SECURITIES AND EXCHANGE COMMISSION
In the Matter of
JOHN J. KENNY
OPINION OF THE COMMISSION
INVESTMENT ADVISER PROCEEDING
Grounds for Remedial Action
Associated person of a broker-dealer and of a registered investment adviser who also controlled the investment adviser violated antifraud provisions of the federal securities laws by misrepresenting material facts to two individual investors and aiding and abetting scheme to defraud two insurance companies. Investment adviser and associated person breached their fiduciary duty to one of the insurance companies by failing to disclose conflict of interest. Held, it is in public interest to bar associated person from association with any broker, dealer, or investment adviser; to revoke registration of investment adviser; to order associated person to cease and desist from committing or causing any violation or future violation 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; to order associated person and investment adviser to cease and desist from committing or causing any violation or future violation of Section 206 of the Investment Advisers Act of 1940; to order associated person to pay a civil money penalty of $700,000 and investment adviser to pay a civil moneypenalty of $500,000; and to order respondents, jointly and severally, to pay disgorgement in the amount of $1,333,000.
L. Steven Goldblatt, of Evans & Dixon, L.L.C., for John J. Kenny and Nicholson/Kenny Capital Management, Inc.
Thomas D. Carter and Polly A. Atkinson, for the Division of Enforcement.
Appeal filed: August 27, 1999
Last brief received: April 25, 2003
Oral argument: April 2, 2003
John J. Kenny, a former associated person of a broker-dealer, and Nicholson/Kenny Capital Management, Inc. ("Nicholson/Kenny"), a registered investment adviser of which Kenny is chairman and chief executive officer ("CEO") and which is owned by a holding company owned by Kenny and his wife, appeal from an administrative law judge's decision.1 The law judge found that Kenny misrepresented and failed to disclose material facts to two individuals in violation of Section 17(a) of the Securities Act of 19332 and Section 10(b) of the Securities Exchange Act of 19343 and Exchange Act Rule 10b-54 and aided, abetted, and caused violations of those provisions through his involvement with Robert C. Wilson in a scheme to defraud two insurance companies.5 The law judge also found that the Respondents violated Section 206 of the Investment Advisers Act of 19406 with respect to one of the insurance companies with which Nicholson/Kenny had an investment advisory relationship by ignoring their fiduciary duty to the company through, among other things, failing to disclose a conflict of interest involving Kenny and Wilson to the company.7
The law judge ordered the Respondents to cease and desist from committing or causing any violations or future violations of these provisions; barred Kenny from association with any broker, dealer, or investment adviser; revoked Nicholson/Kenny's investment adviser registration; required Respondents, jointly and severally, to pay disgorgement in the amount of $1,333,000; and assessed civil penalties of $700,000 against Kenny and $500,000 against Nicholson/Kenny. We base our findings on an independent review of the record, except with respect to those findings that are not challenged on appeal.
The common threads uniting the two individuals and two insurance companies whose accounts are at issue in this case are their interest in participating in Wilson's alleged bond trading program and their relationships with Kenny. Wilson represented himself to potential customers as an experienced bond trader whose proprietary trading program guaranteed high yields. The representations about how the trading program would work and what it would yield varied from customer to customer. In fact, the "program" was never implemented in any of the customer accounts. Instead, money was moved to other accounts beyond the customers' control. Much of it was eventually taken by Wilson for his own purposes. Kenny was the registered representative, and in one instance, Nicholson/Kenny was the investment adviser, for the customer accounts in question. Kenny received commissions based ontransactions in the accounts. Nicholson/Kenny was paid an advisory fee in its capacity as investment adviser. Additionally, Kenny benefitted from a $913,000 loan from Wilson and a $1,000,000 line of credit provided by Wilson.
B. Kenny's Relationship with Robert C. Wilson at Dean Witter
Kenny has been active in the securities industry since 1981. From 1990 to 1992, he was associated with Dean Witter Reynolds in the St. Louis, Missouri office.
In 1990, one of Kenny's clients at Dean Witter, Douglas A. McClain, introduced Kenny to McClain's employer, Robert C. Wilson. At first meeting, Wilson impressed Kenny as a very "together" businessman. Wilson claimed to be "a large currency trader with accounts at various European banks."
Wilson opened two accounts at Dean Witter under the name of Earnscliffe Trust Co. Ltd., with Kenny as account executive. As time passed, several incidents involving Wilson and Earnscliffe Trust revealed that Wilson was not as "together" as Kenny had originally thought.
1. Wilson Is Enjoined from Any Improper Use of Dean Witter's Name.
On October 24, 1990, without Dean Witter's approval, Kenny provided Wilson with a letter stating that the Earnscliffe Trust accounts were "fully established and in good standing."8 Two days later, Kenny's letter was sent to a potential investor in a scheme in which Earnscliffe Trust, in transactions allegedly designed and implemented by Wilson, would issue "100% world prime bank deposit collateralized AAA rated bonds."9 Kenny's letter, on Dean Witter letterhead, was apparently sent to the potential investor to allay concerns about the legitimacy of the scheme. 10
By December 1990, Kenny knew that Dean Witter's legal department had objected to Wilson's use of the firm's name and had initiated litigation to prevent Wilson from using the Dean Witter name in any improper manner.11 In June 1991, the litigation initiated by Dean Witter resulted in an order enjoining Wilson from any improper use of Dean Witter's name.
2. Dean Witter Refuses to Extend Credit to Earnscliffe
Trust and Closes the Earnscliffe Trust Accounts.
Kenny also knew that Dean Witter's corporate credit department had reviewed financial statements for Earnscliffe Trust and refused to extend credit to the company. In December, 1990, Kenny learned that Dean Witter would be closing the Earnscliffe Trust accounts effective December 20, 1990.
3. A Federal Grand Jury Subpoenas Documents Related to the Earnscliffe Trust Accounts.
In March 1991, Dean Witter's St. Louis office received a federal grand jury subpoena seeking documents related to the Earnscliffe Trust accounts for which Kenny was the account executive. Although Kenny testified that he never saw the subpoena while he was at Dean Witter, a copy of the subpoenawas found in files in Kenny's desk at Dean Witter after he left that firm.12
C. Kenny's Early Relationship with Wilson at Pauli & Co., Inc.
In July, 1992, Kenny became associated with Pauli & Co., Inc., a registered broker-dealer. Pauli & Co. was an introducing broker that cleared its trades through Bear Stearns Securities Corporation ("Bear Stearns"). Wilson opened a number of accounts at Pauli & Co., with Kenny as account executive. As Kenny's customer at Pauli & Co., Wilson did trades for his own accounts totaling hundreds of millions of dollars, as well as additional trades in accounts he controlled. Several troublesome incidents involving Wilson occurred after Kenny became associated with Pauli & Co.
1. Wilson Transfers Money from a Trading Account in Transactions That Do Not Benefit the Account Holder.
John Parrott, president of North American Technologies, Inc. ("NAT"), a Canadian company, and other holders of options of NAT stock had entered into an agreement to sell NAT options to Wilson, who proposed to exercise the options, margin the shares received, and use part of the proceeds in a complicated bond trading program.13 NAT initially opened a trading account at Royal Bank of Canada, but in the spring of 1993 Wilson persuaded the former options holders that it should be moved to Pauli & Co., allegedly to facilitate the rapid transactions necessary to the success of Wilson's bond trading program. Kenny met with Parrott and became the account executive for the account at Pauli & Co., denominated "Euro Scotia Funding Limited a/c Designation NAT" ("Euro Scotia - NAT").
While NAT's account was at Royal Bank of Canada, trading required the signature of a designated NAT officer to authorize transactions. When NAT transferred the account to Pauli & Co., however, Kenny and Wilson persuaded NAT to eliminate the signature authorization requirement, because the success of Wilson's trading program allegedly depended on Wilson's ability to conduct transactions swiftly. Once Wilson had control over the NAT account, he instructed Kenny to transfer $20,000 to Pauli & Co.'s bank account, $70,000 to the bank account of one of Kenny's business associates, and $125,000 to an account maintained by one of Wilson's companies. Kenny transferred the funds, with no apparent benefit to NAT.14
2. Wilson Is Sued and His Accounts Are Frozen, Then Liquidated, When a Buyer Affiliated With Him Fails to Conclude a Transaction.
In late 1993, Wilson arranged to sell stock of two companies to C.S. First Boston Corp., which, in turn, was to sell the securities to a buyer affiliated with Wilson. Shares from Wilson's accounts at Pauli & Co. were used to fill the order. The identified buyer, however, refused to pay C.S. First Boston and, in early 1994, C.S. First Boston sued Wilson in connection with the transaction. The court ordered Wilson's accounts at Pauli & Co. and Bear Stearns to be frozen, then liquidated, to pay C.S. First Boston for losses incurred in the transaction. Kenny knew that Wilson had accepted responsibility for C.S. First Boston's losses, and that Wilson's accounts were frozen. Kenny also knew that Pauli & Co. was concerned that the transactions might cause losses to the firm; Kenny was asked to sign a note promising to repay Pauli & Co. the commissions he had been paid on Wilson's sell transactions if the transactions were lost, canceled, or reversed.
3. Wilson Attempts to Deposit Counterfeit Bonds With a Face Value of $400 Million Into His Accounts at Pauli & Co.
In November 1993, Wilson informed Kenny that in the Bahamas he had bought Mexican bonds with a face value of $400 million, and that he wanted to bring them into the United States and deposit them into his accounts at Pauli & Co. When the bonds were brought to the Pauli offices, Kenny called Citibank to verify the instruments and was informed that the bonds were counterfeit.15 Kenny then notified the FBI, which seized the counterfeit bonds.
D. Kenny's Involvement with Albert N. Kaufman
In June 1993, Albert N. Kaufman, a retired salesman and entrepreneur in his seventies, signed a service agreement with Euro Scotia Funding Limited ("Euro Scotia"), a Canadian corporation established by Wilson in the early 1990s.16 The agreement provided that Kaufman and Euro Scotia would open an account at Pauli & Co., in the name of "Euro Scotia Funding Limited Account Des[ig]nation AK" (the "AK account"). The service agreement further provided that, while Wilson could conduct trading in the AK account, money was to be withdrawn from that account only on Kaufman's instructions.
The account was opened on June 23, 1993, with Kenny as account executive. Kaufman opened the account in order to participate in Wilson's bond trading program, which Kaufman understood to involve trading United States Treasury bonds.
Kenny testified that he understood both that the AK account was for the benefit of Kaufman, and that Kaufman had engaged Wilson, acting through his company Euro Scotia, to act as an adviser. But the Bear Stearns report of new account form, which Kenny completed as account executive, did everything possible to conceal Kaufman's interest in the account. Consistent with the service agreement, the form identified "Euro Scotia Funding Ltd. A/C Designation (AK)" as the customer. It showed Wilson's rather than Kaufman's address. The form identified the customer not as an individual, nor as a corporation, but as "other," without specifying what the "other" was. The spaces for the customer's age, business, annual income, and net worth were left blank, as was the space where persons authorized to enter orders and issue instructions were to be identified. In response to the question, "Is account handled by an investment advisor [sic]?" the box marked "no" was checked. The form did not identify any third party holding trading authorization. Other than the "AK" account designation, there was no reference to Kaufman on the form. Nonetheless, Kenny clearly understood Kaufman's connection to the account, because he had Kaufman sign a Bear Stearns trading authorization form that identified Kaufman as the customer and Wilson as his agent. Kaufman did not receive monthly statements or confirmations for the AK account; instead, these documents were sent to Euro Scotia, attention Robert Wilson.
Kaufman initially deposited $100,000 in the AK account. Between September 28 and November 13, 1993, Kaufman sent a series of four additional checks totaling $105,000 directly to Kenny for deposit in the AK account. In each case, a letter accompanying the check instructed Kenny to deposit the funds into the AK account, which Kaufman referred to twice as "the Euro Scotia Funding Limited-AK account," once as "the AK account," and once as "my account."17 The first letter, which enclosed a check in the amount of $30,000, stated that McClain would be depositing an additional $20,000 into the account. The second letter, which enclosed a check for $20,000, stated that the money "will be used for additional shares of Tri Northern Resources when the stock becomes available on the market. With this check, that will be a total of $70,000.00 placed in this account."18 Tri-Northern Resources, a mining company, was a privately-held corporation. Its stock was therefore not publicly traded.19 Kaufman told Kenny to keep the money in a money market account until Tri-Northern stock became publicly available.
The third letter enclosed a check for $25,000, which was also to be used "for additional shares of Tri Northern Resources." The letter further stated: "With this check, the account should now total $175,000."20 A fourth letter enclosed a check for $30,000, noted that the money was "for the purpose of purchasing stock in Tri Northern Resources," and requested "confirmation on each check so that I know it has been received. This should total $225,000."
Kenny wrote to Kaufman to acknowledge receipt of the second, third, and fourth checks. In each case, Kenny stated that Kaufman's check would be forwarded to Bear Stearns, "so that your account will be credited accordingly." In his acknowledgments of the third and fourth checks, Kenny also included itemized lists of the "amounts deposited into your account." As noted above, Kaufman's third letter was phrased not in terms of what had been deposited, but rather in terms of what the AK account "should now total," which Kaufman concluded was $175,000. Kenny neither confirmed nor denied Kaufman's assertion about what the account "should total," i.e., what the net equity was. Instead, he itemized the deposits into the account and provided the total, which was $175,000. Kaufman's fourth letter asserted a figure as a "total," and Kenny again responded by giving amounts deposited.21
At about the time that Kaufman sent his third check to Kenny, Wilson directed Kenny to wire $33,318 out of the AK account to an account unrelated to Kaufman, without Kaufman's knowledge or authorization. The wire transfer occurred on October 25, 1993, two days before Kenny wrote to Kaufman confirming that $175,000 had been "deposited" into the AK account. Kenny's letter did not mention the wire transfer, nor did it disclose Wilson's two purchases of a total of 23,500 shares of NAT stock, which affected the cash balance in the account. Kenny's November 16, 1993 response to Kaufman's fourth letter, while accurately stating that $205,000 had been deposited into the AK account, did not inform Kaufman that the net equity in the account was muchlower than that as a result of the $33,318 wire transfer and a decline in the value of the NAT stock.22
In November 1993, Kenny, at Wilson's direction, transferred $36,000 from the AK account to an account in the name of Euro Scotia Funding - MAF (the "MAF account"), which Wilson controlled. Also in November 1993, 13,750 shares of NAT stock were transferred out of the AK account to the Euro Scotia - NAT account, which, as discussed above, Wilson also controlled. In January 1994, Kenny transferred an additional $21,770 from the AK account to the MAF account, and later in January 1994, the remaining $5.89 in the AK account was transferred to an account maintained by another of Wilson's companies.
None of these accounts to which money or stock was transferred was related to Kaufman, none of the transfers was known to or authorized by Kaufman, and none of the transfers was for Kaufman's benefit. Kenny did not ask Kaufman about the terms of his purported advisory agreement with Wilson or whether Kaufman had authorized the transfers. Kenny did not inform Kaufman that Kenny accepted Wilson's instructions to transfer funds out of the AK account to other unrelated Wilson-controlled accounts.
Moreover, Kaufman had directed in three of his letters that his funds be used to buy Tri-Northern shares. Kenny's replies to Kaufman's letters did not disclose to Kaufman that Tri-Northern was not yet trading publicly.23 Nor did Kenny inform Kaufman that the money was not maintained in a money market account as Kaufman had directed, but instead was being used by Wilson to buy other securities, including speculative shares of stock in a company in which Wilson had an interest.
The AK account was closed in January 1994, without Kaufman's knowledge. No bonds were ever purchased for Wilson's alleged trading program, nor was any Tri-Northern stock ever purchased for the account. Kaufman did not receive any money, or any Tri-Northern stock, when the account was closed.24
Violations with respect to Kaufman
The antifraud provisions of the federal securities laws prohibit employing a scheme to defraud, or any act, practice, or course of business that operates as a fraud or deceit in connection with the offer, sale, or purchase of a security.25 A material misrepresentation, or a material omission where there is a duty to speak, can constitute a violation of the antifraud provisions.26
Scienter is a necessary element of a violation of Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Section 206(1) of the Advisers Act,27 although it need not be found to support a finding of violation of Sections 17(a)(2) and (a)(3) of the Securities Act and Section 206(2) of the Advisers Act.28 Reckless behavior satisfies the scienter requirement.29
Kenny intentionally omitted material information from the letters he wrote to Kaufman. Kaufman's third letterreflected his understanding that "the account should now total $175,000." In fact, the account "totaled" significantly less; the NAT stock that Wilson had bought for $96,770 had declined in value about 20%, and Wilson had made an unauthorized transfer of $33,318 to an unrelated account. Kenny's response misled Kaufman. Kenny echoed Kaufman's use of the $175,000 figure, but used it to show the total amount deposited in the account, with no indication of the activity that had reduced that total.
As the account executive for the AK account, Kenny knew that Kaufman was not receiving account statements or confirmations from Bear Stearns. He encouraged Kaufman to contact him if Kaufman had questions about his account, thereby leading Kaufman to think of Kenny as a source of information. The use of the term "your account" in his letters to Kaufman reinforced Kaufman's belief that Kenny recognized Kaufman as the account owner. In fact, Kenny was permitting Wilson to withdraw Kaufman's funds from Kaufman's account without any apparent authority. This makes Kenny's failure to provide adequate information particularly egregious.30
Once Kenny undertook to reply to Kaufman's inquiries, he was obligated to do so truthfully and in a way that was notmisleading.31 Kenny cannot escape liability by selecting isolated statements from his letters and characterizing them as "completely truthful and accurate." Although the letters contain some truthful statements, the letters are misleading because of the omitted information.32
Kenny argues that his omissions were not material. But among other things, the fact that Wilson transferred out of Kaufman's account more than $33,000, almost 20% of the money Kaufman had deposited at that point, was clearly material.33 The wire transfer occurred on October 25, and Kenny did not mention it in either of the two letters he sent Kaufman after that date.
The scheme employed by Kenny, and the omissions made to further that scheme, were in connection with the purchase and sale of securities. Kaufman was initially induced to deposit money into his Pauli & Co. account by representations that by doing so he could participate in Wilson's alleged bond trading program. He subsequently sent additional funds to be used for the purchase of Tri-Northern stock, or to be held in a money market account until that stock became publicly available. Rather than using the money in this way, Kenny acted as registered representative for the purchase of NATstock for the account. By sending letters that omitted any mention of the actual transactions in the account, Kenny led Kaufman to believe that his money was being handled in accordance with his instructions, which encouraged him to continue depositing money and ordering trades that never happened.
We reject Kenny's argument that he owed no duty to Kaufman because Kaufman was not his client. Kenny was the account executive responsible for Kaufman's account, and he received commissions for transactions in the account. While the account was denominated "Euro-Scotia Funding Limited - AK account," Kenny had Kaufman execute a Bear Stearns trading authorization that identified Kaufman as the customer. At Pauli & Co., the account was commonly referred to as Kaufman's account. Kenny's letters to Kaufman referred to it as "your account." Under these circumstances, Kenny's denial that Kaufman was his client is meritless.
Kenny argues that he did not know the terms of the relationship between Wilson and Kaufman since Kaufman did not discuss that relationship with Kenny, nor provide Kenny with copies of documents establishing the relationship between Kaufman and Wilson. Kenny, however, knew that Kaufman was supplying the funds for the account. The Bear Stearns trading authorization that Kaufman signed identified Kaufman as the customer and Wilson as his agent. Although Kenny testified that he thought Wilson was acting as Kaufman's investment adviser, the Bear Stearns report of new account form that Kenny completed as account executive indicated that the account was not handled by an investment adviser.34
Kenny appears to be claiming that he was uncertain as to the relationship between Wilson and Kaufman. However, Kenny did not ask Kaufman whether Wilson could withdraw Kaufman's funds and put the money in accounts in which Kaufman had no interest. Had he done so, he would have learned that Kaufman had not authorized Wilson to withdraw funds from the account. Under these circumstances, Kenny was at best reckless in following Wilson's directions.
We find that Kenny omitted material information in his dealings with Kaufman. We further find that Kenny acted with scienter. By this conduct, Kenny willfully violated Securities Act Section 17(a), Exchange Act Section 10(b), and Exchange Act Rule 10b-5.
E. Kenny's Involvement with Charles G. Smith, Jr.
In June 1994, McClain introduced Charles G. Smith, Jr. to Kenny. Smith was retired and in his late sixties; he had formerly operated a helicopter spare parts business. Smith and his wife met with Kenny at the Pauli & Co. offices in St. Louis, Missouri, to discuss establishing an account that would engage in a bond trading program at Pauli & Co.35 After Kenny showed Smith around the offices and let him observe some traders at work, Kenny described the proposed bond trading program in more detail. According to Kenny, Smith could use the program to buy Treasury bonds and "margin them up to ten times." Kenny told Smith that he "absolutely [couldn't] make less than 10 percent" and that "it could go as high as 32 or 33 percent." Kenny also told Smith, "[Y]ou can't get any safer than Treasury bonds." Kenny did not discuss with Smith the risks associated with the use of margin. Kenny explained to Smith that investments of the type he was describing ordinarily required an investment of millions of dollars, but that Pauli & Co. allowed parties with less money to participate by pooling their funds.
Kenny then took Smith to a conference room, where he introduced Smith to Wilson. While Kenny prepared documents necessary to open an account for Smith, Wilson tried to interest Smith in investing in a company called Tensiodyne.36 Wilson offered to sell Smith 50,000 shares of Tensiodyne at $1.50 per share in exchange for Smith's assistance in obtaining business for Tensiodyne. Smith replied that he had come to Pauli & Co. for the purpose of investing in the bond trading program, and that he was not interested in buying Tensiodyne.
Wilson nonetheless suggested that Smith send $50,000 to be put in a trust account controlled by Samuel L. Boyd, Wilson's attorney, for the purchase of Tensiodyne stock. Kenny encouraged Smith, stating: "Mr. Wilson is heading up this Tensiodyne situation and I don't see any way that you could lose any money at it." Smith did not immediately agree to buy Tensiodyne stock. After talking to his usual stockbroker, however, Smith sent $50,000 to Boyd for the purchase of shares of Tensiodyne.
To open his account at Pauli, Smith gave Kenny two Treasury bonds with a total value of nearly $300,000. Smith authorized Kenny to use the funds only for the bond trading program. In late June, however, without Smith's authorization, Kenny used funds in Smith's account at Pauli & Co. to buy 30,000 shares of Tensiodyne at $2.63 per share.37
At about the time of the unauthorized Tensiodyne purchase, Kenny told Smith that Pauli & Co. was buying a brokerage firm in Florida to handle the bond trading program. Kenny told Smith to transfer all the assets in his Pauli & Co. account to a trust account maintained by Boyd at Pauli & Co. while the purchase of the Florida firm was being finalized. To this end, Kenny dictated to Smith a letter authorizing the transfer of $171,000 in cash, a $50,000 Treasury bond, and 30,000 shares of Tensiodyne stock to Boyd's trust account at Pauli & Co.38 The inclusion of the 30,000 shares of Tensiodyne stock among the assets to be transferred alerted Smith to the unauthorized transaction in his account. Smith told Kenny "in no uncertain terms" that he disapproved of the Tensiodyne transaction. Kenny promised to dispose of the stock. Despite Smith's disapproval of Kenny's purchase of Tensiodyne stock, Smith and his wife signed the letter, as dictated, on July 1, 1994.
Although Smith had opened his account at Pauli & Co. for the sole purpose of engaging in a bond trading program, no bonds were ever bought for that account. Smith's assets were transferred to Boyd's account during the first week in July. Smith never received any further information about the account, despite repeated telephone calls to and inquiries of Kenny, Wilson, McClain, and Boyd. Smith lost at least $325,000 as a result of his dealings with Wilson and Kenny.39
Violations with respect to Smith
Kenny was responsible for introducing Smith to Wilson. He implicitly vouched for Wilson by letting Wilson use a Pauli & Co. conference room for his meeting with Smith. Kenny touted the alleged bond trading program by guaranteeing Smith profits of between 10% and 33%. Kenny also touted Wilson's performance, telling Smith that he did not see how Smith could lose money by investing in the Tensiodyne stock Wilson was promoting.
Kenny made both misrepresentations and omissions to Smith regarding Wilson's alleged bond trading program. Kenny represented that the trading program was operating at Pauli, although that was not true and he had no reason to think that the firm had plans to conduct such a program. Kenny told Smith that he "absolutely [couldn't] make less than 10%" and could perhaps make 32% or 33% by investing in the bond trading program at Pauli & Co. These guarantees were made recklessly, because based on their prior dealings, Kenny had no basis for representing that Wilson could consistentlydeliver such performance. Securities professionals who testified at the hearing found Wilson's descriptions of his program incomprehensible, or could not see anything special about what he proposed to do. Kenny contends that "Wilson successfully traded the assets in the North American Technologies account, resulting in great profit to North American while the money was in the Pauli & Co. account." Even if this were true, profitable trading in one account over a limited time does not provide a sufficient basis for representations like those Kenny made to Smith.
Moreover, although Kenny told Smith that the program involved trading Treasury securities on margin, he said nothing about the risks involved in the use of margin. To the contrary, he told Smith, "Well, you can't get any safer than Treasury bonds."
Kenny also made misrepresentations regarding Tensiodyne stock, assuring Smith, "Mr. Wilson is heading up this Tensiodyne situation and I don't see any way that you could lose any money at it." By the time of this conversation with Smith, however, Kenny had numerous reasons to question Wilson's abilities and integrity, and the soundness of transactions in which he was involved. Kenny knew that Dean Witter had obtained an injunction against Wilson's unauthorized use of its name, and that Dean Witter had refused to extend credit to Earnscliffe Trust and had closed the Earnscliffe Trust accounts. Kenny also knew that a grand jury had requested documents related to Earnscliffe Trust accounts. Kenny knew that Wilson had transferred money out of NAT's account in transactions that were of no apparent benefit to NAT. Kenny knew that, because a buyer affiliated with Wilson had refused to pay for stock in a transaction arranged by Wilson, Wilson's accounts at Pauli & Co. and Bear Stearns were frozen, then liquidated, to cover losses incurred in the transaction. Kenny also knew that Wilson, allegedly an astute bond trader, had brought $400 million of worthless Mexican bonds into the United States. More recently, Kenny acted on Wilson's instructions that systematically took all the assets out of Kaufman's account. Especially in light of this knowledge of Wilson's past, Kenny's representations to Smith that he could not lose money in one of Wilson's enterprises violated the antifraud provisions.
Smith deposited his bonds in the Pauli & Co. account with instructions that the money should be used in the bond trading program. However, none of the money was used for bond trading. Instead, Kenny made an unauthorized purchase of 30,000 shares of Tensiodyne stock. Kenny dictated to Smith a letter ordering the transfer of that stock and other assets to Boyd's trust account. Once the assets were in Boyd's account, they were misappropriated.
We find that Kenny made material misrepresentations and omitted material information in his dealings with Smith. We further find that Kenny acted with scienter. By this conduct, Kenny willfully violated Securities Act Section 17(a), Exchange Act Section 10(b), and Exchange Act Rule 10b-5.
F. Kenny's Involvement with the National Family Care Insurance Company
The National Family Care Insurance Company ("NFC") is a Texas-based company that sells supplemental disability income insurance and life insurance. Robert and Sandra Erwin were the sole shareholders of NFC; they also chaired the Board of Directors. Clyde W. Tullis, the President of NFC, was responsible for filing certain forms with state and federal regulators.
On May 12, 1994, Wilson met with Tullis, the Erwins, and others to discuss his bond trading program. Wilson proposed that NFC make loans to him for his investment program. Wilson or Wilson-related entities would put up collateral equal to approximately 120% of the loan amount. The collateral would be in the form of U.S. Treasury instruments or other assets that would qualify as admitted assets, which, Tullis explained, were "assets that are authorized as proper investments" under Texas Department of Insurance regulations.40 Wilson proposed to use the money loaned to him for leveraged trading in U.S. Treasury instruments, which "would be secured at all times." Wilson promised NFC yields of 10-15% annually. To illustrate the success of his program, Wilson provided a Form 10-K from one of his companies, North American Technologies Group, Inc., which showed a return on investment of approximately 180%. Wilson also provided financial statements of another of his companies, Euro American Insurance ("EAIC"), which showed assets of more than $200,000,000.
NFC understood that its investment with Wilson would be structured so that it would qualify as an admitted asset. Tullis testified (1) that a collateralized loan can be an admitted asset if the collateral itself qualifies as an admitted asset, and (2) that, although Texas law permitted insurance companies to engage in margin trading, only the equity portion of any margin accounts could be considered in calculating admitted assets. To facilitate auditing, Tullis testified, NFC's account needed to have a full cash position at the end of each quarter, with no liens or loans against the securities held.41 Thus, the parties agreed that eachcollateralized loan would be paid in full at the end of each quarter, leaving only cash assets in NFC's account.
After the May 12, 1994 meeting with Wilson, NFC opened an account at Mark Twain National Bank. In mid-June, however, Wilson urged NFC to transfer its funds to Pauli & Co., with Kenny as the account executive. Wilson said that he had worked with Kenny on many occasions and that Kenny would do a better job than the bank.
NFC accordingly transferred its funds to Pauli & Co. The Pauli & Co. account was intended to hold funds that NFC could lend to Wilson, once Wilson put up appropriate collateral. Until the end of June 1994, NFC's account was maintained as a cash account. As of June 30, 1994, the net equity in the account was approximately $7.7 million. In early July 1994, however, Tullis became aware that margin trading was being conducted in the account. Only Tullis and the Erwins had authority to authorize margin trading in the NFC account, and they had not done so. NFC complained to Kenny about the margin trading and told Kenny to stop any margin trading in the NFC account. Kenny agreed to look into the matter and take care of any margin trading that had occurred. Nonetheless, margin trading continued, with approximately 100 separate margin trades in NFC's account over the next seven months.
In July 1994, shortly after NFC had learned of the margin trading in its account, Wilson again told NFC to move its money, this time to Boyd's trust account at NationsBank. Wilson told NFC that the transfer was necessary since Pauli & Co. had not avoided conducting margin trading in the account. Once the money was in the trust account, Boyd was to invest it in Wilson's trading program. On July 22, 1994, NFC began withdrawing funds from its account at Pauli & Co. and transferring them to Boyd's trust account.
As explained above,42 NFC and Wilson had agreed that NFC's Pauli & Co. account was to contain only cash assets as of September 29, 1994, the last business day of the quarter. On July 20, 1994, EAIC had issued an $11.2 million note to NFC, due September 29, 1994. As the payment deadline neared, Wilson told Tullis that he would repay the note by depositing money into NFC's Pauli & Co. account for the purchase of Treasury bills. According to Wilson, with the Treasury bill purchases, the total amount in the NFC cash account should beabout $11.2 million. When Tullis received the account statement for the period ending September 30, 1994, however, it showed that Treasury bills had been purchased on margin and that the net equity in the account was only $1,326,929.43 Tullis complained to Wilson, and Wilson told him that Pauli & Co. had made "banking" mistakes, that the funds had not been wired to the correct account, and that he was discussing the problem with Kenny.
On October 18, 1994, Kenny sent Tullis a letter stating that as of September 30, 1994, the NFC account at Pauli & Co. held three Treasury securities totaling approximately $10.6 million. Kenny's letter did not disclose that the Treasury securities were margined, so that NFC would get much less than $10.6 million if it sold them. The account statement for the period ending October 28, 1994 showed additional margin transactions. Tullis requested more documentation and eventually received another letter from Kenny, dated November 15, 1994, which stated that, as of September 30, 1994 the NFC account at Pauli & Co. had a cash balance of $565 and held Treasury securities totaling approximately $10.8 million. In the letter, Kenny claimed that he had received erroneous instructions to margin the securities in NFC's account, but that the problem had been resolved as of October 31, 1994. Despite Kenny's assurances, however, the November and December account statements showed that all of the transactions involving Treasury instruments were on margin.
The NFC account needed to be in a cash position again as of December 30, 1994. By letter dated November 30, 1994, Wilson told NFC that he would transfer approximately $11.4 million in Treasury securities to the NFC account by the end of the year to pay off the collateralized loan. Instead, Wilson wired $1.125 million in cash into NFC's account, which Kenny used, at Wilson's direction, to purchase a Treasury note. Because Wilson did not wire the sum he had promised, the note was purchased on margin. By letter dated December 30, 1994, Kenny confirmed to Tullis that an $11.4 million Treasury note was "held in the [NFC] account as of today." He did not disclose that the note had been purchased on margin. As soon as Tullis received Kenny's letter, he asked Kenny to send a breakdown of the note's principal and interest. On January 3, 1995, Kenny sent Tullis a breakdown of the principal and interest, but again did not disclose that the note had been acquired on margin.
In early January 1995, Bear Stearns issued a December statement for the NFC account at Pauli & Co., as well as a margin call. Tullis learned at that time that the NFCaccount had a cash balance of only approximately $1,000,000.44
Boyd's trust account at NationsBank, into which much of NFC's money was transferred, made two wire transfers totaling $913,000 in October 1994. The $913,000 represented a loan from Wilson to Kenny so that Kenny could purchase the Nicholson Group, a registered investment adviser that he subsequently renamed Nicholson/Kenny Capital Management, Inc.45 Kenny purchased the firm in October 1994. However, he did not sign a promissory note for $913,000 to repay Wilson until the third quarter of 1995. Kenny put up no collateral for the loan. At the time of the hearing, he had not paid any interest or repaid any principal to Wilson. There is no evidence that he has done so since then.
Wilson also established a $1,000,000 line of credit against which Kenny could draw. Between September 1994 and February 1995, Kenny borrowed $420,000 against this line of credit: $140,000 from Boyd's trust account and the balance from Debenture Guaranty Association ("DGA"), another Wilson company.
Violations with respect to NFC
Kenny was charged with aiding and abetting and being a cause of Wilson's violations of Securities Act Section 17(a), Exchange Act Section 10(b), and Rule 10b-5 thereunder. The three elements necessary to find aiding and abetting liability are: (1) a primary violation of the securities laws by another party, (2) substantial assistance by the aider and abettor to the primary violation, and (3) general awareness, or knowledge, on the part of the aider and abettor that his or her actions were part of an overall activity that was improper.46
Kenny does not dispute that Wilson's conduct with respect to NFC violated the antifraud provisions. Like Kaufman and Smith, NFC was told that its funds would be used for trading U.S. Treasury instruments. Although bonds were indeed bought for the account, Wilson misled NFC about the margin status of those bonds. This lulled NFC into believing that its funds were secure and that the assets in its Pauli account could properly be considered admitted assets. To the contrary, there were repeated margin purchases in the account, and repeated misstatements about the status of the account. Wilson further induced NFC to transfer funds from Pauli into Boyd's account for securities purchases and stole millions of dollars from NFC.
Kenny was well aware that there was margin trading in the NFC account; indeed, as account executive he effected the margin trades. But, when Tullis expressed concern about the statements he received reflecting the margin trading, Kenny sent purportedly explanatory letters that concealed the useof margin. Although Kenny knew of NFC's concerns regarding margin trading, he recklessly continued to execute margin trades in the account after Tullis and Robert Erwin told him that margin trades should stop. By making margin trades contrary to NFC's instructions and concealing the margin status of those trades, Kenny assisted Wilson in deceiving NFC about the purported securities transactions in the account and enabled Wilson's successful conversion of NFC's funds.
Based on these facts, we find that Kenny willfully aided and abetted Wilson's defrauding of NFC, in violation of Securities Act Section 17(a), Exchange Act Section 10(b), and Exchange Act Rule 10b-5. We find that Kenny acted with scienter. We further find that Kenny was a cause of Wilson's violations.
G. Kenny's Involvement with the United States Employer Consumer Fund of Florida
The United States Employer Consumer Fund of Florida ("USEC-FL") was organized in 1991 to offer workers' compensation insurance in Florida. The United States Employer Consumer Association ("USECA") fulfilled certain management functions for USEC-FL, including conducting its investments.
In November 1994, USEC-FL received a notice from state insurance regulators stating that the company would have to stop including approximately four to five million dollars in delinquent accounts receivable as an admitted asset. Excluding these accounts receivable from its assets put USEC-FL in financial deficit from a regulatory standpoint. The regulators required USEC-FL either to clear up the deficit balance within 60 days or to cease operations.47
In December 1994, representatives of USEC-FL met with Wilson, who proposed several measures to help the company improve its financial position. Wilson offered to buy USEC-FL's delinquent accounts receivable for $4,000,000 and a surplus debenture for $1,000,000, enough cash to offset USEC-FL's financial deficit position. As a condition of the purchase, Wilson required USEC-FL to participate in his investment program, which, he promised, would yield a return on investment of 9.35%.
Wilson proposed to put the $5 million to be paid to USEC-FL into an account to be opened at Pauli & Co., with Kenny as the account executive. Wilson additionally requested that USEC-FL use Kenny as the adviser handling its funds.
In December 1994, USEC-FL entered into an investment advisory agreement with Nicholson/Kenny. The agreement required Nicholson/Kenny "to act as investment adviser" to USEC-FL pursuant to the terms of the agreement. Among other things, the agreement required Nicholson/Kenny to "provid[e] a continuous investment program and strategy" for USEC-FL and to maintain USEC-FL's books and records with respect to securities transactions. Nicholson/Kenny was to receive a fee of .30% of the fair market value of the account for acting as investment adviser. Although USEC-FL in fact did not expect Nicholson/Kenny to provide any investment advice to it in spite of the written agreement, USEC-FL nonetheless paid Nicholson/Kenny the agreed-upon fee. Respondents did not disclose to USEC-FL that Wilson had funded Kenny's purchase of Nicholson/Kenny with a $913,000 loan.
USEC-FL deposited securities valued at approximately $3.4 million, the amount specified in the investment advisory agreement, into an account at Pauli & Co. Although neither we nor security professionals who reviewed these documents can determine how these transactions were to profit USEC-FL, USEC-FL understood that Wilson's company, DGA, would deposit an additional "$3.4 million plus" into the account as security to guarantee the repayment of USEC-FL's $3.4 million, in addition to purchasing the delinquent accounts receivable and surplus debenture. The combined funds were then to be used to purchase approximately $7 million in U.S. Treasury bills. Interest from the Treasury bills would be used to repay USEC-FL its $3.4 million, in semi-annual installments over a ten-year period. At the end of the ten years, the bills would belong to DGA. As the account executive, Kenny received part of the mark-up or mark-down paid to Pauli & Co. on USEC-FL's bond purchases, in addition to the investment advisory fee paid to Nicholson/Kenny.
In late December 1994, USECA received a trade confirmation for the USEC-FL account at Pauli & Co. showing that a $7 million U.S. Treasury note had been purchased. At about the same time, Wilson told Thomas Beckett, the CEO of USECA, that DGA had deposited $2.3 million more than necessary into the Pauli & Co. account. Wilson asked that the alleged excess funds be returned. Before transferring funds to Wilson, Beckett contacted Kenny's office in order to verify that the account contained approximately $7 million in securities.48 Kenny's assistant confirmed that the securities had been purchased and that there were $7,011,000 in securities in the USEC-FL account. While USECA believed that the securities were in a cash position, they wereactually margined, but Kenny's assistant did not reveal that fact. Acting on the belief that the account contained $7,011,000 in unmargined securities, plus an additional $2.3 million erroneously deposited by DGA, USECA asked Kenny to transfer the $2.3 million of apparently excess funds from the USEC-FL account at Pauli & Co. to USECA's bank in Florida. After the funds had been transferred, USECA wired them to DGA.
In early January 1995, USEC-FL received a margin call on the securities in its account at Pauli & Co. The margin call indicated that the account had a cash value of only about $700,000. Wilson told Beckett that there had been a mistake in transferring funds and that the problem regarding the margin call would be resolved. In addition, Kenny sent Beckett a letter dated January 6, 1995, stating that there was no margin position in the USEC-FL account and that there would be no margin position in that account in the future. Kenny's letter did not disclose that the reason there was no margin position was that the note held on margin had been sold. After Beckett received the letter, he told Kenny that Florida law prohibited margin trading using USEC-FL assets and that under Florida law USEC-FL's account had to be in an equity position without any liens or encumbrances.
After these conversations with Wilson and Kenny, and after receiving Kenny's letter of January 6, Beckett once again believed that USEC-FL's account at Pauli & Co. was a cash account with a value of at least $7 million. In fact, the value of the account was only about $700,000. The margined Treasury note had been sold on January 6, so the account contained only cash at that time.
Wilson had promised by early January 1995 to deposit $8.4 million into the USEC-FL account at Pauli & Co.49 Kenny reassured USECA that Wilson would eventually follow through on his promises, stating that although Wilson was "a little slow in getting things done sometimes" he was "a very reputable, honorable man" and "a great man to do business with." Kenny rated Wilson "A on integrity and a C on performance." Kenny sent USECA a letter dated January 10, 1995, stating that he had been advised that "$8.4 million of U.S. Treasury bonds with a maturity of three to five years will be transferred" into the USEC-FL account. Beckett believed that Kenny's letter "added credence" to Wilson's promise. Acting on its belief that the funds had been deposited, USECA transferred $728,000 from the USEC-FL account to USECA's bank, from which the money was transferredto DGA. Between December 27, 1994 and January 10, 1995, USEC-FL lost more than $3 million through its dealings with Wilson and Kenny.50
Violations with respect to USEC-FL
By defrauding USEC-FL in connection with its securities transactions, Wilson violated the federal securities laws. As was true with regard to NFC, an essential aspect of the fraud was convincing USEC-FL that the Treasury securities in its Pauli & Co. account were held in a cash position. USEC-FL had been told that approximately $7 million in U.S. Treasury bills would be purchased for its account. This was crucial because, if USEC-FL had known that the securities had been bought on margin, it would have known that the "excess" cash available in the account was there, not because Wilson had deposited extra money, but rather because the cost of securities bought on margin was less than the cost of fully paid securities. Believing that the securities were fully paid and that Wilson had deposited excess funds, USEC-FL authorized the transfer of the money to Wilson entities.
Kenny aided and abetted Wilson's violations of the antifraud provisions with respect to USEC-FL. He substantially assisted that conduct. Kenny lent credence to Wilson and his schemes by telling USECA that Wilson was "a very reputable, honorable man" and "a great man to do business with" who rated "A on integrity." This characterization was false; as discussed above, Kenny was aware of numerous incidents in Wilson's past that cast doubt on both his integrity and his business acumen. Similarly, Kenny assisted Wilson's fraud by reassuring USECA that, although Kenny rated Wilson only "C on performance," Wilson would eventually follow through on his promises. These representations were instrumental in convincing USECA that Wilson had deposited all the funds he had promised and had accidentally deposited even more, yielding what USECA believed to be a surplus in the Pauli & Co. account that could appropriately be transferred to Wilson-related entities.
Kenny's letters of January 6 and January 10, 1995 also furthered Wilson's fraudulent scheme. The January 6 letterto Beckett stated in part, "[T]here is currently no margin position . . . nor will there be a margin position in the future" in the USEC-FL account. This statement was misleading because there was a margin position in the account on January 6, although the sale of the note bought by USEC-FL on margin settled that day. Moreover, since Wilson had told Beckett that the problem regarding the margin call was due to a mistake in transferring funds and would be resolved, Kenny's letter created the impression that the margin position had been resolved by transferring funds into the account, not by selling the note. Kenny's January 10 letter to Beckett stated in part, "I have just been advised that $8,400,000 market value of a U.S. Treasury Note . . . will be transferred into the [USEC-FL] account." This was misleading because it implied that Kenny had reason to believe that the transfer would take place. In fact, Kenny was simply repeating a representation made by Wilson, which he had every reason to question. Kenny acted recklessly in vouching for Wilson's conduct, given his knowledge of Wilson's failure to follow through in the past. Indeed, the transfer never occurred.
We find that, with scienter, Kenny willfully aided and abetted Wilson's defrauding of USEC-FL, in violation of Securities Act Section 17(a), Exchange Act Section 10(b), and Exchange Act Rule 10b-5. We further find that Kenny was a cause of Wilson's violations.
Violations under Section 206 of the Advisers Act
Advisers Act Section 206(1) makes it unlawful for any investment adviser "to employ any device, scheme, or artifice to defraud any client or prospective client."51 Section 206(2) makes it unlawful for any investment adviser "to engage in any transaction, practice or course of business which operates as a fraud or deceit upon any client or prospective client."52
As USEC-FL's investment adviser, Nicholson/Kenny had a fiduciary duty to exercise the utmost good faith in dealing with its client, USEC-FL; to disclose all material facts; to disclose all conflicts of interest; and to employ reasonable care to avoid misleading its client.53 Nicholson/Kenny received an advisory fee for handling USEC-FL's account. The fact that USEC-FL did not expect to receive investment advice from Nicholson/Kenny did not relieve Nicholson/Kenny of these obligations. Moreover, as investment adviser, Nicholson/Kenny took on responsibility for monitoring USEC-FL's account. Instead of helping USEC-FL understand its account status, however, Nicholson/Kenny failed to disclose that Wilson was not effecting the securities transactions that he had promised USEC-FL, which in turn facilitated Wilson's transfer of the allegedly "excess" cash.
Nicholson/Kenny did not disclose Kenny's knowledge of Wilson's business dealings. Moreover, Nicholson/Kenny never disclosed to USEC-FL that Wilson had paid $913,000 to finance Kenny's purchase of Nicholson/Kenny in November 1994. This payment created a conflict of interest that should have been disclosed. USEC-FL was entitled to consider this information in evaluating Kenny's representation that Wilson rated A for integrity and C for performance. Nicholson/Kenny's reckless failure to disclose this conflict of interest violated Advisers Act Section 206.
Kenny did not dispute that he was properly charged as primarily liable under Sections 206(1) and (2). We need not reach the question whether Kenny waived this issue. Kenny conceded at oral argument that he controlled the firm, and the record shows that Kenny, as chairman and CEO of Nicholson/Kenny and as an owner with his wife of Nicholson/Kenny's holding company, controlled Nicholson/Kenny. As a result, charging himas a primary violator is in accord with case law.54 In any event, the bar, civil penalty, and disgorgement against Kenny are amply supported by his willful violations of Sections 17(a) and 10(b) and Rule 10b-5, even apart from any violations of the Advisers Act.
Thus, we find that Kenny and Nicholson/Kenny willfully violated their fiduciary duty and omitted material information in their dealings with USEC-FL in violation of Advisers Act Section 206. We further find that Kenny and Nicholson/Kenny acted with scienter.55
Agencies have substantial discretion in assessing administrative sanctions.56 Exchange Act Section 15(b)(6)(A)(i) provides the Commission with authority to suspend or bar a person associated with a broker or dealer who, among other things, willfully violates, or willfully aids and abets the violation of, any provision of the Securities Act, the Exchange Act, or the Advisers Act, if it determines that such sanctions are in the public interest.57 Similarly, Advisers Act Section 203(e) and 203(f) respectively provide the Commission with authority to imposesuch sanctions against an investment adviser, or a person associated with an investment adviser, among other things, for willfully violating, or willfully aiding and abetting the violation of, any provision of the Securities Act, the Exchange Act, or the Advisers Act.58
In determining whether such sanctions serve the public interest, we are guided by the following factors: the egregiousness of a respondent's actions, the isolated or recurrent nature of the violation, the degree of scienter, the sincerity of a respondent's assurances against future violations, the respondent's recognition that the conduct was wrongful, and the likelihood of recurring violations.59
We find that it is in the public interest to bar Kenny from association with any broker, dealer, or investment adviser, and to revoke the registration of Nicholson/Kenny. Kenny's actions were egregious, and he committed multiple violations with respect to four customers. He defrauded customers by encouraging them to entrust their money to Wilson, although he knew of Wilson's past defalcations. He facilitated Wilson's scheme by opening accounts, effecting transactions at Wilson's direction that were contrary to the interests of his customers, failing to inform customers of the activity in their accounts, confirming activity he had no reason to believe was taking place, and giving incomplete information that did not present an accurate picture of what was happening. At Kenny's direction, Nicholson/Kenny violated its fiduciary duties to its client, USEC-FL.
Kenny points to certain statements he made that were accurate, as far as they go -- for example, his letters to Kaufman confirming amounts deposited into the AK account --and argues that those statements satisfied his disclosure obligations. We reject that argument for the reasons discussed above. Kenny's argument shows no appreciation of the responsibilities of a securities professional. Moreover, Kenny's argument that his disciplinary record is clean except for these charges related to Wilson gives us little reassurance since Wilson was a significant source of commissions for Kenny. Kenny's continued involvement in the securities business presents opportunities for future violations.
Disgorgement is an equitable remedy designed to deprive a wrongdoer of his or her ill-gotten gains and to deter others from violating the securities laws.60 Kenny argues that he should not be ordered to pay disgorgement because the Division did not prove that the $1,333,000 he was ordered to disgorge were "ill-gotten gains." We disagree. As discussed above, Kenny's involvement with the four customers at issue was crucial to the carrying out of Wilson's fraud. Between September 1994 and February 1995, a total of $1,333,000 was paid by Wilson or at Wilson's behest to Kenny or on Kenny's behalf.61 We find that Wilson arranged for Kenny to receive or benefit from these funds as compensation for Kenny's assistance with Wilson's scheme. Thus, the funds are ill-gotten gains, and they should be disgorged.
C. Cease-and-desist order
Securities Act Section 8A, Exchange Act Section 21C, and Advisers Act Section 203(k) each authorize the Commission to impose a cease-and-desist order if it finds that any person has violated or caused violations of the federal securities laws or rules thereunder.62 We impose such orders only where there is some risk of future violations, although the risk need not be very great and is ordinarily established by a showing that a respondent has already violated the law once.63 In determining whether a cease-and-desist order is appropriate, we consider the entire range of factors relevant to whether a sanction serves the public interest.64 Ourinquiry is a flexible one, and no single factor is dispositive.65
Applying these factors to the present case, we find that the violations warrant cease-and-desist relief. The violations were recurrent and caused serious harm to investors. The narrowness of Kenny's views concerning the ethical obligations incumbent on those active in the securities industry -- for example, his attitude that he owed no duty to Kaufman because Kaufman was not his customer --provides little reassurance that Kenny will refrain from future violations. Thus, we find it appropriate to order Kenny to cease and desist from violating or causing violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. We also find it in the public interest to order Kenny and Nicholson/Kenny to cease and desist from violating Section 206 of the Advisers Act.66
D. Civil money penalties
Exchange Act Section 21B(a) and Advisers Act Section 203(i)(1)67 authorize the Commission to assess civil money penalties against any person in any proceeding instituted pursuant to Exchange Act Section 15(b)(6) and Advisers Act Section 203(e) or (f). Such penalties may be assessed if the Commission finds that such person has willfully violated the Securities Act, the Exchange Act, or the Advisers Act, or has willfully aided, abetted, or counseled such a violation by any other person.68 In view of the fraudulent activities by Kenny and Nicholson/Kenny, we find the assessment of a civil money penalty to be in the public interest.69
Both Exchange Act Section 21B(b) and Advisers Act Section 203(i)(2) establish a three-tier system for determining the amount of civil penalty to be assessed.70 In cases where an act or omission (1) involved fraud, deceit, or manipulation, and (2) 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, a natural person may be assessed a maximum of $100,000 for each act or omission, and any other person may be assessed a maximum of $500,000 for each act or omission. Based on the misconduct discussed above, we find that Kenny should be assessed a civil penalty totaling $700,000. Nicholson/Kenny should be assessed a civil penalty totaling $500,000.
Kenny argues that he should not be required to pay civil penalties, or should be required to pay less than the penaltyimposed by the law judge, both because (he asserts) he and Nicholson/Kenny did not commit the violations charged and because they demonstrated inability to pay. We have already found that the violations were committed. We also find that Kenny did not demonstrate inability to pay.
Rule 410(c) of our Rules of Practice requires any person who files a petition for review that asserts inability to pay a penalty to file a sworn financial disclosure statement with his or her opening brief.71 Kenny did not comply with this rule. He thus failed to establish the inability he asserts.72
Kenny argues that a receiver for the Florida Department of Insurance brought an action in federal court against Kenny, Nicholson/Kenny, and others, alleging securities fraud on the basis of the same facts alleged in this proceeding. Because the court entered judgment in favor of all defendants in that action, Kenny argues, the doctrine of res judicata precludes the Division from seeking penalties now.73
Res judicata precludes parties or those in privity with them from relitigating certain issues in a subsequent proceeding.74 The Commission was not a party to the Florida action, nor in privity with a party. Thus, res judicata is inapplicable.75
Kenny notes that an NASD arbitration panel has ordered him to pay more than a million dollars to NFC, and he argues that assessing a civil penalty based on his dealings with NFC would be duplicative, unfair, and excessive, and would violate his constitutional right to be free from double jeopardy. The double jeopardy clause prohibits successive governmental criminal prosecutions and successive criminal punishments for the same conduct.76 The NASD is not a governmental agency and an arbitration is not a criminal prosecution, so the results of such an arbitration have no bearing on a double jeopardy analysis.77 Moreover, the civil penalties we assess here are not criminal punishments.78 In light of the seriousness of Kenny's misconduct, the penalties are in the public interest.79
* * * *
An appropriate order will issue.80
By the Commission (Chairman DONALDSON and Commissioners GLASSMAN, GOLDSCHMID, and CAMPOS); Commissioner ATKINS, concurring in part and dissenting in part.
Jonathan G. Katz
I concur in part but dissent as to the extent of the civil penalties, which I would impose in a lesser amount in light of the order for full disgorgement and the administrative record of the case.
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 47847 / May 14, 2003
INVESTMENT ADVISERS ACT OF 1940
Rel. No. 2128 / May 14, 2003
Admin. Proc. File No. 3-9611
In the Matter of
JOHN J. KENNY
ORDER IMPOSING SANCTIONS
On the basis of the Commission's opinion issued this day it is
ORDERED that John J. Kenny be, and he hereby is, barred from association with any broker, dealer, or investment adviser; and it is further
ORDERED that the investment adviser registration of Nicholson/Kenny Capital Management, Inc. be, and it hereby is, revoked; and it is further
ORDERED that John J. Kenny cease and desist from committing or causing any violations or future violations of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; and it is further
ORDERED that John J. Kenny and Nicholson/Kenny Capital Management, Inc. cease and desist from committing or causing any violations or future violations of Section 206 of the Investment Advisers Act of 1940; and it is further
ORDERED that John J. Kenny pay a civil money penalty of $700,000 and Nicholson/Kenny Capital Management, Inc. pay a civil money penalty of $500,000; and it is further
ORDERED that Kenny and Nicholson/Kenny Capital Management, Inc., jointly and severally, pay disgorgement in the amount of $1,333,000, together with prejudgment interest; and it is further
ORDERED that the Division of Enforcement submit a plan of disgorgement in accordance with Rule 610 of the Rules of Practice, 17 C.F.R. § 201.610, within 60 days of the date of this order; and it is further
ORDERED that Respondents shall, within 21 days of the entry of the Order, pay the civil money penalties and the disgorgement. Payment shall be: (i) made by United States postal money order, certified check, bank cashier's check, or bank money order; (ii) made payable to the Securities and Exchange Commission; (iii) delivered by hand or mailed to the Office of Financial Management, Securities and Exchange Commission, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and, (iv) submitted under cover letter which identifies the particular respondent's name as a respondent in these proceedings and the file number of this proceeding. A copy of this cover letter and check shall be sent to Polly A. Atkinson, Counsel for the Division of Enforcement, Securities and Exchange Commission, Central Regional Office, 1801 California Street, Suite 4800, Denver, Colorado 80202-2648.
By the Commission.
Jonathan G. Katz
|1||John J. Kenny, Initial Decision Rel. No. 147 (Aug. 6, 1999), 70 SEC Docket 1011.|
|2||15 U.S.C. § 77q(a).|
|3||15 U.S.C. § 78j(b).|
|4||17 C.F.R. § 240.10b-5.|
|5||In May 1997, Wilson pleaded guilty to charges of conspiracy to commit wire fraud in connection with the dealings with one of the insurance companies, United States Consumer Fund of Florida ("USEC-FL"), described below. United States v. Wilson, No. 97-189-CR-T-99(E) (M.D. Fl. May 20, 1997). In January 1998, Wilson pleaded guilty to charges of wire fraud and tax evasion arising out of conduct unrelated to the matters discussed in this opinion. He was sentenced to a 57-month prison term. United States v. Wilson, CR 97-177 (C.D. Cal. Jan. 15, 1998).|
|6||15 U.S.C. § 80b-6.|
|7||Respondents had been charged with violating Section 207 of the Advisers Act, 15 U.S.C. § 80b-7, by willfully omitting to state in Form ADV filed with the Commission a material fact required to be stated therein. The law judge found that the violation charged was not established. The issue was not appealed.|
|8||The branch manager of Dean Witter's St. Louis office testified that Dean Witter would not have approved the sending of such a letter because "there were known misuses of [such letters] by people making representations to potential clients or investors on a less than above board basis."|
|9||The Commission, federal financial institution supervisory agencies, and Canadian regulators have all issued alerts warning the public about the fraudulent nature of "prime bank" schemes. See Martin R. Kaiden, Exchange Act Rel. No. 41629 (July 20, 1999), 70 SEC Docket 439, 448 (listing agencies that have issued alerts). See also SEC v. Lauer, 52 F.3d 667, 670 (7th Cir. 1995) ("Prime Bank instruments do not exist.").|
|10||The investor had asked, "What degree of responsibility does Dean Witter take?" The promoter of the schemereplied that Dean Witter was not serving as underwriter or broker of the "deposit promissory note" to be issued by Earnscliffe, and that it would therefore not participate in pre-deposit correspondence. The promoter explained that he had therefore asked Dean Witter to provide a letter stating that Earnscliffe was "an account holder in good standing." Kenny's letter, using that wording, was enclosed with the promoter's letter to the investor.|
|11||In addition to objecting to the use of its name in promoting Earnscliffe's alleged program, Dean Witter also objected to "unauthorized references" to Dean Witter in a private placement memorandum for a "Structured Note Program" originated by Earnscliffe Trust. The record does not show that Kenny was aware of the particular uses of its name to which Dean Witter objected. Kenny admitted, however, that he knew both that Dean Witter had objected to Wilson's use of its name and that Dean Witter had initiated litigation in connection with that use.|
|12||Kenny testified that he was not asked to provide documents responsive to the subpoena. The branch officer at Dean Witter's St. Louis office testified, however, that in the normal course of business Dean Witter would have asked the account executive to provide materials from his or her files in order to comply with the subpoena.|
|13||Wilson proposed to pay NAT the strike price for the options, $1.96 (Canadian) per share. He also proposed to pay the options holders $2.20 per share, and to share the proceeds of his trading program with the options holders and NAT. At the time, NAT stock was trading at approximately $6.00 per share.|
|14||Parrott testified that he never fully understood Wilson's trading program, but that he was relatively unconcerned as long as the monthly statements showed that the account was increasing in value. He testified that the NAT account yielded nearly 100% return on investment between March 1993 and December 1993, when it was at Pauli & Co. In early 1994 the account was transferred to Johnson & Kent. Although NAT ultimately received $1.96 per share for each of the options, the options holders did not receive the $2.20 per share promised to them. When the options holders and NAT tried to recover their funds from Johnson & Kent, there was nothing in the account.|
|15||Wilson initially told Kenny that he had paid over $70 million for the bonds, but he admitted at his deposition that he never paid anything for them.|
|16||Kaufman had been introduced to Wilson by McClain. McClain and his family were close friends of Kaufman's stepdaughter.|
|17||It is undisputed that Kaufman always meant to refer to the same account.|
|18|| The $70,000 figure is apparently a typographical error. Had McClain deposited the $20,000 that Kaufman expected, the total deposited would have been $170,000.
It is not clear why the second letter referred to the purchase of "additional" shares of Tri-Northern Resources; the record does not show that Kaufman had previously earmarked funds for the purchase of such shares. Nor does the record explain Kaufman's apparent decision to use funds from the account for stock purchases rather than for the bond trading program, as originally planned.
|19||Wilson and his attorney, Samuel L. Boyd, repeatedly told Kaufman that Tri-Northern stock would be listed on an exchange.|
|20||The figure $175,000, unlike those used elsewhere in Kaufman's letters to Kenny, indicates only deposits by Kaufman and does not include the $20,000 that Kaufman expected McClain to deposit.|
|21||There was a $20,000 discrepancy between the "total" that Kaufman's letter mentioned and the amounts deposited that Kenny's letter specified. The discrepancy apparently reflects Kaufman's erroneous belief that McClain had deposited $20,000.|
|22||Kenny bought 22,000 shares of NAT at $4.16 a share for Kaufman's account on July 6 and another 1,500 shares at $3.38 on August 17. As of October 29, the price per share was $3.031.|
|23||Kenny stated that he told Kaufman in late October 1993 that Tri-Northern was not yet trading publicly.|
|24||Kaufman initiated arbitration against Pauli & Co. to recover the $205,000 he had deposited into the AKaccount. Kaufman was awarded $5,000.|
|25||See Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a); Section 10(b) of the Exchange Act, 15 U.S.C. § 78j; Exchange Act Rule 10b-5, 17 C.F.R. § 240.10b-5; and Section 206 of the Advisers Act, 15 U.S.C. § 80b-6.|
|26||SEC v. Monarch Funding Corp., 192 F.3d 295, 308 (2d Cir. 1999); SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1467 (2d Cir. 1996).|
|27||See Aaron v. S.E.C., 446 U.S. 680, 695, 697 (1980); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976); Steadman v. S.E.C., 603 F.2d 1126, 1134 (1979), aff'd, 450 U.S. 91 (1981); Scienter requirement in actions under antifraud provision of Investment Advisers Act, 133 A.L.R. Fed. 549 (and cases there cited).|
|28||Aaron v. S.E.C., 446 U.S. at 696; S.E.C. v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 196 (1963); Steadman, 603 F.2d at 1134.|
|29||See, e.g., Howard v. Everex Systems, Inc., 228 F.3d 1057, 1063 (9th Cir. 2000). Reckless conduct involves "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." Id.|
|30|| Kaufman's fourth letter stated, "This should total $225,000." The phrase "[t]his should total" is less precise than the phrase "the account should now total," which Kaufman used in his third letter, since "this should total" could mean "this should total $225,000 that I've now sent you." Even if Kenny interpreted Kaufman's letter as seeking confirmation of the amount sent, however, it was misleading to respond by referring simply to Kaufman's deposits while keeping silent about other activity in the account. As discussed infra, once Kenny undertook to answer Kaufman's letters, he was obligated to include information necessary to make his answers not misleading. By merely reviewing the amounts deposited into the account without mentioning the stock purchases, decline in value of securities purchased with money in the account, or amount transferred out of the account, Kenny failed to satisfy this obligation.
We note that Kenny did correct Kaufman's apparent erroneous belief that McClain had deposited $20,000 into the account.
|31|| See Kline v. First W. Gov't Sec., Inc., 24 F.3d 480,
490-91 (3d Cir. 1994) ("[W]hen a professional 'undertakes
the affirmative act of communicating or disseminating information,' there is a general obligation or 'duty' to speak truthfully . . . .[E]ncompassed within that general obligation is also an obligation or 'duty' to communicate any additional or qualifying information, then known, the absence of which would render misleading that which was communicated.") (quoting Rose v. Arkansas Valley Envtl. & Util. Auth., 562 F. Supp. 1180, 1207-08 (W.D. Mo. 1983)).
|32||Kenny asserts that the Division was required to demonstrate that Kaufman and another customer, Smith, relied on his statements. The Commission does not have to demonstrate reliance in an enforcement action. SEC v. Blavin, 760 F.2d 706, 711 (6th Cir. 1985); Martin R. Kaiden, Exchange Act Rel. No. 41629 (July 20, 1999), 70 SEC Docket 439, 451 n.34.|
|33||An omitted fact is material if there is "a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information available." TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).|
|34||We note that the failure to reveal Kaufman's interest in the account more clearly in the new account documents helped to disguise Wilson's and Kenny's activities from Pauli & Co. and Bear Stearns.|
|35||The president and CEO of Pauli & Co. testified that the firm was not even considering creating a bond trading program at that time.|
|36||According to Wilson, Tensiodyne would use x-ray technology to examine aircraft parts for corrosion and cracks.|
|37||Kenny argues that his alleged misrepresentations were not in connection with the purchase or sale of a security because the only bond transaction in the account was the sale of a $250,000 Treasury bond pursuant to Smith's instructions. Here, Smith opened his account to participate in a trading program involving purchasing and margining Treasury bonds. He authorized Kenny to use the funds only for that program. Kenny misled Smith by leading him to believe that he would use the proceeds from the sale of the Treasury bond for the bond trading program. Instead, Kenny purchased Tensiodyne stock for Smith's account. Thus, there were misrepresentations in connection with the purchase and sale of specific securities.|
|38||Kenny testified that Wilson or McClain told Smith to write the letter. The law judge, however, credited Smith's testimony.|
|39||In addition to the approximately $300,000 in assets that were transferred from Smith's account at Pauli & Co. to the Boyd trust account, Smith lost $50,000 in his attempt to buy Tensiodyne shares directly from Wilson. Smith ultimately received a check for $25,000 from a Wilson employee, but the record does not establish its purpose.|
|40||The record does not explain how it could make sense from Wilson's point of view for him to put up collateral in the form of Treasury instruments valued at 120% of the loan amount in order to borrow funds for his investment program rather than simply investing the "collateral" in the program.|
|41||Tullis explained that it would be easier for an auditorto see NFC's assets reflected on a single brokerage statement than to have to review loan documentation and collateral.|
|42||See supra pp. 29-30.|
|43||By this time, $8 million had been wired from NFC's account at Pauli & Co. into Boyd's trust account.|
|44|| Between July 22, 1994 and October 26, 1994, Kenny carried out NFC's instructions to withdraw more than $9 million from Pauli & Co. and transferred the money to Boyd's trust account at NationsBank. Although NFC believed that these funds were being used in Wilson's bond trading program, Wilson misappropriated all the money, putting it to various uses that did not benefit NFC.
NFC went to arbitration to recover the funds lost through its involvement with Wilson. NFC was awarded more than $1.7 million, to be paid by Kenny and others, including Bear Stearns and Pauli & Co. NFC was also awarded $650,000 in punitive damages, of which $550,000 was to be paid by Kenny. The award was affirmed by court order. Euro American Ins. v. National Family Care, No. 95-11063-J (Tex. Dist. Ct. June 2, 1999); final judgment entered, (Tex. Dist. Ct. Aug. 30, 2000); appeal dismissed as to Kenny, No. 05-00-01994-CV (Tex. App. Feb. 28, 2002).
|45||Nicholson/Kenny is a wholly owned subsidiary of Kenny Capital Management, which, in turn, is wholly owned by Kenny and his wife. Kenny Capital Management also owns Kenny Securities Corp., a sister corporation to Nicholson/Kenny.|
|46|| Graham v. SEC, 222 F.3d 994, 1000 (D.C. Cir. 2000); Armstrong v. McAlpin, 699 F.2d 79, 91 (2d Cir. 1983); Richard D. Chema, 53 S.E.C. 1049, 1055-56 (1998); Adrian C. Havill, 53 S.E.C. 1060, 1065 (1998); Donald T. Sheldon, 51 S.E.C. 59, 66 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995).
A finding that a respondent willfully aided and abetted violations of the securities laws necessarily makes that respondent a "cause" of those violations. See, e.g., Sharon M. Graham, 53 S.E.C. 1072, 1085 n.35 (1998), aff'd, 222 F.3d 994 (D.C. Cir. 2000); Dominick & Dominick, Inc., 50 S.E.C. 571, 578 n.11 (1991). As noted above, to conclude that a respondent aided and abetted another's violations, it must be found that the respondent acted with scienter. A respondent is a "cause" of another's violation if the respondent "knew or should have known" that his or her act or omission would contribute to such violation. Exchange Act Section 21C(a), 15 U.S.C. § 78u-3(a).
|47||The state of Florida took over USEC-FL in 1995.|
|48||The hearing transcript repeatedly refers to the "securities" in the USEC-FL account, although the only security held in the account during January 1995 was the $7 million U.S. Treasury note discussed above.|
|49||The total apparently represented $3.4 million as security for USEC-FL's $3.4 million deposit and $5 million for the purchase of USEC-FL's surplus debenture and delinquent receivables. See supra p. 34.|
|50||USECA subsequently lost additional funds through its involvement with Wilson. In March 1995, when USEC-FL no longer had an account at Pauli & Co., USECA sent Wilson $1.1 million in securities so that Wilson could pay the state of Florida $1.1 million; if USECA had cashed the securities in order to pay the state, it would have lost $100,000 on the investment. Wilson, however, did not pay the state, and USEC-FL lost the entire $1.1 million.|
|51||15 U.S.C. § 80b-6(1).|
|52||15 U.S.C. § 80b-6(2).|
|53||SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191-92, 194 (1963).|
|54||An associated person may be charged as a primary violator under Section 206 where the activities of the associated person cause him or her to meet the broad definition of "investment adviser." For example, courts have found that an associated person is liable under Section 206 where the investment adviser is an alter ego of the associated person or is controlled by the associated person. See, e.g., SEC v. Berger, 2001 U.S. Dist. LEXIS 18448, at *28 (S.D.N.Y. Nov. 13, 2001) (finding associated person liable under §§ 206(1) and (2) based on control of investment adviser), aff'd on other grounds, 2003 U.S. App. LEXIS 3562 (2d Cir. Feb. 27, 2003); SEC v. Gotchy, 981 F.2d 1251 (4th Cir. 1992) (unpublished table decision) (finding president and half-owner of investment adviser liable under §§ 206(1) and (2)).|
|55|| On June 29, 2001, counsel for Respondents filed a motion to supplement the record. The motion seeks leave to adduce two arbitration awards in which Kaufman and Smith respectively were claimants; a settlement agreement and related order of dismissal with prejudice between Wilson, Boyd, McClain, and several Wilson-related entities on the one hand and NFC, Sandra Erwin, and several other parties on the other hand; a federal district court order in a case brought by the Commission against Gary Long, a Wilson associate, and others; and a brief filed by Kenny in state court contesting the confirmation of an arbitration award against Kenny in favor of NFC.
On September 23, 2002, counsel for Respondents filed a second motion to supplement, this time seeking to adduce material from the Central Registration Depository ("CRD") related to Kenny's disciplinary history; a release and settlement agreement between the Florida Department of Insurance as receiver for USEC-FL, with an accompanyingorder approving the release and settlement agreement; and an opinion and order dismissing Kenny's appeal of a Texas District Court judgment affirming an arbitration award among Kenny and others, see supra n. 44, with related documents, including a settlement agreement.
Rule 452 of our Rules of Practice, 17 C.F.R. § 201.452, provides, in relevant part, that the Commission may allow the submission of additional evidence upon the motion of a party. Such a motion must "show with particularity that such additional evidence is material and that there were reasonable grounds for failure to adduce such evidence previously." Id.
Respondents have not shown that there were reasonable grounds for failure to adduce the arbitration awards or the CRD record of Kenny's pre-hearing disciplinary history previously. The awards were mailed to counsel months before the law judge issued his decision, and the CRD material was readily available. Respondents have not shown why this evidence could not have been adduced before the initial finder of fact. We therefore decline to consider the arbitration awards and the CRD material related to Kenny's disciplinary record up to the date of the hearing.
We decline to allow the submission of the settlement agreements and related materials because they are not material. Neither the record nor the proposed new evidence shows why the parties settled the claims in question. The fact of settlement is not material to the question of Kenny's liability. Moreover, others' decisions to settle their civil cases do not affect our responsibility to conduct this proceeding in the public interest.
The district court order in the case brought against Long is also immaterial. The order reflects that a default judgment was entered against Long, but that the relief sought was denied due to an inadvertent failure to provide supporting evidence in a timely fashion. This says nothing material about Respondents' liability, or about the propriety of sanctions against them.
Kenny's brief contesting the confirmation of the arbitration award also is immaterial. We have no authority to reviewthe actions of the arbitration panel.
Finally, the material from the CRD is immaterial insofar as it reflects Kenny's recent disciplinary record. The knowledge that a disciplinary proceeding is pending may lead one to take special care in conducting business; this is not a reliable indicator that the same care will be taken in the future.
For these reasons, Respondents' first two motions to supplement the record are denied.
In a third motion to supplement, filed after oral argument, Respondents made additional arguments based on other proceedings involving Kenny, sought to introduce materials related to those proceedings, and asked the Commission to sanction counsel for the Division of Enforcement for alleged misstatements made at oral argument. The materials in question are irrelevant, immaterial, and/or duplicative. We therefore deny the third motion to supplement. Further, we see no reason to sanction Division counsel for the conduct about which Respondents complain, and we therefore deny the motion for sanctions as well.
|56||Butz v. Glover Livestock Comm'n Co., 411 U.S. 182, 187-88 (1973); accord, Valicenti Advisory Servs., Inc. v. SEC, 198 F.3d 62, 66 (2d Cir. 2000) (amended opinion) (courts will affirm sanctions imposed unless they are either unwarranted in law or without justification in fact) (citation omitted).|
|57||15 U.S.C. § 78o(b)(6)(A)(i).|
|58||15 U.S.C. § 80b-6(3)(e), (f).|
|59||Donald T. Sheldon, 51 S.E.C. at 86 (quoting Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981)).|
|60||SEC v. First City Financial Corp., 890 F.2d 1215, 1230 (D.C. Cir. 1989); SEC v. Tome, 833 F.2d 1086, 1096 (2d Cir. 1987); Hibbard, Brown & Co., 52 S.E.C. 170, 183 n. 64 (1995).|
|61||On September 9, 1994, $25,000 was transferred to Kenny from Boyd's trust account at NationsBank. On October 21, 1994, $913,000 was wired from the Boyd account to Robert Nicholson as Kenny's payment to acquire the Nicholson Group. An additional $115,000 was wired from the Boyd account to Kenny Capital Management in February 1995. Finally, in January and February 1995, $280,000 was wired from a DGA account to the Kennys.|
|62||15 U.S.C. §§ 77h-1, 78u-3, 80b-3(k).|
|63||KPMG Peat Marwick LLP, Exchange Act Rel. No. 43862 (Jan. 19, 2001), 74 S.E.C. Docket 384, 435, petition for review denied, 289 F.3d 109 (D.C. Cir. 2002).|
|64||See supra p. 49.|
|65||Id., 74 S.E.C. Docket at 436.|
|66||Although we have revoked Nicholson/Kenny's registration, see supra p. 44, we nonetheless find the imposition of a cease-and-desist order in the public interest, since the order would apply should Nicholson/Kenny improperly act as an unregistered investment adviser in the future and to prevent Nicholson/Kenny from causing another person's violation of the securities laws.|
|67||15 U.S.C. §§ 78u-2(a), 80b-3(i)(1).|
|68||Section 21B(b) of the Exchange Act, 15 U.S.C. § 78u-2(b); Section 203(i)(1) of the Advisers Act, 15 U.S.C. § 80b-3(i)(1).|
|69|| In considering whether a penalty is in the publicinterest, we consider:
(1) whether the act or omission for which such penalty is assessed involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement;
(2) the harm to other persons resulting either directly or indirectly from such act or omission;
(3) the extent to which any person was unjustly enriched, taking into account any restitution made to persons injured by such behavior;
(4) whether such person previously has been found by the Commission, another appropriate regulatory agency, or a self-regulatory organization to have violated the Federal securities laws, State securities laws, or the rules of a self-regulatory organization, has been enjoined by a court of competent jurisdiction from violations of such laws or rules, or has been convicted by a court of competent jurisdiction of violations of such laws or of [certain felonies or misdemeanors];
(5) the need to deter such person and other persons from committing such acts or omissions; and
(6) such other matters as justice may require.
Exchange Act Section 21B(c), 15 U.S.C. § 78u-2(c); Advisers Act Section 203(i)(3), 15 U.S.C. § 80b-3(i)(3).
|70||15 U.S.C. §§ 78u-2(b), 80b-3(i)(2).|
|71||17 C.F.R. § 201.410(c).|
|72|| Kenny did submit financial information at the hearing. The financial statements he submitted were not sworn, and an accountants' report attached to financial statements submitted on behalf of Nicholson/Kenny noted departures from generally accepted accounting principles. Additionally, the validity of Kenny's asserted $1.3 million debt to a Wilson entity, a sum that represents more than 50% of his asserted liabilities, appears highly questionable since, as discussed above, the note was not executed until 1995, no collateral was posted, and no payments were made.
After oral argument was held, Kenny submitted additional materials purporting to reflect a current inability to pay a penalty. The Division objects and expresses doubt about the accuracy and completeness of the financial statements. By failing to comply with Rule 410(c) by filing a sworn financial statement with his opening brief, Kenny waived his opportunity to assert inability to pay in this proceeding. Moreover, Kenny has not established that these materials should be admitted under Rule 452 because he has not demonstrated that there were reasonable grounds for his failure to file sworn financial statements at a time the Division could have responded to, and the Commission could have evaluated, the statements more thoroughly. We note, however, that nothing precludes Kenny's seeking to prove inability to pay if an attempt is made to enforce the disgorgement order against him.
|73||Kenny does not assert that res judicata applies to the determination of issues of liability in this proceeding.|
|74||E.g., SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1463 (2d Cir. 1996).|
|75||We further find that Kenny waived the defense of res judicata by failing to assert it in his answer. Rule 220(c) of the Rules of Practice, 17 C.F.R. § 201.220(c).|
|76||U.S. Const. amend. V. See also Hudson v. United States, 522 U.S. 93, 98-99 (1997) (reaffirming traditional rule that double jeopardy clause prohibits multiple sanctions for same offense only if those sanctions are criminal punishment).|
|77||See Jones v. SEC, 115 F.3d 1173, 1183 (4th Cir. 1997) (double jeopardy clause not applicable where sanctions were imposed first in NASD disciplinary proceeding, then in Commission administrative proceeding, in part because "the NASD is a private party and not a governmental agent").|
|78||See, e.g., SEC v. Palmisano, 135 F.3d 860, 864-66 (2d Cir. 1998) (civil penalty assessed in Commission enforcement action not a criminal punishment).|
|79|| On October 1, 2001, Respondents filed a motion asking us to "vacate" this proceeding summarily as a sanction imposed pursuant to Rule 180(a) of the Rules of Practice, 17 C.F.R. § 201.180(a), on the ground that the Division allegedly made numerous misrepresentations during the hearing. Rule 180(a) provides:
Contemptuous conduct by any person before the Commission or a hearing officer during any proceeding, including any conference, shall be grounds for the Commission or the hearing officer to: (i) exclude that person from such hearing or conference, or any portion thereof, and/or (ii) summarily suspend that person from representing others in the proceeding in which such conduct occurred for the duration, or any portion, of the proceeding.
The statements to which Respondents object are in many cases arguments by counsel; they are not misrepresentations and were not improper conduct. Moreover, the rule is intended to ensure that hearings and conferences proceed in an orderly fashion. The sanctions provided for by the rule are designed to be imposed at the time of the conduct, so that the proceeding may continue without improper conduct. Invoking the rule long after the conclusion of the hearing at which the allegedly contemptuous conduct occurred makes no sense. In addition, the sanction sought is not within the scope of the rule. The motion for sanctions is thus denied, as is the motion for leave to supplement Respondents' brief to include additional instances of allegedly improper behavior.
|80||We have considered all of the parties' contentions. We have rejected or sustained them to the extent that theyare inconsistent or in accord with the views expressed in this opinion.|
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