SECURITIES AND EXCHANGE COMMISSION
SECURITIES ACT OF 1933
Rel. No. 8061 / January 24, 2002
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 45330 / January 24, 2002
Admin. Proc. File No. 3-9402
In the Matter of
BRIAN A. SCHMIDT
c/o Erwin Cohn, Esq.
Cohn & Cohn
77 West Washington Street, Suite 1422
Chicago, IL 60602
JOHN ARISTOTLE DILWORTH, II
630 East 144th Place
Dalton, IL 60419
EURO-ATLANTIC SECURITIES, INC.
P.O. Box 294458
Boca Raton, FL 33429
Opinion of the Commission
BROKER-DEALER AND CEASE-AND-DESIST PROCEEDINGS
Grounds for Remedial Action
Fraud in the Offer and Sale of Securities
Failure to Supervise
Respondents engaged in a fraudulent scheme that purported to lease United States Treasury Bills. Broker-dealer failed to supervise associated person to prevent his violations. Held, it is in the public interest to order both individual respondents to cease and desist from committing or causing any violations or future violations of Section 17(a) of the Securities Act of 1933; to bar respondent who was formerly associated with a broker-dealer from association with any broker or dealer; to order associated person to pay a civil money penalty; to order remaining respondent to pay disgorgement, plus prejudgment interest; and to revoke registration of broker-dealer.
Erwin Cohn, of Cohn & Cohn, for Brian A. Schmidt.
John Aristotle Dilworth, II, pro se.
Mitchell E. Herr, for the Division of Enforcement.
Appeal filed: March 27, 2000
Last brief received: July 10, 2000
Brian A. Schmidt, formerly associated with Euro-Atlantic Securities, Inc. ("Euro-Atlantic"), which was formerly a registered broker-dealer, and John Aristotle Dilworth, II, who allegedly participated with Schmidt in violative conduct, appeal from the decision of an administrative law judge.1 The law judge found that Schmidt and Dilworth had willfully violated Section 17(a) of the Securities Act of 19332 in connection with a scheme that purported to lease United States Treasury Bills ("T-Bills").
The law judge ordered both Schmidt and Dilworth to cease and desist from committing or causing any violation of Securities Act Section 17(a). The law judge barred Schmidt from association with any broker or dealer and ordered Schmidt to pay a civil money penalty of $100,000. He further ordered Dilworth to pay disgorgement in the amount of $300,000, plus prejudgment interest from August 28, 1995. We base our findings on an independent review of the record, except with respect to those findings not challenged on appeal.
These proceedings involve a new variation on a classic scheme to offer non-existent securities. Schmidt and Dilworth, together with Darlan Gordon and William Avent, engaged in a scheme that purported to lease T-Bills. One of the targets of their efforts was Palmer Stoutt.
Brian Schmidt. Schmidt was hired by Euro-Atlantic in its Chicago office in January 1994, and for a time served as temporary branch manager. At the time of the hearing before the law judge, Schmidt was employed as an insurance salesman. Throughout the proceeding, Schmidt's testimony contradicted Stoutt's.
John Dilworth. Dilworth and Schmidt met through William Avent. Dilworth testified that, in 1995, he was engaged in a venture to develop mortgage pools for low-income families.
William Avent. In 1995, Avent owned a one-third interest in Northern Industries, Inc., a Bahamian corporation that, according to Avent, constructs runways and airstrips. However, Avent earned most of his income from a part-time job in a clothing store.
Avent and Schmidt met in January 1995, when Avent approached Schmidt with letters of credit purportedly issued by the Republic of Georgia and certificates of deposit purportedly issued by Mexican banks. Together, Schmidt, Gordon, and Avent attempted to authenticate these instruments and deposit them in a margin account at a broker. They were unsuccessful.
Darlan Gordon. Gordon met Schmidt when they both worked in Euro-Atlantic's Chicago office from January 1994 to May 1995. In May 1995, Euro-Atlantic fired Gordon because of poor production and customer complaints. That month he joined the Chicago office of La Jolla Capital Corporation ("La Jolla"), a registered broker-dealer, where he was employed until the end of July 1995.
Palmer Stoutt. Palmer Stoutt is a businessman who resides in the British Virgin Islands. In 1995 he was president of Rancal International, Inc., and its subsidiary, Rancal Puerto Rico, Inc. (collectively "Rancal"). Rancal was a car rental and information technology company doing business in the British Virgin Islands and Puerto Rico. Before his contacts with the respondents, Stoutt had maintained two inactive brokerage accounts and had purchased only mutual funds. Stoutt is a graduate of the London School of Economics, where he received a masters degree in Finance and Information Systems.
The Purported Transaction
In 1995 Stoutt sought to secure a $1.5 million loan from Banco Popular in Puerto Rico. According to Stoutt, the bank wanted him to post $2 million in collateral, preferably in T-Bills, for the loan. Since Stoutt did not have sufficient collateral, he began to explore ways to obtain it.
On July 14, 1995, Stoutt saw an advertisement promising "unlimited and immediate financing." From the advertisement, he contacted Heddy Hetherington, who operated Cal-West International in Sacramento, California, a company that brokered commercial loans.3 Hetherington directed Stoutt to Schmidt, who Hetherington said was knowledgeable about T-Bill "leasing" and could help Stoutt secure collateral.
Schmidt and Stoutt spoke for the first time on a July 20, 1995 conference call with Hetherington.4 Schmidt told Stoutt that he was a licensed broker and could obtain a lease for T-Bills.5 Schmidt claimed that T-Bill leases were available only in $10 million increments, requiring monthly lease payments of $300,000. Stoutt told Schmidt that he could not afford such payments and needed only $2 million in collateral. Schmidt offered to obtain $2 million in T-Bills to collateralize the bank loan if Stoutt agreed to pay the first month's lease payment of $300,000 on a lease of $10 million. Schmidt claimed that the remaining $8 million in T-Bills covered by the lease could be deposited in a margined trading program that would generate enough revenue to cover the lease payments for the entire $10 million in T-Bills and additional profits for Stoutt.
Stoutt sent Schmidt a letter of intent, as instructed by Schmidt, and a packet of materials about Stoutt and Rancal. Stoutt included a cover letter that, on Schmidt's instructions, stated that Stoutt would receive T-Bills that were "PD1832s."6
Schmidt initially told Stoutt that he attempted to lease T-Bills for him from one source, but was unsuccessful. Schmidt then told Stoutt that he knew someone, Dilworth, who, according to Schmidt, had the legal right to assign $10 million in T-Bills. In a conference call among Schmidt, Stoutt, and Dilworth, Dilworth represented that he was an agent of Equity Enhancement and Guarantee ("EEG"), which, Dilworth stated, was a private bank headquartered in London. Dilworth claimed that EEG had over $10 billion in assets in a trust in Ireland, and that he had the legal right to assign to Stoutt $10 million from EEG's trust. After their telephone conversation, Dilworth forwarded a "contract for assignment" to Schmidt, who faxed it to Stoutt. The contract directed Stoutt to wire $300,000 into the account of "Northern Industries," and stated that the leased T-bills would be on deposit "in an account established for [Dilworth] to be margined and traded by La Jolla."7
Schmidt and Dilworth also represented to Stoutt that La Jolla would confirm that the balance of $8 million of leased T-Bills would be deposited in a margin account and used in a trading program.8 On August 8, 1995, Schmidt faxed to Stoutt a letter from Gordon. Gordon stated that he was "personally knowledgeable of the circumstances" surrounding "Dilworth's relationship with the trust." Gordon represented that Dilworth had submitted paperwork to La Jolla, and that "[a]fter careful review, my company," La Jolla, had agreed to margin the T-Bills and "trade the cash value of the margin. The weekly interest on this program will be 3% to 5% net."
Stoutt complained to Schmidt that none of the documents provided that Stoutt would not be responsible for the monthly lease payments after the initial payment of $300,000. On August 9, 1995, Schmidt faxed Stoutt a second letter from Gordon, entitled "Pre-Trading Client Advisement." It was nearly identical to Gordon's August 8 letter with the following additional paragraph:
Upon Mr. Dilworth's written [acknowledgment] to La Jolla, your assigned Ten Million U.S.D. US Treasury Bills will immediately be margined and traded. You will not be liable to return the Deed of Assignments to the trust. You will be given transaction reports of every trade. [Y]ield weekly for the one year term will be at least 3%. [You] will not have any liability to the trust for La Jolla's administration of the program. Upon opening your account, I anticipate engaging your business.
Although both the August 8 and August 9 letters appeared to be on La Jolla letterhead, at the hearing a comparison with authentic La Jolla letterhead demonstrated that the stationery used for these letters was not genuine.9
Stoutt remained unconvinced that the T-Bills in question actually existed. Stoutt told all the parties, including Schmidt and Dilworth, that he needed proof that EEG held the T-Bills before he would complete the transaction.
Schmidt organized another telephone conference call with Stoutt and Avent. Schmidt described Avent as a "trader directly connected with the trust that has the T-Bills." Avent stated that the trust had been in existence for over 50 years and had substantial assets, including the T-Bills, but that, because of confidentiality concerns, the trust would not provide any of the information that Stoutt was seeking unless the trust had evidence in the form of liquid funds that Stoutt was serious about completing the transaction.10 Schmidt suggested that Stoutt wire $300,000 into a Euro-Atlantic account to demonstrate that he had the requisite funds. Schmidt assured Stoutt that the money would be held in "safekeeping." Upon deposit, the trust would release a letter to Stoutt verifying the T-Bills' existence and, upon receipt of this "proof of assets" letter, Schmidt would release the money to Dilworth and Avent. Schmidt further agreed to provide a letter confirming that the money would be held in safekeeping.
After this conversation, Schmidt faxed several letters to Stoutt on August 28, 1995. One of the letters contained wire instructions, which differed from those contained in the original contract and did not identify an account name. Schmidt explained the new wire instructions to Stoutt, claiming that Euro-Atlantic had recently changed clearing firms. Schmidt also wrote that Stoutt's "funds will be held in safekeeping and not released to the trust until you have received the letter [verifying the assets] as you requested."11
On August 28, Stoutt sent a notarized and executed contract to Dilworth. The contract provided that Stoutt would control the T-Bills for the remainder of the life of the instruments and could use them in any way that he wanted. The accompanying "deed of assignment" specified that the maturity date of the T-Bills delivered would be December 12, 1995. The contract provided that, when these T-Bills matured, they would be replaced with a like amount to complete the terms of the contract. The contract itself was renewable for another year at Stoutt's option.
Stoutt wired $300,000 to the account designated by Schmidt. Stoutt did not know that he had wired his money to Northern Industries' account, which was controlled by Avent. On August 30, 1995, without Stoutt's knowledge, Avent wired $44,900 from the Northern Industries account to the account of N&J Industries, which was controlled by a friend of Avent's. This money was then withdrawn and divided between Avent and Dilworth. Again without Stoutt's knowledge, on August 31, 1995, Avent wired $250,000 from Northern Industries to "Thomas Ross."
On August 29, 1995, Stoutt executed and faxed to Schmidt a document titled "Irrevocable Master Pay Order" ("MPO"). The MPO consisted of two separate pay orders: one order provided for a commission of 1.5 percent on every trade, to be split equally among Schmidt, Hetherington, and William Dedman.12 The other authorized a $25,000 commission payable to Schmidt and Hetherington for arranging the $10 million T-Bill lease.13
By September 6, 1995, Stoutt was concerned that he did not have his $300,000, any T-Bills, an executed proof of assets letter, or a brokerage account at La Jolla. He called Schmidt. By letter, Schmidt confirmed that Stoutt's funds had been received on August 30, and that the funds were wired out on August 31 per the instructions of Avent and Dilworth, "the holders of the account."14 Avent and Dilworth also sent Stoutt a letter, stating that they had received Stoutt's funds from Euro-Atlantic, that Dilworth would be traveling to Texas to complete the finalization of the lease, and that the transaction would be completed by September 8, 1995.
These letters provided the first notice to Stoutt that his funds were not in fact in safekeeping. Stoutt complained to Schmidt and, on September 7, wrote requesting an explanation. In response, Schmidt, Dilworth, and Avent made a series of misrepresentations to Stoutt that the transaction would be completed or that his money would be returned. On several occasions Stoutt spoke or exchanged faxes with Dilworth, Avent, and Schmidt, but never received a satisfactory answer to his concerns.
Stoutt continued to negotiate with Schmidt, Avent, and Dilworth to obtain the collateral that he needed. On September 26, Stoutt demanded his money back. Both Schmidt and Dilworth continued their attempts to delay and deceive Stoutt, telling him that they were in the process of opening an account for him at another broker-dealer. Stoutt then hired an attorney to help him retrieve his $300,000. The attorney made several attempts to obtain Stoutt's money from Schmidt, Dilworth, and Avent. Each time they promised to pay the money back by a date certain and then failed to do so. Stoutt never received repayment of his $300,000.
Schmidt and Dilworth made misrepresentations to Schmidt's employer, Euro-Atlantic, about the scheme. Schmidt's branch manager, John Madden, noticed that Stoutt's funds had been wired into Euro-Atlantic and quickly thereafter he saw instructions to wire them out again. Madden asked for a letter from Dilworth and Avent explaining the transaction. On September 6, 1995, Dilworth and Avent wrote to Madden, stating that Stoutt's $300,000 deposit represented "proceeds from a transaction performed at La Jolla Capital (clearing through Paine Webber)" between Rancal and Northern Industries. This letter was false because there was neither a La Jolla account for Stoutt nor a transaction at La Jolla. Schmidt provided the letter to Madden. Schmidt admitted that he read the letter and knew it was false, but did nothing to correct it.
In October, Avent and Dilworth wrote to Euro-Atlantic's compliance officer, James Sinclair. In this letter, they claimed that Northern Industries had acted as "escrow agent for the two parties" in what the letter termed the "contract" between Dilworth and Stoutt. They represented that the conditions of the escrow had been satisfied, and that Schmidt had no role in "any solicitation or promoting to Rancal." The letter further claimed that Dedman, the attorney in California, had introduced Stoutt to them. This letter too was false.
There is no evidence that either Schmidt or Dilworth had any basis for their representations to Stoutt. Dilworth claims that he conducted due diligence by researching the issue of T-Bill leasing for five hours. He testified that he asked an unidentified woman in the office of a broker-dealer to conduct an inquiry, which Dilworth described as a "soft probe" of the specific CUSIP numbers on the deed of assignment. According to Dilworth, the broker-dealer representative had to conduct the "soft probe" through her firm's London office, because the firm's "American operation" did not know much about T-Bill leasing. Dilworth also stated that he received a legal opinion from Lesley Valdez, whom he described as La Jolla's "legal counsel." However, Valdez was in fact a paralegal at La Jolla who did not even work in the legal department.
Schmidt previously attempted to lease T-Bills to several other parties using some of the same tactics employed with Stoutt. In 1995 Schmidt offered to lease T-Bills to persons introduced to him by Hetherington. He represented that the T-Bills would be placed in a trading program and would generate three to five percent interest a week. Later in 1995, he again attempted with Avent to solicit prospective investors to lease T-Bills. At that time, Schmidt represented that Avent had $25.5 million in four accounts at Euro-Atlantic when Schmidt knew that the balance in Avent's four accounts was zero. That same year, Schmidt again offered to lease T-Bills to a prospective lessee, telling him that the minimum amount for a T-Bill lease was $5 million, but that the excess T-Bills could be leveraged and used to generate profits for the lessee. In a fourth attempt, Schmidt and Gordon attempted to lease T-Bills to an acquaintance of Gordon's.
Section 17(a) of the Securities Act of 1933 makes it unlawful in the offer or sale of securities, using the jurisdictional means, to: 1) employ any device, scheme, or artifice to defraud; 2) obtain money or property by any untrue statement of or omission of a material fact necessary to make the statement not misleading; or 3) engage in any transaction, practice, or course of business which is or would be a fraud on the purchaser. T-Bills are securities.15
As discussed below, neither the T-Bills nor the transaction offered to Stoutt actually existed. In SEC v. Lauer, the United States Court of Appeals for the Seventh Circuit held that representations made by a promoter can be sufficient to invoke the antifraud provisions of the Securities Act.16 In Lauer, the promoters offered to sell what they termed "prime bank instruments," which were in reality what the Court described as a "non-existent high yield security."17 The Court concluded that "[i]t would be a considerable paradox if the worse the securities fraud, the less applicable the securities laws," since "[a] central purpose of the securities laws is to protect investors and would-be investors in the securities markets against misrepresentations."18 Since Schmidt and Dilworth represented to Stoutt that Dilworth controlled T-Bills and would lease those T-Bills to Stoutt, it is their representations that we look to in determining whether they engaged in the offer or sale of a security and whether they violated Section 17(a).
A. Offer or Sale of a Security
Respondents do not dispute that T-Bills are securities. The record further establishes that Schmidt and Dilworth proposed and purported to engage in a transaction in T-Bills. Respondents assert, however, that their transaction did not involve "the offer or sale of a security."
Section 2(a)(3) of the Securities Act of 1933 defines the sale and offer of a security as:
[e]very contract of sale or disposition of a security or interest in a security
, for value. The term "offer to sell," "offer for sale," or "offer" shall include every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.19
In order to determine whether novel transactions involving securities are offers or sales and thus subject to the antifraud provisions, courts examine the characteristics of the transaction and its relationship to the security. For purposes of Securities Act Section 17(a), an offer or sale can occur even if the purchaser does not receive title to the security.20 In Rubin v. United States, stock was pledged as security for a loan. The Supreme Court held that "obtaining a loan secured by a pledge of shares of stock unmistakably involves a disposition of [an] interest in a security, for value.' Although pledges transfer less than absolute title, the interest thus transferred nonetheless is an interest in a security.'"21 The Court further observed that "[i]t is not essential under the terms of the Act that full title pass to a transferee for the transaction to be an offer' or a sale,'"22 noting that the value of a pledge is tied to the value of the underlying securities.23
Forward contracts for GNMA certificates also have been held to be contracts to purchase or sell securities under the Act. The Court of Appeals for the Seventh Circuit has held that the antifraud provisions apply to GNMA forward contracts because these contracts have a "sufficient nexus with the underlying GNMA certificates."24
Here, the "lease" documents purported to grant Stoutt, in return for his lease payments, the power to use or dispose of the subject T-Bills in any manner that he deemed appropriate. Although the transaction did not purport to give Stoutt absolute title to them, because of the duration of the agreement and the option to extend that term Stoutt's control of the initial T-Bills or their replacements would have extended for the instruments' entire existence.25 Thus, the "lease" effectively transferred the unfettered right to dispose of the T-Bills. We conclude that this transaction was an offer of a security.
B. Scheme to Defraud
The transaction Schmidt and Dilworth purported to engage in was fraudulent. They further made numerous misrepresentations to Stoutt to induce him to enter into the "lease." The T-Bills they proposed to lease to Stoutt did not exist. The deed of assignment Schmidt and Dilworth provided to Stoutt specified the leased T-Bills as "PD1832s." Enforcement's expert witness testified that a PD1832 is a form used internally by the United States Department of the Treasury ("Treasury Department") to correct mistakes in the terms of assignments, ownership, or title of ownership for government securities. It is used only in connection with registered certificates and is valid only when the registered certificate to which it pertains is attached to the form. It cannot be used to create book-entry T-Bills.26 Enforcement's expert witness testified that he had never seen a legitimate T-Bill leasing transaction.
Schmidt admits that he failed to investigate the purported transaction. He also failed to investigate his colleagues in the transaction, Dilworth and Avent. Schmidt did not have any basis for recommending this transaction to Stoutt.27
Dilworth and Schmidt each maintain they reasonably believed the transaction was legal. Schmidt introduced no evidence as to the basis of his belief. To the contrary, he admits he made no inquiry about the transaction. Dilworth claims that he investigated the transaction by conducting the so-called "soft probe" of the T-Bills.28 He also claimed to have received a legal opinion from an employee of La Jolla's who, in fact, was not an attorney.29 Particularly given that Dilworth represented that he controlled deeds of assignment for EEG's T-Bills when in fact he did not, we do not believe his inquiries constituted any basis for his representations.
Schmidt and Dilworth made various material misrepresentations about the transaction to Stoutt. Both Schmidt and Dilworth claimed that the T-Bills existed and that Dilworth controlled the disposition of the T-Bills. They further represented that the balance of the T-Bills would be deposited in a trading program at La Jolla. They instructed Gordon to write bogus letters regarding the La Jolla trading program. When Stoutt expressed concern about the existence of the T-Bills, respondents and Avent induced him to send them his $300,000 to demonstrate his "good faith" and intent to do business with them. They represented, both orally and in writing, that his funds would be held in "safekeeping," when this was not true. They then immediately transferred his money out of Avent's account.30
Schmidt claims that his role in this scheme was that of a "gofer."31 This characterization belies his central role in the scheme. Schmidt claimed to Stoutt that he could arrange T-Bill leases. Schmidt introduced Dilworth and Avent to Stoutt and made misrepresentations to Stoutt about their duties and business background. Schmidt participated in telephone calls and transmitted documents. Schmidt and Dilworth coordinated with Gordon to transmit false letters to Stoutt on fraudulent La Jolla stationery, with the intent to assuage Stoutt's concerns about the transaction. Schmidt arranged for the funds transfer, faxing Stoutt the account number to which the money was wired, and promised, both orally and in writing, that the funds would be held in "safekeeping." The funds were transferred almost immediately upon receipt.32
We must find scienter to conclude that there was a violation of Section 17(a)(1) of the Securities Act of 1933.33 Scienter is "a mental state embracing intent to deceive, manipulate or defraud."34 Reckless conduct can be sufficient to establish scienter,35 and has been defined as "an extreme departure from the standards of ordinary care . . . which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it."36 Scienter may be inferred from circumstantial evidence.37 Schmidt's and Dilworth's misrepresentations to Stoutt and their actions were at best reckless and resulted in the loss of Stoutt's funds. They continued to attempt to lull both Stoutt and Euro-Atlantic after they received Stoutt's money.38
Schmidt and Dilworth argue that Stoutt is to blame for the loss of his $300,000 because he is a sophisticated investor who graduated from the London School of Economics. Despite his advanced degree Stoutt had no experience trading securities, and testified that, when he described himself as having worked in "financial services and investment management," he was referring to work in real estate. Even if respondents' assertions about Stoutt's level of sophistication were correct, a sophisticated person is entitled to the protection of the antifraud provisions of the securities laws.39
Respondents claim that Stoutt was the wrongdoer in the transaction and was involved in a scheme to defraud the bank in Puerto Rico, which led to his arrest. In the fall of 1995 Stoutt was arrested in Puerto Rico in connection with the $300,000 withdrawal that Stoutt made to transfer funds from his line of credit at the bank to Euro-Atlantic. The case against him was dismissed. In any event, Stoutt's problems in Puerto Rico do not excuse respondents' conduct.
Respondents also assert that Stoutt did not rely on their representations and instead relied on the advice of Dedman, the attorney in California, and Hetherington. Stoutt's reliance on respondents' misrepresentations is not an element of an administrative proceeding alleging violations of Section 17(a).40 Respondents also assert that Hetherington, Dedman, and Ross violated the securities laws and that they should have been the subjects of these proceedings. Whether they too participated in the scheme to defraud Stoutt has no impact on Schmidt and Dilworth's liability.41
* * *
Based on the record described above, we conclude that Schmidt and Dilworth willfully violated Securities Act Section 17(a).
A. Agencies have substantial discretion in assessing administrative sanctions.42 Exchange Act Section 15(b)(6) authorizes the Commission to censure, place limitations on, suspend, or bar a person associated with a broker-dealer, when such sanction is in the public interest.43 Exchange Act Section 21B authorizes the Commission to impose a money penalty in any proceeding instituted pursuant to Exchange Act Section 15(b) when such penalty is in the public interest.44 Exchange Act Section 21C authorizes the Commission to issue a cease-and-desist order when a person has violated, or had been a cause of the violation of, the federal securities laws or regulations.45
1. Schmidt participated in a fraudulent scheme that purported to lease non-existent T-Bills, when T-Bills cannot be leased. He made repeated misrepresentations about the transaction, his expertise, the abilities of others involved in the scheme, and the existence of EEG and a trading program and account at La Jolla. He induced Stoutt to send Euro-Atlantic $300,000 representing that the funds would be held in safekeeping. In fact Stoutt's funds were placed in Avent's account, and Schmidt immediately permitted their transfer to third parties. Schmidt attempted to cover up this scheme, conveying letters to his employer that he knew contained misrepresentations. He has not taken responsibility for his actions and appears to lack contrition. The bar from association with any broker or dealer and the cease and desist order46 are, therefore, warranted.
Schmidt contends that he should not be required to pay a civil monetary penalty because he lacks the ability to pay. For the first time in these proceedings he offers sworn financial statements purporting to document his financial situation.
Schmidt did not raise this issue before the law judge. We have previously held that, since the respondent carries the burden of demonstrating inability to pay, financial information supporting that argument must be presented before the law judge, who may then require the filing of sworn financial statements.47 Respondents who fail to raise this issue before the law judge may be considered to have waived this issue unless, pursuant to Commission Rule of Practice 452, we grant the party leave to submit additional evidence.48 Schmidt has not filed such a motion.
Exchange Act Section 21B enumerates the factors we are to consider in determining whether a penalty is in the public interest.49 Ability to pay is but one of these factors.50 We have examined the financial statements submitted by Schmidt. Even taking them at face value, we nonetheless find that the egregiousness of Schmidt's conduct far outweighs any consideration of his ability to pay the civil penalty.
Schmidt's actions were fraudulent and deceitful. He misrepresented himself not only to Stoutt but also to his employer, Euro-Atlantic. His actions led to Stoutt losing $300,000, money which has not been recovered. Schmidt acted with scienter, and continues to deny any responsibility for his misconduct. Moreover, Schmidt has a history of attempting other T-Bill leasing schemes. Schmidt's conduct is a classic example of the type of behavior against which Section 17(a) was intended to protect, and a severe penalty against him is necessary to deter others from committing such acts in the future. We therefore impose a $100,000 civil penalty.51
2. The law judge ordered Dilworth to disgorge, jointly and severally with Avent and Gordon, the entire $300,000 removed from Stoutt's account.52 Like Schmidt, Dilworth also purported to lease non-existent T-Bills, when T-Bills cannot be leased. He made representations about his relationship with EEG and about EEG's existence and its financial situation with no basis for such representations. He helped convince Stoutt to wire his money to Euro-Atlantic, and then profited from its withdrawal. While Dilworth directly received some of the proceeds of Stoutt's $300,000, he claims that the balance of the funds cannot be traced to him because Avent wired the funds out of Avent's account and sent them to Thomas Ross.
The purpose of disgorgement is to deprive a person of "ill gotten gains" and to prevent unjust enrichment.53 Courts have held that when assessing liability for disgorgement of multiple wrongdoers, it is appropriate to hold all jointly and severally liable for the full amount of the obligation unless the liability is reasonably apportioned.54 Thus, in Hughes Capital, the court held that it can be difficult or impossible to apportion liability among collaborators in a fraudulent scheme because they engage in complex and heavily disguised transactions, and often "move funds through various accounts to avoid detection,[and] use several nominees to hold . . . improperly deprived profits."55 The court reasoned that any risk of uncertainty should fall on the wrongdoer whose illegal conduct created that uncertainty. The court therefore ordered joint and several disgorgement.56
Dilworth induced Stoutt to wire his funds. Since Dilworth was a participant in the scheme, Dilworth had the responsibility to show he did not receive any of this money. Dilworth did not call Ross as a witness, or provide any evidence regarding Ross's identity or otherwise demonstrate that Dilworth did not benefit by this wrongdoing. Therefore, the law judge held Dilworth jointly and severally liable with Avent and Gordon. We concur. We believe that Dilworth properly is jointly and severally liable for the entire $300,000. We further find that a cease-and-desist order is warranted because of Dilworth's role in this fraudulent scheme.
Like Schmidt, Dilworth contends for the first time in these proceedings that he is unable to pay the ordered disgorgement, and he too offers sworn financial statements purporting to document his financial situation. Dilworth did not raise this issue before the law judge, and he has failed to file with us a motion to submit additional evidence.57
While Dilworth's financial statements, on their face, indicate that he is impecunious, the egregiousness of his conduct outweighs any consideration of his ability to pay. Dilworth's actions were fraudulent and deceitful. He represented to Stoutt that the T-Bills existed and that he controlled their disposition. He represented that the T-Bills would be deposited in a trading program, and he instructed Gordon to write false letters intended to induce Stoutt to wire his money, money which has not been recovered.58
The Commission may impose sanctions on a broker-dealer if the Commission finds that the broker-dealer engaged in any of the conduct enumerated in Exchange Act Section 15(b)(4). Among other provisions, Section 15(b)(4)(E) permits the Commission to revoke the registration of a broker-dealer if the Commission finds that the broker-dealer failed reasonably to supervise a person subject to its supervision with a view to preventing that person's violations.
Euro-Atlantic defaulted in this proceeding by failing to appear or defend at the hearing below. Under Rule of Practice 155(a),59 the Commission may determine the proceeding against a defaulting party upon consideration of the record, including the order instituting proceedings, the allegations of which may be deemed to be true. The Order Instituting Proceedings ("OIP") alleged that Euro-Atlantic had failed to supervise Schmidt. However, when the law judge revoked Euro-Atlantic's registration, the law judge failed to make a finding with respect to whether Euro-Atlantic's conduct provided a basis for sanction under Exchange Act Section 15(b). As a result, we were unable to issue a notice of finality with respect to Euro-Atlantic. We find, pursuant to Rule 155(a), that Euro-Atlantic has admitted the allegations of the OIP that it failed reasonably to supervise its associated person, Schmidt, with a view to preventing his violations, and revoke Euro-Atlantic's registration as a broker-dealer.
An appropriate order will issue.60
By the Commission (Chairman PITT and Commissioners HUNT and UNGER).
Jonathan G. Katz
UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
SECURITIES ACT OF 1933
Rel. No. 8061 / January 24, 2002
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 45330 / January 24, 2002
Admin. Proc. File No. 3-9402
In the Matter of
BRIAN A. SCHMIDT
c/o Erwin Cohn, Esq.
Cohn & Cohn
77 West Washington Street, Suite 1422
Chicago, IL 60602
JOHN ARISTOTLE DILWORTH, II
630 East 144th Place
Dalton, IL 60419
EURO-ATLANTIC SECURITIES, INC.
P.O. Box 294458
Boca Raton, FL 33429
ORDER IMPOSING REMEDIAL SANCTIONS
On the basis of the Commission's opinion issued this day, it is
ORDERED that Brian A. Schmidt and John Aristotle Dilworth, II be, and they hereby are, ordered to cease and desist from committing or causing any violations or future violations of Section 17(a) of the Securities Act of 1933; and it is further
ORDERED that Brian A. Schmidt be, and hereby is, barred from association with any broker or dealer; and it is further
ORDERED that Brian A. Schmidt pay to the United States Treasury a civil money penalty in the amount of $100,000, within 21 days of the issuance of this Order; and it is further
ORDERED that John Aristotle Dilworth, II pay disgorgement in the amount of $300,000, plus prejudgement interest from August 28, 1995, through the last day of the month preceding the month in which payment of disgorgement is made. Interest shall be paid at the rate established under 26 U.S.C. §6621(a)(2), compounded quarterly.
Payment of the civil penalty and of disgorgement shall be made to the United States Treasury within 21 days of the issuance of this order. The disgorgement shall be: (a) made by United States postal money order, certified check, bank cashier's check, or bank money order; (b) made payable to the Securities and Exchange Commission; (c) mailed or delivered by hand to the Comptroller, 6432 General Green Way, Alexandria, VA 22312; and (d) submitted under cover letter that identifies the particular respondent in these proceedings, as well as the Commission's case number. A copy of this cover letter and money order or check shall be sent to J. Cindy Eson, Southeast Regional Office, Securities and Exchange Commission, 1401 Brickell Avenue, Suite 200, Miami, FL 33131; and it is further
ORDERED that, within 60 days after funds have been turned over by John Aristotle Dilworth, II in accordance with this order and any appeals of the disgorgement order have been waived or completed or appeal is no longer available, the Division of Enforcement shall submit a proposed plan for the administration and distribution of disgorgement funds, a provided in Rules of Practice 610 through 614, 17 C.F.R. §§201.610-614.
ORDERED that the registration of Euro-Atlantic Securities, Inc. be, and hereby is, revoked.
By the Commission.
Jonathan G. Katz
|| In the Matter of Euro-Atlantic Securities, Inc., Initial Decision Rel. No. 161 (Feb. 25, 2000), 71 SEC Docket 2391. The Order Instituting Proceedings ("OIP") also named John T. Madden, Euro-Atlantic, Darlan E. Gordon, and William Avent as respondents. Madden settled the charges against him. John T. Madden, Securities Act Rel. No. 40891 (Jan. 7, 1999) 68 SEC Docket 2788. Euro-Atlantic did not appear or defend in the case below, and the law judge revoked its registration as a broker-dealer.
The law judge found that Gordon and Avent violated Section 17(a) of the Securities Act of 1933. They were held jointly and severally liable (along with Dilworth) for disgorgement in the amount of $300,000, plus prejudgment interest from August 28, 1995. They did not petition for review of the initial decision, which became final as to them on March 23, 2000.
|| 15 U.S.C. §77q.|
|| At the time of the hearing, Hetherington worked in the admissions office of a local California college.|
|| Stoutt never met any of the people with whom he was doing business. All interaction was via telephone, facsimile transmission, and mail.|
|| The law judge did not credit Schmidt's testimony about his role in the events at issue.
The credibility determination of an initial fact-finder is entitled to considerable weight and deference, since it is based on hearing the witnesses' testimony and observing their demeanor. Keith L. DeSanto, 52 S.E.C. 316, 319 (1995), petition denied, 101 F.3d 108 (2d Cir. 1996) (Table). Such determinations can be overcome "only where the record contains substantial evidence' for doing so." Anthony Tricarico, 51 S.E.C. 457, 460 (1993).
|| See infra, discussion in text accompanying note 27. |
|| This contract went through several revisions to satisfy Stoutt. During the revision process, Schmidt transmitted the revisions between Stoutt and Dilworth. Schmidt told Stoutt that La Jolla would direct the trading because Euro-Atlantic did not have the mechanism to lease T-Bills.|
|| The law judge found that Dilworth did not offer any credible evidence to exculpate himself with respect to his role in this scheme.|
|| Gordon's employment with La Jolla had ended in July, 1995. While Gordon denied creating the letterhead and authoring and sending the letters, and Schmidt testified that he had nothing to do with either of the letters, Avent testified that he and Schmidt directed Gordon to prepare both letters, and that Gordon wrote both of them.
The law judge determined that Gordon has "not offered any credible evidence to exculpate" himself with respect to the scheme directed at Stoutt.
|| The law judge determined that Avent has "not offered any credible evidence to exculpate" himself with respect to the scheme directed at Stoutt.|
|| Although Schmidt denied promising Stoutt that his money would be held in safekeeping, Schmidt admitted sending this letter, which he wrote as a "courtesy." He claimed that, by using the term "safekeeping," he did not mean that the funds would be in escrow, but rather that Stoutt's money would be held safely in an account at the clearing firm. The law judge specifically did not credit Schmidt's testimony on this point.|
|| Dedman is an attorney in California who was recommended to Stoutt by Hetherington. Dedman reviewed various documents related to the transaction for Stoutt, and drafted the MPO. In lieu of fees for service, Dedman was to be paid a commission.|
|| A separate agreement among Schmidt, Dilworth, and Avent provided that Schmidt would also receive an additional $5,000 finder's fee. |
|| Avent was the sole owner of the account. Schmidt claimed that, at the time he wrote this letter, "things had gotten muddy," and he mentioned Dilworth in error.|
|| Rubin v. United States, 449 U.S. 424 (1981). 15 U.S.C. §77b(a)(1). Security is defined by Securities Act Section 2(a)(1) as:
any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement,. . . investment contract,. . . or, in general, any interest or instrument commonly known as a "security," or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.
|| 52 F.3d 667, 670 (7th Cir. 1995).|
|| Id. at 669.|
|| Id. at 670.|
|| 15 U.S.C. §77b(a)(3) (emphasis added).|
|| Rubin v. United States, 449 U.S. 424, 429-30 (1981). See also Harmsen v. Smith, 693 F.2d 932, 947 (9th Cir. 1982) (a pledge of stock is an offer to purchase or sell even though plaintiff had less than a complete interest in the pledged shares); United States v. Kendrick, 692 F.2d 1262, 1264 (9th Cir. 1982), (pledge of securities used as collateral for loans subject to the antifraud provisions because lender acquired interest in securities when it agreed to accept pledged securities as collateral).|
|| Rubin, 449 U.S. at 429-30. In Pinter v. Dahl, 486 U.S. 622, 642-43 (1988), which involved the sale of fractional undivided interests in oil and gas leases, the Supreme Court reaffirmed that a person may offer or sell property without necessarily being the person who transfers title to, or other interest in, that property, and that, with respect to Securities Act Section 17(a), "transactions other than traditional sales of securities are within the scope of Section 2(3) and passage of title is not important."|
|| Rubin, 449 U.S. at 429-30. |
|| Id. at 431.|
|| Abrams v. Oppenheimer Gov't Sec., 737 F.2d 582, 587 (7th Cir. 1984). A forward contract for a GNMA certificate is a cash market transaction that requires the buyer to take delivery at a specified date in the future or assign its rights and obligations under the contract to another party.|
|| Richard J. Teweles & Edward S. Bradley, The Stock Market 59 (John Wiley & Sons 7th Ed. 1998) (describing Treasury Bills).|
|| This information is available on the Treasury Department's web site at: http://www.publicdebt.treas.gov/cc/ccphony2.htm#rent, updated November 26, 1999. The information contained therein was admitted into evidence by the law judge. |
|| See Quinn and Co. v. SEC, 452 F.2d 943, 947 (10th Cir. 1971) (brokers and securities salesmen are under a duty to investigate); Donald T. Sheldon, 51 S.E.C. 59, 71 (1992) (registered representative has a duty to have a reasonable basis for his recommendations), aff'd, 45 F.3d 1515 (11th Cir. 1995).|
|| Dilworth used the term "soft probe" at the hearing below, but did not describe what it means.|
|| Had the source of this alleged opinion been a La Jolla attorney Dilworth still could not rely on her advice because the attorney was not Dilworth's counsel. Harold B. Hayes, 51 S.E.C. 1294, 1299 n.16 (1994) (one cannot rely on advice of another's counsel because counsel cannot be relied upon to give disinterested advice). See SEC v. Savoy Indus., Inc., 665 F.2d 1310, 1314 n.28 (D.C. Cir. 1981)(setting forth the criteria required for a defense of reliance on advice of counsel). Moreover, advice of counsel is not a complete defense but merely one factor for consideration. Markowkski v. SEC, 34 F.3d 99, 105 (2d Cir. 1994).|
|| Schmidt and Dilworth's misrepresentations were material. Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976) (The test for materiality is whether there is a substantial likelihood that under all the circumstances, a reasonable person would consider the omitted or misstated information significant in making an investment decision.).|
|| Schmidt also claims that his representations do not violate the securities laws because he did not owe Stoutt any fiduciary duty. Stoutt did not have to be Schmidt's client to make Schmidt's misrepresentations a violation of Section 17(a). See Jay Houston Meadows, 52 S.E.C. 778, 783-4 (1996) (salesman made fraudulent statements and omitted material facts to friends in connection with the offer and sale of securities), aff'd, 119 F.3d 1219 (5th Cir. 1997).|
|| We are aware of the decision in SEC v. Zandford, 238 F.3d 559 (4th Cir.), cert. granted, 122 S. Ct. 510 (2001), which held that misappropriation of client funds generated by a securities transaction was not a fraud "in connection with" the purchase or sale of a security. The decision in Zandford conflicts with other cases holding that the "in connection with" standard is satisfied when the deceptive practice touches the sale of securities. See, e.g., Superintendent of Ins. v. Bankers Life and Cas. Co., 404 U.S. 6, 10 (1971). See also United States v. O'Hagan, 521 U.S. 642, 655 (1997) (misappropriation of insider information was in connection with subsequent trades); Carras v. Burns, 516 F.2d 251, 258 (4th Cir. 1975) (finding churning is a deceptive device).
In any event, this case is distinguishable from Zandford. In this case the fraud involved proposing a securities transaction that was entirely fictitious. Zandford, in contrast, involved misappropriation of the proceeds of a securities transaction.
|| Aaron v. SEC, 446 U.S. 680, 697 (1980). The Court in Aaron also held that scienter is not required for violations of Securities Act Sections 17(a)(2) and 17(a)(3).|
|| Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976).|
|| SEC v. Steadman, 967 F.2d 636, 641-42 (D.C. Cir. 1992); Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 & n.6 (9th Cir. 1990); David Disner, 52 S.E.C. 1217, 1222 (1997).|
|| Hollinger, 914 F.2d at 1569-70 (citations omitted).|
|| Herman & Maclean v. Huddleston, 459 U.S. 375, 390 n.30 (1983); Pagel, Inc. v. SEC, 803 F.2d 942, 946 (8th Cir. 1986); Meyer Blinder, 50 S.E.C. 1215, 1229-30 (1992).|
|| Schmidt, moreover, as discussed above, acted as a principal in other attempts to lease T-Bills to several other parties using some of the same tactics employed with Stoutt. This repeated pattern is further evidence of Schmidt's scienter and his central role in the scheme at issue here. See Jonathan Feins, Securities Exchange Act Rel. No. 41943, (Sept. 29, 1999) 70 SEC Docket 2116 (respondent not charged with some fraudulent trades, but similarity of pattern provides further circumstantial support for the fraud findings as to the other trades).|
|| See Adena Exploration Inc. v. Sylvan, 860 F.2d 1242, 1251 (5th Cir. 1988) (citing Nor-Tex Agencies Inc. v. Jones, 482 F.2d 1093 (5th Cir. 1973)); Stier v. Smith, 473 F.2d 1205, 1207 (5th Cir. 1973) (sophisticated investors, like all others, are entitled to the truth); Jay Houston Meadows, 52 S.E.C. at 785 (rejecting arguments that the antifraud provisions do not apply to customers who are experienced or sophisticated).|
|| SEC v. Blavin, 760 F.2d 706, 711 (6th Cir. 1985); Hanly v. SEC, 415 F.2d 589, 595-96 (2d Cir. 1969). |
|| See Richard J. Puccio, 52 S.E.C. 1041, 1046 (1996) (holding that the fact that proceedings have not been brought against other [wrongdoers] is irrelevant. To the extent that respondents claim selective prosecution, a respondent must demonstrate not only that he was unfairly singled out, but that his prosecution was motivated by improper considerations such as race, religion, or the desire to prevent the exercise of a constitutionally protected right).|
|| Butz v. Glover Livestock, 411 U.S. 182, 187 (1973); Valicenti v. SEC, 198 F.3d 62, 66 (2d Cir. 1999), cert. denied, 530 U.S. 1260 (2000).|
|| 15 U.S.C. §78o(b)(6). |
|| 15 U.S.C. §78u-2. Section 21B provides that, in determining the public interest, we may consider whether the violation involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement; the harm to others resulting from the violation; the extent of the violator's unjust enrichment; the violator's disciplinary history, and the need for deterrence. Id.|
|| 15 U.S.C. §78 u-3. Section 21C (e) provides that, in any cease-and-desist proceeding, the Commission may enter an order requiring disgorgement. Id.|
|| 15 U.S.C. §77h-1(a)|
|| Terry T. Steen, Exchange Act Rel. No. 40055 (June 2, 1998) 67 SEC Docket 837, 847.|
|| Id.; 17 C.F.R. §201.452.|
|| The factors we may consider in determining whether a penalty is in the public interest are:
(1) whether the act involved fraud, deceit, manipulation, or deliberate and reckless disregard of a regulatory requirement;
(2) the harm to other persons resulting from the conduct;
(3) the extent to which any person was unjustly enriched;
(4) whether the person previously has been found by the Commission or other regulatory agency to have violated the Securities laws;
(5) the need to deter such person and other persons from committing such acts; and
(6) other matters as justice may require.
15 U.S.C. §78u-2(c).
|| The Commission may, in its discretion, consider evidence of the respondent's ability to pay in determining whether the penalty is in the public interest. 15 U.S.C. §78u-2(d).|
|| 15 U.S.C. §77t(d)(2)(C); Securities Act Rel. No. 7946 (Jan. 29, 2001) 74 SEC Docket 703 (granting the Commission the authority to order the payment of a third tier penalty of up to $120,000 if the violation in question involved fraud, deceit, manipulation or deliberate or reckless conduct, and if the violation directly or indirectly resulted in substantial losses to other persons).|
|| As found by the law judge below, Avent and Gordon participated in the scheme to induce Stoutt to send his funds to the Euro-Atlantic account.|
|| Hateley v. SEC, 8 F.3d 653, 655 (9th Cir. 1993) (citing SEC v. Wang, 944 F.2d 80, 85 (2d Cir. 1991)).|
|| SEC v. First Pacific Bancorp, 142 F.3d 1186, 1191(9th Cir. 1998) ("where two or more individuals or entities collaborate or have a close relationship in engaging in the violations of the securities laws, they have been held jointly and severally liable for the disgorgement of illegally obtained proceeds."); SEC v. Hughes Capital Corp., 124 F.3d 449, 455 (3d Cir. 1997)("[w]hen apportioning [disgorgement] liability among multiple tortfeasors, it is appropriate to hold all tortfeasors jointly and severally liable for the full amount of the damage unless the liability is reasonably apportioned.").|
|| 124 F.3d at 455.|
|| Id. (citing SEC v. First City Fin. Corp. 890 F.2d 1215, 1232 (DC Cir. 1989)). Cf. Excel Financial, Inc., 53 S.E.C. 303, 312 n.26 (1997)(NASD).|
|| See supra note 48 and accompanying text. |
|| We recognize that this decision does not necessarily foreclose Dilworth's ability to raise the issue of ability to pay at the time any enforcement of this order is sought.|
|| 17 C.F.R. §201.155(a).|
|| We have considered all of the contentions advanced by the parties. We have rejected or sustained them to the extent that they are inconsistent or in accord with the views expressed in this opinion.|