's greater experience. For instance, he argues that Fuller told him to value the Bankas Hermis shares at market in the July letter. Fuller's position at the firm vis-à-vis Seavey does not, however, excuse Seavey from the consequences of his participation in the July letter. See Sharon M. Graham, 53 S.E.C. at 1084-86 (holding registered representative liable for aiding and abetting customer's antifraud violations despite direction and reassurance from branch manager and owner that the trades were legal, and emphasizing the registered representative's responsibility to comply with the law); Adrian C. Havill, 53 S.E.C. 1060, 1068-70 (1998) (holding registered representative liable for aiding and abetting customer's antifraud violations despite reassurance from branch manager that the trades were legal, and emphasizing the registered representative's responsibility to comply with the law); cf. James J. Pasztor, 70 SEC Docket 2611, 2624 (Oct. 14, 1999) (holding branch manager failed reasonably to supervise registered representative who aided and abetted customer's antifraud violations. The branch manager tried to stop the violative trades but was overruled by the broker-dealer's owner. In finding his efforts insufficient, the Commission emphasized the branch manager's responsibility despite his superior's role in the violations.).
As to the April letter, in light of the Division's burden of proof, the evidence does not show that Seavey had awareness or knowledge that his role was part of an overall activity that was improper, nor was he negligent. As Hardy, the Division's expert witness, opined, the settlement process in Lithuania was cause for caution in accounting for the Bankas Hermis transaction. Seavey, however, reasonably relied on Fuller's representations that a one-month delay in settling the transaction was usual for Lithuania. As Seavey knew, Fuller had prior business dealings in Eastern Europe, including with Bankas Hermis. In April, neither Seavey nor Fuller had any reason to suspect that the shares would not be re-registered to Morgan Fuller. They were unaware of Lushtak's deceitful actions and were lulled by assurances from the bank and Lushtak and by the account statement they received from Bankas Hermis that indicated that Khabay owned 26,320 shares.
In sum, it is concluded that, as to the July letter, Seavey willfully aided and abetted Morgan Fuller's violations of Sections 206(1) and 206(2) of the Advisers Act. Since he aided and abetted the violations, he also caused them.
The Division requests a cease-and-desist order, a civil money penalty of $10,000, censure, and a thirty-day suspension. Seavey argues that no sanctions are warranted under the facts of this case, even if violations occurred. For the reasons discussed below, the sanctions requested by the Division will be ordered.
A. Sanction Considerations
When the Commission determines administrative sanctions, it considers:
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 at 1140 (quoting SEC v. Blatt, 583 F.2d 1325, 1334 n.29 (5th Cir. 1978)).
The Commission determines sanctions pursuant to a public interest standard.21 Thus, in addition to issues related to the violator, it "weigh[s] the effect of [its] action or inaction on the welfare of investors as a class and on standards of conduct in the securities business generally." Arthur Lipper Corp., 46 S.E.C. 78, 100 (1975); see also Richard C. Spangler, Inc., 46 S.E.C. 238, 254 n.67 (1976). The amount 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 (2d Cir. 1963); Leo Glassman, 46 S.E.C. 209, 211-12 (1975).
1. Cease and Desist
Section 203(k) of the Advisers Act authorizes the Commission to issue a cease-and-desist order against a person who "is violating, has violated, or is about to violate" any provision of the Acts or rules thereunder. Whether there is a reasonable likelihood of such violations in the future must be considered. See KPMG, 74 SEC Docket at 429. In determining whether a cease-and-desist order is appropriate, the Commission considers the Steadman factors quoted above, as well as the recency of the violation, the degree of harm to investors, and the combination of sanctions against the respondent. See KPMG, 74 SEC Docket at 436.
Seavey's aiding and abetting violation was isolated; it was confined to misrepresentations and omissions in one letter to investors. As to Seavey's degree of scienter, he knew that the letter was not accurate. He did, however, alert Fuller and Taubenheim to Lushtak's fraud and diligently tried to obtain the stock from Bankas Hermis, Khabay, and Lushtak. Consistent with defending the charges against him, he recognized the wrongful nature of his conduct as shown by his sincere renunciation of managing other people's money. Nonetheless his occupation will present the opportunity for future violations. He consults and writes business plans and his age, education, and experience would enable him to reenter the investment adviser business despite his present intent. The violation was also recent. The letter added little to the harm from Lushtak's scheme to investors already in the Fund, since they had no opportunity to withdraw their capital at that time, and no one invested additional capital in the Fund. Finally, a cease-and-desist order is appropriate in light of the combination of sanctions ordered, which also include a $10,000 penalty, censure, and thirty-day suspension. Accordingly, Seavey will be ordered to cease and desist from committing or causing any violations or future violations of Section 206 of the Advisers Act.
2. Civil Money Penalty
Section 203(i) of the Advisers Act authorizes the Commission to impose civil money penalties for willful violations of the Advisers Act. In considering whether a penalty is in the public interest, the Commission may consider six factors: (1) fraud; (2) harm to others; (3) unjust enrichment; (4) previous violations; (5) deterrence; and (6) such other matters as justice may require. See Section 203(i)(3) of the Advisers Act; New Allied Dev. Corp., 52 S.E.C. 1119, 1130 n.33 (1996); First Sec. Transfer Sys., Inc., 52 S.E.C. 392, 395-96 (1995); see also Jay Houston Meadows, 52 S.E.C. 778, 787-88, aff'd, 119 F.3d 1219 (5th Cir. 1997); Consolidated Inv. Servs., Inc., 52 S.E.C. 582, 590-91 (1996).
Seavey aided and abetted antifraud violations, so his violative actions "involved fraud" within the meaning of Section 203(i)(2)(B) of the Advisers Act. Although Seavey worked to diminish the harm to investors after he understood that wrongdoing had taken place, the July letter contributed at least minimally to the harm to others caused by Lushtak's scheme. Seavey was not unjustly enriched, since he received no compensation from the Fund as there were no profits. Seavey has no previous violations. However, a penalty is appropriate for deterrence, particularly since investment advisers and their associated persons are fiduciaries and have an affirmative duty of utmost good faith and full and fair disclosure of all material facts.
Thus, a penalty is in the public interest in this case. A penalty in addition to the cease-and-desist order, censure, and thirty-day suspension are necessary for the purpose of deterrence. See Section 203(i)(3)(E) of the Advisers Act; see also H.R. Rep. No. 101-616 (1990). A second-tier penalty, as the Division requests, is appropriate because the violative act involved fraud. See Section 203(i)(2)(B) of the Advisers Act.
The maximum second-tier penalty applicable in this case for each act or omission is $55,000 for a natural person.22 The Division requests a $10,000 second-tier penalty. This penalty amount takes into account the need for deterrence and is consistent with Commission precedent.23 See Sections 203(i)(3)(E) of the Advisers Act. Accordingly, a $10,000 penalty will be ordered.
3. Censure and Suspension
The Division requests, pursuant to Section 203(f) of the Advisers Act, that Seavey be censured and suspended from association with an investment adviser for thirty days. Based on the Steadman factors, a censure and short suspension, rather than a lengthy suspension or bar, are in the public interest. Seavey's violation was isolated. His degree of scienter must be viewed in the context of his strenuous efforts to obtain the shares and to persuade Fuller to disclose and report Lushtak's fraud and take legal action against the perpetrators. Consistent with defending the charges against him, he recognized the wrongfulness of his conduct by his renunciation of managing other people's money. A censure and thirty-day suspension, combined with other sanctions ordered, are appropriate remedies and deterrents and consistent with Commission precedent.24 Accordingly, a censure and thirty-day suspension will be ordered.
V. RECORD CERTIFICATION
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.351(b), it is certified that the record includes the items set forth in the record index issued by the Secretary of the Commission on August 27, 2001.
Based on the findings and conclusions set forth above:
IT IS ORDERED that, pursuant to Section 203(f) of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-3(f), Charles K. Seavey IS CENSURED for willfully aiding and abetting violations of Section 206 of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-6.
IT IS FURTHER ORDERED that, pursuant to Section 203(f) of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-3(f), Charles K. Seavey IS SUSPENDED from association with an investment adviser for thirty days, effective on the first business day following the date when this Order becomes effective.
IT IS FURTHER ORDERED that, pursuant to Section 203(i) of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-3(i), Charles K. Seavey PAY A CIVIL MONEY PENALTY OF $10,000.
Payment shall be made on the first business day following the day this Order becomes effective by certified check, U.S. Postal money order, bank cashier's check, or bank money order payable to the Securities and Exchange Commission. The check and a cover letter identifying the Respondent and Administrative Proceeding No. 3-10336, 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 at the same address.
IT IS FURTHER ORDERED that, pursuant to Section 203(k) of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-3(k), Charles K. Seavey CEASE AND DESIST from committing or causing any violations or future violations of Section 206 of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-6.
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 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.
Carol Fox Foelak
Administrative Law Judge
|1||The proceeding, originally styled Charles K. Seavey and Alexander Lushtak, has ended as to Lushtak. See Charles K. Seavey, Order Making Findings and Imposing Sanctions by Default Against Alexander Lushtak, 75 SEC Docket 1879 (A.L.J. Aug. 16, 2001). The February 20 amendments concerned Lushtak's January 24, 2001, conviction for money laundering and did not affect the charges against Seavey.|
|2||Citations to the hearing transcript, and exhibits offered by the Division and Seavey will be noted as "Tr. __," "Div. Ex. __," and "Resp. Ex. __," respectively.|
|3||See 5 U.S.C. § 557(c); 17 C.F.R. § 201.340.|
|4||Morgan Fuller was not registered in any other state or with the Commission pursuant to the Advisers Act. Div. Ex. 6 at 11.|
|5||Hedge funds are usually organized as private partnerships and are free from many regulatory requirements. The investors are limited partners and are accredited investors, as defined in Rule 501(a) of the Securities Act of 1933 (Securities Act), meeting a minimum net worth and income requirement, and are presumed to be sophisticated and able to withstand risk. Tr. 354-55, 389; Div. Ex. 6 at 2, 40-41. Rule 501(a) is part of Regulation D, which contains rules governing the limited offer and sale of securities without registration under the Securities Act. Typically, a hedge fund's investment adviser/general partner receives 20% of profits as incentive compensation, due after a year of operation. Tr. 348, 354, 392. The offering circular, also known as a private purchase memorandum, is the governing document of a hedge fund.|
|6||At the hearing Fuller did not recall Lushtak's being a manager. Tr. 124-25. However, the Fund's Offering Circular lists Lushtak as a member of the board of managers of Morgan Fuller, the Fund's general partner. Div. Ex. 6 at 1, 5. The Offering Circular, which was drafted contemporaneously with Morgan Fuller's formation, is accepted as better evidence than Fuller's recollection.|
|7||L.H. Alton & Co. was disciplined by the National Association of Securities Dealers, Inc., as a result of Fuller's and Lushtak's activities at the firm. See L.H. Alton & Co., 53 S.E.C. 1118 (1999).|
|8||Emerging markets were those outside Western Europe, the United States, Hong Kong, and Japan. Tr. 190-94.|
|9||Seavey originally learned of Fuller from his father, William A. Seavey (W. Seavey), a lawyer in San Francisco, California. Tr. 200-01, 428-29. Fuller was a member of an organization that W. Seavey chaired and encountered him at a meeting in the fall of 1996; Fuller mentioned that he was starting a hedge fund and W. Seavey suggested his son might be interested. Tr. 27, 429-30.|
|10||The S&P 500 is a composite of 500 widely held common stocks that measure stock market conditions based on average performance. See Barron's Dictionary of Finance and Investment Terms 552 (4th ed. 1995).|
|11||An investor who purchases a put profits if the underlying index or equity declines in price. Tr. 221. The S&P 100 (OEX) is an index calculated in a similar manner to the S&P 500 and made up of stocks for which options are listed on the Chicago Board Options Exchange. Its components are mainly NYSE industrials, with some transportation, utility, and financial stocks. OEX options are listed on the Chicago Board of Trade. See Barron's Dictionary of Finance and Investment Terms 562 (4th ed. 1995).|
|12||For example, assets in the Fund's account at Montgomery Prime Brokerage Services (Montgomery Securities) declined in value between February 10 and 18, 1997, from $764,056.86 to $305,324.69. Tr. 229; Div. Ex. 8. These numbers do not reflect 100% of the Fund and do not include private investments or overseas holdings. Tr. 48, 217, 227. Montgomery Securities, which could not clear foreign equity transactions, was the prime, but not the only, broker for the Fund. Tr. 48, 131, 217, 425.|
|13||There is a disparity between Fuller's and Seavey's testimony as to the role of each. As discussed above, Fuller's version magnified Seavey's role and minimized his own in a manner that is not believable. Fuller and Lushtak decided on the transaction, and Seavey was not at liberty to reject it, had he wanted to do so. Seavey, however, studied Fuller's file on Bankas Hermis. Tr. 52-54, 108-09, 241; Resp. Ex. 1-2.|
|14||Fuller refers to Jurna's first name as Rolandes. Tr. 54-55.|
|15||A&A Financial, one of Lushtak's companies, did business with Bank Frunzensky. Tr. 60, 115-16; Div. Ex. 9. Khabay was an officer of the bank and also employed at A&A Financial. Tr. 80, 116, 162.|
|16||If the Bankas Hermis transaction had not occurred and the Fund had liquidated investments to hold $239,000 in cash, the Fund would have lost a third to a half of its value. Tr. 70, 255.|
|17||Seavey wrote to the U.S. Treasury and the U.S. Embassy in Vilnius, Lithuania on July 16 and 18, respectively, asking for assistance. Resp. Exs. 28-29. On July 24 Seavey contacted the U.S. Agency for International Development in Lithuania. Resp. Exs. 32-33.|
|18||Seavey and Fuller differ as to which of the two decided to mark the position to market. Tr. 164, 287-88.|
|19||If the Bankas Hermis transaction had not occurred and the Fund had liquidated investments in the first quarter and held $239,000 in cash, it would have been down about 60%. Tr. 289.|
|20||Seavey was charged pursuant to Sections 203(f) and 203(k) of the Advisers Act. Section 203(f) authorizes the Commission to impose specified sanctions for violations of those provisions on associated persons of all advisers, registered or not. Teicher v. SEC, 177 F.3d 1016, 1017-19 (D.C. Cir. 1999). Section 203(k) authorizes a cease-and-desist proceeding against "any person" for violations.|
|21||See Sections 203(f) and 203(i) of the Advisers Act.|
|22||The $55,000 value applies to 1997 violations, pursuant to Section 203(i)(2)(B) of the Advisers Act and 17 C.F.R. § 201.1001. The Commission increased the $50,000 value set in Section 203(i)(2)(B) of the Advisers Act for violations occurring after December 9, 1996, and, again, for violations occurring after February 2, 2001. See 17 C.F.R. §§ 201.1001 (1996 adjustment) and .1002 (2001 adjustment). The 1996 and 2001 adjustments to the civil penalty amounts are pursuant to the Federal Civil Penalties Inflation Adjustment Act of 1990, as amended by the Debt Collection Improvement Act of 1996. Each federal agency is required to adopt regulations at least once every four years adjusting for inflation the maximum civil penalties under the statutes that it administers.|
|23||See, e.g., Clarence Z. Wurts, 74 SEC Docket 2559 (Jan. 16, 2001) (imposing a $5,000 penalty, censure, six-month supervisory suspension, and undertakings. Individual failed reasonably to supervise registered representative who defrauded investors who bought limited partnership units in a series of entities that operated as a Ponzi scheme. Individual's lack of care was uncharacteristic and he contacted authorities as soon as he discovered the fraud.); Valicenti Advisory Servs., Inc., 68 SEC Docket 1805 (Nov. 18, 1998), aff'd, 198 F.3d 62 (2d Cir. 1999) (imposing $50,000 and $25,000 penalties against investment adviser and owner, respectively; cease-and-desist order; censure; and undertakings. Investment adviser violated, aided and abetted by owner, antifraud provisions by distributing two pieces of fraudulent sales literature to prospective clients.).|
|24||See, e.g., Wurts, 74 SEC Docket at 2566-71; Pasztor, 70 SEC Docket at 2626 (imposing a three-month supervisory and proprietary suspension on former branch manager who had tried to stop violative trades but was overruled by firm's owner); Sharon M. Graham, 53 S.E.C. at 1090 (imposing a two-month suspension and cease-and-desist order on registered representative for aiding and abetting customer's antifraud violations; supervisors had reassured her that the violative trades were legal); Havill, 53 S.E.C. at 1071 (imposing a two-month suspension and cease-and-desist order on registered representative for aiding and abetting customer's antifraud violations; branch manager had reassured him that the violative trades were legal).|
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