Initial Decision of an SEC Administrative Law Judge
In the Matter of
In the Matter of
J.W. BARCLAY & CO., INC.
INITIAL DECISION AS TO
October 23, 2003
Joy M. Boddie, Charles J. Kerstetter, and Kathryn A. Pyszka for the Division of Enforcement, Securities and Exchange Commission.
Norman B. Arnoff for Respondent Edgar B. Alacan.
James T. Kelly, Administrative Law Judge.
The Securities and Exchange Commission (Commission or SEC) instituted this proceeding against Edgar B. Alacan (Alacan) and others on April 24, 2002, pursuant to Section 8A of the Securities Act of 1933 (Securities Act) and Sections 15(b) and 21C of the Securities Exchange Act of 1934 (Exchange Act). Alacan filed a timely answer.
The Order Instituting Proceedings (OIP) alleges that Alacan engaged in a pattern of unauthorized trading, churning, and unsuitable trading in the accounts of several customers from in or about June 1997 through in or about December 1998. The OIP also charges that Alacan failed to follow his customers' instructions. At the time of the alleged misconduct, Alacan was associated with J.W. Barclay & Co., Inc. (Barclay), a registered broker and dealer. The OIP claims that, by such misconduct, Alacan willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder.
To protect the public interest, the Commission's Division of Enforcement (Division) seeks a cease-and-desist order against Alacan, an order barring Alacan from association with any broker or dealer, and an order imposing a civil penalty of $110,000. The Division also seeks an order requiring Alacan to disgorge $9,768.16, plus prejudgment interest of $4,376.14 (as of May 31, 2003).
I held four days of hearings during March and April 2003 in New York City.1 The parties have filed posthearing pleadings and the matter is now ready for decision.2 I base my findings and conclusions on the entire record and on the demeanor of the witnesses who testified at the hearing. I have applied "preponderance of the evidence" as the standard of proof. See Steadman v. SEC, 450 U.S. 91, 97-104 (1981). I have considered and rejected all arguments, proposed findings, and proposed conclusions that are inconsistent with this decision.
Edgar B. Alacan
Alacan, age 31, resides in Staten Island, New York (Answer; Tr. 589). He began his career in the securities industry in 1989 (Answer; Tr. 589). Alacan holds Series 7, 24, and 63 licenses from the National Association of Securities Dealers (NASD) (Tr. 276-77, 590, 689). The NASD has never sanctioned Alacan for his handling of customer accounts (Tr. 642).
Alacan was associated with Barclay, a registered broker and dealer, from April 1996 to September 2000 (Answer; Tr. 589, 680). At the times relevant to the OIP, Alacan had approximately 200 customers and he was one of Barclay's top producers (Tr. 289, 591, 686). Alacan characterized Barclay as a firm that specialized in underwriting and making markets in the securities of small capitalization companies (Tr. 590-91, 620). He described his customers as "high net worth individuals," "high risk takers," and "individuals who were not only willing to speculate but had the ability to speculate" (Tr. 591).
In September 2000, Alacan and three colleagues left Barclay to open an office of supervisory jurisdiction for Salomon Grey Financial Corporation (Salomon Grey) (Answer; Tr. 637, 688-89). Alacan has been a registered representative at Salomon Grey from that time to the present (Tr. 6, 637).
The Division presented testimony about eight of Alacan's customers at Barclay. In this section of the initial decision, I briefly describe each customer's background. I have organized the discussion chronologically, based on the date each customer first transacted business with Alacan. In the Discussion and Conclusions, I address the Division's claims that Alacan engaged in unauthorized trading, churning, and unsuitable trading, as well as its charge that Alacan failed to follow his customers' instructions.
Sebastian Sollecito is a retired commercial fisherman and cannery owner from Salinas, California (Tr. 106; RX 2). He maintained an account at Barclay from November 1996 to May 1997 (DX 6C). When Sebastian Sollecito opened the account, he was eighty-three years of age (Tr. 105; RX 2). Alacan and Emanuele A. Scarso (Manny Scarso) jointly serviced Sollecito's account in November and December 1996 (account executive # 173) (Tr. 97-98; DX 6C, DX 6K; RX 2). Alacan was solely responsible for the account from January to May 1997 (DX 6C, DX 6K).
Sebastian Sollecito maintained ten brokerage accounts, and the Barclay account was his smallest (Tr. 154-55, 157, 163-64; DX 6C). The largest account held assets valued at $6 or $7 million (Tr. 164-65). Sebastian Sollecito has an eighth-grade education (Tr. 106). Susan Sollecito, his wife for twenty-four years, described him as "entrepreneurial" and "a sharp businessman" (Tr. 104-06; DX 6D). Although Susan Sollecito has significantly more formal education than her husband, Sebastian Sollecito managed the family's finances as long as he was able to do so (Tr. 105-06, 109).
Sebastian Sollecito did not attend the hearing because he has advanced-stage Alzheimer's disease (Tr. 107, 153-54). Since January 2000, he has been receiving around-the-clock care (Tr. 107). Susan Sollecito testified in his place (Tr. 104-05). This has proven to be a contentious issue (Alacan Br. at 2, 41-44). First, Susan Sollecito was not a joint owner of Sebastian Sollecito's account. Unlike her husband, she never was a Barclay customer. Second, Susan Sollecito listened to some of her husband's telephone conversations with Alacan, but she did not offer specific testimony as to what her husband and Alacan said to each other. Third, identifying the date of Sebastian Sollecito's incapacity-the point at which early-stage Alzheimer's disease had progressed sufficiently to leave him unable to give informed consent to Alacan's recommendations-requires consideration of all the surrounding facts and circumstances.3
The Division alleges that Alacan executed unauthorized trades in Sebastian Sollecito's account between January and May 1997 and that Alacan also failed to follow instructions to transfer the account to a different brokerage firm in April and May 1997. All the alleged misconduct occurred before June 1997, the starting month identified in the OIP. Most of the alleged misconduct also occurred more than five years before the Commission issued the OIP.
George Wittemyer (Wittemyer) resides in Portland, Oregon (Tr. 83). He is an attorney in private practice and has earned an advanced law degree in taxation (Tr. 84). In the spring of 1997, Wittemyer was fifty-six years old and a widower (Tr. 84). At the time, two of his children were attending private colleges and a third was enrolled in medical school (Tr. 85).
Wittemyer opened a Barclay account when his account executive transferred from another firm to Barclay (Tr. 85-86). In the spring of 1997, that account executive left Barclay and Alacan and Manny Scarso became the brokers of record on Wittemyer's account (Tr. 86; DX 7C; RX 9). Alacan could not remember having any conversations with Wittemyer about Wittemyer's investment objectives, but he believes he did have conversations with Wittemyer about Wittemyer's net worth and income (Tr. 619).
The Division alleges that Alacan made unauthorized purchases and sales of three securities in Wittemyer's account during early April 1997 (Tr. 101-02; DX 7D, DX 7E). All the alleged misconduct occurred before June 1997, the starting month identified in the OIP. It also occurred more than five years before the Commission issued the OIP.
Wittemyer closed his Barclay account approximately one year after the alleged misconduct (Tr. 90, 96, 98-100; RX 9). Wittemyer could not recall if he traded through Alacan and Manny Scarso in the year after April 1997, although he "may certainly have" done so (Tr. 99).
Joseph Latimer (Latimer) resides in Miami, Florida (Tr. 433). He is a college graduate who served as an officer in the United States Air Force for four and one-half years and as a commercial airline pilot for eighteen years (Tr. 434, 473-74). From 1989 to the present, Latimer has been a self-employed yacht salesman (Tr. 434, 656). Latimer was fifty-two years old when he opened his first Barclay account in 1996 (Tr. 433, 438-39). At that time, his annual income was approximately $150,000, and his net worth was under $1 million (Tr. 477-78). Latimer had limited investment experience at two other brokerage firms (Tr. 436-37).
Latimer maintained several Barclay accounts between mid-1996 and late 1998 (Tr. 435, 439, 476-77). Manny Scarso was Latimer's first registered representative at Barclay (Tr. 435, 477, 654). Alacan gradually assumed responsibility for servicing Latimer's accounts, starting in mid-1997 (Tr. 477, 718; DX 33B, DX 33G, DX 33I, DX 33L, DX 33M, DX 33P). Latimer filed a petition for bankruptcy on July 1, 1998 (Bankr. S.D. Fla., No. 98-15976) (official notice). He continued to transact business with Alacan for another four months and closed his Barclay accounts in November 1998 (Tr. 471; DX 33G).
The parties disagree about Latimer's investment objectives. Latimer testified that he wanted to take as few risks as possible because he could not afford to lose money (Tr. 435, 446, 474). In contrast, Alacan testified that Latimer was willing to take risks, speculate in high growth areas of the market, and participate in initial public offerings (Tr. 656).
The Division alleges that Alacan engaged in unauthorized trading in Latimer's accounts from May 1997 through October 1998. The first contested transaction occurred before June 1997, the starting month identified in the OIP.
Max Knopf (Knopf) resides in Brooklyn, New York (Tr. 195). He was born in Switzerland, attended high school in Germany, and immigrated to the United States in 1939 (Tr. 195-96). Knopf has been self-employed as a real estate broker and apartment manager for forty years (Tr. 196-97, 643). Knopf's annual income during 1997 was in the "low six figures" and his net worth was between $500,000 and $1 million (Tr. 199). Knopf has maintained three or four brokerage accounts over the past twenty years, and his typical trades were in the range of $10,000 to $100,000 (Tr. 214). Most of the securities in those other accounts were bonds or "better class stocks" (Tr. 217).
Knopf and his wife opened a joint account at Barclay in April 1997, following a cold call by Alacan (Tr. 197-98, 642; DX 3C, RX 10). At the time, Knopf was seventy-six years of age (Tr. 195). Knopf's wife was not actively involved with the account (Tr. 201). The parties disagree about Knopf's investment objectives. According to Alacan, Knopf said that he was interested in growth and speculation, and was willing to take risks (Tr. 642-43). According to Knopf, he told Alacan that he wanted "sound investments which are going to be profitable" and Alacan never asked him about the level of risk he was willing to take (Tr. 199). Knopf also testified that he was not willing to take any risk at all, and he denied telling Alacan that he wanted to speculate (Tr. 199, 215).
The Division alleges that Alacan executed unauthorized and unsuitable trades in Knopf's account between May and November 1997 (Tr. 201-02, 210, 216; DX 3D, DX 3E; Div. Br. at 22). The first contested transaction occurred before June 1997, the starting month identified in the OIP. Knopf closed the account in January 1998 (DX 3C).
Louis Kerlikowske (Kerlikowske) resides in Cape Coral, Florida, during the winter and Watervliet, Michigan, during the summer (Tr. 411, 414; DX 2C). He is a college graduate (Tr. 411). Until he retired in his late fifties, Kerlikowske was a tree fruit farmer in Michigan (Tr. 411). His net worth in 1997 was about $1 million and his annual income was about $75,000 (Tr. 411, 422; RX 16). In 1997, Kerlikowske had two brokerage accounts in addition to his Barclay account: one with a balance of approximately $300,000, and another with a balance of approximately $250,000 to $300,000 (Tr. 422).
Kerlikowske's trust opened an account at Barclay in April 1997, in response to several cold calls from an individual other than Alacan (Tr. 412, 428; DX 2D).4 At the time, Kerlikowske was seventy-three years old (Tr. 411). Alacan was the account executive with sole responsibility for the Kerlikowske trust account from August 1997 to March 1998 (Tr. 413; DX 2C).
Barclay's account opening form, signed by Alacan on April 8, 1997, identified Kerlikowske's investment objectives as "speculation and growth" (Tr. 649-50; RX 16). Kerlikowske described his securities portfolio as "very diversified" and "most of the time" his investment objectives were "income and growth" (Tr. 422-23). However, he was also interested in initial public offerings (Tr. 412). Kerlikowske liked to deal with different brokers to get investment ideas from multiple sources (Tr. 423).
The Division alleges that Alacan executed several unauthorized trades in Kerlikowske's trust account during August 1997 (Tr. 424). At that time, Kerlikowske and his wife were on a six-week motor home tour of the western United States and he did not communicate with anyone at Barclay (Tr. 414-15, 421; DX 2D). Kerlikowske learned of the unauthorized activity in his account only when he returned home on September 9, 1997, and read his monthly statement for the period ending August 29, 1997.
Joseph Old (Old) resides in Alhambra, California (Tr. 167). He is a high school graduate and has also completed several college-level courses (Tr. 168). Before Old retired in 1985, he was a project engineer for a company that manufactured aircraft equipment (Tr. 168-69). In 1997, Old was eighty-three years of age (Tr. 167-68). His annual income at the time was approximately $50,000 to $60,000, and his net worth was about $1.5 million (Tr. 171). Old's income consisted of dividends from securities in a brokerage account, Social Security benefits, and rental payments from two apartments (Tr. 169). Offsetting this income at the time were monthly expenses of $3,600 to $5,000 for his wife's nursing home care (Tr. 168, 173).
Old opened his Barclay account in September 1997, in response to a cold call from a Barclay registered representative who is not a party to this proceeding (Tr. 170, 633). Alacan became the broker of record on Old's account in November 1997, and continued in that capacity through December 1998, when the account's equity was depleted (Tr. 173, 185, 187; DX 5C).
The Division alleges that Alacan engaged in unauthorized and unsuitable trading in Old's account between November 1997 and December 1998.
William Lassiter (Lassiter) resides in West Palm Beach, Florida (Tr. 391). He is a college graduate and a self-employed commercial real estate developer (Tr. 391). Lassiter estimated his net worth at $5 to $10 million, and his annual income at $500,000 (Tr. 399).
Lassiter opened his Barclay account in April 1998, as a result of a cold call from Alacan (Tr. 391-92, 407; DX 4C). At the time, Lassiter was sixty-eight years old (Tr. 390; DX 4C). Lassiter told Alacan that his objective was to own "good growth stocks and some speculative stocks" (Tr. 399).
The Division alleges that Alacan executed unauthorized trades in Lassiter's account in May 1998 (Tr. 409; DX 4C; DX 4D). The trades in question involved purchases and sales of $300,000 to $400,000 of securities without Lassiter's knowledge or approval, and they took place while Lassiter was on a two-week vacation (Tr. 394, 399, 403, 409; DX 4D).
Lassiter transferred the remaining positions out of his Barclay account in July 1998 and closed the account in October 1998 (Tr. 397-98; DX 4C, DX 4D).
Leonard Beare and Cora Belle Beare lived in Lansing, Illinois, at the times relevant to this proceeding (Tr. 12). Leonard Beare is a college graduate who worked as a chemist at a petroleum refinery until he retired in the mid-1970s (Tr. 11-12, 53). His wife, Cora Belle Beare, was a high school history teacher until her retirement in the 1970s (Tr. 8-9, 13, 53). The Beares lived a modest and frugal lifestyle, residing in the same house for sixty-two years (Tr. 12-13).
Barclay opened two accounts for the Beares in November 1995: Leonard Beare's individual account and a loving trust account, for which Leonard Beare was trustee and Cora Belle Beare was co-trustee (Tr. 17, 23; RX 6, RX 12). Only the loving trust account is at issue here.5 At the time, Mr. and Mrs. Beare's annual income was approximately $50,000 and their net worth was approximately $1 million (Tr. 13). The couple's previous investment experience was limited. They had owned three blue chip common stocks for decades, and also held shares in a mutual fund and municipal bonds (Tr. 13-14, 20-22). Barclay identified the investment objective of the Beare loving trust account as "growth" (RX 12).
From November 1995 through September 1998, the Beares dealt with a Barclay registered representative who is not a party to this proceeding (Tr. 20, 26). When that individual left Barclay in September 1998, Alacan became the Beares' account executive (Tr. 22, 26). Alacan continued to handle all transactions in the Beares' accounts until October 1999, when the Beare-Barclay relationship finally ended (DX 1K).
Mrs. Beare died in November 2002 (Tr. 9). Mr. Beare is ninety-one years of age and has been in assisted living facilities since 2000 (Tr. 9, 12). He was unable to testify at the hearing because of his deteriorating health. James Vander Weide (Vander Weide), Ph.D., the Beares' son-in-law, testified in their place. Vander Weide is a professor of finance and economics at Duke University's Fuqua School of Business, and the Beares granted him powers of attorney in September 1999 to help them close their Barclay accounts (Tr. 7-8, 14-16, 26, 35; DX 1I, DX 1J, DX 1K). Alacan objected to Vander Weide's testimony about events occurring before August 1999 on the grounds that Vander Weide lacked first-hand knowledge of the Beares' prior dealings with Barclay (Alacan Br. at 2, 41-44).
The Division alleges that Alacan executed unauthorized and unsuitable transactions and churned the loving trust account from September through December 1998. In addition, the Division charges that Alacan failed to follow the customer's instructions to close the accounts in August and September 1999. The latter allegation involves misconduct occurring after December 1998, the ending month identified in the OIP.
The View From Barclay's Compliance Office
Theo S. Basis (Basis) was Barclay's director of compliance from July 1996 through July 1998 (Tr. 227-28, 281). Before joining Barclay, Basis had been a senior compliance examiner for the NASD for four years and he had conducted compliance reviews of sales literature for a brokerage firm for another two years (Tr. 226-27). Basis's duties at Barclay involved reviewing, investigating, and responding to customer complaints, filing compliance-related documents with various regulatory agencies, and keeping Barclay's principals informed about compliance matters (Tr. 228-29). Basis testified for the Division (Tr. 224).
Basis first met Alacan when he joined Barclay in July 1996 (Tr. 229). At that time, Barclay had fifty to seventy-five registered representatives (Tr. 289). Staffing later increased to approximately 110 registered representatives (Tr. 289). When Basis left the firm, there were about eighty-five registered representatives (Tr. 289).6 The professional relationship between Basis and Alacan was quite poor (Tr. 675).
By June 1997, Barclay had received several customer complaints and an arbitration claim against Alacan within a relatively short time period (DX 6M). As a result, Barclay fined Alacan $2,500, suspended him for seven business days, and relieved him of any supervisory duties that would utilize his NASD Series 24 license (Tr. 257-58; DX 6M). Barclay also subjected Alacan to heightened supervision after he returned from the suspension. A principal of the firm began to review all of Alacan's transactions on a daily basis, and Alacan was required to meet weekly with Basis to discuss his handling of customer accounts (DX 6M).
In September 1997, Basis ordered Alacan and certain other registered representatives to bring all order tickets to him for review and approval prior to execution (Tr. 236-37; DX 60). Failure to obtain advance approval would be sanctioned by escalating fines (DX 60). Basis testified that Alacan did not follow this review procedure to a great degree (Tr. 237). Alacan and the other registered representatives typically claimed that they could not locate Basis when they needed to see him, and they submitted their order tickets to John Bruno (Bruno), Barclay's president, instead (Tr. 238-39). Basis insisted that he was not absent from the office for any unusual amount of time and that the registered representatives' claim that he was unavailable was only a pretext for avoiding his scrutiny (Tr. 238-39). In essence, Basis implied that Bruno was a less-demanding supervisor. Basis complained to Bruno that the review procedure was not working and that he could not enforce it on his own (Tr. 239). The review procedure "just kind of fizzled" as a result (Tr. 239).
In October or November 1997, Bruno and Basis ordered Alacan to start taping his telephone conversations with customers (Tr. 243-45, 280-81; DX 62). The idea was to provide the compliance office with an additional tool for monitoring Alacan's sales practices (Tr. 243-44). Because Barclay did not have a firm-wide taping system, Alacan controlled his own taping (Tr. 284-86). In Basis's judgment, Alacan generally failed to perform as instructed. When Basis received a customer complaint, he would ask Alacan to provide him with a tape of the relevant conversation. On some occasions, Alacan failed to produce the tape (Tr. 244; DX 62). On other occasions, Alacan gave Basis a tape that was incomplete or edited (Tr. 244-45).
In December 1997, Basis recommended to Bruno that Alacan be terminated from Barclay. As grounds, he identified the sheer number of customer complaints against Alacan, the manner in which Alacan conducted his business, and Alacan's general lack of attention to and disregard of compliance-related and regulatory matters, among other things (Tr. 239-40). Basis put his recommendation for immediate termination in writing, had the document notarized, and hand-delivered it to Bruno (Tr. 240-42, 282-83, 286; DX 62). The three-page memorandum identified Alacan's transgressions, as Basis saw them, in vivid detail.
Bruno told Basis that he would look into the matter and take care of it (Tr. 286-87). Bruno did not terminate Alacan or even sanction him (Tr. 259-60). Basis tried to disassociate himself from Alacan after December 1997 and leave the supervision of Alacan to Bruno (Tr. 242, 259-60). However, Basis still received complaints about Alacan during 1998 (Tr. 260-61; DX 64). Basis continued to recommend that Alacan be terminated until Basis resigned from the firm in July 1998 (Tr. 260-61, 281; DX 64).
Charles Lake (Lake) was a part-time compliance consultant for Barclay from July 1997 to December 2000 (Tr. 540, 565-66). Lake was typically in Barclay's office three days a week (Tr. 566). His duties included reviewing and investigating customer complaints and arbitration claims, and monitoring sales practices (Tr. 538-39). Lake's prior experience included nine years as an examiner/investigator with the NASD (Tr. 538; RX 7). He then became a self-employed compliance consultant for various brokers and dealers, including Barclay (Tr. 538; RX 7).
Lake testified as Alacan's witness (Tr. 535-36). He confirmed that Basis and Alacan had an acrimonious relationship, but he believed that it improved over time (Tr. 574). In Lake's view, Basis was occasionally confrontational, short tempered, and unwilling to work with Alacan (Tr. 574, 580). Lake himself never had any problems with Alacan (Tr. 573).
Lake observed that "things seemed to run a lot smoother" at Barclay once Alacan was subject to heightened supervision (Tr. 575). He also testified that customer complaints against Alacan diminished significantly, although not entirely, after December 1997 (Tr. 573, 575-79; RX 11).
John E. Parkes, Jr. (Parkes), testified for the Division as an expert witness (Tr. 490-528). Before starting his own independent consulting business in 1988, Parkes served for twelve years as compliance officer for a registered broker and dealer. Prior to that, Parkes was an account executive with another brokerage firm for seven years. He has testified as an expert in more than 150 proceedings.
The Division engaged Parkes to review the activity in certain customer accounts, to offer written opinions, and to testify at the hearing (DX 37, DX 37A, DX 37B). Parkes analyzed the trading activity for seven of the Division's eight customer witnesses (i.e., all but Latimer). Parkes opined that Alacan engaged in unauthorized trading in the accounts of six customers (i.e., all but Latimer and Old) (DX 37 at 42-47); churned the Beare loving trust account (DX 37 at 17-21); executed unsuitable trades in the Knopf, Old, and Beare accounts (DX 37 at 17-21, 36-37); and failed to follow instructions in the Sollecito and Beare accounts (DX 37 at 47-48). Parkes also prepared schedules showing the commissions, markups, and markdowns that Barclay charged to Alacan's customers for the transactions at issue. The Division has based its request for disgorgement on these schedules. I found Parkes's data to be accurate and his testimony to be helpful.
Alacan did not sponsor an expert witness of his own, but he did offer an exhibit that analyzed the trading activity in the Beare accounts (RX 8). The document was prepared for use in an arbitration hearing, but Alacan and the Beares settled their differences before the arbitration hearing took place (Tr. 28-29, 31, 714-15). The document is clearly labeled as a draft. Its author was never identified. No one with first-hand knowledge of the document testified in this proceeding. Despite these shortcomings, the document has proven helpful in analyzing the September 1999 activity in account # 689-46255, the account that Alacan tried to persuade Leonard Beare to open after Beare had closed the loving trust account. See supra note 5 and infra note 23. Otherwise, I have given this exhibit very little weight (Tr. 592, 594-95, 604-10, 615-16).
Fact Witness Credibility
I found customers Old, Lassiter, and Kerlikowske to be very credible witnesses. Knopf and Wittemyer were generally credible. There was an element of overstatement in Knopf's claim that he was willing to take "no risk" with his Barclay account (Tr. 199). Wittemyer's explanations of his differing reactions to the first and second purchases of Tellurian, Inc., were somewhat labored. He was not the strongest customer witness to testify for the Division. Latimer was credible on the subject of unauthorized trading because his contemporaneous notes corroborated his hearing testimony. Other parts of Latimer's testimony, including his efforts to disclaim responsibility for his own actions and to portray himself as putty in Alacan's hands, were less persuasive.
Vander Weide was a truthful witness, but he lacked first-hand knowledge of critical events. Vander Weide was not directly involved in the Beares' dealings with Alacan until September 1999. I nonetheless consider his testimony about earlier events to be reliable to the extent that it is supported by contemporaneous documents that Leonard Beare prepared.
Susan Sollecito monitored some, but not all, of her husband's telephone conversations with Alacan. However, she offered no specific testimony about what her husband or Alacan said to each other during these conversations. Her testimony is trustworthy as to events occurring in April and May 1997, but somewhat less reliable as to events occurring between December 1996 and March 1997. For example, Susan Sollecito told the NASD that she wrote to Alacan in the autumn of 1996 (DX 6I). However, at the hearing, she acknowledged that she had not written the letter in question until January 1997 (Tr. 161; DX 6D). In addition, counsel twice asked Susan Sollecito if she had spoken with Alacan about her husband's deteriorating health before January 14, 1997. The first time the issue arose, she said she could not remember (Tr. 114). The second time, after the importance of the issue had become clear, she said she had (Tr. 156, 160). Finally, Susan Sollecito's hearing testimony was partially impeached by notes the Division wrote during her investigative interview. At the hearing, she testified that her husband's impairment was "obvious" to third parties (Tr. 155). During her investigative interview, she left a distinctly different impression (Tr. 155; RX 1).
When the customer testimony is considered collectively, patterns emerge that bolster the credibility of the individual witnesses. Four illustrations suffice to make the point. First, both Kerlikowske and Lassiter returned from vacations, only to find unauthorized trades entered in their accounts while they were away. Second, Susan Sollecito, Old, and Vander Weide disputed the authenticity of signatures on important documents. A colleague of Alacan's at Barclay also disputed the authenticity of his signature on a letter to an Alacan customer (Tr. 747; DX 6F). Third, when Susan Sollecito, Wittemyer, Kerlikowske, and Vander Weide telephoned Alacan to complain about unauthorized transactions, they somehow found themselves dealing with intermediaries, rather than with Alacan himself. I consider this little more than a ploy on Alacan's part to create distance and deniability. Finally, both Basis and Latimer testified that Alacan flew into a rage at the prospect of having to pay fines or assume responsibility for cancelled trades (Tr. 247-48, 250-51, 466).
Basis was the Division's key witness, and I found him to be generally credible. Lake suggests that Basis was too stern with Alacan. This is rejected on the grounds that an easy-going, accommodating compliance officer is likely to be an ineffective compliance officer. Alacan suggests that Basis's testimony should be discounted because Basis had personal animosity for him. This is also rejected. It is not surprising that a no-nonsense compliance officer would lack a warm relationship with a registered representative who repeatedly received customer complaints for allegedly engaging in questionable sales practices. I have considered the possibility that Basis wrote his notarized memorandum to Bruno as a self-serving device for insulating himself from anticipated criticism by regulators, while simultaneously divesting himself of a troublesome supervisory duty. I have also considered that Basis continued to collect a Barclay paycheck for another seven months after December 1997. By December 1997, at the very latest, Basis knew that Bruno was ignoring his recommendations and countermanding his instructions to the firm's registered representatives (Tr. 281, 287-88). However, I cannot conclude that such matters detract from Basis's general credibility.
Lake was a marginally credible witness. His mother has performed work for Alacan at Salomon Grey (Tr. 584-85). Some of his testimony was unbelievable, such as his claim that he discussed the Beare arbitration claim with Basis (Tr. 544). When Vander Weide filed that claim on behalf of Mr. and Mrs. Beare, Basis had been gone from Barclay for over a year. Equally unbelievable was Lake's claim that he reviewed Old's complaint to Barclay (Tr. 570-71). In fact, Old never filed such a complaint. Finally, Lake left his NASD employment on poor terms (Tr. 586-87). To the extent that there are conflicts, I have given more weight to Basis's testimony than I have to Lake's.
Alacan was generally not credible. For the reasons discussed below, I find that some of his testimony was internally inconsistent, inconsistent with his prior statements and investigative testimony, and contradicted by both the documentary evidence and the testimony of the other fact witnesses.
Paragraphs II.B.3 and II.B.4 of the amended OIP allege that Alacan willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder through a series of sales practice abuses that defrauded his customers while generating significant commissions for himself. Willfulness is shown where a person intends to commit an act that constitutes a violation. There is no requirement that the actor also be aware that he is violating any statutes or regulations. Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000); Arthur Lipper Corp. v. SEC, 547 F.2d 171, 180 (2d Cir. 1976).
Section 17(a) of the Securities Act proscribes fraudulent conduct in the offer or sale of securities and Section 10(b) of the Exchange Act and Rule 10b-5 proscribe fraudulent conduct in connection with the purchase or sale of securities. These provisions prohibit essentially the same type of conduct. See United States v. Naftalin, 441 U.S. 768, 773 n.4 (1979). To prevail under Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5, the Division must show: (1) misstatements or omissions of material facts or other fraudulent devices; (2) made in connection with the offer, sale, or purchase of securities; and (3) that Respondent acted with scienter. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). No scienter requirement exists for violations of Sections 17(a)(2) or 17(a)(3) of the Securities Act; negligence alone is sufficient. Aaron v. SEC, 446 U.S. 680, 701-02 (1980); Pagel, Inc. v. SEC, 803 F.2d 942, 946 (8th Cir. 1986).
A fact is material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision and would view disclosure of the omitted fact as having significantly altered the total mix of information made available. 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. TSC Indus., 426 U.S. at 450.
Courts have interpreted broadly the requirement of Exchange Act Section 10(b) and Rule 10b-5 that violations must occur "in connection with" the purchase or sale of a security. See Superintendent of Ins. v. Bankers Life & Cas. Co., 404 U.S. 6, 12 (1971); Ames Dep't Stores, Inc., Stock Litig., 991 F.2d 953, 964-65 (2d Cir. 1993). The jurisdictional requirements of the antifraud provisions are also interpreted broadly, and are satisfied by intrastate telephone calls and even the most ancillary mailings. SEC v. Softpoint, Inc., 958 F. Supp. 846, 865 (S.D.N.Y. 1997), aff'd, 159 F.3d 1348 (2d Cir. 1998).
Scienter is defined as "a mental state embracing intent to deceive, manipulate, or defraud." Hochfelder, 425 U.S. at 193 n.12. It may be established by a showing of recklessness. David Disner, 52 S.E.C. 1217, 1222 & n.20 (1997) (citing Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990) (en banc)). The en banc Ninth Circuit adopted the standard of recklessness articulated by the Seventh Circuit in Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1044-45 (7th Cir. 1977): "[A] highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and 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." Scienter is a question of fact and can be proved by circumstantial evidence. SEC v. Hasho, 784 F. Supp. 1059, 1107 (S.D.N.Y. 1992) (collecting cases).
The OIP alleges that Alacan knowingly or recklessly made unauthorized purchases and sales of securities, including unauthorized purchases of securities on margin, in the accounts of several customers (OIP ¶ II.B.2.a).
A broker who trades in a customer's account without authorization commits fraud if there is accompanying deceptive conduct. Sandra K. Simpson, 77 SEC Docket 1983, 2001 (May 14, 2002); Laurie Jones Canady, 69 SEC Docket 1468, 1484 (Apr. 5, 1999), recon. denied, 70 SEC Docket 682 (Aug. 6, 1999), pet. denied, 230 F.3d 362 (D.C. Cir. 2000). The deceptive conduct element of the offense is met if the broker fails to inform the customer of the materially significant fact of the trade before it is made. Donald A. Roche, 53 S.E.C. 16, 24 & n.17 (1997). Purchasing securities on margin in a customer's account without the customer's approval also violates the antifraud provisions of the federal securities laws. J. Stephen Stout, 73 SEC Docket 1441, 1459 (Oct. 4, 2000); Hasho, 784 F. Supp. at 1110.
A liability analysis for unauthorized trading focuses on two issues: (1) whether there was a written power of attorney in effect at the time of the transaction at issue; and, if not, (2) whether the transaction was specifically authorized by the customer in advance of its execution. A customer's oral grant of general discretion to an account executive is irrelevant to the analysis of liability. Cf. Article III, Section 15, NASD's Rules of Fair Practice; New York Stock Exchange Rule 408.
None of Alacan's customers executed a written power of attorney authorizing him to trade their accounts on a discretionary basis. Thus, the issue is whether Alacan's customers granted him specific verbal authority to execute each of the transactions in question. The customer must select the type of transaction (purchase or sale), the specific security (common stock, warrants, or units), and the quantity in advance of execution. The focus is on whether the registered representative exceeded his authority by initiating the transactions. It is not on the customer's post-transaction conduct (i.e., whether the customer protested in a timely and vigorous manner).
In an arbitration proceeding or a federal district court action, a customer may be barred from recovering damages for unauthorized trading if the defendant establishes the elements of ratification or estoppel. However, the goal of an enforcement action is the vindication of public policy and deterrence of wrongdoing, not recovery of damages by customers. The Division does not fail in its burden of proof merely because a particular customer's testimony would not result in a recovery in an arbitration proceeding or federal district court. Cf. Howard Alweil, 51 S.E.C. 14, 16 (1992) ("The fact that a customer accepts an unauthorized trade does not affect the NASD's authority to discipline the salesman for effecting it.") (dictum); Roger Heitschmidt, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,263 at 42,204 (CFTC, Nov. 9, 1994) ("For enforcement purposes, whether or not a fraudulent act was later `ratified' is essentially irrelevant.").
For these reasons, I find little merit to Alacan's defenses that certain customers paid for disputed trades and continued to add funds to their accounts after they learned of the unauthorized transactions. Unless otherwise noted, I have identified each transaction by settlement date rather than trade date.
Sebastian Sollecito. The Division relies on Susan Sollecito's testimony and exhibits to show that Alacan entered several unauthorized transactions in Sebastian Sollecito's account between January and May 1997. As already noted, Susan Sollecito did not offer specifics as to what Alacan and Sebastian Sollecito said to each other in the conversations that she overheard (Tr. 155-56). Likewise, Alacan offered no testimony regarding any specific trade in Sebastian Sollecito's account or any conversations he may have had with Sebastian Sollecito regarding any purchase or sale of a security.
Sebastian Sollecito's gradual impairment. Susan Sollecito testified that Sebastian's physicians made a firm diagnosis of "dementia/Alzheimer's type" in November 1998 (Tr. 107, 159). However, "looking back" with the full benefit of hindsight, she could see signs that her husband's mental condition started to deteriorate gradually in 1993 (Tr. 107-08). By 1995, Sebastian Sollecito occasionally failed to open his mail and pay the household bills in a timely manner (Tr. 109, 121). Sebastian also expressed frustration that he was unable to assist his accountant in preparing an income tax return, a task he had routinely performed in the past (Tr. 109-10). Sebastian Sollecito became anxious if he was apart from his spouse (Tr. 109-11, 145; DX 6E). By mid-1996, Sebastian Sollecito's physicians told Susan Sollecito that her husband had "dementia of the Alzheimer's type" (Tr. 160).
There is no evidence that Alacan, or anyone else at Barclay, knew or should have known of Sebastian Sollecito's deteriorating mental condition in November 1996, when Sebastian opened his Barclay account. Susan Sollecito conceded "you don't really notice [the mental decline] because it's gradual" (Tr. 108). She also told the Division's investigators that her husband's impairment was not obvious to outsiders, at least at first (Tr. 158-59; RX 1). Sebastian Sollecito had an autonomous streak: for example, when his wife hid his automobile keys to prevent him from driving, he would summon locksmiths (Tr. 143). Sebastian Sollecito was not disqualified on mental health grounds from voting in the November 1996 national election (Tr. 162-63). Presumably, Sebastian Sollecito was still lucid as late as April 1997, when he executed two customer account transfer forms (DX 6J). Those documents directed Barclay and its clearing broker to transfer his account to the Pershing Division of Donaldson, Lufkin & Jenrette Securities Corporation (Pershing).7
Susan Sollecito's authority to act for her husband. In late 1996, Susan Sollecito began to monitor her husband's telephone conversations with others, including Alacan (Tr. 111-12, 155-56). She did so because she believed that Sebastian was not retaining the information conveyed to him during the conversations.
Susan Sollecito wrote a letter to Alacan on January 14, 1997, explaining that, in her judgment, her husband "no longer should be buying/selling in the stock market" (Tr. 113-14, 694; DX 6D). Her letter did not specifically mention dementia or Alzheimer's disease, but it did state that Sebastian "is 83 and some days he is more forgetful and `fuzzy' than on other days" (DX 6D). The letter did not ask Alacan to close her husband's account, but only to refrain from entering into new transactions, while allowing existing positions to remain open (Tr. 117). The record is inconclusive as to whether Susan Sollecito had spoken to Alacan about her husband's condition before January 14, 1997 (Tr. 114, 156, 160).
The letter further stated that "[t]hose [who] deal with [Sebastian] locally understand the problem and are `downsizing' what they do with him" (DX 6D). At the hearing, Susan Sollecito elaborated on the meaning of this passage. She explained that one registered representative told her that he would simply ignore Sebastian's orders to buy or sell securities because he knew that Sebastian was not capable (Tr. 113-14).8 Finally, the letter contained a red flag that called into question Susan Sollecito's authority to speak for her husband: "If [Sebastian] knew I was sending this, he would be very mad at me!!" (DX 6D). See Restatement (Second) of Agency § 7 (1958) ("Authority is the power of the agent to affect the legal relations of the principal by acts done in accordance with the principal's manifestations of consent to [her]").
In 1990, Susan Sollecito was granted a power of attorney to act as a conservator in financial affairs for her husband under certain circumstances (Tr. 161-62). However, she did not tell Alacan or anyone at Barclay about that document in 1996 or 1997 (Tr. 161-62). She mentioned it for the first time at the hearing. The record does not show when or if the conditions necessary to activate that conservatorship were fulfilled. See Cal. Probate Code §§ 1872-73.
The Division maintains that Alacan engaged in unauthorized trading because he failed to follow Susan Sollecito's instructions not to trade (Div. Prop. Find. # 35; Div. Br. at 4, 28; Div. Reply Br. at 3). I reject this argument. Susan Sollecito was never a Barclay customer.9 The Division has not shown that Susan Sollecito obtained written or other specific authority from Sebastian Sollecito to instruct Alacan how his account should be handled. Indeed, if Susan Sollecito had given instructions in her husband's account, and if Alacan had followed those instructions without making reasonable inquiry into the nature and extent of her authority to do so, that alone could have resulted in unauthorized trading. Cf. Peltz v. SHB Commodities, Inc., 115 F.3d 1082, 1086-89 (2d Cir. 1997); Drexel, Burnham, Lambert, Inc. v. CFTC, 850 F.2d 742, 748-49 (D.C. Cir. 1988); Plunk v. Shearson/Am. Exp., Inc., [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,489 (Jan. 25, 1985), summarily aff'd, 1985 CFTC LEXIS 248 (CFTC, Aug. 29, 1985). The Division's inability to show that Susan Sollecito had authority to act with respect to her husband's account contrasts sharply with its showing that Vander Weide had authority to act with respect to the Beares' accounts, discussed below. See infra at pp. 39-40.
I agree, in part, with the nuanced testimony offered by the Division's expert witness on this subject (Tr. 519-21). Once Susan Sollecito had informed Alacan that her husband was gradually becoming impaired, that notice created a duty of further inquiry on Alacan's part, as well as the responsibility to document all his future actions concerning the account. By essentially ignoring Susan Sollecito's January 14, 1997, letter, Alacan was proceeding at his own peril. To the extent that the Division is able to show by competent evidence that unauthorized transactions occurred after January 14, 1997, findings of willfulness and recklessness will easily follow. However, the January 14, 1997, letter did not flip the burden of proof from the Division to Alacan. Nor did the letter create a legal presumption that all subsequent transactions were unauthorized, and thus shift the burden of persuasion to Alacan to demonstrate that each such transaction was authorized. Finally, the record will not support an inference that, because Alacan executed transactions without authority in April and May 1997, it is likely that he acted without authority from January through March 1997, as well.
Contested trades: January 30 to April 9, 1997. The earliest contested transactions in Sebastian Sollecito's account were the January 30, 1997, purchase of 2,000 shares of Trans Global Services, Inc.; the March 24, 1997, purchase and April 9, 1997, sale of 10,000 shares of Tellurian, Inc.; and the March 31, 1997, purchase of 2,500 units of Hungarian Broadcasting Corporation (DX 6C, DX 6K, DX 159B, DX 159D). At the relevant times, Susan Sollecito was unsure if her husband had authorized the transactions and then forgotten that he had done so, or if Alacan had entered the trades without her husband's prior approval (Tr. 120; DX 159D at 5). The Division has failed to sustain its burden of showing through competent evidence that these transactions lacked the advance approval of Sebastian Sollecito. In the alternative, even if these specific transactions had been shown to be unauthorized, they could not support an associational bar or a civil penalty.10 Since the Division can ordinarily obtain a cease-and-desist order upon proof of a single violation, evidence of misconduct before April 24, 1997, is not necessary for that relief, either. Finally, the Division has not sought disgorgement relief in connection with these transactions (DX 160). The value of such evidence is accordingly limited.
Contested trades: April 14 to May 7, 1997. The Division fares much better with respect to four unauthorized transactions that Alacan executed during April and May 1997. Three of these four transactions generated income for Alacan, and they underlie the Division's request for disgorgement (DX 160). I conclude that Alacan is liable for unauthorized trading in all four instances, not because he failed to follow Susan Sollecito's instructions, but rather, because he failed to follow Sebastian Sollecito's instructions to transfer his account to another brokerage firm. Pending completion of the transfer, the account at Barclay should have been frozen. See NASD Rule 11870, Customer Account Transfer Contracts (July 1996).
Sebastian Sollecito executed customer account transfer forms on April 2 and April 25, 1997, directing Barclay and its clearing broker to transfer his account to Pershing (DX 6J). Under NASD Rule 11870, Barclay had three business days to validate the transfer instructions. At that juncture, the account to be transferred should have been frozen. All open orders should have been cancelled and no new orders should have been taken. See infra notes 19-20.
In mid-April 1997, Sebastian Sollecito received a confirmation statement showing that Alacan had purchased 2,000 units of NAM Corp. for his account on April 14, 1997 (trade date) (Tr. 130, 695-96; DX 6C at DIV 609, DX 6K at 630). Barclay charged Sebastian Sollecito a commission of $100 for the execution (DX 6K at DIV 630). The confirmation statement puzzled the Sollecitos, because Sebastian's account at Barclay should have been frozen until it was transferred to Pershing.11 Sebastian Sollecito told his wife he had not authorized the purchase (Tr. 130). When Susan Sollecito telephoned Barclay to complain, she dealt with Thomas J. Granite (Granite), a non-party registered representative (Tr. 119, 131, 746; DX 159B).12 Granite promised to report back after he had looked into the matter (Tr. 134; DX 159B). In fact, neither he nor anyone else at Barclay ever resolved the matter. I conclude that the transaction was unauthorized.13
A few days later, Alacan bought 1,000 shares of Tellurian, Inc., for Sebastian Sollecito's account (DX 6C at DIV 609, DX 6I at DIV 619, DX 6K at DIV 628). The transaction had a trade date of April 17, 1997, and a settlement date of April 22, 1997. Barclay charged Sebastian Sollecito a commission of $187 for the execution (DX 6C at DIV 609, DX 6K at DIV 628). At the same time, Alacan sold 2,000 shares of Trans Global Services, Inc., but that sale did not result in commission income (DX 6C at DIV 609, DX 6I at DIV 619, DX 6K at DIV 627). Susan Sollecito promptly protested to Granite by telephone that the trades had been unauthorized (DX 159B at 10). Once again, Barclay did not take any corrective action. I conclude that these transactions were also unauthorized.
Any perceived confusion at Barclay about Sebastian Sollecito's desire to transfer his account should have been eliminated after April 25, 1997, when Sebastian executed his second customer account transfer request. Nonetheless, Alacan sold 2,000 units of NAM Corp. from Sebastian Sollecito's account on May 7, 1997 (trade date) (Tr. 146, 697; DX 6C at DIV 595; DX 6K at DIV 624). Barclay charged Sebastian Sollecito a commission of $326.47 for the execution (DX 6C at DIV 595, DX 6K at DIV 624). I conclude that this transaction was unauthorized, as well.14
Upon receipt of the confirmation statement, Susan Sollecito immediately protested to Granite by letter and telephone, informing him that the transaction was unauthorized (DX 6I at DIV 620, DX 159D at 4-6). Granite promised her that Barclay would cancel the transaction (DX 159D at 4, 9). In fact, Barclay did not cancel the transaction and it did not reverse the commission charge.
George Wittemyer. In early April 1997, Wittemyer received three confirmation statements showing the sales of 500 shares of Mellon Bank Corporation and 2,000 shares of Retix, Inc., and the purchase of 10,000 shares of Tellurian, Inc. (Tr. 86-87; DX 7C). Wittemyer immediately complained to Alacan that the transactions were unauthorized (Tr. 87). He told Alacan that he wanted the trades reversed at no cost to him (Tr. 87). Alacan responded that the transactions were perfectly legitimate (Tr. 87-88). After Alacan and Wittemyer exchanged harsh words, Alacan put Manny Scarso on the telephone (Tr. 87-89). Wittemyer and Scarso had a less argumentative discussion, but Wittemyer still insisted that the transactions be cancelled (Tr. 89).
On April 7, 1997, Wittemyer wrote a letter to Barclay, demanding that the transactions be cancelled (Tr. 89-91; DX 7C). He sent copies of his letter to the NASD, the Commission, and the Oregon Corporate Securities Division (Tr. 90-91; DX 7C). Basis reversed (or "busted") the trades on April 11, 1997 (Tr. 89-90, 92-93, 254-55; DX 7D at DIV 676, DX 7F).15 Barclay later told the NASD that the purchase had been authorized, and that it had busted the trades only "to avoid the cost of possible litigation and to eliminate further complications with this problematic client" (RX 9). The NASD eventually issued a "close out" letter, terminating its inquiry without taking formal action on Wittemyer's complaint (Tr. 560-63, 624; RX 9).16
Alacan insists that all three trades were authorized (Tr. 621, 623). He recalled that he spoke with Wittemyer shortly after he began to service the account. At that time, Wittemyer authorized the purchase of 10,000 shares of Tellurian and instructed Alacan to liquidate his positions in Retix and Mellon Bank Corp. to cover the purchase cost (RX 9). Alacan also attacks Wittemyer's credibility for asserting in his April 7, 1997, letter that he never heard of Tellurian. Alacan observes that his predecessor had purchased 2,500 shares of Tellurian for Wittemyer's account only one week earlier (Tr. 623-24; DX 7C, DX 7D at DIV 675).
Wittemyer did not complain that the March 31, 1997, purchase of 2,500 shares of Tellurian had been unauthorized until after his April 7 letter to Barclay (Tr. 92-94). In essence, Alacan argues that Wittemyer's alleged ratification of the first Tellurian purchase detracts from the credibility of Wittemyer's claim that he had never heard of Tellurian. I conclude that it does not. I accept Wittemyer's explanation that he failed to recall receiving a confirmation statement for the March 31 transaction, and that he did not notice that purchase until he received a monthly statement for the period ending April 25, 1997. I treat his complaint letter of May 2, 1997, about the margin balance in his account as an indirect complaint about the March 31 purchase of Tellurian.
Although Wittemyer's explanation is somewhat labored, I credit his testimony and conclude that the trades were unauthorized. However, because the misconduct occurred more than five years before the Commission issued the OIP, the violation cannot be used to support an associational bar or a civil penalty. See supra note 10. The Division does not seek disgorgement relief in connection with any transactions in Wittemyer's account (DX 160). The Division's ability to obtain a cease-and-desist order does not depend on Alacan's handling of the Wittemyer account, either. The Commission has held that a single violation is ordinarily enough to warrant a cease-and-desist order.
Joseph Latimer. The Division alleges that Alacan executed several unauthorized trades in Latimer's accounts between May 1997 and October 1998 (Tr. 443-44, 454-55, 458, 465-66, 483; DX 33R at DIV 3551-52).
On May 7, 1997, Alacan purchased 5,000 shares of Digital Data Networks, Inc., for Latimer's account (Tr. 456, 458; DX 33Q at DIV 3540). Latimer's handwritten notes on the confirmation statement recite that the trade was "not authorized." Latimer "very probably" wrote the note when he received the confirmation statement and "started complaining about it" (Tr. 458). The record does not show if, or when, this dispute was resolved.
On August 16, 1997, Latimer sent a facsimile note to Alacan seeking to correct various transactions in his account (Tr. 455; DX 33Q at DIV 3534). In relevant part, Latimer's note stated: "Ed: I've asked you repeatedly to tell me or check before you sold or bought anything-then I get these 4 tickets. What happened?" The "tickets" in question confirmed the sale of 5,000 shares of American Eco Corporation on August 11, 1997, and the sales of 10,000 warrants of Lexington Health Care Group, Inc., 3,450 shares of Optimax Industries, Inc., and 500 units of Hungarian Broadcasting Corporation on August 13, 1997 (DX 33G at DIV 3298, DX 33Q at DIV 3536-37). On September 22, 1997, Barclay cancelled all four sales (DX 33G at DIV 3301-02).
On May 22, 1998, Alacan bought 1,000 shares of Dell Computer Corporation for Latimer's account (Tr. 465-66; DX 33R at DIV 3553). Latimer complained to Bruno that the transaction was unauthorized and Bruno reversed it (DX 33C at DIV 3233-35, DX 33R at DIV 3553). Alacan's description of the episode is instructive. Alacan had been on vacation when Bruno cancelled the Dell Computer purchase (Tr. 465-66, 655). Alacan subsequently told Bruno that he had taped his telephone conversation with Latimer and he then played the tape for Bruno (Tr. 655). The implication is that the tape vindicated Alacan by demonstrating that the customer had indeed authorized the trade. However, Alacan neither offered the tape as a hearing exhibit nor called Bruno as a witness on his behalf. Under the circumstances, I give little weight to Alacan's uncorroborated testimony on this issue. Alacan also expressed anger toward Latimer because Bruno's decision to reverse the transaction meant that Barclay held Alacan responsible for the $10,000 drop in the market price of Dell Computer stock (Tr. 466). See supra note 15.
On September 29, 1998 (trade date), Alacan bought 10,000 shares of Hungarian Broadcasting Corporation stock for Latimer at a price of $8.1875 per share (DX 33D at DIV 3268). However, Latimer had entered a limit order, specifying that he was willing to buy only if the purchase price did not exceed $7.00 per share (Tr. 467-70; DX 33R at DIV 3549-52). On October 1, 1998, Latimer complained to Steve Gerstel, Basis's successor as Barclay's compliance officer, and he demanded that the transaction be cancelled (Tr. 466-70; DX 33R at DIV 3549-52). On October 7, 1998, Barclay cancelled the trade (Tr. 470; DX 33D at DIV 3268).
I conclude that Latimer's testimony about the unauthorized trading in his accounts is credible. Prompt protests and/or contemporaneous written records provide additional evidence of reliability. In contrast, Alacan's testimony was general and lacked documentary support.
Max Knopf. Knopf testified about three unauthorized transactions. The first episode began when Knopf received a bill for the May 22, 1997, purchase of 2,000 shares of Lexington Health Care Group, Inc. (Tr. 202-03; DX 3D). Knopf immediately wrote a letter to Basis, stating that he had not authorized the purchase and instructing Barclay to remedy the matter (Tr. 202; DX 3D). Barclay cancelled the transaction at no cost to Knopf, but only after Knopf had made "vigorous demands" (Tr. 202-03; DX 3E, RX 10). Alacan acknowledged that this trade was made in error, but he placed responsibility for the error on Barclay's trading desk or operations department (Tr. 644-46). I conclude that the transaction was unauthorized. I further conclude that Alacan has failed to sustain his defenses that others were culpable and that only inadvertent error was involved.
The second episode involved Knopf's complaint that Alacan bought without permission 3,000 shares of Tellurian, Inc., common stock for his account on October 3, 1997 (Tr. 203-04; DX 3C at DIV 320). Alacan had previously executed three other purchases of Tellurian for Knopf. The first occurred before June 30, 1997 (1,000 shares); the second, on August 21, 1997 (1,000 shares); and the third, on October 3, 1997 (2,000 shares) (DX 3C at DIV 311, 320; DX 3K at DIV 341; DX 37A at DIV 4240, 4246; RX 10). Those earlier purchases are not at issue in this proceeding, and I infer that each one was authorized. Knopf and the Division focus only on the second Tellurian purchase on October 3, 1997 (RX 10).
When Knopf learned of the second Tellurian purchase on October 3, he complained to Alacan. Knopf instructed Alacan to sell the 3,000 shares of Tellurian at the purchase price (Tr. 203-04). Alacan sold 4,000 shares of Tellurian for Knopf on October 29, 1997 (DX 3K at DIV 362-63). He sold another 3,000 shares of Tellurian for Knopf on November 18, 1997 (DX 3K at DIV 366-67). I infer that the November 18, 1997, sale corresponds to the contested purchase of October 3, 1997, not only because the number of shares matched, but also because the order ticket was marked "client limit."
Because Knopf does not dispute that he authorized the first purchase of 2,000 shares of Tellurian on October 3, Alacan argues that it is reasonable to infer that Knopf also must have authorized the second purchase of 3,000 additional shares on the same day and at the same price (Tr. 644-45; RX 10). I decline to embrace this reasoning. It is equally plausible to infer that, if Knopf had intended to purchase 5,000 shares of Tellurian on October 3, he would have placed one order for that quantity and that Alacan would have prepared one order ticket. I note that the order tickets are sequential (## 6673-76), which suggests that Alacan filled them out at the same time (DX 3K at DIV 357, 359). I find that Knopf was credible, and I conclude that the second transaction on October 3 was unauthorized.
The third episode occurred on October 27, 1997, when Alacan purchased 10,000 warrants of Hungarian Broadcasting Corporation for Knopf at $3.00 per warrant (Tr. 203-04; DX 3C at DIV 320; DX 3K at DIV 360-61; RX 10). Knopf complained to Alacan that he only had authorized the purchase of 4,000 warrants. The date of this conversation is unclear from the record. Alacan responded that the market price had already increased to $3.125 per warrant. Knopf then told Alacan to sell the disputed 6,000 warrants at the increased price (Tr. 204; DX 3E).
Alacan sold 6,000 Hungarian Broadcasting Corporation warrants for Knopf's account on November 18, 1997, at a sale price of $2.00 per warrant (DX 3C at DIV 323; DX 3K at DIV 364-65; DX 3M). Knopf thus incurred a loss of $1.00 per warrant, or a total of approximately $6,000.
Alacan maintains that Knopf authorized the purchase of 10,000 warrants (RX 10). He also asserts that Knopf did not raise a claim of unauthorized trading until after the market for Hungarian Broadcasting Corporation warrants had moved against him (RX 10). That defense lacks support in the record.
Knopf wrote a complaint letter to the NASD in January 1998, alleging unauthorized trading (DX 3E). I give very little weight to the fact that the NASD eventually issued a "close out" letter on Knopf's complaint (Tr. 568, 647-48; RX 10). See supra note 16.
Louis Kerlikowske. Kerlikowske and his wife left home for a vacation on July 29, 1997, and they returned on September 9, 1997 (Tr. 414, 421; DX 2D). During the vacation, Kerlikowske did not communicate with anyone from Barclay (Tr. 415). Upon his return home, Kerlikowske read his mail and discovered that Alacan had sold 200 shares of Conseco, Inc., and bought 2,000 shares of Digital Data Networks, Inc., and 1,000 shares of Orbit/FR, Inc., without his approval (Tr. 414, 419-20; DX 2C at DIV 288-89).
When Kerlikowske reviewed his August 1997 monthly statement, he also learned that Alacan had purchased the Orbit stock on margin (Tr. 420; DX 2C at DIV 289). According to Kerlikowske, Alacan never asked if he could place margin trades in the account, and Kerlikowske never told Alacan that Alacan could trade on margin in the account (Tr. 413). Kerlikowske was not interested in margin trading at Barclay (Tr. 413).
As soon as he found out what happened, Kerlikowske called Alacan. He told Alacan that he wanted Alacan to remove the unauthorized securities from his account, eliminate the margin balance, and restore 200 shares of Conseco into the account (Tr. 415). Alacan told Kerlikowske that he would take care of it, but he failed to do so (Tr. 415-16; DX 2D). Over the next several months, Kerlikowske tried to straighten out his account with Alacan, Frank and Manny Scarso, and others at Barclay (Tr. 416-17; DX 2D). His efforts were not successful.
Oppenheimer later referred Kerlikowske to Basis (Tr. 416-17; DX 2D). Kerlikowske told Basis that he wanted his account corrected, and on December 15, 1997, he sent Basis a letter explaining the situation (Tr. 416-17; DX 2D). In January 1998, Barclay cancelled the disputed transactions and reversed the commission charges (Tr. 417, 420-21; DX 2C). Kerlikowske asked for his Conseco shares in certificate form and he closed his Barclay account in March 1998, shortly after he received the certificates (Tr. 420-21; DX 2C).
Alacan defends on the grounds that he spoke with Kerlikowske, who authorized the transactions while he was still in Michigan (Tr. 651-52). If the conversation took place before July 29, 1997, as Alacan says, there is no explanation for the delayed executions, which did not occur until August 6, 7, and 29, 1997 (DX 2C at DIV 288-89). Alacan also testified that Kerlikowske never complained to him in the months before Kerlikowske spoke to Basis (Tr. 653). This conflicted with Kerlikowske's testimony, which I consider more credible. Alacan's hearing testimony failed to address the margin issue.
Alacan's hearing testimony differed from his investigative testimony. During the staff's investigation, Alacan could barely recall Kerlikowske (Tr. 690-94; DX 162, Investigative Testimony of Mar. 21, 2001, at 132, 151-52). I give little weight to Alacan's hearing testimony, and I conclude that the transactions were unauthorized.
Joseph Old. Between November 1997 and December 1998, Alacan executed several purchases and sales in Old's account without Old's prior knowledge (Tr. 180, 184-85; DX 5C). In some cases, Old was not aware of the issuer involved, the number of shares, or the cost until he received a confirmation statement in the mail (Tr. 180-81). Old did not ask Alacan detailed questions about any of these transactions because he assumed that Barclay and Alacan had his best interests at heart and were capable (Tr. 181).
Alacan also purchased securities on margin in Old's account (Tr. 175-76, 180; DX 5C). Old credibly testified that margin trading was not his idea, that Alacan never discussed the risks of margin trading with him, and that he did not even know how margin worked (Tr. 174-76, 178-79). Old learned of the margin trades only when he received confirmation statements (Tr. 176). Old could not recall signing a margin agreement (Tr. 174). Although Barclay produced a signed margin trading agreement, Old credibly denied that the signature on that document was his (Tr. 174; DX 5B).
Old made his last deposit of funds in his Barclay account on May 11, 1998 (DX 37A at DIV 4335). Nonetheless, Alacan continued to purchase several additional securities for Old's account between June and December 1998. He financed these transactions by selling the securities already in the account (DX 5C; DX 37A at DIV 4324-25, 4331-32). Alacan ceased trading only when there was no more equity in Old's account (Tr. 185, 187).
Alacan does not take issue with Old's testimony that the transactions were unauthorized. Rather, he defends on the grounds that Old never complained about unauthorized trading, and that Old infused $75,442 in cash into his Barclay account despite his losses (Tr. 180-81, 187-89, 637, 641; DX 37A at 4337). In addition, Alacan notes that Old subsequently opened an account at Salomon Grey, Alacan's next employer (Tr. 189, 637-39, 718; RX 15). This is essentially the sort of ratification and/or estoppel defenses that might be successful if Old had filed an arbitration claim or a federal district court action. However, Alweil and Heitschmidt teach that such defenses are irrelevant in an enforcement action brought in the public interest. I conclude that the charge of unauthorized trading has been sustained.
William Lassiter. The Division alleges unauthorized trading in Lassiter's account between May 13 and May 28, 1998, while Lassiter was on vacation and out of touch with his home and office (Tr. 394-95, 399; DX 4D). During this period, Alacan purchased 50,000 shares of Scoop, Inc., and 2,000 shares of Dell Computer, Inc., for Lassiter's account, without Lassiter's prior knowledge or permission (Tr. 394-95; DX 4C). He also sold 2,000 shares of American Express, Inc., without Lassiter's prior approval (Tr. 394, 406-07; DX 4C).
On June 1, 1998, Lassiter wrote a letter to Bruno, complaining about the unauthorized transactions (Tr. 394-95; DX 4D). Lassiter demanded that the Scoop and Dell Computer transactions be reversed, and that the commissions charged to his account on the unauthorized sale of his American Express stock be refunded (Tr. 406; DX 4D).
On June 18, 1998, Alacan sent Lassiter a letter stating, "This letter is to confirm that the 2,000 shares of Dell Computer that you purchased on 5/19/98 was cancelled as you requested" (Tr. 395-96; DX 4E). Lassiter took issue with the wording of the letter, because he had not authorized the purchase of the stock (Tr. 395-96). He immediately wrote Alacan a reply, reiterating that the Dell purchase had been made without his knowledge (Tr. 396; DX 4F). He also demanded that the cancellation of the purchase be reflected on Barclay's normal invoice, not just by a letter from Alacan (Tr. 396; DX 4F). Barclay then cancelled the Scoop and Dell Computer purchases and reversed the commissions (Tr. 396-97; DX 4C; DX 4G).
Alacan maintains that the transactions were authorized (Tr. 666). He insinuates that Lassiter's complaint about unauthorized trading merely reflected the fact that the market prices of Scoop and Dell Computer had declined after their purchase dates (Tr. 671). I reject this unsupported allegation and conclude that Lassiter's explanation is more credible than Alacan's testimony.
The Division acknowledges that "Lassiter ultimately assented to the American Express sale" (Div. Reply Br. at 21). On June 12, 1998, Barclay reduced the commissions it had charged Lassiter on that sale from $2,500 to $100 (Tr. 665; DX 4G at DIV 411, 416, 421; DX 37 at 45). The Division now seeks an order requiring Alacan to disgorge his share of the $100 commission (DX 160). The issue is not whether Lassiter "ratified" the unauthorized sale of his American Express stock, but whether the commission fees accruing to Alacan because of the unauthorized sale constitute ill-gotten gains in the first instance. I conclude that they do.
Leonard Beare and Cora Belle Beare. The Division claims that Alacan engaged in unauthorized trading in the Beare loving trust account from September through December 1998. The best evidence in support of this charge comes from contemporaneous handwritten notes that Leonard Beare made on his confirmation statements and on a margin demand letter (Tr. 45; DX 1F). The notes are corroborated by subsequent conversations in which Leonard Beare told Vander Weide that Alacan had engaged in unauthorized trading (Tr. 35-36, 43, 70).
Beare's notes on the confirmation statement for the September 28, 1998, purchase of 10,000 shares of Euroweb International Corporation state "authorized no shares to buy" and "Josh Chaffey corrects to 2,500 sh. Net to send $852.79" (Tr. 39-40; DX 1F at DIV 96). Chaffey was a compliance manager at Barclay (Tr. 40). Beare's notes on the confirmation statement for the December 1, 1998, purchase of 5,000 shares of VDC Communications, Inc., state "complaints Nat Ass of Sec Dealers Sec & Exchange Comm." These notes reflect that Beare was exploring how he could protest to regulators about the trading activity in his account (Tr. 41-43; DX 1F at DIV 97). Beare's notes on the confirmation statement for the December 1, 1998, purchase of 10,000 shares of Shop at Home, Inc., show that Beare placed two telephone calls to Chaffey on December 7, 1998, to discuss the trading in his account (Tr. 45-46; DX 1F at DIV 98). Finally, Beare's notes on the December 3, 1998, margin call letter from Barclay's clearing broker state "will ask that this unauthorized trade be stopped by Josh Chaffey" (Tr. 46-47; DX 1F at DIV 99).
Alacan aggressively traded on margin in the Beare loving trust account. The Beares incurred margin interest charges of $937 in November and December 1998 alone (DX 37 at 19-20; DX 37A at DIV 4109). Beare told Vander Weide that he did not understand margin trading (Tr. 53-54). Although Barclay produced an undated margin trading agreement that the Beares purportedly signed, both Mr. and Mrs. Beare told their son-in-law that the signatures on that document were not theirs (Tr. 64-66; DX 1G).
The weight of the evidence shows that Alacan willfully and recklessly engaged in a series of unauthorized trades in the accounts of several customers, and that he did so to generate substantial income for himself. This aspect of the OIP has been sustained.
The Division next alleges that Alacan knowingly or recklessly churned the Beare loving trust account from September through December 1998 (OIP ¶ II.B.2.b; Tr. 507, 516-17; DX 37 at 33-37, 41-42, DX 37A at DIV 4098-4112; Div. Br. at 23-27).
Churning occurs when a broker buys and sells securities for a customer's account, without regard to the customer's investment interests, for the purpose of generating commissions. The three elements of churning are control-either actual or de facto-of the account by the broker; trading that is excessive in light of the customer's objectives; and scienter on the part of the broker. Churning violates the antifraud provisions of the securities laws. Rizek v. SEC, 215 F.3d 157, 162 (1st Cir. 2000); Simpson, 77 SEC Docket at 2006-07; Roche, 53 S.E.C. at 22-23.
Churning involves a conflict of interest in which a broker seeks to maximize his remuneration in disregard of the interests of the customer. This motivation creates the element of scienter necessary for a violation of the antifraud provisions of the securities laws. Scienter, in turn, is what separates "churning" from "excessive trading." See Roche, 53 S.E.C. at 22 (collecting cases).
Alacan denies churning (Tr. 603). He acknowledges that he made recommendations to the Beares and that the Beares never entered unsolicited orders (Tr. 714). However, Alacan notes that he did not hold discretionary authority to initiate trades (Tr. 62, 714). Alacan also argues that Leonard Beare never complained to him while he was servicing the account (Tr. 603). Finally, Alacan emphasizes that the Beares made frequent cash deposits to their account, even though it was losing money (Tr. 79, 596; RX 8; Alacan Br. at 50). Between September and December 1998, the period of the alleged churning, the Beares wrote ten checks to Barclay, worth $83,433 (DX 1B at 48-61, DX 37A at 4109). Alacan asks me to treat these deposits as proof that the Beares were not conservative investors, but rather, customers who were willing to take risks.
De facto control. Because the Beare loving trust account was non-discretionary, the Division contends that Leonard Beare surrendered de facto control over it to Alacan. De facto control may be inferred from all the facts and circumstances (Tr. 499-500). Hotmar v. Lowell H. Listrom & Co., 808 F.2d 1384, 1386 (10th Cir. 1987). The inquiry requires the fact finder to examine the relationship between the broker and the customer to determine if the broker or the customer is responsible for the level of trading. "The touchstone is whether or not the customer has sufficient intelligence and understanding to evaluate the broker's recommendations and to reject one when he thinks it unsuitable." Follansbee v. Davis, Skaggs & Co., 681 F.2d 673, 677 (9th Cir. 1982). "[A] customer retains control of his account if he has sufficient financial acumen to determine his own best interests," even if he acquiesces in the broker's management of the account. Id. (quoting Carras v. Burns, 516 F.2d 251, 258-59 (4th Cir. 1975)); see also Morris v. CFTC, 980 F.2d 1289, 1295-96 (9th Cir. 1992). When the customer does not testify, control over the account may be established through other evidence (Tr. 498). Michael David Sweeney, 50 S.E.C. 761, 767 (1991).
The Beares were not sophisticated investors. Their experience with the securities markets was limited and their familiarity with the small capitalization segment of the market in which Barclay specialized was nil. Alacan acknowledged that he made the trading recommendations and that the Beares did not initiate any unsolicited trades (Tr. 714). By late 1998, Leonard Beare was gradually losing the ability to manage his affairs (Tr. 80). The high number of unauthorized trades also supports a finding that Alacan usurped control over the loving trust account. I thus conclude that Alacan exercised de facto control over the account.
Excessive trading. The appropriate starting point for analyzing the issue of excessive trading is to determine the investment strategy of the customer involved. This has proven to be a frustrating task here, because the record does not contain a clearly articulated statement of the investment strategy for the loving trust account in and after September 1998. Rather, I am left to piece together snippets of evidence provided by Vander Weide, who was not a party to any of the telephone conversations between the Beares and Alacan, and by Alacan, whose testimony about the Beares' investment strategy was based only on his memory, and not on any documents (Tr. 78-79, 601).
Barclay's account opening document from November 1995 shows that the investment objective of the Beare loving trust account was "growth" (RX 12). This contrasted with the investment objective of Leonard Beare's personal account, which Barclay identified as "growth and speculation" (Tr. 599-600; RX 6). Based on RX 12, and on Vander Weide's description of the Beares' financial circumstances and prior investment experience, I conclude that the Beares did not want to speculate with their trust account from November 1995 through September 1998.
Certainly, the Beares could have changed their investment objectives in September 1998, but the question is whether they did so. When Alacan became the account executive for the Beares in September 1998, he spoke with Leonard Beare about the loving trust account's goals (Tr. 599-600). According to Alacan, "this was [Leonard Beare's] risk account. He wanted to take a risk, [he] wanted to trade the account" (Tr. 600). Alacan never memorialized in writing his conversations with Leonard Beare. He never updated Barclay's November 1995 account opening document, even though the conversations in question purported to reflect a very significant change in the customers' investment objective (Tr. 601, 634-35).
Alacan essentially asks me to equate the Beares' interest in growth with a willingness to speculate (Tr. 517, 600-03, 618). That requires an extremely fast shuffle on a very critical point, and the case for doing so was not persuasive. I reject Alacan's testimony on this issue as incredible. I thus conclude that the investment objective of the loving trust account continued to be confined to growth, not speculation, in and after September 1998. Cf. Henrickson v. Henrickson, 640 F.2d 880, 882 (7th Cir. 1981) (contrasting the goals of growth and speculation).
In the absence of direct evidence of a broker's intent to trade an account excessively, the Commission has focused its inquiry on various circumstantial factors. Portfolio turnover rate, cost-to-equity ratio, and the number of days a security is held in an account are all methods that the Commission has used to determine whether an account has been excessively traded. See Simpson, 77 SEC Docket at 2004; Al Rizek, 70 SEC Docket 927, 934 (Aug. 11, 1999), aff'd, 215 F.3d 157 (1st Cir. 2000).
No turnover rate is universally recognized as determinative of churning, but an annualized portfolio turnover rate in excess of 6 is generally presumed to reflect excessive trading if the customer's objective is conservative. Rizek, 70 SEC Docket at 934 & n.15. On occasion, the Commission has found excessive trading based on turnover rates of less than 4 where the customer's objective is conservative. Joseph J. Barbato, 53 S.E.C. 1259, 1277 (1999). Of course, if a customer wants to speculate, the portfolio turnover rate could be unlimited (Tr. 499).
The cost-to-equity ratio or "break even" analysis is another generally recognized indicator of churning. It reflects the rate of return necessary for an account to break even after considering transaction costs, including the cost of commissions and margin interest. A cost-to-equity ratio of 15% to 21% on a conservative account generally indicates churning (DX 37 at 34). See Rizek, 70 SEC Docket at 935. A pattern of in-and-out trading, showing that positions have been held only for a short period of time, is also an indicator of churning. Costello v. Oppenheimer & Co., 711 F.2d 1361, 1369 & n.9 (7th Cir. 1981).
Between September and December 1998, Barclay, acting through Alacan, executed over thirty trades in the loving trust account. These trades generated $55,441 in commissions, half of which went to Alacan (Tr. 681, 684-85; DX 37A at DIV 4104-06). The annualized portfolio turnover rate was 86 (DX 37A at DIV 4101). The annualized break-even rate was 611% (DX 37A at DIV 4104). Positions in the loving trust account were typically closed out after only fifteen days (DX 37A at 4107-08). By each of these measures, trading in the loving trust account was excessive in light of the Beares' objective.
Scienter. The Beares were sustaining large losses while Alacan was generating substantial commission income for himself (DX 37A). Commissions also exceeded average monthly account equity by a significant amount (DX 37A). I conclude that, at the very least, Alacan acted in reckless disregard of his customers' interests and account objectives, and in favor of his own interests. On that basis, scienter has been established. Cf. David Wong, 76 SEC Docket 2680, 2687-88 (Feb. 8, 2002).
Alacan's defense. The fact that the Beares did not complain to Alacan about churning does not establish that they were indifferent to what Alacan was doing. In late 1998, Leonard Beare was bringing his concerns to the attention of Barclay's clearing broker and Barclay's compliance manager (Tr. 40; DX 1F). The Beares also told Vander Weide about their difficulties with Barclay and they were attempting to determine how best to express their complaints (Tr. 43, 78-79). The fact that the Beares wrote ten checks to Barclay from October through December 1998 does not persuade me that the Beares, who were unsophisticated investors, had suddenly become aggressive speculators.
The nature of churning is such that it rarely lends itself to early detection by the customer. "The vice of churning," as one court has noted, "is not to be localized within a particular transaction. It is the aggregation of transactions excessive in number and effect which constitutes the gravamen of the complaint." Fey v. Walston & Co., 493 F.2d 1036, 1050 (7th Cir. 1974). Churning is an ongoing offense that often can be detected only by hindsight analysis of the entire history of a broker's management of an account and his pattern of trading in that account in comparison with the needs and desires of the customer. Miley v. Oppenheimer & Co., 637 F.2d 318, 327 (5th Cir. 1981), rev'd on other grounds sub nom. Dean Witter Reynolds, Inc. v. Byrd, 470 U.S. 213 (1985). This difficulty of detection persuades me that the Beares were unaware at the time that their account was being churned. For that reason, Alacan's defense fails.
The OIP also alleges that Alacan knowingly or recklessly recommended securities that were not suitable for his customers in light of the customers' ages, investment experience, financial status, risk tolerance, and investment objectives (OIP ¶ II.B.2.d). To sustain this charge, the Division presented evidence that Alacan recommended high risk, speculative securities and then traded excessively in the Old, Knopf, and Beare accounts (Div. Br. at 22). Alacan insists that the securities he recommended were suitable for Old and Beare (Tr. 604, 637). He also testified that Knopf was suitable to open a Barclay account (Tr. 643).
The suitability doctrine, always somewhat nebulous and amorphous with respect to its content and parameters, may be broadly defined as a duty on the part of the broker to recommend to a customer only those securities which are suitable to the investment objectives and peculiar needs of that particular customer. The suitability doctrine entails the matching of two elements: (i) the investment objectives, peculiar needs, and other investments of the particular customer with (ii) the characteristics of the security which is being recommended.
Lewis D. Lowenfels and Alan R. Bromberg, Suitability in Securities Transactions, 54 Bus. Law. 1557 (Aug. 1999).
Unsuitable trading violates the antifraud provisions of the federal securities laws. See Clark v. John Lamula Investors, Inc., 583 F.2d 594, 599-601 (2d Cir. 1978) (holding that Rule 10b-5 was violated where defendant recommended unsuitable securities that he knew or reasonably believed were unsuitable); Stout, 73 SEC Docket at 1460-64; Canady, 69 SEC Docket at 1482-83 (holding that a sales agent's securities recommendations violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 where she knew that the transactions were unsuitable for customers and failed to disclose associated risks); see also Banca Cremi, S.A. v. Alex. Brown & Sons, Inc., 132 F.3d 1017, 1032 (4th Cir. 1997) (collecting appellate cases).
Courts have analyzed unsuitability claims asserted under Section 10(b) of the Exchange Act and Rule 10b-5 using two distinct theories. The majority of courts have viewed such claims as equivalent to the misrepresentation or omission of a material fact, and liability is imposed on the theory that a broker misstated to the customer that the investment was suitable; or alternatively, failed to disclose that the security was unsuitable in circumstances in which he had the duty to disclose this information. See Brown v. E.F. Hutton Group, Inc., 991 F.2d 1020, 1031 (2d Cir. 1993). Under the minority view (the "fraud by conduct" theory), the broker's recommendation of an unsuitable security is deemed inherently deceptive. See O'Connor v. R.F. Lafferty & Co., 965 F.2d 893, 898 (10th Cir. 1992); see also Lewis D. Lowenfels and Alan R. Bromberg, Beyond Precedent: Arbitral Extensions of Securities Law, 57 Bus. Law. 999, 1008 (May 2002).
The Commission has not stated whether it prefers to follow the Brown (majority) approach or O'Connor (minority) approach. However, the Commission's orders in settled suitability proceedings often cite Brown and rarely cite O'Connor. I will follow the majority approach here.
Recommendations. Alacan functioned as much more than a mere "order taker" for Old, Knopf, and Beare. Alacan either brought the specific securities to the attention of his customers or executed the transactions without first discussing the matter with his customers (Tr. 182-83, 209, 714). Alacan did not simply execute trades that the customers wanted to initiate.
Customers' circumstances and objectives. Old was 83, Knopf was 76, and Leonard Beare was 86 when they first transacted business with Alacan. Old and Beare had been retired for many years, while Knopf was actively self-employed.
I credit Old's testimony that he was seeking investments with limited risk (Tr. 171). I also credit Old's testimony that Alacan never asked Old about his investment objectives or risk tolerance (Tr. 172). Finally, I credit Old's testimony that Alacan regularly predicted that the recommended securities would appreciate in value, and that Alacan told Old nothing about the financial condition of the issuers (Tr. 184). I do not credit Alacan's description of Old as a multimillionaire who wanted to speculate (Tr. 633-35). Nor do I give much weight to an account-opening document that Salomon Grey filled out three years later as to Old. That document identified Old's investment objectives as "speculation and growth" (Tr. 638-40; RX 15). Old did not sign it and there is no evidence that he ever saw it. The document lacks probative value on the only relevant issue: Old's investment objectives when he did business with Alacan at Barclay.
Knopf told Alacan he wanted "sound investments" and he did not express an interest in speculating (Tr. 198-99). Knopf also testified that Alacan regularly predicted that the securities he was recommending would appreciate, while telling Knopf nothing about the risk of the proposed investments or the financial condition of the issuers (Tr. 209-10). I credit Knopf's testimony on these points. I do not credit Alacan's testimony that Knopf was interested in "growth, speculation, [and] taking risks" (Tr. 642-43).
I recognize that Knopf's complaint letter to the NASD alleged unauthorized trading but not unsuitable trading (Tr. 216-17; DX 3E). I do not give much weight to the absence from that letter of an unsuitability claim. Alacan had provided Knopf with little, if any, information about the issuers of the securities in question. Under the circumstances, it would be unrealistic to insist that Knopf had to articulate every one of his possible causes of action at such an early date. In any event, the fact that Knopf may have missed a possible cause of action does not estop the Division from raising the issue in the OIP.
For the reasons discussed above, I have already concluded that the Beare loving trust account had an investment objective of "growth," but not "speculation," as of September 1998.
Quality of securities. The Division's expert witness identified nine securities Alacan purchased for Old as "high risk, thinly traded securities of a very speculative nature" (DX 37 at 21). These nine securities were Cellex Biosciences, Inc., Harvey Electronics, Inc., Hudson Technologies, Inc., Hungarian Broadcasting Corporation, Invision Technologies, Inc., Rockwell Medical Technologies, Inc., Sforza Enterprises, Inc., Ursus Telecom Corporation, and VDC Communications, Inc. (DX 37A at DIV 4333-34). He also named three securities Alacan purchased for Knopf as "very speculative" and "high risk"-Hungarian Broadcasting Corporation, Tellurian, Inc., and Digital Data Networks, Inc. (DX 37 at 20; DX 37A at DIV 4246).17 Finally, the Division's expert opined that six securities Alacan recommended and/or purchased for the Beare loving trust account were "high risk"-Euroweb International Corporation, PeopleSoft, Inc., Nextel Communications, Inc., Navarre Corporation, Doubleclick, Inc., and Excite, Inc. (DX 37 at 19; DX 37A at DIV 4107-08).
Before offering his opinions about the quality of these securities, Parkes reviewed prospectuses, research reports on securities for which Barclay was an investment banker and/or market maker, and reports relating to the financial and operating histories of the issuers, including Forms 10-K and 10-Q and publications from Standard & Poor's Corporation and Moody's Investors Service (DX 37 at 4-6). Alacan did not challenge Parkes's characterization of any of the named securities as high risk, thinly traded, and very speculative. I conclude that he has waived the opportunity to do so.18
Despite this waiver, Alacan now cautions about the danger of "hindsight bias" (Alacan Br. at 46-48). He argues that during the period in question-before the bursting of the stock market bubble in 2000-investors were willing to take risks that not even speculators are willing to take today. Alacan concedes that, viewed in hindsight, it was not appropriate for any of his customers to invest in the securities they purchased at Barclay. Alacan also contends that the customers lost money not through any fault of his, but because of adverse market conditions and an economy that few were able to predict. Finally, Alacan insists that the securities at issue were the precise securities that, at the time, these customers wished to purchase.
This defense is rejected. The securities that Alacan purchased for Old, Knopf, and Beare were unsuitable when considered in light of what Alacan knew about these customers during 1997 and 1998. Alacan's recommendations of high risk, speculative securities were unsuitable for Old because of his age, his status as a long-time retiree, and his need for liquid funds. Alacan's recommendations to Knopf were unsuitable because of his interest in sound investments and his lack of interest in speculation. Alacan's recommendations of high risk, speculative securities were unsuitable for the Beares because of their ages, their long-time retirement status, and their limited prior investment experience.
Turnover. While a suitability inquiry often focuses on whether a particular security is appropriate for an investor, the Commission has stated that the frequency of trading must be suitable, as well. See Simpson, 77 SEC Docket at 2004. Parkes computed the frequency of turnover in the three customers' portfolios. On an annualized basis, Old's account was turned over 4.94 times, Knopf's account was turned over 8.11 times, and the Beare loving trust account was turned over 86.44 times (DX 37 at 19-21). As discussed above, an annualized portfolio turnover rate in excess of 6 is generally presumed to reflect excessive trading if the customer's objective is conservative. Cf. Rizek, 70 SEC Docket at 934 & n.15. The Commission has on occasion found excessive trading based on turnover ratios of less than 4 if the customer's investment objective is conservative. Cf. Stout, 73 SEC Docket at 1464; Barbato, 53 S.E.C. at 1277. Based on their ages and investment objectives, I conclude that the frequency of trading was unsuitable for all three customers.
Margin. The OIP further alleges that Alacan made unsuitable purchases and sales of securities on margin without ascertaining his customers' understanding of the risks associated with the use of margin (OIP ¶ II.B.2.d). To prove this charge, the Division focuses on the margin trading that Alacan conducted in the Old and Beare accounts (Div. Br. at 22).
Opening a margin account or making a margin trade in a customer's account may constitute unsuitable trading in violation of the antifraud provisions of the securities laws if the account executive knowingly or recklessly fails to disclose the risks of margin trading. See Troyer v. Karcagi, 476 F. Supp. 1142, 1152 (S.D.N.Y. 1979); Canady, 69 SEC Docket at 1482-83. The Commission has held that it is unsuitable, in violation of the antifraud provisions of the securities laws, to use margin in the accounts of conservative investors. See Simpson, 77 SEC Docket at 2005-06 (focusing on the investors' modest means, ignorance of the risks involved, and general lack of investment sophistication).
Old incurred margin interest charges of $1,198 to finance transactions between November 1997 and July 1998, while Alacan was his account executive (DX 37 at 21; DX 37A at DIV 4336). In contrast, during September and October 1998, before Alacan became involved, there was no margin trading in Old's account (DX 5C at DIV 493-99). Old credibly testified that margin trading was not his idea, and that Alacan never discussed the risks of margin trading with him (Tr. 174-76). Old could not recall signing a margin agreement (Tr. 174). Although Barclay eventually produced a signed margin trading agreement, Old credibly denied that the signature on that document was his (Tr. 174; DX 5B).
Margin trading in the Beare loving trust account was extremely aggressive during Alacan's tenure as account executive, and the Beares incurred margin interest charges of $937 in November and December 1998 alone (DX 37 at 19-20; DX 37A at DIV 4109). In contrast, between June 1997 and September 1998, before Alacan took over as the account executive, there was no margin trading in the loving trust account (DX 1B at DIV 2-50). Leonard Beare told his son-in-law that he did not understand margin trading (Tr. 53-54). Although Barclay produced an undated margin trading agreement, both Mr. and Mrs. Beare told their son-in-law that the signatures on that document were not theirs (Tr. 64-66; DX 1G).
Old and the Beares opened their Barclay accounts through registered representatives other than Alacan, and they did not engage in margin trading while those registered representatives serviced their accounts. Alacan initiated margin trading in both accounts as soon as he became the account executive of record. Both customers disputed the authenticity of their signatures on margin trading agreements. I conclude that margin trading was unsuitable for these customers in the absence of full disclosure by Alacan of the risks involved. See Canady, 69 SEC Docket at 1482-83.
Scienter. To the extent that the unsuitable transactions were also unauthorized transactions, scienter has been discussed above. To the extent that Alacan offered recommendations before executing trades, I conclude that he made material misrepresentations when he told his customers that the securities in question would appreciate in value. He also omitted to disclose material information concerning the risk and potential downside of the recommended investments. On this basis, scienter is also established for the unsuitable recommendations that did not involve unauthorized trading. See Kenneth R. Ward, 79 SEC Docket 3035, 3057-59 (Mar. 19, 2003), aff'd, 2003 U.S. App. LEXIS 19782 (5th Cir. Sept. 25, 2003).
Failure To Follow Customer Instructions
Paragraph II.B.2.e of the OIP alleges that Alacan failed to follow a customer's instructions and failed to complete the transfer of a customer's account to a different broker-dealer.
A registered representative who willfully fails or refuses to follow a customer's instructions concerning the management of an account violates Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5. See Steven D. Goodman, 74 SEC Docket 707, 712-13 (Jan. 26, 2001) (refusing a customer's order to sell his stock and then refusing to send the customer his share certificates so that the customer could sell them through another broker); Albert Vincent O'Neal, 51 S.E.C. 1128, 1131-32 (1994) (ignoring a customer's instructions to wind down or eliminate options positions). As a general matter, a customer has plenary power to close an account and a broker is bound to follow such instructions.
Sebastian Sollecito. On April 2, 1997, Sebastian Sollecito visited Ron San Chirico (San Chirico), a broker in Monterey, California (Tr. 128). Sebastian Sollecito had worked with San Chirico for several years and trusted him (Tr. 128). Sebastian Sollecito signed a customer account transfer form directing Barclay and its clearing firm to transfer his account to San Chirico, in care of Pershing (DX 6J at DIV 621). San Chirico's home office then sent the account transfer form to Bear Sterns and Barclay (Tr. 128-30).19
In mid-April 1997, Sebastian Sollecito received a statement confirming that Alacan had purchased 2,000 units of NAM Corp. for his Barclay account on April 14, 1997 (Tr. 130; DX 6K at DIV 630). The confirmation statement puzzled the Sollecitos, because Sebastian's account at Barclay should have been frozen until it was transferred to Pershing. Sebastian Sollecito told his wife that he had not authorized the transaction (Tr. 130). Susan Sollecito then telephoned San Chirico, who made an inquiry and learned that Pershing had received a letter rescinding the April 2 transfer (Tr. 135-36; DX 6H; DX 159B at 3).
The rescission letter purported to be signed by Sebastian Sollecito. The letter, dated April 16, 1997, was addressed to Barclay's clearing firm and it stated (DX 6H):
Please use this letter as my authorization to stop the transfer in progress for my account, account # 631-15139-1-2, titled Sebastian Sollecito, at J.W. Barclay & Co. I do not wish to transfer this account. This letter will supersede any previous instructions.
Alacan later asserted that Sebastian Sollecito had verbally rescinded his April 2, 1997, instructions to transfer the account on several occasions prior to April 16, 1997 (DX 162 at 238, RX 13). This testimony is rejected as incredible. Under NASD Rule 11870, there is no such thing as a verbal rescission of a written transfer request.20
Alacan eventually acknowledged that the rescission letter had originated at Barclay, that its wording was similar to transfer rescission letters used by some of his other customers, and that either he or Manny Scarso had been responsible for initiating the letter (Tr. 698-702; DX 162 at 238-40). At the time, however, Granite was telling Susan Sollecito a completely different story. When Susan Sollecito contacted Granite to ask why Alacan had executed the April 14 transaction, Granite said that he did not know but would look into the matter (Tr. 131; DX 159B at 3). Granite also told her-incorrectly-that Sebastian's account already had been transferred (Tr. 131, 133-34; DX 159B at 3).
The Division has made a strong case that the "Sebastian Sollecito" signature on the April 16 letter is not genuine. Sebastian Sollecito told his wife that he had not signed the rescission letter (Tr. 136-37, 697-98). Susan Sollecito testified that the signature was not her husband's (Tr. 138, 154). The fact that Mr. and Mrs. Sollecito were away from their home on April 16, 1997, lends further credence to Susan Sollecito's testimony that her husband could not possibly have signed the letter on that date (Tr. 137, 145; DX 6I at DIV 619).
Alacan and Granite denied forging Sebastian Sollecito's signature on the rescission letter (Tr. 627, 746-47; DX 6H). For purposes of deciding this case, I have given Alacan the benefit of the doubt and treated the signature as an unattributed forgery. Wholly apart from the issue of forgery, however, Alacan has failed to offer a plausible explanation for how the rescission letter, which originated in Barclay's New York City office, might have reached Sebastian Sollecito in California, and how Sebastian Sollecito might have signed the letter and returned it to Barclay. At the time, Sebastian Sollecito was incapable of sending a letter by facsimile or Federal Express, or of driving to the post office to mail one (Tr. 143-45).
Alacan executed another unauthorized transaction in Sebastian Sollecito's account on April 17, 1997. Upon receipt of the confirmation, Susan Sollecito telephoned Granite to protest (DX 159B at 8-10). Granite again told Susan Sollecito that nothing should be happening in Sebastian's account and that he would look into it (Tr. 138; DX 159B at 11). He also recommended that Sebastian Sollecito resubmit the customer account transfer form (Tr. 131, 134, 138; DX 159B at 11).
On April 25, 1997, Sebastian Sollecito visited San Chirico's office and executed a second customer account transfer form (DX 6J at DIV 622). Susan Sollecito followed up with a letter of protest to the NASD. These steps had little immediate impact. Alacan executed yet another unauthorized transaction in Sebastian Sollecito's account on May 7, 1997 (trade date) (Tr. 146, 697; DX 6K at DIV 624). After receiving the confirmation, Susan Sollecito immediately protested to Granite by letter and telephone (DX 6I at DIV 620, DX 159D at 4-6). Granite promised her that Barclay would cancel the transaction (DX 159D at 4, 9). In fact, Barclay did not do so. Barclay eventually transferred Sebastian's account to Pershing on May 19, 1997 (Tr. 147; DX 6C at DIV 596).
At first glance, it may seem unusual that the Division has charged Alacan, who had no discernable back office duties, with fraud for failing to complete the transfer of a customer's account. ACATS is a firm-to-firm system and, in the ordinary course, a registered representative with only front office responsibilities would lack custody and control of a customer's cash and securities. A retail broker usually is not in a position to thwart ACATS. Things were different at Barclay, where Alacan's status as a major producer gave him the power to influence back office functions.21 The Division has not charged Alacan with aiding and abetting Barclay's violation of NASD Rule 11870, but rather with violations of the antifraud provisions of the federal securities laws. Those provisions proscribe fraud by "any person." For that reason, Alacan has been properly charged as a primary violator for the offense in question.
I conclude that Alacan did everything he could to frustrate Sebastian Sollecito's two written requests to transfer his account from Barclay to Pershing. I further conclude that Alacan's handling of Sebastian Sollecito's account between April 2 and May 19, 1997, involved not simply recklessness, but deliberate and knowing misconduct.
Leonard Beare and Cora Belle Beare. In July 1999, Leonard Beare's family became worried about the gradual decline in his mental health and ability to manage his affairs (Tr. 10, 76-78). The family then assisted Leonard Beare in closing his Barclay accounts.
On August 24, 1999, Leonard Beare, his daughter, Janice Bibee, and his son-in-law, Jack Bibee, telephoned Frederick Camarano (Camarano), the operations manager at Barclay, and told him to close the loving trust account (Tr. 49-51). Camarano promised that he would mail the Beares a check for $1,834.32, the cash balance remaining in the account (Tr. 49-51; DX 1F at DIV 101).22 He then did so. Leonard Beare received Barclay's check, endorsed it, and deposited it in his local bank (Tr. 51-52; DX 1F at 102, RX 8, Ex. B at 34, 36, 38).
On September 1, 1999, one week after the loving trust account had been closed, Alacan purchased 1,500 shares of IDT Corporation on Leonard Beare's behalf (Tr. 69-70; DX 1P at DIV 231) (trade date).23 A few days later, Alacan telephoned Leonard Beare. When Beare told Alacan that he had closed the loving trust account, Alacan informed Beare that he had not heard that the account was closed and that, in any event, he had recently purchased stock for Beare (Tr. 51-52, 57, 70). Alacan also told Beare that the stock had appreciated in value and that, if Beare hoped to realize that gain, he would have to send money to cover the purchase price (Tr. 57). Beare then mailed payment to Barclay (Tr. 56-57; RX 8, Ex. B at 51). Beare later told Vander Weide that the purchase had been unauthorized (Tr. 70).
On September 21, 1999, the Beares granted Vander Weide powers of attorney to handle their financial affairs (Tr. 14-16, 26, 55). However, when Vander Weide telephoned Alacan to inform him about the powers of attorney and to discuss the status of the account, Alacan quickly passed the call to his assistant, Joseph Carrera (Carrera) (Tr. 55-56, 618-19).
Vander Weide told Carrera that he wanted the account closed and all future correspondence addressed to him, rather than the Beares (Tr. 56). Carrera responded that he could not even speak to Vander Weide about the account without having copies of the powers of attorney in his possession (Tr. 55).
Vander Weide faxed Carrera a letter the next day, reiterating his telephonic instructions and providing copies of the powers of attorney (Tr. 55-56; DX 1I). Two days later, when Vander Weide called to confirm that the account had been closed, Carrera told Vander Weide that he had not received the signature page on one of the power of attorney documents (Tr. 59-60). Vander Weide promptly provided the missing page and all other necessary documents, and he again instructed Barclay and its agents to cease all trading in the account (Tr. 60; DX 1J).
On September 29, 1999, Leonard Beare received a Federal Express package from Alacan (Tr. 59; DX 1H). A handwritten post-it note asked Beare to "Please sign all documents [and] include original power of attorney papers" (DX 1H at DIV 105). The package is noteworthy in two respects. First, by addressing the package to Beare at his home address, Alacan had disregarded Vander Weide's instructions that all correspondence from Barclay should be directed to Vander Weide (DX 1I). Second, the package contained a customer profile and new account report with several curious entries (DX 1H at DIV 112). The new account report bore a date of September 1, 1999. It also stated that the initial transaction in the new account had been the purchase of 1,500 shares of IDT Corporation on September 1, 1999. The customer profile contained some major discrepancies. It understated Leonard Beare's age, embellished his annual income and net worth, and broadened his purported trading objectives (Tr. 61-62). Because Alacan had signed the document, two inferences are possible: either Alacan knew virtually nothing about Leonard Beare's financial circumstances despite having handled his account for one year, or Alacan signed a document that made Leonard Beare appear as a younger, wealthier, more aggressive investor than he was in fact. The document instructed Beare "If all info is correct, sign here" (DX 1H at DIV 112). Leonard Beare never signed the document (Tr. 63-64).
Alacan offered no explanation for his behavior in September 1999. Of course, Alacan was required to make reasonable inquiry into the nature and extent of Vander Weide's authority to act for Beare, and it was reasonable for him to ask for written evidence of Vander Weide's authority (Tr. 526). However, Alacan was not free to ignore Vander Weide until he had in hand the originals of the powers of attorney.24 Vander Weide's efforts to communicate with Alacan were persistent and entirely reasonable under the circumstances. Alacan makes no claim that he had reason to question Vander Weide's identity, or that he was somehow confused or uncertain about Vander Weide's instructions and authority. Once Vander Weide made telephone contact with Alacan, identified himself as attorney-in-fact for the Beares, and provided facsimile copies of the power of attorney documents, Alacan was bound to deal with Vander Weide as the customer. From that point onward, he was also bound to follow Vander Weide's instructions. Cf. Peltz, 115 F. 3d at 1087.
Leonard Beare felt pressured by the telephone calls he continued to receive from Barclay. As a result, he changed the home telephone number his family had used for over sixty years (Tr. 58). Vander Weide felt frustrated that Alacan was ignoring his instructions to communicate only with him about the account (Tr. 67). To rectify the situation, Vander Weide assisted the Beares in drafting their own letter to Alacan (Tr. 67; DX 1K). In that letter, dated October 5, 1999, the Beares directed Alacan to halt all trading, close all accounts, cease contact with either Mr. Beare or Mrs. Beare, and communicate only with Vander Weide.
After Barclay's back office had already closed the loving trust account in late August 1999, Alacan still refused to honor the Beares' wishes to sever the broker-customer relationship. He executed an unauthorized margin transaction on September 1, 1999. Alacan's professed ignorance of the fact that the Beares had closed the loving trust account was not credible. Indeed, the unauthorized transaction is further evidence that Alacan felt he could overturn actions taken by Barclay's back office. Alacan continued to contact Leonard Beare by telephone and overnight courier even after receiving clear instructions from Vander Weide to cease all such contacts. Alacan's signature on a new customer account form that contained several major discrepancies and his efforts to avoid dealing with Vander Weide amply demonstrate scienter. I conclude that Alacan failed to follow his customer's instructions, as charged in OIP ¶ II.B.2.e.
To protect the public interest, the Division seeks a cease-and-desist order and an order barring Alacan from association with any broker or dealer. It also seeks an order requiring Alacan to pay a civil penalty of $110,000, disgorgement of $9,768.16, and prejudgment interest of $4,376.14 (through May 31, 2003) (Div. Br. at 29-35 and Appendix A).
Alacan believes that the charges should be dismissed. However, if liability is established, he suggests that reduced sanctions are appropriate on the grounds that the proven misconduct diminished after December 1997 (Tr. 725; RX 11). He also requests that the proposed associational bar not be imposed (Alacan Br. at 55).
As to cease-and-desist orders and associational bars, the public interest analysis requires that several factors be considered. These include: (1) the egregiousness of the respondent's actions; (2) the isolated or recurrent nature of the infractions; (3) the degree of scienter involved; (4) the sincerity of the respondent's assurances against future violations; (5) the respondent's recognition of the wrongful nature of his conduct; and (6) the likelihood that the respondent's occupation will present opportunities for future violations. Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981). The severity of sanctions depends on the facts of each case and the value of the sanctions in preventing a recurrence of the violative conduct. See Berko v. SEC, 316 F.2d 137, 141 (2d Cir. 1963). Sanctions should demonstrate to the particular respondent, the industry, and the public generally that egregious conduct elicits a harsh response. See Arthur Lipper, 547 F.2d at 184. Registration or associational sanctions are not intended to punish a respondent, but to protect the public from future harm. See Leo Glassman, 46 S.E.C. 209, 211-12 (1975).
Section 8A(a) of the Securities Act and Section 21C(a) of the Exchange Act authorize the Commission to impose a cease-and-desist order upon any person who "is violating, has violated, or is about to violate" any provision of the Securities Act, the Exchange Act, or the rules and regulations thereunder.
The Commission has determined that 28 U.S.C. § 2462 does not apply to cease-and-desist orders. See Terence Michael Coxon, __ SEC Docket ___, ___ n.60, Exchange Act Release No. 48,385 at 27 n.60 (Aug. 21, 2003); Herbert Moskowitz, 77 SEC Docket 481, 500-02 (Mar. 21, 2002).
In KPMG Peat Marwick LLP, 74 SEC Docket 384, 428-38 (Jan. 19, 2001), recon. denied, 74 SEC Docket 1351 (Mar. 8, 2001), pet. denied, 289 F.3d 109 (D.C. Cir. 2002), the Commission addressed the standard for issuing cease-and-desist relief. It concluded that it would consider the Steadman factors in light of the entire record, noting that no one factor is dispositive. It explained that the Division must show some risk of future violations. However, it also ruled that such a showing should be "significantly less than" that required for an injunction and that, "absent evidence to the contrary," a single past violation ordinarily suffices to establish that the violator will engage in the same type of misconduct in the future. Id. at 430, 435.
Here, a cease-and-desist order is plainly warranted in the public interest. Alacan's violations were egregious and far from isolated. His misconduct harmed several customers and continued over a long period of time. The violations involved a high degree of scienter. Alacan has not offered any persuasive assurances against future violations, nor has he acknowledged the wrongful nature of his past conduct. Alacan is currently working as a registered representative and he wants to remain in the securities industry. In the absence of a cease-and-desist order, future violations are quite likely to occur.
Section 15(b)(6) of the Exchange Act empowers the Commission to impose a sanction against a person associated with a broker or dealer if such a person willfully violated the Securities Act, the Exchange Act, or the rules or regulations thereunder. Specifically, the Commission may censure an associated person, place limitations on the activities or functions of that person, suspend that person for a period not exceeding twelve months, or bar that person from being associated with a broker or dealer if the Commission finds, on the record and after notice and opportunity for hearing, that such censure, placing of limitations, suspension, or bar is in the public interest.
Section 3(a)(18) of the Exchange Act defines a "person associated with a broker or dealer" as including "any employee of such broker or dealer." Barclay was registered as a broker and dealer at the times relevant to this proceeding. As an employee of Barclay who willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5, Alacan is subject to a sanction under Section 15(b)(6) of the Exchange Act.
Alacan contends that something less than a bar from the industry is appropriate, because the proven misconduct diminished after December 1997 (Tr. 725; RX 11; Alacan Br. at 55). He expresses his willingness to accept heightened supervision, to attend continuing education courses, and to take whatever other remedial actions the Commission might order (Tr. 679).
It is not clear that the Commission is foreclosed from imposing the maximum permissible sanction unless it first demonstrates that a lesser sanction will not suffice to protect investors. Compare Rizek, 215 F.3d at 161 (holding that the Commission is not required to "[explain] to the satisfaction of a court why no lesser remedy will do" before imposing a bar) with Steadman, 603 F.2d at 1139-40 (holding that "the greater the sanction the Commission decides to impose, the greater is its burden of justification"); see also Nolan Wayne Wade, 80 SEC Docket 2683, 2690 n.10 (July 29, 2003).
Assuming, without deciding, that a literal reading of Steadman is still warranted after Rizek, the Division has shown that nothing less than a bar will protect the public interest here. Alacan committed several very serious violations of the antifraud provisions after December 1997, including misconduct as to customers Latimer, Old, Lassiter, and the Beares. On a more fundamental level, I do not accept the premise that a serial violator of the antifraud provisions is entitled to a second chance or that, if Alacan is so entitled, December 1997 ought to mark the point at which his second chance begins to run. Alacan fails to explain why the $2,500 fine and the seven-day suspension that Barclay imposed in June 1997 did not gain his immediate attention and prompt a change in his behavior.
As a general matter, I also conclude that, if a respondent offers an enhanced supervisory program as an alternative to a bar or suspension, it is the duty of the respondent to structure the proposal and to show by a preponderance of the evidence that it satisfies the public interest. It is not the Division's responsibility (or the Commission's) to structure an enhanced supervisory program and then submit it to the respondent for his approval. Alacan has not met his burden on this issue. In any event, previous attempts at special supervision have failed to stop Alacan from committing further misconduct.
After considering the Steadman factors, I conclude that Alacan should be barred from association with any broker or dealer for misconduct occurring from in or about June 1997 to in or about December 1998. Nothing less will protect the public interest. In so holding, I have not considered evidence of misconduct occurring more than five years before the Commission issued the OIP, specifically, evidence relating to customers Sebastian Sollecito and Wittemyer before April 24, 1997. See Coxon, __ SEC Docket at ___ n.59, Exchange Act Release No. 48,385 at 26 n.59; Wheat, First Secs., Inc., __ SEC Docket ___, ___ n.63, Exchange Act Release No. 48,378 at 27 n.63 (Aug. 20, 2003); Feeley & Willcox Asset Mgmt. Corp., 80 SEC Docket 2075, 2098 (July 10, 2003), recon. denied, __ SEC Docket ___, Exchange Act Release No. 48,607 (Oct. 9, 2003); Robert Thomas Clawson, 80 SEC Docket 2129, 2138 (July 9, 2003), appeal pending, No. 03-73199 (9th Cir.). Given the scope of Alacan's violations within the time period identified in the OIP, I have not found it necessary to consider Alacan's subsequent misconduct (i.e., after December 1998) to determine whether an associational bar is warranted.25 Accord, Russo Secs., Inc., 75 SEC Docket 1124A, 1124V n.67 (Apr. 17, 2001); Barbato, 53 S.E.C. at 1281.
Civil Monetary Penalty
Under Section 21B(a) of the Exchange Act, the Commission may assess a civil monetary penalty if the respondent has willfully violated the Securities Act, the Exchange Act, or the rules and regulations thereunder. It must also find that such a penalty is in the public interest. See Section 21B(c) of the Exchange Act. Six factors are relevant to the public interest determination: (1) fraud; (2) harm to others; (3) unjust enrichment; (4) prior violations; (5) deterrence; and (6) such other matters as justice may require. Not all factors may be relevant in a given case, and the factors need not all carry equal weight. In its discretion, the Commission may consider evidence of the respondent's ability to pay. See Section 21B(d) of the Exchange Act.
Section 21B(b) of the Exchange Act specifies a three-tier system identifying the maximum amount of a penalty. For each "act or omission" by a natural person, the maximum amount of a penalty is $5,000 in the first tier; $50,000 in the second tier; and $100,000 in the third tier.26 A second-tier penalty is permissible if the act or omission involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement. A third-tier penalty not only must have involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement, but also must have "directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons or resulted in substantial pecuniary gain to the person who committed the act or omission."
The statutory maximum is not an overall limitation, but a limitation per violation. Thus, each unauthorized trade and each unsuitable transaction constitutes a separate act or omission. See Mark David Anderson, __ SEC Docket ___, ___, Exchange Act Release No. 48,352 at 21 (Aug. 15, 2003) (imposing a civil penalty of $1,000 for each of the respondent's ninety-six violations); cf. United States v. Reader's Digest Ass'n., 662 F.2d 955, 966, 970 (3d Cir. 1981) (holding that each individual mailing constitutes a separate violation of an FTC consent order). The Division requests a civil penalty against Alacan for multiple acts and omissions (Tr. 753-54). I conclude that the requested penalty of $110,000 is well within the statutory ceiling.
A third-tier penalty is warranted for the proven antifraud violations occurring from in or about June 1997 to in or about December 1998. The misconduct established on this record involved fraud, deceit, and the reckless disregard of regulatory requirements. It also created significant risk of substantial losses to the investing public and resulted in substantial financial gain to Alacan. On this record, I will impose a civil penalty of $110,000 against Alacan, as requested by the Division. As with the associational bar, I have not considered any misconduct occurring more than five years before the Commission issued the OIP. See Feeley & Willcox, 80 SEC Docket at 2100. Nor have I found it necessary to consider misconduct after December 1998, the ending month specified in the OIP. See Russo; Barbato.
Well before the hearing, I advised all nine Respondents that, if they were going to claim inability to pay disgorgement or civil penalties, they would have to submit detailed financial statements, as well as supporting income tax returns, at the hearing (Orders of October 22, 2002, and February 19, 2003). See Rule 630 of the Commission's Rules of Practice; Steen, 53 S.E.C. at 626-28 (holding that an ALJ may require the filing of sworn financial statements). Alacan elected not to make such a filing. I conclude that he has waived any claim of inability to pay.
Section 8A(e) of the Securities Act and Section 21C(e) of the Exchange Act provide that the Commission may enter an order requiring disgorgement, including reasonable interest. Disgorgement seeks to deprive the wrongdoer of his ill-gotten gains. See SEC v. First City Fin. Corp., 890 F.2d 1215, 1230-32 (D.C. Cir. 1989). It returns the violator to where he would have been absent the violative activity. An order to disgorge a certain amount need only be a reasonable approximation of the profits causally connected to the violations. Id. at 1231.
Once the Division shows that its disgorgement figure reasonably approximates the amount of unjust enrichment, the burden of going forward shifts to the respondent to demonstrate clearly that the Division's disgorgement figure is not a reasonable approximation. SEC v. Lorin, 76 F.3d 458, 462 (2d Cir. 1996); SEC v. Patel, 61 F.3d 137, 140 (2d Cir. 1995). Any risk of uncertainty as to the disgorgement amount falls on the wrongdoer whose illegal conduct created that uncertainty. First City, 890 F.2d at 1232.
The Division has presented a disgorgement chart, based on the calculations of its expert witness (DX 37 at DIV 4031, DX 160). That evidence shows that Alacan earned $37,388 in commissions from fraudulent transactions in the accounts of Sollecito, Old, Knopf, Lassiter, and the Beares. Barclay reversed the commissions Alacan earned on unauthorized trades in the Wittemyer and Kerlikowske accounts, and the Division is not seeking disgorgement in connection with unauthorized trades in Latimer's accounts (Div. Br. at 32-33). The Division has deducted from its disgorgement calculations, on a customer-by-customer basis, any amounts that Alacan paid to specific customers in settlement of claims made by that customer with respect to the conduct at issue. Taking a deduction for the Beare settlement, the Division seeks an order requiring Alacan to disgorge $9,768.16 (Tr. 29, 31; DX 160). Alacan has not challenged the Division's theory or its calculations.
Two issues warrant brief mention. First, most of the ill-gotten gains that the Division wants Alacan to disgorge resulted from transactions in Old's account (DX 160). These gains include not only traditional "commissions," but also markups and markdowns (Tr. 684-86; DX 37A at DIV 4331-32; DX 83G at DIV 9979). This is entirely proper. Cf. Roche, 53 S.E.C. at 25. Second, a small amount of the proposed disgorgement involves misconduct in Sebastian Sollecito's account occurring more than five years before the Commission issued the OIP (DX 160). The five-year limitation in 28 U.S.C. § 2462 does not apply to disgorgement relief. Johnson, 87 F.3d at 489-91; Feeley & Willcox, 80 SEC Docket at 2101 n.65; Barbato, 53 S.E.C. at 1279 & n.27. I will order Alacan to disgorge $9,768.16.
Section 8A(e) of the Securities Act and Sections 21B(e) and 21C(e) of the Exchange Act provide that the Commission may order disgorgement, "including reasonable interest," in any administrative proceeding in which a cease-and-desist order is sought or a civil monetary penalty could be imposed. These statutory provisions also authorize the Commission to adopt rules and regulations and issue orders concerning rates of interest and periods of accrual. The Commission promulgated Rule 600 of its Rules of Practice, Interest On Sums Disgorged, in 1995.
It is a tautology that the prejudgment interest period can end no later than the entry of judgment. "Prejudgment interest is, by definition, interest that accrues until judgment is rendered." Bel-Bel Int'l Corp. v. Cmty. Bank of Homestead, 162 F.3d 1101, 1110 (11th Cir. 1998). Prejudgment interest accrues "to the date of payment or to the date judgment is entered, whichever first occurs." Bangert Bros. Constr. Co. v. Kiewit W. Co., 310 F.3d 1278, 1297 (10th Cir. 2002) (citing Colorado law). In this proceeding, the Division acknowledges the point when it requests disgorgement "with prejudgment interest continuing to run through the date of judgment" (Div. Prehear. Br. at 38).
When the Commission wins the remedy of disgorgement in the federal court system, an award of prejudgment interest is discretionary. "The decision whether to grant prejudgment interest and the rate used if such interest is granted are matters confided to the district court's broad discretion, and will not be overturned on appeal absent an abuse of that discretion." SEC v. First Jersey Secs., Inc., 101 F.3d 1450, 1476 (2d Cir. 1996) (citation omitted). "[N]o case hold[s] that an award of disgorgement must always be accompanied by an award of prejudgment interest . . . ." SEC v. Sargent, 329 F.3d 34, 41 n.1 (1st Cir. 2003). In contrast, when the Division wins the remedy of disgorgement in an administrative proceeding, an Administrative Law Judge has no discretion whatsoever. Prejudgment interest "shall" be due on any sum required to be paid pursuant to an order of disgorgement. See Rule 600(a) of the Commission's Rules of Practice. In addition, interest on the sum to be disgorged "shall" be computed at the underpayment rate of interest established by the Internal Revenue Code, 26 U.S.C. § 6621(a)(2), and "shall" be compounded quarterly. See Rule 600(b) of the Commission's Rules of Practice.
Prior Commission opinions have often used boilerplate language to order prejudgment interest on the sum to be disgorged. Those opinions and orders typically did not discuss the methodologies to be used for selecting the precise rate (or rates) of interest, for deciding when the prejudgment period begins, for determining what to do with fractional periods at the beginning or the end of a quarterly compounding period, or for distinguishing between prejudgment and postjudgment interest. Rather, such opinions and orders stated summarily: "Respondent shall pay prejudgment interest, computed at the rate set forth in Rule 600 of the Commission's Rules of Practice, from [the date the violation occurred] to the date of this order," or words to that effect. Presumably, someone other than the Commissioners and the presiding Administrative Law Judge actually exercised the responsibility for "filling-in-the-blanks" at a later date.27
That hands-off approach to ordering interest on disgorgement is now at least questionable in view of the recent opinion in SEC v. Bosque Puerto Carrillo, 325 F.3d 1268 (11th Cir. 2003). In Bosque Puerto Carrillo, a district court ordered the defendant to pay disgorgement plus prejudgment interest to the Commission. However, the district court's disgorgement order did not specify either the interest rate or the date from which interest accrued. The Eleventh Circuit therefore dismissed the appeal for lack of jurisdiction, holding that the district court's order was not a final judgment. In doing so, the Eleventh Circuit rejected the Commission's argument that the district court's failure to calculate the amount of prejudgment interest should not affect the finality of the judgment because the calculation of prejudgment interest was only a ministerial task:
The ministerial task of calculating prejudgment interest can be accomplished if the judgment amount, the prejudgment interest rate, and the date from which prejudgment interest accrues have been established. If these three components have been established, the court's failure to calculate the precise amount of prejudgment interest does not prevent the court's order from constituting a final judgment under [28 U.S.C.] § 1291. However, if the judgment amount, the prejudgment interest rate, or the date from which prejudgment interest accrues is unclear, the calculation of prejudgment interest is no longer a ministerial act and the court's order is not final. . . .
In an attempt to persuade this court that the district court's order is nonetheless an appealable final decision, the parties contend that the order implicitly adopts the calculation method proposed by the SEC. We reject this argument because we decline to hold that the court's silence regarding the method of calculation is tantamount to its adoption of the SEC's proposed method.
Bosque Puerto Carrillo, 325 F.3d at 1272-73 (citations omitted). The Commission has not yet embraced the Eleventh Circuit's admonition when issuing disgorgement orders in administrative proceedings.28 The Division's initial explanation of prejudgment interest in this proceeding was somewhat cryptic, but its reply brief has filled most of those gaps. To avoid the possibility of a Bosque Puerto Carrillo-type remand, I address each of the variables involved in the calculation of pre- and postjudgment interest on the $9,768.16 to be disgorged by Alacan.
When should Alacan's multiple violations be "deemed to have occurred"? In adopting Rule 600 of its Rules of Practice, the Commission explained the rationale for requiring prejudgment interest on all disgorgement awards: it did not want a wrongdoer to benefit unjustly by having the equivalent of an interest-free loan from the victims of his wrongdoing. "In order to fulfill the remedial purposes of disgorgement, a respondent should never be allowed free use of funds wrongfully obtained from others." Rules of Practice, 59 SEC Docket 1546, 1596 (June 23, 1995) (emphasis added). As a result, Rule 600(a) of the Rules of Practice requires that a "disgorgement order shall specify each violation that forms the basis for the disgorgement ordered [and] the date [when] . . . each such violation was deemed to have occurred." Prejudgment interest begins to run "from the first day of the month following each such violation."
Of course, if all the misconduct producing ill-gotten gains took place on a single, identifiable date, the process of "deeming" when the violations occurred is not complex. Difficulty arises only if the misconduct requiring disgorgement continued over a period of months or years. The Commission's opinions requiring disgorgement have not provided much guidance for determining when such ongoing violations should be "deemed to have occurred." Often, in cases involving ongoing misconduct, the violations have not been deemed to occur, and prejudgment interest on disgorgement has not started to accrue, until the wrongdoing has stopped. See, e.g., Anderson, __ SEC Docket at ___, Exchange Act Release No. 48,352 at 22-23 (ordering the respondent to disgorge $66,691 for violations that occurred from 1992 through 1997, but awarding prejudgment interest only from March 5, 1997, "the date of the last transaction at issue in this matter"); Ward, 79 SEC Docket at 3064 (finding that the respondent earned illicit commission income from fraudulent conduct over several dates in 1992, 1993, and 1994, but ordering prejudgment interest on the disgorgement of those commissions should run only from March 31, 1994, "the date of the last transaction at issue in this matter"); Rizek, 70 SEC Docket at 939-40 & n.26 (finding churning violations from January through November 1993, but ordering prejudgment interest to run only from April 1, 1994).29 It is respectfully submitted that such results (i.e., no interest accruing while the misconduct was ongoing) are at some tension with the admonition that a respondent should never be allowed an interest-free loan of ill-gotten gains.
In the present case, I order Alacan to disgorge $9,768.16. That sum represents the commissions Alacan earned between April 1997 and December 1998 on a series of unauthorized trades, unsuitable trades, and churning in the accounts of several customers (DX 37, DX 37A, DX 37B). The Division has grouped together the commissions Alacan charged these customers on a quarterly basis (Div. Br. at Exhibit A). The Division asks me to deem that all of Alacan's violations during a given quarter occurred at the end of the quarter. Consistent with Rule 600(a), the Division then requests that prejudgment interest begin to accrue on each quarter's violations as of the first day of the next quarter (i.e., as of October 1, 1997, January 1, 1998, April 1, 1998, October 1, 1998, January 1, 1999, and April 1, 1999, respectively). The Division's approach to deeming when Alacan's violations occurred is one of several reasonable alternatives it could have recommended. It achieves "rough justice" and is preferable to the approach followed in Kenny, Anderson, Ward, and Rizek. I adopt the Division's recommendation as my own for purposes of this case. Apportioning an award of prejudgment interest from the actual dates the customers paid commissions to Alacan on each unlawful transaction would be even more accurate, but it would also be too complicated and burdensome to administer.
Computing prejudgment interest: fixed interest rate or variable interest rates? Rule 600(b) of the Commission's Rules of Practice provides that interest on the sum to be disgorged shall be computed at the underpayment rate of interest established by the Internal Revenue Code, 26 U.S.C. § 6621(a)(2), and shall be compounded quarterly. Neither Rule 600 nor the Commission's opinions provide guidance on whether an Administrative Law Judge should effectuate the quarterly compounding by applying a fixed rate of interest or variable rates of interest. The Commission has offered conflicting signals on the issue: on the one hand, the plain language of the text of Rule 600(b) refers to "the underpayment rate," not to fluctuating underpayment rates, thus suggesting a single, fixed rate is appropriate. Cf. Kaiser Alum. & Chem. Corp. v. Bonjorno, 494 U.S. 827, 838-39 (1990). On the other hand, the preamble to the Rules of Practice twice describes the Internal Revenue Code's underpayment rate as a "floating rate." See Rules of Practice, 59 SEC Docket at 1596.
The choice between a fixed interest rate and fluctuating interest rates cannot be brushed off as an academic exercise. In this proceeding, interest on $9,768.16 must be compounded quarterly over six years. The Internal Revenue Code underpayment rate for the fourth quarter of 1997, when the Division would start to accrue prejudgment interest against Alacan, was 9%. See Rev. Rul. 97-40. The Internal Revenue Code underpayment rate for the second and third quarters of 2003 was 5%, and for the fourth quarter of 2003 it is 4%. See Rev. Ruls. 2003-30, 2003-63, 2003-104. The difference between the calculation of prejudgment interest at a flat rate of 4%, on the one hand, and the calculation of prejudgment interest at rates varying between 9% and 4%, on the other hand, is of considerable significance, not only to Alacan, but also to the customers who may benefit from the distribution of any disgorgement collected.
The obvious advantage of using a fixed rate is that the prejudgment interest calculation is easier. "The cost of such [an approach], however, is loss of accuracy: sometimes too much interest and sometimes too little interest will be awarded." Michael S. Knoll, A Primer On Prejudgment Interest, 75 Tex. L. Rev. 293, 316 (Dec. 1996). In Professor Knoll's view (id. at 319):
The problem with using a fixed interest rate is that it interferes with the incentive to settle. When interest rates rise, the defendant, who is borrowing from the plaintiff at below-market rates, has an incentive to delay. Similarly, when rates fall, the plaintiff, who is receiving an above-market rate from the defendant, has an incentive to delay. In contrast, when prejudgment interest is calculated using a floating-rate measure, neither party has an incentive to delay.
Awards of prejudgment interest at variable rates of interest are not unreasonable per se and are not an abuse of discretion, because the result normally will approximate an acceptable "average" for the prejudgment period. See Pimentel v. Jacobsen Fishing Co., 102 F.3d 638, 640 (1st Cir. 1996) (collecting cases). The Division has persuaded some federal district courts to exercise their discretion to order prejudgment interest on disgorgement awards at the fluctuating Internal Revenue Code underpayment rate. See SEC v. Rosenfeld, Fed. Sec. L. Rep. (CCH) ¶ 91,300 at 95,701 (Magistrate Judge) (S.D.N.Y. Jan. 9, 2001); SEC v. Antar, 97 F. Supp. 2d 576, 588-92 (D.N.J. 2000); SEC v. Federated Alliance Group, Inc., 1997 U.S. Dist. LEXIS 9075 at *4-5 (W.D.N.Y. June 25, 1997).
In this case, the Division urges me to order the accrual of prejudgment interest at Internal Revenue Code underpayment rates that have fluctuated downward from 9% in 1997 to 4% at the present (Div. Br. at Exhibit A). I agree with that approach.
Fractional Periods. Rarely will the beginning or the end of the prejudgment period coincide precisely with the beginning or the end of Rule 600(b)'s quarterly compounding periods. Thus, to calculate interest for the prejudgment period, it may be necessary to calculate interest for fractional periods at the beginning or the end of the prejudgment period. The academic literature on this subject finds it permissible to use simple interest within each compounding period. See Knoll, 75 Tex. L. Rev. at 334. I have followed that approach here.
Calculation. The Division calculates Alacan's prejudgment interest at $4,376.14 through May 31, 2003 (Div. Br. at 33 and Exhibit A). As discussed above, I approve of the Division's approach to identifying the dates on which Alacan's violations should be deemed to have occurred. I also agree with the Division's recommendation to use fluctuating interest rates throughout the prejudgment interest period. I accept the Division's calculation of prejudgment interest through the first quarter of 2003. However, I cannot accept the Division's calculation of prejudgment interest for April and May 2003 (Div. Br. at Exhibit A). The Division has shifted to monthly compounding for that fractional period, when Rule 600(b) only authorizes quarterly compounding.
I have recalculated the prejudgment interest Alacan owes for the second quarter of 2003, using 5% as the appropriate rate of interest. See Rev. Rul. 2003-30. The result is $175.32. The beginning balance as of July 1, 2003, was thus $14,200.54. I have also calculated prejudgment interest for the third quarter of 2003, using 5% as the appropriate rate of interest. See Rev. Rul. 2003-63. Prejudgment interest for the third quarter of 2003 was $177.51, and the beginning balance as of October 1, 2003, was thus $14,378.05. Finally, I have calculated prejudgment interest for the fractional period of the fourth quarter of 2003 at issue here, using 4% as the appropriate rate of interest. See Rev. Rul. 2003-104. Interest for the entire fourth quarter of 2003 (92 days) would be $143.78. That equates to $1.56 per day, or $35.88 from October 1, 2003, through the date of this initial decision.
I thus compute the amount of prejudgment interest owed by Alacan as of the date of this initial decision at $4,645.77. When the sum to be disgorged ($9,768.16) is added to the accrued prejudgment interest ($4,645.77), the total amount owed by Alacan for disgorgement and prejudgment interest is $14,413.93.
"The purpose of postjudgment interest is to compensate the successful plaintiff for being deprived of compensation for the loss from the time between the ascertainment of the damage and the payment by the defendant." Bonjorno, 494 U.S. at 835-36 (citation omitted). Postjudgment interest properly starts to run from the date of the entry of judgment. Id. at 835.
When the Commission wins the remedy of disgorgement in the federal court system, an award of postjudgment interest pursuant to 28 U.S.C. § 1961(a) is mandatory and the rate of interest is fixed as of the date of judgment.30 As explained in Bosque Puerto Carrillo, 325 F.3d at 1271:
[T]he SEC is statutorily entitled to postjudgment interest under 28 U.S.C. § 1961. The district court does not have any discretion to deny or modify the terms upon which the SEC may receive postjudgment interest under § 1961; section 1961(a) establishes the applicable interest rate and instructs that interest shall be calculated from the date of the entry of the judgment.
When the Division wins an order of disgorgement in an administrative proceeding, however, the rate of postjudgment interest presents an unsettled issue. Rule 600(a) of the Commission's Rules of Practice does not specifically address postjudgment interest, although it does require a disgorgement order to state that "interest shall continue to accrue on all funds owed until they are paid." The Commission's orders in settled proceedings go in two different directions. The Commission sometimes orders postjudgment interest on disgorgement awards pursuant to 28 U.S.C. § 1961.31 At other times, it orders postjudgment interest on disgorgement awards pursuant to 26 U.S.C. § 6621(a)(2), or by reference to "the rate of interest set forth in Rule 600(b)."32 Nothing in the text of Rule 600 and nothing in the Commission's opinions compels the conclusion that there is only one way to calculate postjudgment interest on disgorgement in an administrative proceeding.33
There are significant differences between 28 U.S.C. § 1961 and 26 U.S.C. § 6621(a)(2). The current rate under 28 U.S.C. § 1961(a) is 1.29%; under 26 U.S.C. § 6621(a)(2), it is 4%. Annual compounding is required under 28 U.S.C. § 1961(b), while daily compounding is required under 26 U.S.C. § 6621(a)(2). See 26 U.S.C. § 6622(a). Finally, the rate under 28 U.S.C. § 1961(a) remains fixed, while the rate under 26 U.S.C. § 6621(a)(2) fluctuates quarterly. See 26 U.S.C. § 6621(b)(2)(A).
The third sentence of Rule 600(a) of the Commission's Rules of Practice states: "Prejudgment interest shall be due from the first day of the month following [the] violation through the last day of the month preceding the month in which payment of disgorgement is made" (emphasis added). That statement could be true in either of two ways. First, it could be true if a respondent voluntarily pays disgorgement and interest before the entry of judgment or, in the words of Rule 600(a), before an Administrative Law Judge or the Commission has issued a disgorgement order. Cf. Bangert, 310 F.3d at 1297. In that instance, however, there would be no remaining case or controversy, and the decision maker would not need to enter a disgorgement order.34 Second, the statement could be true if it means that the prejudgment interest that has accrued as of the date of judgment, like the sum to be disgorged (the disgorgement principal), does not become self-extinguishing over time (i.e., it will remain owing until it is paid).35 The third sentence of Rule 600(a) cannot possibly mean that prejudgment interest continues to accrue after judgment is entered. That is illogical, because it confuses prejudgment interest with postjudgment interest. Cf. Atchison, Topeka and Santa Fe Ry. Co. v. Pena, 44 F.3d 437, 445 (7th Cir. 1994) (Easterbrook, J., concurring) (en banc), aff'd, 516 U.S. 152 (1996) (noting that the use of "one word" for distinct concepts "breeds confusion," and positing that "vocabulary affects analysis").
Rules 600(a) and 600(b) of the Rules of Practice draw a distinction between interest on "the sum to be disgorged" and interest on "all funds owed." "The sum to be disgorged" refers only to the principal amount of disgorgement, which in this case is $9,768.16. Cf. Federated Alliance Group, 1997 U.S. Dist. LEXIS 9075 at *3 ("the sum to be disgorged should reasonably approximate the ill-gotten gains"). "All funds owed" refers to the principal amount of disgorgement plus the prejudgment interest accrued as of the date of judgment, which in this case is $14,413.93. As to the rate of prejudgment interest on "the sum to be disgorged," 26 U.S.C. § 6621(a)(2) clearly applies. See Rules of Practice, 59 SEC Docket at 1596 ("Rule 600 prescribes the payment of prejudgment interest at the Internal Revenue Code underpayment rate.") (emphasis added). As to the rate of postjudgment interest on "all funds owed," Rule 600 is silent. Regulations, like statutes, should be construed, where possible, so that no part is rendered superfluous. United States v. Hassanzedeh, 271 F.3d 574, 582 (4th Cir. 2001).
Consistent with the Commission's orders in Monski, Weissman, Gilbert, and Freeman, see supra note 31, I order Alacan to pay postjudgment interest on all funds owed ($14,413.93) pursuant to 28 U.S.C. § 1961(a) at the fixed interest rate of 1.29%.36
The Date Of Judgment
The "date of judgment" marks the ending point for the computation of prejudgment interest on a disgorgement award and the beginning point for the computation of postjudgment interest. In civil litigation in the federal courts, "judgment" occurs when a district court enters "any order from which an appeal lies." Fed. R. Civ. P. 54(a). If a money judgment in a civil case is affirmed on appeal, interest is payable from the date when the district court's judgment was entered unless the law provides otherwise. Fed. R. App. P. 37(a). If a court of appeals modifies or reverses a district court's money judgment, then the mandate of the court of appeals "must contain instructions about the allowance of interest." Fed. R. App. P. 37(b).
The "date of judgment" in an SEC administrative proceeding is an open question. There are three possible choices: the "date of judgment" could be the date an Administrative Law Judge issues an initial decision ordering disgorgement; the date the Commission declares the initial decision to be final; or (if the parties seek review or the Commission reviews on its own motion) the date the Commission issues its opinion and order. Four Commission opinions have treated the date of the Commission's opinion and order as controlling, but each involved a modification to the award of disgorgement in the underlying initial decision.37 No Commission opinion has yet addressed the issue in a context where the parties agree about "the total sum to be disgorged," or where the Commission and the Administrative Law Judge reach an identical result.
Obviously, the "date of judgment" in an administrative proceeding would not matter if the methodology for computing interest remains the same after judgment as before judgment. In contrast, identifying the "date of judgment" is important if the disgorgement order marks a break point: the end of prejudgment interest, calculated at variable rates and compounded quarterly pursuant to 26 U.S.C. § 6621(a)(2) and Rule 600(b), and the beginning of postjudgment interest, calculated at a fixed rate pursuant to 28 U.S.C. § 1961(a) and either compounded annually pursuant to 28 U.S.C. § 1961(b) or calculated as simple interest pursuant to 31 U.S.C. § 3717(c)(2) and 31 C.F.R. § 901.9(b)(3). See infra.
Applying Fed. R. Civ. P. 54(a) and Fed. R. App. P. 37(a) and (b) by analogy to the Commission's administrative proceedings, I conclude that the "date of judgment" should ordinarily be the date an Administrative Law Judge issues an initial decision ordering disgorgement. The date of the Commission's opinion and order would become the "date of judgment" if the Commission modified or reversed the disgorgement award in an initial decision. Under this approach, the date of the initial decision would remain the "date of judgment" if the Commission affirmed the disgorgement award in an initial decision.
External Constraints On Compounding
Postjudgment Interest And On
Shifting Rates Of Postjudgment Interest
There is one final matter. Whether the benchmark rate for postjudgment interest is 28 U.S.C. § 1961(a) or 26 U.S.C. § 6621(a)(2) or something else, statutes and regulations beyond the federal securities laws may constrain the Commission's ability to assess compound postjudgment interest and to allow the rate of postjudgment interest to shift over time. See Amax Land Co. v. Quarterman, 181 F.3d 1356, 1367-69 (D.C. Cir. 1999) (holding that the Debt Collection Act of 1982, as codified at 31 U.S.C. § 3717(c)(2), and the Federal Claims Collection Standards, 31 C.F.R. § 901.9(b)(3), place external constraints on a Department of the Interior regulation assessing compound interest and employing shifting rates for postjudgment interest on debt). The Commission has not yet addressed this issue.
Disgorgement is "debt" for some purposes, but not for others. Compare SEC v. Bilzerian, 153 F.3d 1278, 1281-83 (11th Cir. 1998) with SEC v. AMX, Int'l, Inc., 7 F.3d 71, 74 (5th Cir. 1993); SEC v. Huffman, 996 F.2d 800, 803 (5th Cir. 1993). The Commission wrote its Rules Relating to Debt Collection, 17 C.F.R. Part 204, to comply with the Debt Collection Act of 1982 and the Federal Claims Collection Standards. Thus, disgorgement is "debt" for purposes of the Commission's administrative wage garnishment program, 17 C.F.R. §§ 204.60-.65. See Report Pursuant to Section 308(c) of the Sarbanes-Oxley Act of 2002 at 25 (Jan. 24, 2002) ("To pursue judgments for disgorgement . . . the Commission can utilize its administrative wage garnishment process"); Testimony Concerning Returning Funds To Defrauded Investors, by Stephen M. Cutler, Director, Division of Enforcement, before the House Subcomm. On Capital Markets, Insurance, and Government Sponsored Enterprises, Committee on Financial Services, U.S. House of Representatives, Feb. 26, 2003, at 3-4 (same), available at http://www.sec.gov/news/testimony.shtml. I conclude that the reasoning of Amax applies to administrative proceedings awarding postjudgment interest on disgorgement, and that simple interest, rather than annually compounded interest, is appropriate here. See Rule 103(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.103(b) ("In any particular proceeding, to the extent that there is a conflict between [Rule 600] and a procedural requirement contained in any statute, or any rule or form adopted thereunder, the latter shall control.").
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 May 28, 2003.
Based on the findings and conclusions set forth above:
IT IS ORDERED THAT, pursuant to Section 8A of the Securities Act of 1933 and Section 21C of the Securities Exchange Act of 1934, Edgar B. Alacan shall cease and desist from committing or causing any violations or future violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder.
IT IS FURTHER ORDERED THAT, pursuant to Section 15(b)(6) of the Securities Exchange Act of 1934, Edgar B. Alacan is barred from association with any broker or dealer.
IT IS FURTHER ORDERED THAT, pursuant to Section 21B of the Securities Exchange Act of 1934, Edgar B. Alacan shall pay a civil penalty of $110,000.
IT IS FURTHER ORDERED THAT, pursuant to Section 8A of the Securities Act of 1933 and Section 21C of the Securities Exchange Act of 1934, Edgar B. Alacan shall disgorge $9,768.16, plus prejudgment interest of $4,645.77, computed as set forth in Rule 600 of the Commission's Rules of Practice, as interpreted herein. Prejudgment interest shall run on $306.74 from October 1, 1997, on an additional $374.50 from January 1, 1998, on an additional $2,340.50 from April 1, 1998, on an additional $4,600.00 from October 1, 1998, on an additional $1,521.00 from January 1, 1999, and on an additional $625.42 from April 1, 1999, as explained herein, through the date of this initial decision.
IT IS FURTHER ORDERED THAT Edgar B. Alacan shall pay postjudgment interest on all funds owed ($14,413.93). Postjudgment interest shall be computed at 1.29%, the rate set forth in 28 U.S.C. § 1961(a). Postjudgment interest shall start to accrue as of the date of this initial decision. Postjudgment interest shall be computed as simple interest, consistent with 31 U.S.C. § 3717(c)(2) and 31 C.F.R. § 901.9(b)(3), and shall continue to accrue on all funds owed until they are paid.
Payment of the disgorgement, interest, and civil penalty shall be made on the first day following the day this initial decision becomes final. Payment shall be made by certified check, United States Postal money order, bank cashier's check, or bank money order, payable to the Securities and Exchange Commission. The payment, and a cover letter identifying the Respondent and the proceeding designation, shall be delivered 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 shall be sent to the Commission's Division of Enforcement, directed to the attention of counsel of record.
This initial decision 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 initial decision. It shall become the final decision of the Commission as to each party who has not filed a petition for review pursuant to Rule 360(d)(1) within twenty-one days after service of the initial decision upon that party, unless the Commission, pursuant to Rule 360(b)(1), determines on its own initiative to review this initial decision as to that party. If a party timely files a petition for review, or the Commission acts to review on its own motion, the initial decision shall not become final as to that party.
James T. Kelly
Administrative Law Judge
1 I amended the OIP on March 19, 2003, to correct a statutory citation. By the end of the hearing, four Respondents had settled and three had defaulted. I issued an initial decision as to Respondent Mayer Dallal on July 23, 2003. That initial decision is now final. The proceeding is ongoing only as to Alacan.
The Division contends that there is great probative value to testimony that Barclay cancelled trades after Wittemyer and other customers complained (Div. Reply Br. at 28-30). I disagree. Evidence of such busted trades is not necessarily an indication that the transactions were unauthorized, as the Division's expert witness acknowledged (Tr. 515). Nor does such evidence estop Alacan from now arguing that the trades were authorized. I have given such evidence no weight on the issue of liability. I have cited it for two limited purposes: first, to explain why the Division seeks such a modest sum in disgorgement; and second, to show that certain customers had no financial motive to testify against Alacan in this proceeding.
Under NASD Rule 11870, when a customer whose securities account is carried by a member (carrying member) wishes to transfer the entire account to another member (receiving member), the customer submits a signed broker-to-broker transfer instruction to the receiving member. The receiving member must immediately submit the customer's instruction to the carrying member, and the carrying member has three business days either to validate and return the transfer instruction to the receiving member (with an attachment reflecting all positions and money balances as shown on its books) or to take exception to the instruction. Prior to or at the time of validation of the transfer instruction, the carrying member must request in writing instructions from the customer with respect to the disposition of any assets in the account that it identifies as nontransferable, including any asset that is a proprietary product of the carrying member. The customer may ask the carrying member to liquidate the asset, continue to retain the asset, or physically transfer the asset in the customer's name to the customer. Upon validation of a transfer instruction, a carrying member must freeze the account to be transferred. All open orders must be cancelled and no new orders may be taken. New York Stock Exchange Rule 412 contains similar provisions.
Vander Weide prepared a summary of the transactions in the Beare account (Tr. 26-27, 30-33, 75-76; DX 1P). That summary shows that 1,500 shares of IDT Corporation were purchased on September 4, 1999, and sold at a loss on September 20, 1999 (DX 1P at DIV 231). The purchase date in Vander Weide's summary cannot be accurate, because September 4, 1999, was a Saturday and the markets were closed. Alacan's analysis of the trading in the Beare account identifies these transactions by their settlement dates: September 7, 1999 (purchase), and September 23, 1999 (two sales) (RX 8, Ex. B at 47). As to the purchase date, I find that Alacan's exhibit is more reliable than Vander Weide's summary.
An administrative proceeding before the Commission is not an "internal revenue tax case." The Commission adopted the Internal Revenue Code underpayment rate, 26 U.S.C. § 6621(a)(2), in Rule 600(b) of the Rules of Practice because it viewed that rate as "a reasonable proxy for an unsecured loan rate" to a respondent. Rules of Practice, 59 SEC Docket at 1596. In litigation over a debtor's failure to repay an unsecured loan to a creditor, postjudgment interest would accrue in accordance with 28 U.S.C. § 1961(a), not 26 U.S.C. § 6621(a)(2). I therefore conclude that 28 U.S.C. § 1961(c)(1) has no role to play in disgorgement orders issued under the Commission's Rules of Practice.
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