SECURITIES AND EXCHANGE COMMISSION
In the Matter of
TERENCE MICHAEL COXON
WORLD MONEY MANAGERS
OPINION OF THE COMMISSION
INVESTMENT ADVISER PROCEEDING
INVESTMENT COMPANY PROCEEDING
Grounds for Remedial Action
Violations of Prohibitions against using Investment Company Funds for Distribution
Violation of Investment Company Governance Provisions
Investment adviser to an investment company, adviser's general partner, and consultant to the adviser violated, aided and abetted, and were causes of violations of antifraud provisions and provisions governing affiliation of directors, use of portfolio funds for distribution, fund investment policies, and of transactions among affiliates. Held, it is in the public interest to order adviser and general partner to cease and desist from committing or causing any violations or any future violations of the provisions that they violated and to pay disgorgement, plus prejudgment interest, and to dismiss proceeding as to consultant.
John W. Cotton, of Cotton & Gundzik LLP, for Terence Michael Coxon and World Money Mangers. 1
Robert A. Graham, Jr., of Adams, Hawekotte & Adams, for Alan Michael Sergy.
Valerie Caproni, John S. Yun, and Sheila E. O'Callaghan, for the Division of Enforcement.
Appeal filed: April 21, 1999
Last brief received: March 22, 2000
Oral argument: June 25, 2003
World Money Managers, a California limited partnership and a registered investment adviser ("WMM"), Terence Michael Coxon, one of two WMM general partners, 2 and Alan Michael Sergy, a former WMM consultant and a WMM limited partner and special limited partner, appeal from the decision of an administrative law judge. The Division of Enforcement appeals with respect to the sanctions imposed on WMM and Coxon.
The law judge found that (a) WMM violated, and Coxon and Sergy willfully aided and abetted and were causes of violations of, Section 206(2) of the Investment Advisers Act of 1940; 3 (b) Coxon and Sergy willfully violated Section 34(b) of the Investment Company Act of 1940 ("IC Act"); 4 (c) WMM, Coxon, and Sergy willfully violated Section 17(a) of the Securities Act of 1933, 5 Section 10(b) of the Securities Exchange Act of 1934, and Exchange Act Rule 10b-5; 6 and (d) WMM, Coxon, and Sergy willfully aided and abetted and were causes of violations of IC Act Sections 10(b)(2), 12(b), 13(a)(3), and 17(d) and IC Act Rules 12b-1 and 17d-1. 7
The law judge suspended WMM as an investment adviser for three months and ordered it to pay a $100,000 civil penalty. The law judge suspended Coxon and Sergy from association for three months with an investment adviser or with an investment company and imposed on each of them civil penalties of $20,000. The law judge ordered WMM, Coxon, and Sergy to cease and desist from committing or causing any violations or any future violations of Advisers Act Section 206(2), Securities Act Section 17(a), Exchange Act Section 10(b), Exchange Act Rule 10b-5, IC Act Sections 10(b), 12(b), 13(a)(3), 17(d), and 34(b), and IC Act Rules 12b-1 and 17d-1. WMM, Coxon, and Sergy were ordered to disgorge $1,608,018, plus prejudgment interest of $1,236,726. We base our findings on an independent review of the record, except for those findings not challenged on review.
A. Background. In the early 1980's, Coxon founded the Permanent Portfolio Family of Funds, Inc. ("Fund"), a Maryland corporation and open-end investment company. Initially the Fund consisted of a single portfolio -- the Permanent Portfolio, whose investment policy was based on economic theories propounded by Coxon and Harry Browne. 8 Coxon planned to market the Permanent Portfolio to adherents of Browne's economic philosophy (a group that some witnesses described as "hard money" or "alternative" investors) through direct-mail marketing.
In the early 1980's, Sergy began to work with Coxon on a part-time basis. By the mid-1980's, Sergy was a paid, full-time WMM consultant. Coxon is president and a director of the Fund. Until 1998, Sergy was the secretary-treasurer and a director of the Fund. 9
This proceeding involves a series of actions and transactions by WMM, Coxon, and Sergy that had the effect of using assets of the Permanent Portfolio to benefit other entities. As described below, a number of these actions relatedto efforts to market other portfolios offered by the Fund. Others involved the use of Fund assets to pay for various transactions that disadvantaged the Fund or benefitted Respondents.
B. WMM's Relationship to the Fund. Coxon formed WMM to organize, promote, and advise the Fund. In 1988, WMM and the Fund entered into an Investment Advisory and Marketing Contract ("Advisory Contract"). Under the Advisory Contract, the Fund paid WMM an advisory fee of 7/8 of 1% on the first $200 million of average daily net assets. 10 The Advisory Contract also included the Fund's written 12b-1 plan, 11 which provided that the Fund would use a portion of its assets to pay "promotional, marketing, advertising, and other expenses incurred" in the Fund's distribution.
The Fund's prospectus, dated May 31, 1989, represented that, under the Advisory Contract, WMM agreed to reimburse the Fund "for all [the Fund's] ordinary operating expenses," with certain exceptions not at issue here. The Fund's prospectus continued, "[w]hile the advisory fee is higher than the fees of other mutual funds, [WMM] absorbs substantially all of the Fund's ordinary operating expenses." The prospectus gave as examples of ordinary operating expenses "charges by the Fund's transfer agent, charges by the Fund's custodian, accounting fees, auditing and legal fees not associated with registration or litigation, officer's [sic] salaries and expenses, rent and occupancy, printing, postage and general administrative expense."
In spite of this statement, during 1989, WMM sought reimbursement for transfer agent, accounting, and auditing expenses from the Fund's 12b-1 plan. During Ernst & Young's audit of the Fund's fiscal year ending January 31, 1990, Michael Cuggino, then a senior audit manager with Ernst & Young, became concerned about the appropriateness of charging these expenses to the Fund's 12b-1 plan. 12 The engagement partner directedCuggino to inform Sergy that charging transfer agent, accounting, and auditing expenses to the 12b-1 plan was "aggressive" and could cause "exposure" for the Fund.
Sergy discussed the auditors' concerns with Coxon. Sergy and Coxon did not change their practice of seeking reimbursement for these fees under the 12b-1 plan. Neither Sergy nor Coxon informed the independent directors of the Fund about the auditors' warning, nor did the Fund disclose in its prospectus that it was reimbursing WMM for these expenses.
The Fund's prospectus dated May 31, 1990 again asserted that WMM would, in return for its higher advisory fees, pay the Fund's ordinary operating expenses. However, during the Fund's fiscal year ending January 31, 1991, WMM charged the Permanent Portfolio as 12b-1 plan distribution expenses: $224,872 in transfer agent fees; $38,661 for the Fund and WMM's accounting fees; $13,424 in custodial fees; the costs of printing and mailing the semiannual report and the annual report to existing shareholders; and Coxon's and Sergy's travel expenses to attend certain board meetings. The Fund, through the 12b-1 plan account, also paid consulting fees to both Coxon and Sergy in addition to WMM's advisory fee. However, in its May 31, 1991 Statement of Additional Information ("SAI"), the Fund represented that, during the fiscal year ending January 31, 1991, the Permanent Portfolio incurred distribution expenses of $215,650 under the 12b-1 plan. The SAI claimed that Fund had spent this money for "advertising" and "printing and mailing of prospectuses to other than current shareholders."
C. The Goal of Expanding the Fund's New Portfolios and the Capitalization of WMS.
WMM's asset-based advisory fees and its receipt of certain asset-based distribution fees were based on the size of the Fund. During the period at issue, however, the value of the Permanent Portfolio, the Fund's original component, was declining. From a June 1988 peak of $103 million, the Permanent Portfolio's net asset value declined to $96.6 million in December 1989. The Permanent Portfolio's overall average net asset value for the 1989 calendar year was $94.8 million. During 1988 and 1989, thenet asset value of a second, new portfolio, the Treasury Bill Portfolio, increased from $6.4 million to $53.9 million. As a result, the fees that WMM received from the Permanent Portfolio stagnated or declined while fees from the Treasury Bill Portfolio rose.
Respondents sought to expand the assets of the Treasury Bill Portfolio and a new Aggressive Growth Portfolio by increasing marketing. Respondents wanted to undertake a direct mail solicitation to 200,000 recipients, which would cost $1 per solicitation. Under the Fund's 12b-1 plan, each portfolio was responsible for paying distribution expenses "allocable" to that portfolio, i.e., the costs to promote a particular portfolio could be charged solely to that portfolio. Neither the Treasury Bill Portfolio nor the Aggressive Portfolio generated sufficient 12b-1 fees to pay for the projected direct mailing. 13
WMM had been paying the distribution expenses for all the Fund's portfolios. The parties dispute both whether WMM's financial situation was poor and whether WMM could afford to finance the proposed direct-mail solicitations without another source of funds. We conclude that WMM was not in good financial condition. 14 WMM's audited financial statements for the fiscalyear ending December 31, 1988 reported that WMM had incurred a net operating loss of $131,911.34.
As part of a plan to make increased marketing efforts possible, Coxon in 1989 proposed that the Permanent Portfolio create a broker-dealer subsidiary. The Fund's 1989 proxy statement represented that the proposed subsidiary would save the Permanent Portfolio money by, among other things, executing orders to purchase and sell securities for the Permanent Portfolio and participating in primary or secondary offerings of securities to be purchased by the Fund and other investors. The proxy statement further represented that the Permanent Portfolio's capital contribution would be "limited to those [amounts] reasonably necessary to cover [the broker-dealer's] organizational expenses and provide it with working capital."
In July 1989, after receiving shareholder approval, the Fund's Board approved capitalization of the new broker-dealer subsidiary, called Permanent Portfolio Brokerage, Inc. ("PPB"). The Board approved a $950,000 investment in PPB by the Permanent Portfolio, although at the meeting, Sergy estimated that the broker-dealer's organizational costs and initial operations would be approximately $72,000. 15 Coxon testified that he chose the $950,000 amount as small enough not to cause concern among the Permanent Portfolio's shareholders but sufficient to finance at least two direct mailings.
In December 1989, WMM donated its wholly-owned broker-dealer, WMS, to the Fund's Permanent Portfolio. In January 1990, the Fund's Board merged PPB into WMS to take advantage of WMS' pre-existing registrations. Sergy and Coxon were elected to WMS' board. Sergy became WMS' president, and Coxon was elected WMS' secretary. 16 WMS became the Fund's underwriter. Coxon and Sergy did not disclose to the Fund's independent directors that WMS could not participate in underwriting securities (other than shares of mutual funds) because WMS was subject to a restriction letter by the National Association of Securities Dealers, Inc.("NASD"), and WMS did not have a limited principal - financial and operations ("FINOP"). 17
D. WMS' Operations. On February 1, 1990, the Fund, its adviser (WMM), and its underwriter (WMS), entered into an agreement under which WMS agreed to distribute Treasury Bill Portfolio and Aggressive Growth Portfolio shares ("Selling Agreement"). 18 The 1990 Selling Agreement required WMS to advance up to $200,000 in printing and mailing costs for the direct mail marketing of these portfolios. WMS was to receive "trailing" commissions over a 6-1/2-year period on the value of additional portfolio shares attributable to the marketing program, but those commissions were to be paid only once a year, 75 days after the end of each calendar year. Coxon and Sergy testified that they did not know of any other broker-dealer willing to pay $200,000 in printing costs in exchange for trailing commissions. Sergy also admitted that he did not know of any broker-dealer that would wait 75 days after the end of a calendar year for payment of trailing commissions. 19
On March 18, 1991, the Fund Board approved the renewal and amendment of the Selling Agreement. Under the 1991 Selling Agreement, WMS agreed to incur another $200,0000 in printing costs under the same terms as set forth in the 1990 Selling Agreement. WMS paid $182,005 in costs under the 1990 Selling Agreement, and $154,566 under the 1991 Selling Agreement. 20 WMS received $232,000 in trailing commissions from the 1990 Selling Agreement and $69,510 from the 1991 Selling Agreement, for a total of $289,294. 21
E. The Symantec Transaction. In the 1980's and early 1990's, Coxon also individually provided advisory services. Andrew Layman, a software engineer, was one of Coxon's individual clients. Layman had acquired a substantial number of shares of Symantec Corp. common stock. Coxon recommended that Layman sell to a third-party the right to purchase 22,500 of his shares of Symantec in order to generate income while deferring taxes. 22
The Fund's prospectus stated that, as part of the Permanent Portfolio's fundamental investment policy, the portfolio would invest in stock and stock warrants. At the Fund's January 27, 1990 Board meeting, Coxon recommended that the Board approve the Permanent Portfolio's acquisition of a right to purchase Symantec stock from Coxon's client, Layman. In the minutes of the Board meeting and in a letter to independent director Martin, sent in advance of the meeting, Coxon described the instrument as a "15-year, long-term, deep-in-the-money call option." The Fund's Board approved the transaction at this meeting, but did not review a copy of the actual agreement between Layman and the Fund.
The parties did not execute the Symantec contract until April 1990. 23 Coxon signed the Symantec agreement on behalf ofthe Fund. The executed agreement included a so-called "Right of Prevention" provision. Under the Right of Prevention provision, if the Permanent Portfolio exercised its right to receive Symantec stock, Layman had seven days after receiving notice to determine whether to deliver the Symantec shares or cash. While Respondents note that the Fund's Board approved the Symantec agreement, the Board did not approve the Right of Prevention provision in that contract, and independent director Martin testified that he was not aware of the Right of Prevention or Layman's ability to settle the transaction in cash until several years after the Board's vote.
F. The WMM and WMS Leases. As discussed earlier, the Fund's 1989 and 1990 prospectuses represented that, in return for its higher-than-normal advisory fee, WMM would pay, among other things, for the Fund's "rent and occupancy." In May 1991, WMS and WMM executed two leases covering a single, new office suite from a third-party landlord. 24 WMS' lease covered three of the offices in the suite and the suite's common area for a base rent of $2326 per month. WMM leased the portion of the suite that included Coxon's office and a conference room, for which WMM paid a base rent of $1800 per month.
WMS subleased its three offices to Sergy, Richard Rolnick, the Fund's and WMM's in-house counsel, and Michael Cuggino, who had become the Fund's treasurer. 25 After deducting thepayments under the subleases, WMS paid $1226 per month for its share of the suite.
Sergy, at Coxon's direction, signed the lease and subleases, including his own, on behalf of WMS. While Sergy occupied the WMS space, he also acted as a director and officer of the Fund, a paid consultant to WMM, an officer of Bullion Security Corporation, and operated an individual advisory business. Nevertheless, no other WMM-affiliated entity contributed to WMS' share of the rent. WMS paid for all of the suite's common area although that space was used by all of the suite's tenants and subtenants. 26
G. The Passport Transaction. In 1993, in connection with a proposed underwriting agreement, 27 WMS agreed to pay up to $40,000 in offering expenses to Passport Financial, Inc., a wholly-owned subsidiary of WMM. 28 Under the proposed agreement, WMS would be reimbursed for its advance if the underwriting were successful. If the underwriting failed, however, WMM would reimburse WMS for only half of the advanced expenses. 29
While Coxon claimed that WMS would earn a 6% commission that could total $240,000 and would demonstrate its skill at direct-mail marketing in the Passport transaction, it appears unlikely that WMS would have received those commissions. Respondents planned to have WMS enter into Selected Dealer Selling Agreements with selling broker-dealers. Those proposed agreements would have required WMS to pay the selling brokers a 5% commission, leaving WMS with the balance, or a 1% commission. The draft selling agreements did not require the selling brokers to advance costs. 30
WMS advanced Passport more than $39,011. Coxon testified that Passport used the funds "chiefly for legal, accounting, and filing fees." Passport filed a Regulation A offering statement with the Commission. Subsequently, Commission staff informed Coxon that they would not process the offering until this proceeding was resolved. WMM did not repay WMS $20,289 of the $39,011 that WMS had advanced for the offering.
A. Violations with Respect to the Creation of WMS and Execution of the Selling Agreements.
1. Advisers Act Section 206(2) makes it unlawful for an 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." Section 206(2) imposes on an investment adviser as a fiduciary "an affirmative duty of 'utmost good faith, and full and fair disclosure of all material facts,' as well as an affirmative obligation 'to employ reasonable care to avoid misleading his clients.'" 31
WMM, through Coxon and Sergy, engaged in self-dealing and failed to disclose material facts in willful violation of Advisers Act 206(2). WMM, which operated and advised the Fund, recommended that the Permanent Portfolio invest its funds in a broker-dealer. WMM claimed that Permanent Portfolio could save brokerage costs with its own broker-dealer. Instead, the broker-dealer used the Permanent Portfolio's moneys to market the Treasury Bill Portfolio and the Aggressive Growth Portfolio. These activities also were contrary to the terms of the Fund's 12b-1 plan, which provided that no portfolio of the Fund would be responsible for paying the distribution costs of any other portfolio. The marketing did not benefit the Permanent Portfolio's shareholders, but had the potential to increase the net asset value of the Fund and consequently WMM's fees. It also relieved WMM of the burden of marketing the Fund.
Coxon and Sergy aided and abetted and were causes of WMM's violations. 32 Coxon originated the idea of funding a broker-dealer, and, according to Sergy, Coxon and Sergy collaborated on the idea that the broker-dealer should be owned by the Permanent Portfolio. Coxon and Sergy prepared and/or reviewed the 1989 Fund's proxy statement. The proxy did not disclose that the broker-dealer subsidiary would use substantial funds to promote and distribute shares of two other Fund portfolios. This omission was significant because the proxy statement, which also sought approval of the Fund's 12b-1 plan, stated that no Fund portfolio would be required to pay distribution expenses of another portfolio. 33
Coxon and Sergy together convinced the independent directors to authorize the Permanent Portfolio to contribute $950,000 to the broker-dealer. The proxy statement represented that the Permanent Portfolio would capitalize its broker-dealer subsidiary "in amounts limited to those reasonably necessary to cover" organizational expenses and working capital. The Permanent Portfolio's contribution was far in excess of the $72,000 that Sergy estimated was necessary for those costs. Coxon admitted that he chose to capitalize WMS at $950,000 because that amount was sufficient to undertake direct-mail solicitations, but not so large as to result in objections from the Permanent Portfolio's shareholders.
The 1989 proxy statement also represented that the proposed broker-dealer subsidiary would participate in underwritings. Respondents did not inform the independent directors that WMS could not participate in underwritings of corporate securities because it was subject to the NASD restriction letter or that Sergy had tried unsuccessfully to have that restriction lifted. Sergy, as WMS' president, failed to inform the directors that WMS did not have a FINOP, which would have been required for underwritings. Respondents also did not correct the proxy disclosure to the shareholders.
Respondents induced the Board's independent directors to authorize the Selling Agreements among the Fund, WMS, and WMM. The Selling Agreements benefitted WMM to the detriment of the Permanent Portfolio's shareholders. WMM earlier had paid the Fund's distribution costs but could no longer afford to do so. WMM used WMS' funds (which had come from Permanent Portfolio shareholders) to market the Treasury Bill Portfolio and Aggressive Growth Portfolio. When asked by Martin if the 1990 Selling Agreement contravened the Fund's 12b-1 plan's requirement that each portfolio would pay its own distribution costs, Coxon misrepresented that the Selling Agreement did not.
Through the Selling Agreements, WMM decreased its expenses and, if the solicitations were successful, stood to receive greater advisory fees. While WMS would receive trailing commissions in return, payment was spread over 6-1/2 years and payable only once a year. If the Treasury Bill Portfolio or Aggressive Growth Portfolio investors liquidated their positions, WMS was at risk of receiving substantially diminished commissions. Martin testified that, after interest rates declined, many Treasury Bill Portfolio investors did redeem their shares, substantially reducing WMS' commissions. Respondents negotiated conditions in the Selling Agreement that they knew no other broker-dealer would agree to: advancing marketing costs inreturn for trailing commissions and then delaying payment of those commissions until 75 days after the end of each year. They did not inform the Fund's independent directors that these conditions would not be acceptable to independent, third-party broker-dealers. Coxon and Sergy's repeated disregard of previous representations and their misrepresentations and omissions of material of facts are at least reckless.
2. Violations of Self-Dealing Provisions. IC Act Section 17(d) and IC Act Rule 17d-1 make it unlawful, absent a Commission exemptive order, for any affiliated person of an investment company (or a person who is affiliated with the affiliate) to engage in a transaction in which the investment company or a company controlled by it is a joint or several participant. Section 17(d) "seeks to protect investment companies and their shareholders from overreaching and self-dealing by affiliated persons." 34 Section 17(d) further attempts "to prevent affiliated persons from injuring the interests of stockholders of registered investment companies by causing the company to participate 'on a basis different from or less advantageous than such other participant.'" 35
The Selling Agreements were executed by the Fund, WMM (an affiliate of the Fund), and WMS (which was controlled by the Fund's Permanent Portfolio). The Fund did not seek an exemption from the Commission. 36 As described above, these agreements imposed unfavorable terms on WMS, an asset of the Permanent Portfolio. As a result of WMS' expenditures, WMM received increased advisory fees from the Treasury Bill Portfolio. WMMalso avoided expenses that it was obligated to pay. Coxon and Sergy urged the Board to approve the transactions, although they were aware that an unaffiliated third-party would not agree to advance funds or agree to receive trailing commissions only once a year. 37 Coxon executed the Selling Agreements on behalf of WMM, and Sergy executed the agreement on behalf of WMS. 38 Based on the foregoing, we find that WMM willfully violated, and Coxon and Sergy willfully aided and abetted and were causes of WMM's violations of, IC Act Section 17(d) and IC Act Rule 17d-1.
B. Violations in Connection with WMM's Obligation to Pay the Fund's Ordinary Operating Expenses.
1. Disclosure Violations. Respondents willfully violated Securities Act Section 17(a), Exchange Act Section 10(b), and Exchange Act Rule 10b-5, and Coxon and Sergy willfully violated IC Act Section 34(b). Coxon and Sergy admit that they reviewed and/or prepared each of the Fund's disclosure documents. The 1989 and 1990 prospectuses represented that WMM would pay "ordinary operating expenses," and provided examples of those operating expenses as "including" transfer agent, custodial and auditing fees, and certain mailing costs. However, Respondents solicited from the Board and received reimbursement from the Fund's 12b-1 plan for a portion of each of these categories ofexpenses. The prospectuses also stated that the Fund would not be responsible for paying WMM's overhead or administrative costs. Yet Respondents obtained "general partners'" fees, as well as costs associated with the audit of WMM, from the Permanent Portfolio's 12b-1 plan. 39
Respondents assert that the prospectuses made clear that WMM's obligation to pay "ordinary operating expenses" was subject to the exception for payment under the 12b-1 plan of "the portion of marketing and promotional expenses described" in the prospectus. The prospectuses, however, imply that such distribution expenses relate to preparation and dissemination of prospectuses, marketing materials, and advertising. The prospectuses did not disclose that the 12b-1 plan had reimbursed and might continue to reimburse ordinary operating expenses. These omissions were compounded by the misleading statement in the 1991 SAI that the bulk of the expenses charged to the Permanent Portfolio's 12b-1 plan were for "advertising" and certain mailings. Given their participation in compiling the Fund's prospectuses and their receipt nonetheless of payments for these expenses, we find that Respondents acted with scienter.
2. Advisers Act Violations. Coxon and Sergy also willfully aided and abetted and were causes of WMM's violation of Advisers Act Section 206(2) with respect to these reimbursements. As discussed above, WMM had agreed in its advisory agreement with the Fund to pay the Fund's ordinary operating expenses in return for higher-than-normal advisory fees. Having represented to the Fund's shareholders that WMM would pay these expenses in return for its increased fees, Coxon and Sergy instead induced the Fund's independent directors to reimburse WMM for many of these same expenses, representing to the independent directors that the expenses were properly marketing expenses reimbursable under the Fund's 12b-1 plan. Although Coxon and Sergy had a duty on WMM's behalf to make full and fair disclosure to the independent directors, they failed to explain to the directors that, under the Advisory Contract, WMM was required to pay these expenses or that the Fund's shareholders would be assuming part or all of WMM's obligations under the Advisory Contract.
Respondents argue that the Board relied on the review by the Fund's independent auditors of 12b-1 distribution expenses. Coxon and Sergy however undercut the effectiveness of this review. Although they were required to provide the Board with "full and fair disclosure of all material matters," Coxon and Sergy did not disclose to the Fund's independent directors that the auditors had warned them that the previous year's reimbursement of certain transfer agent, accounting, and auditing expenses was "aggressive" under the terms of the Funds' 12b-1 plan. 40
3. Violations of IC Act Rule 12b-1.
Respondents willfully aided and abetted and were causes of violations of IC Act Rule 12b-1(b)(3)(ii). That rule requires that "the directors shall review, at least quarterly, a written report of the amounts so expended [under a 12b-1 plan] and the purposes for which such expenditures were made." The Fund's Board failed to engage in review of 12b-1 plan expenditures in at least one quarter.
The minutes of the meetings of the Fund's Board do not describe "the factors considered and the basis for the decision to use company assets for distribution," as required by Rule 12b-1(d). Instead, the minutes merely state either that a list of 12b-1 expenses was distributed to the Board or that, after such a list was distributed, "a lengthy discussion ensued." We find that Coxon, who chaired the meetings, and Sergy, who prepared the minutes as Secretary, willfully aided and abetted and were causes of these violations. 41
C. Improper Composition of the Fund's Board.
IC Act Section 10(b)(2) prohibits a registered investment company from retaining a principal underwriter unless a majority of the registered company's board of directors are not interested persons of the underwriter. Between August 1990 and the spring of 1992, the Fund's Board consisted solely of Coxon, Sergy, and two independent directors, Robert Martin and Martin Tier. 42 Sergy was the president and a director of WMS. The law judge further found that, although Coxon had resigned as an officer and director of WMS in August 1990, he continued to exert a controlling influence over WMS. Coxon does not dispute this finding, which is based on Sergy's testimony. We therefore find that Coxon was an interested person of WMS. As a result, between August 1990 and the spring of 1992, Sergy and Coxon, who constituted half the Fund's Board, were interested persons of WMS. We find that Respondents willfully aided, abetted, and were causes of violations of Section 10(b)(2).
D. Violations in Connection with the Symantec Agreement Transaction.
1. IC Act Section 13(a)(3) prohibits a registered investment company from deviating from its fundamental investment policy as stated in its registration statement, absent prior shareholder approval. 43 The Permanent Portfolio's May 31, 1989 prospectus stated that, under its fundamental investment policy, the portfolio would invest in stock and stock warrants.
The Division argues that the Symantec instrument was a call option and thus not a permitted investment under the Permanent Portfolio's fundamental investment policy. Respondents assert that there is a "good faith" dispute as to whether the Symantec instrument was a warrant or a call option. They claim, however, that the Fund's shareholders had notice of the possibility that the Permanent Portfolio might acquire instruments like the Symantec agreement because the Fund's registration statement explains that a warrant is a type of long-term option. 44
While we agree that a warrant is a type of option, not every option is a warrant. As commonly understood, a warrant is a right to acquire securities in the future granted by the issuer of those securities. A warrant often is part of an offering of the underlying securities, and the issuance of warrants can have dilutive impact. A call option, in contrast, is a right to purchase a security that can be granted by any person. Options generally are not dilutive. We also agree with the Division's expert that a warrant generally would not contain a "right of prevention" permitting cash settlement, instead of delivery of the underlying shares. 45
Morever, the record demonstrates that Coxon considered the Symantec agreement an option. In the early 1980's Coxon had written a pamphlet that distinguished warrants and options. Coxon explained that warrants were granted by the issuer while options could be granted by any person. Coxon also described the Symantec agreement as an option to the Board and in a letter to Martin. 46 We conclude that the Symantec agreement was an option and that Respondents willfully aided and abetted and caused the Fund's violation of IC Act Section 13(a)(3) when they caused the Fund to deviate from its fundamental investment policy through its purchase of the Symantec option.
2. Respondents willfully violated Securities Act Section 17(a), Exchange Act 10(b), and Exchange Act Rule 10b-5, and Coxon and Sergy willfully violated IC Act Section 34(b). Coxon and Sergy prepared the Fund's 1990 registration statement. That registration statement, which is dated after execution of theSymantec agreement, does not disclose that, contrary to its fundamental investment policy, the Permanent Portfolio had purchased a call option from an individual third party. 47
3. WMM, which was the Fund's adviser, willfully violated Advisers Act Section 206(2) by failing to disclose to the Board that the Symantec transaction favored Coxon's personal client over the Fund and by failing to disclose the potential conflict of interest resulting from the Right of Prevention. Coxon, who was the general partner of WMM, willfully aided and abetted and was a cause of that violation. Coxon understood that the Symantec warrant favored the interests of his client, Layman, over those of the Permanent Portfolio. If the Permanent Portfolio exercised the warrant, Layman had the right to determine to tender cash to the Permanent Portfolio rather than Symantec stock. Coxon admitted that, if the Permanent Portfolio received cash, it would have an immediate capital gain. That gain would be taxable to the Permanent Portfolio's shareholders. 48 Moreover, if Layman elected to settle hisobligation in cash, the Permanent Portfolio could not benefit from any further gain from the Symantec shares. 49
Layman further testified that he intended to seek Coxon's views about whether he should exercise the Right of Prevention. Thus Coxon would face another set of potential conflicts of interest between his roles as Layman's adviser, WMM's general partner, which would advise the Permanent Portfolio, and a director of the Fund. Because the Board was not informed about the Right of Prevention, the independent directors could not properly assess Coxon's conflicts of interest with respect to the Right of Prevention or determine whether to obtain independent advice about the advisability of the transaction. 50
E. The WMM and WMS Leases.
When Respondents used WMS' funds to subsidize a portion of the Fund's rent, they engaged in a practice that operated as a fraud or deceit and self-dealing. The Fund's prospectuses stated that WMM would pay the Fund's rent. Instead, Respondents caused WMS, the Permanent Portfolio's asset, to lease a portion of the offices and relieve WMM of its obligation to pay the Fund's rent. Moreover, the lease benefitted WMM. WMS subsidized office space used by WMM, the Fund, the WMM-affiliated entities, and the subtenants. Coxon organized the transaction, and Sergy executed various leases and subleases. We find that Coxon and Sergy willfully aided and abetted and were causes of WMM's willful violation of Advisers Act Section 206(2).
F. The Passport Financial Transaction.
1. In the Passport Financial transaction, WMM, a fiduciary to the Fund, through Coxon and Sergy, used the assets of WMS, a Permanent Portfolio asset, to finance one of WMM's business ventures on terms that were unfavorable to WMS. Respondents caused WMS to advance $40,000 in offering expenses. However, if the offering did not go forward, as in fact occurred, WMS would be reimbursed for only half of the expenses that WMS advanced.
We agree with the Division's expert that an unaffiliated broker-dealer typically would not advance offering costs to an issuer, and would expect to be reimbursed for all its costs. Sergy admitted that a broker's advancing expenses was unusual. Passport's retention of selling brokers, moreover, would have substantially reduced any commissions that WMS made from the transaction. After the transaction failed, Respondents reimbursed WMS for only a portion of the costs it advanced. We conclude that WMM willfully violated, and Coxon and Sergy willfully aided and abetted and were causes of WMM's violation of Advisers Act Section 206(2).
2. WMM also violated, and Coxon and Sergy aided, abetted, and were the causes of violations of IC Act Section 17(d) and IC Act Rule 17d-1. Respondents failed to seek an exemption for the Passport transaction, which was between WMS, an entity wholly owned by the Fund's Permanent Portfolio, and Passport, an affiliate of WMM. The Passport transaction, in which WMM and its affiliates depleted an asset of the Permanent Portfolio, is the type of self-dealing transaction that these provisions were designed to prevent. 51
G. Respondents' Other Defenses.
Coxon claims generally that he was merely a minority director and is being punished for violations that resulted from actions approved by the entire Fund Board, including the independent directors. 52 Coxon underplays his role. Coxon waspresident of the Fund and chaired the Board meetings. 53 Coxon, as a general partner and sole owner of Terry Coxon, Inc., WMM's remaining general partner, controlled WMM and, to the extent that WMM violated the federal securities laws, it was in substantial part through Coxon's actions. As described above, Coxon used his positions and his influence with the other directors repeatedly and effectively to achieve his desired aims. Coxon willfully aided and abetted and was a cause of WMM's and the Fund's violations. 54
Respondents further argue that, because the Board --including a majority of its independent directors -- approved the various transactions discussed above, Coxon and Sergy are protected by the business judgment rule. 55 The business judgment rule, however, protects only lawful transactions that are entered into in good faith. The rule does not insulate Coxon and Sergy from illegal or fraudulent conduct. 56
Moreover, Coxon and Sergy did not act in good faith. As discussed above, they prepared and/or reviewed misleading disclosure documents. They further made misrepresentations to and omitted material information in their discussions with the independent directors. For example, in response to independent director Robert Martin's question at the January 1990 Fund Board meeting, Coxon asserted that the Selling Agreement was not a violation of the Fund's 12b-1 plan when, contrary to that plan, the Selling Agreement resulted in the Permanent Portfolio paying the distribution costs for the Treasury Bill Portfolio and the Aggressive Growth Portfolio. Although Coxon and Sergy had told the Board that WMS would incur savings from participating in underwritings, they failed to inform the Fund's independent directors that WMS could not underwrite offerings.
We must consider what sanctions are in the public interest. The Supreme Court has held that the determination of sanctions is peculiarly within the expertise of the administrative agency. 57
As a preliminary matter, we recognize that much of the conduct at issue here occurred some time ago. 58 However, we have concluded that an order that WMM and Coxon cease and desist from violative conduct and pay disgorgement is appropriate under the circumstances presented. 59
Cease-and-Desist Order. We may impose a cease-and-desist order on a person who has violated or caused violations of the federal securities laws. 60 In determining whether to impose such an order, we look to a variety of factors. 61 As described above, WMM and Coxon violated or caused the Fund to violate, and Coxon caused WMM to engage in violations of four separate securities statutes over several years. They repeatedly engaged in self-dealing and put their interests above those of the shareholders of the Fund. In her initial decision, the law judge observed that "Coxon's belief in his views and abilities is so unshakable that he does not understand why there should be concern" here "despite the possibility of conflicts of interest or self-dealing." She further observed that a strong sanction was necessary to prevent a recurrence of the violations. We conclude that, for these stated reasons and because WMM and Coxon are in a position to commit such violations in the future, they should be ordered to cease and desist from committing or causing any violations or any future violations of Securities Act Section 17(a), Exchange Act Section 10(b), Exchange Act Rule 10b-5, Advisers Act Section 206(2), IC Act Sections 10(b), 12(b), 13(a)(3), and 17(d), and IC Act Rules 12b-1 and 17d-1 thereunder and that Coxon should be ordered to cease and desist from committing or causing any violations or any future violations of IC Act Section 34(b).
Disgorgement. Disgorgement is designed to deprive a wrongdoer of unjust enrichment and to deter others from violatingthe securities laws by making such violations unprofitable. 62 The Division contends that Respondents received ill-gotten gains from two series of transactions. The first set of transactions involves the capitalization of WMS and Respondents' use of WMS' capital for various ventures. The second set arises from the improper reimbursement of WMM for ordinary operating expenses that WMM was required to pay under its advisory agreement.
The amount of disgorgement "need only be a reasonable approximation of profits causally connected to the violation." 63 Respondents argue that the Division did not prove that Respondents received the benefit of the funds. However, courts have found disgorgement appropriate where the defendant used the ill-gotten gains to sustain business operations. 64
The Division demonstrated that WMM was in weak financial condition in 1988 and 1989 and needed funds to carry on proposed activities. After the capitalization of WMS and the receipt of the Fund's reimbursement for ordinary operating expenses, Respondents engaged in a variety of new business ventures, including the promotion of the Treasury Bill and Aggressive Growth Portfolios, the Passport offering, and the acquisition of new office space. Coxon also attempted to create other ventures and investment vehicles, many of which did not come to fruition.
Respondents argue that any disgorgement amount should be reduced by the amount of the trailing commissions that WMS received under the Selling Agreements. However, for the reasons described below, the Permanent Portfolio's shareholders received no benefit from these trailing commissions. Rather, the trailing commissions appear to be part of Respondents' ill-gotten gains although we will not increase the amount of disgorgement as a result. As Martin testified, WMS' funds went to Sergy, to Chandler's salary, to rent, to the Passport Financial transaction, and regulatory and registration expenses. By 1996, all of WMS' resources were depleted. When WMS was liquidated, none of WMS' funds, including the trailing commissions, were left. 65
We also disagree that Respondents are entitled to offset their waiver of certain advisory fees due to WMM from the Treasury Bill Portfolio. This waiver benefitted the shareholders of the Treasury Bill Portfolio. However, the capital for WMS came from the Permanent Portfolio, whose shareholders did not benefit from WMM's waiver.
WMS was capitalized at $950,000. Because the Division's expert testified that WMS could be properly capitalized at $100,000, the Division asks that we order Respondents to disgorge $850,000. 66 We conclude that the $850,000 amount is a"reasonable approximation of profits causally connected" with the violations discussed in Section III.A supra. 67
The Division also has requested disgorgement of one-half of the transfer agent fees and auditing and accounting fees that Respondents improperly charged to the Fund's 12b-1 plan. The Division introduced evidence that, after excluding the transfer agent fees that were allocable to new account transactions, WMM improperly charged $204,893.12 in transfer fees to the Fund. We further find that WMM charged $38,661.96 to the Fund plan for accounting and auditing fees. We have determined to award one-half of the sum of $204,893.12 and $38,661.96, or $121,777.54, for these violations.
The Division argues that Respondents should be held jointly and severally liable for disgorgement. Courts have held that, "where two or more individuals or entities collaborate or have a close relationship in engaging in the violations of the securities laws, they have been held jointly and severally liable for the disgorgement of illegally obtained proceeds." 68 Coxon enjoyed a close relationship with WMM and the Fund. He persuaded the Fund shareholders and the independent directors to capitalize WMS and to obtain improper reimbursement of WMM's expenses. In addition to his ability to undertake business ventures, the record demonstrates that Coxon personally benefitted from WMM's improved condition. Moreover, Coxon's income increased from salaries and fees.
Coxon argues that the Division failed to establish his separate liability for disgorgement. However, courts have recognized that "[i]mposing the burden upon the defendant of proving the propriety of the apportionment of the disgorgement amount in securities cases is appropriate and reasonable. . . . Generally, apportionment is difficult or even practically impossible because defendants have engaged in complex and heavilydisguised transactions. . . . [U]ncertainty should fall on the wrongdoer whose illegal conduct created that uncertainty." 69
At the hearing, Coxon failed to make the required demonstration. His testimony on the benefits that he received from WMM and the Funds is unclear. While Coxon has now submitted certain financial data, those data do not refute the presumption that Coxon, by virtue of his positions as general partner of WMM and an officer and director of the Fund, was intimately involved in and benefitted from the perpetration of the violations here. Among other things, it appears that Coxon received payments for acting as WMM's general partner during this period. He further did not submit financial data from other affiliated entities. Among those is Terry Coxon, Inc., which Coxon testified received monetary payments from WMM and, in turn, paid him a salary.
Coxon and WMM assert that, because of the passage of time, the award of pre-judgment interest has become punitive. The Division did not respond to this contention. Securities Act 8A(e) and Exchange Act Section 21C(e) authorize us to include "reasonable interest" in a disgorgement award. 70 We believe that, except in the most unique and compelling circumstances, prejudgment interest should be awarded on disgorgement, among other things, in order to deny a wrongdoer the equivalent of an interest free loan from the wrongdoer's victims. We have required that prejudgment interest be computed at the underpayment rate of interest established at Section 6621(a)(2) of the Internal Revenue Code. Here, we have ordered that the interest run from the date of the last violation, September 21, 1993. We further have exercised our equitable judgment in analyzing the circumstances of this case and have determined to exercise that discretion to require that WMM and Coxon pay only half the amount of prejudgment interest otherwise due.
Sergy. Sergy's wife has filed an affidavit with us, stating that Sergy is suffering from a serious, progressive disability. Sergy left WMM and the Fund in 1998 and is no longer in the securities industry. We have determined to dismiss these proceedings as to him.
An appropriate order will issue. 71
By the Commission (Chairman DONALDSON and Commissioners GLASSMAN, GOLDSCHMID, and ATKINS); Commissioner CAMPOS concurring in the result except as to the amount of prejudgment interest, from which he dissents.
Jonathan G. Katz
Concurrence and Dissent of ROEL C. CAMPOS
Commissioner CAMPOS, concurring in part and dissenting in part. I concur in the Commission's opinion in all respects except for its decision to reduce prejudgment interest on disgorgement. I dissent from the reduction of prejudgment interest.
Respondents sought relief from prejudgment interest on the ground of agency delay in bringing and deciding this case. The Commission's opinion correctly recognizes that respondents in securities fraud cases should not even be partially relieved of the obligation to pay prejudgment interest except in the very most extraordinary and unusual circumstances. The Commission's own Rule of Practice 600 states that "[p]rejudgment interest shall be due on any sum required to be paid pursuant to an order of disgorgement." 17 C.F.R. § 201.600(a) (emphasis added). In adopting this rule, the Commission explained the importance of prejudgment interest in its cases:
A respondent who wrongfully takes for his own use monies that belong to investors or other persons has received the equivalent of aninterest free loan from the victims of his wrongdoing. The proper measurement of the benefit of this loan to the respondent is the cost the respondent would otherwise have paid for a comparable, unsecured loan. The actual use to which the respondent put the funds, or the rate of return the respondent earned is irrelevant. . . . In order to fulfill the remedial purposes of disgorgement, a respondent should never be allowed free use of funds wrongfully obtained from others.
Exch. Act Rel. No. 35833 (June 9, 1995), at 108. Courts in Commission enforcement actions have repeatedly rejected attempts by defendants to avoid or reduce prejudgment interest on disgorgement. See SEC v. Warde, 151 F.3d 42, 50 (2d Cir. 1998) (rejecting defendant's argument that "he should not be liable for the total amount of prejudgment interest" because "the SEC was 'ultimately responsible' for the nine-year delay in bringing the action" and holding that "'even if . . . litigation was protracted through some fault of the SEC,' the award of prejudgment interest for the entire period is proper because . . . 'defendant had use of unlawful profits for the entire period'"); SEC v. First Jersey Securities, Inc., 101 F.3d 1450, 1476-1477 (2d Cir. 1996) (rejecting defendant's argument that award of over $52 million in prejudgment interest on a disgorgement amount of $22 million was "grossly disproportionate" and spanned "the entire 12-year period since the violations occurred notwithstanding delays that defendants attribute to the SEC" and affirming full interest award "[g]iven the remedial purpose of the statute, the goal of depriving culpable defendants of their unlawful gains, and the lack of any unfairness to defendants").
Prejudgment interest represents nothing more than the use and time value of money that the respondents should never have had, and that the fraud victims should never have been deprived of, in the first place. Where the Commission is able to return disgorgement awards to defrauded investors, prejudgment interest helps make the victims whole. Relieving a defendant of the obligation to pay prejudgment interest may not only favor the wrongdoer over the victim but may reward a wrongdoer who has spent the proceeds of the fraud in a profligate manner over the different wrongdoer who has used the proceeds in a manner that has preserved them for judgment.
Where I part company with my colleagues is not, I think, on general principles but in our judgments about the record and arguments in this case. The other four Commissioners based their decision to reduce prejudgment interest exclusively on equities. However, the respondents did not make a case against prejudgment interest on the equities. Their argument was based entirely onthe sheer passage of time alone. Despite conceding that it properly could take years after the misconduct to resolve this case -- which has produced a "voluminous record," a 50-page initial decision, 179 pages of briefs on appeal, and a 32-page Commission opinion -- and without recognizing any of the practical limitations on government action, respondents simply asserted that the agency took too long.
Respondents did not allege, much less "point to any evidence of," bad faith, dilatory tactics, or even negligence or "lackadaisical conduct" in the handling of this case by the Commission or its staff. See Vernazza v. SEC, 327 F.3d 851, 863 (9th Cir. 2003); see generally In re Milwaukee Cheese Wisconsin, Inc., 112 F.3d 845, 849 (7th Cir. 1997) ("Discretion must be exercised according to law, which means that prejudgment interest should be awarded unless there is a sound reason not to do so. The only reason appellants give why discretion should have been exercised in their favor is that the case has lasted a long time, so interest has mounted; an award now, they say, would be 'punitive.' This misunderstands why courts award prejudgment interest.").
Respondents, who invest money for a living, made no allegation that they suffered any particular prejudice from delay in the imposition of prejudgment interest. Nor have respondents claimed to have taken any action to mitigate any perceived hardship in paying prejudgment interest, even after the law judge ordered disgorgement and prejudgment interest. See SEC Rule of Practice 600(b), 17 C.F.R. § 201.600(b) (expressly allowing reduction in rate of prejudgment interest "as to any funds which the respondent has placed" in an approved escrow "or otherwise guaranteed for payment of disgorgement upon a final determination of the respondent's liability").
In my view, the equities do not favor the respondents. Indeed, none of the factors courts have traditionally considered in awarding prejudgment interest favors the respondents. See First Jersey, 101 F.3d at 1476 (considering "the need to fully compensate the wronged party for actual damages suffered"; "fairness and the relative equities of the award"; "the remedial purpose of the statute involved," which "takes on special importance" in "an enforcement action brought by a regulatory agency"; and/or "such other general principles as are deemed relevant"). The Commission should have ordered full prejudgment interest in this case. I am afraid the equities were misapplied on the prejudgment issue improperly in favor of the respondents and to the detriment of investors.
In the Matter of
TERENCE MICHAEL COXON
WORLD MONEY MANAGERS
ORDER IMPOSING SANCTIONS
On the basis of the Commission's opinion issued this day, it is
ORDERED that World Money Managers and Terence Michael Coxon be, and they hereby are, ordered to cease and desist from committing or causing any violations or any future violations of Section 206(2) of the Investment Advisers Act of 1940, Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Exchange Act Rule 10b-5, Sections 10(b), 12(b), 13(a)(3), and 17(d) of the Investment Company Act of 1940 and Rules 12b-1 and 17d-1 thereunder; and it is further
ORDERED that Terence Michael Coxon be, and he hereby is, ordered to cease and desist from committing or causing any violations or any future violations of Section 34(b) of the Investment Company Act of 1940, and it is further
ORDERED that World Money Mangers and Terence Michael Coxon, jointly and severally, shall disgorge a total of $971,777.54, and pay half the amount of prejudgment interest as described at 17 C.F.R. § 201.600(b), due from September 21, 1993, which we deemto be the date of their violative conduct, through the last day of the month preceding the month in which disgorgement is made; and it is further
ORDERED that, within 60 days after funds have been turned over by World Money Managers or Terence Michael Coxon in accordance with this order and any appeals of the disgorgement order have been waived or completed or appeal is no longer available, the Division of Enforcement shall submit a proposed plan for the administration and distribution of disgorgement funds, as provided in Rules of Practice 610 through 614, 17 C.F.R. §§ 201.610-614; and it is hereby further
ORDERED that these proceedings against Alan Michael Sergy be, and they hereby are, dismissed.
Payment of disgorgement shall be made to the United States Treasury within 21 days of the issuance of this order. The payment shall be (a) made by United States postal money order, certified check, bank cashier's check, or bank money order; (b) made payable to the Securities and Exchange Commission; (c) mailed or delivered by hand to the Comptroller, 6432 General Green Way, Alexandria VA 22312; and (d) submitted under cover letter that identifies the particular respondent in this proceeding making payment and the Commission's administrative proceeding file number. A copy of the cover letter and money order or check shall be sent to John S. Yun, San Francisco District Office, 44 Montgomery Street, Suite 1100, San Francisco CA 94104.
By the Commission.
Jonathan G. Katz
|1||Jerrold Abeles was on the briefs with Mr. Cotton.|
|2||The second general partner of WMM is Terry Coxon, Inc., a corporation wholly owned by Terry Coxon.|
|3||15 U.S.C. § 80b-6(2).|
|4||15 U.S.C. § 80a-33(b).|
|5||15 U.S.C. § 77q.|
|6||15 U.S.C. § 78j, 17 C.F.R. § 240.10b-5.|
|7||15 U.S.C. §§ 80a-10(b)(2), 80a-12(b), 80a-13(a)(3), and 80a-17(d); 17 C.F.R. §§ 270.12b-1 and 270.17d-1.|
|8|| Browne wrote a series of books on investment strategies and finance in the 1970s and early 1980s. During this period, Coxon was Browne's assistant and, later, his co-author.
Browne and Coxon theorized that an investor could design a portfolio of investments including stocks, bonds, precious metals, and foreign currencies so that if one portion of the portfolio declined another investment would prosper. Under this theory, the investor's overall wealth would be safeguarded, regardless of future economic events.
|9||In 1998, Sergy retired from the Fund for health reasons.|
|10||As average net assets increased above $200 million, the percentage level of the advisory fee was adjusted downward.|
|11||IC Act Rule 12b-1 permits an investment company to pay for its distribution costs pursuant to a written plan that complies with that rule.|
|12|| Cuggino included in the audit work papers the following statement for possible inclusion in a management letter:
During our review of the costs incurred by the investment advisor and 12b-1 reimbursements to the investment advisor from the fund, it was noted that the fund incurred certain costs [i.e., the transfer agentfees and auditing fees] for reimbursement under the 12b-1 [plan] which are not qualifying expenses under the contract. Fortunately, there were sufficient costs incurred so that no adjustment was necessary to the expenses as booked by the fund, however, on a prospective basis, the investment advisor needs to ensure that these costs are not part of the reimburseable [sic] costs.
Ernst & Young did not send a management letter to the Fund.
|13||Coxon testified that, in the previous year, the Treasury Bill Portfolio generated $110,000 in 12b-1 distribution fees.|
|14|| Respondents assert that WMM's financial condition was not bad because it reported income or small losses on its tax returns for 1988 through 1990. We have previously stated that financial statements prepared on an accrual basis provide a more accurate view of a company's condition than its tax returns. "[B]ecause of its fixation on the oft-fortuitous circumstance of actual payment, the cash basis does not relate costs to the period in which they were incurred. Nor does it relate revenues to the slice of time in which they were earned. Hence, cash basis financial statements are necessarily distorted to some extent." Multi Benefit Realty Fund, 46 S.E.C. 286, 288 (1976) (denying application for exemption to file tax-basis, instead of accrual, financial statements). Before the law judge, Coxon admitted that the amounts reported on WMM's tax returns reflected the timing of certain payments of WMM's expenses.
In contrast, accrual accounting allocates items of expense and revenues to accounting periods and matches them, regardless of when the cash expenditures or receipts occur. See D. Edward Martin, Attorney's Handbook of Accounting, Auditing and Financial Reporting § 2.04 (1999) (observing that accrual accounting provides "the most accurate pictureof an entity's operations" because revenue is regarded as earned in the period in which services are rendered and expenses are regarded as applicable to the period in which they are incurred, regardless of when paid).
|15||Sergy reported to the Board that the subsidiary would incur organizational costs of approximately $35,000 (consisting of $18,000 already incurred and a projected additional $16,900), together with $37,000 for first-year operations.|
|16||Although Sergy had not received a salary from WMS when it was owned by WMM, he began to receive a salary as WMS' president after its acquisition by the Permanent Portfolio.|
|17||Sergy had attempted to get the restrictions lifted in December 1989, but the NASD denied his request.|
|18||Coxon executed the Selling Agreement on behalf of the Fund and WMM, and Sergy executed the agreement for WMS. The Fund's signature line stated that it "approved and acknowledged" the agreement.|
|19||At the Board meeting, Martin asked Coxon whether the 1990 Selling Agreement would conflict with the requirement contained in the 12b-1 plan that each portfolio be responsible for its own distribution costs. Coxon represented that there was no conflict because each portfolio would continue to be responsible for its own distribution expenses. In fact, the direct-mail campaigns for the Treasury Bill and Aggressive Growth Portfolios were funded from Permanent Portfolio shareholders' $950,000 investment in WMS.|
|20||Martin testified that WMS earned $200,000 in trailing commissions the first year, and it was projected that WMS would receive more than $600,000 over the 6-1/2 year term. However, interest rates declined and investors redeemed their shares in the Treasury Bill Portfolio, reducingsubsequent years' payments of trailing commissions to WMS.|
|21|| Ultimately, WMS dissipated all its funds, including the revenue generated by the trailing commissions. Martin testified that some of WMS' money went to salaries, including Sergy's salary, some for rent, some for the Passport Financial, Inc. underwriting, discussed at Section II.G., and some for registration and regulatory expenses.
In 1996, WMS filed to withdraw its registration on Form BDW. At the request of the Division, the law judge dismissed WMS as a respondent in this proceeding.
|22||From conversations with Coxon and Layman's personal attorney, Layman understood that the taxable gain or loss on a grant of a right to purchase his Symantec stock would not be recognized unless and until the Permanent Portfolio exercised the right and received the underlying Symantec stock. Thus, Layman's tax liability on the transaction would be deferred until the right was exercised or lapsed.|
|23||The Symantec agreement gave the Permanent Portfolio theright for the period up to April 6, 2005, to purchase up to 22,500 shares of Symantec common stock at an adjustable "Purchase Price," initially equal to 55.6% of the closing price of Symantec on April 6, 1990. For the right, the Permanent Portfolio paid Layman 73.2% of the initial Purchase Price.|
|24||Coxon testified that, before this lease, WMM and the Fund occupied space that was small and cramped, and did not comply with earthquake standards.|
|25|| Sergy paid $100 per month under his sublease.
Richard Rolnick was in-house counsel to the Fund, WMM, and its affiliates. In addition, Rolnick engaged in a private law practice. Rolnick occupied the largest office in the suite and a portion of the common area, which was occupied by his secretary and files. Rolnick paid $500 per month to each of WMS and WMM.
Cuggino paid to WMS $500 per month for his office. In addition to being the Fund's treasurer, Cuggino also engaged in an independent private accounting practice as MichaelCuggino, CPA, a sole proprietorship.
|26|| WMM began paying WMS' share of its rent after WMS was dissolved in 1996. However, WMM had guaranteed to the landlord WMS' performance under WMS' lease, and, therefore, WMM was obligated to pay the rent when WMS could no longer perform.
The record does not indicate that the Fund's Board discussed or approved the leases. The minutes of one Board meeting state only that Coxon informed the Board about the proposed move to the new offices.
|27||The agreement was never executed. The signatories to the proposed agreement were to be WMS, Passport Financial, Inc., WMM with respect to one provision of the agreement, and the Fund, which was to "acknowledge and agree" to its provisions.|
|28||Passport was a start-up company, intended to publish "informational materials" on international investments. Passport proposed to offer $2 million in stock and an additional $2 million in warrants.|
|29||The record is unclear about the level of consideration given by the Fund's Board to the Passport transaction. Independent director Robert Martin testified that the Board discussed the transaction, but that he was not asked toapprove it. Martin Tier, another independent director, testified that he "reviewed" the transaction while on the Board. The Respondents did not introduce minutes of any Board meeting reflecting the Board's deliberations with respect to this transaction. We conclude that Respondents have not shown that the directors approved the transaction.|
|30||In any event, half the projected commissions would be generated only if and when the holders exercised the accompanying warrants.|
|31||SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963). See Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979) ("As we have previously recognized § 206 establishes 'federal fiduciary standards' to govern the conduct of investment advisers.").|
|32|| To find that Respondents aided and abetted, the record must demonstrate (1) the existence of an independent primary violation; (2) general awareness or reckless disregard by the alleged aider and abettor of the primary violation and of his or her role in furthering the violation; and (3) substantial assistance by the respondent in the commission of the primary violation. Graham v. SEC, 222 F.3d 994, 1000 (D.C. Cir. 2000); SEC v. Fehn, 97 F.3d 1276, 1288 (9th Cir. 1996).
Our findings that Respondents willfully aided and abetted the Fund's violations necessarily make them a "cause" of those violations. See Richard D. Chema, 53 S.E.C. 1049, 1059 n.20 (1998); Dominick & Dominick, Inc., 50 S.E.C. 571, 578 n.11 (1991). To conclude that a respondent aided and abetted another violation, we must find that he acted with scienter. A respondent is a "cause" of another's violation if the respondent "knew or should have known" that the respondent's act would contribute to the violation. Exchange Act Section 21C(a); Chema, 53 S.E.C. at 1059 n.20.
|33||Compare Steadman v. SEC, 603 F.2d 1126, 1130 (5th Cir. 1979)(upholding Commission finding that potential self-dealing by adviser to fund's detriment required disclosure), aff'd on other grounds, 450 U.S. 91 (1981).|
|34||SEC v. Advance Growth Capital Corp., 470 F.2d 40, 43 n.2 (7th Cir. 1972).|
|35||SEC v. General Time Corp., 407 F.2d 65, 67 (2d Cir. 1968). See Rule 17d-1(b) (requiring the Commission to consider whether the investment company's participation in a proposed transaction is consistent with the purposes of the Act and the extent to which such participation is on a different or less advantageous basis "than that of other participants").|
|36||Respondents assert that a transaction between "a company of the character described in" IC Act Sections 12(d)(3)(A) and (B) and the controlling investment company is exempt from IC Act Section 17(d). Sections 12(d)(3)(A) and (B) encompass the wholly-owned subsidiary of an investment company that underwrites the investment company's securities. Respondents assert that WMS, which was wholly-owned by the Permanent Portfolio and acted as its underwriter, is a company described in those sections. Here, however, there were three parties to the Selling Agreements -- the Fund, WMS, and WMM -- and, thus, they required a Commission exemption.|
|37||The Division also introduced expert testimony that an independent, third-party broker-dealer would be extremely reluctant to advance funds for distribution or to pay other selling brokers commissions when the broker-dealer was to receive only annual commissions.|
|38|| Respondents also assert that they received advice from Richard Rolnick, the Fund's in-house counsel (who was also counsel to WMM), that the Selling Agreements did not require Commission exemption. Respondents do not explain the precise nature of the purported advice or the circumstances under which it was received. Instead, they cite a memorandum from Rolnick with respect to transactions by the Fund in brokerage stocks. That memorandum merely observes that brokerage stock transactions may be permissible under the same exemption that permitted the Portfolio to acquire WMS. The memorandum does not mention the Selling Agreements.
We conclude that Respondents have not made a showing of reliance on counsel. SEC v. Savoy Industries, Inc., 665 F.2d 1310, 1314 n.18 (D.C. Cir. 1981) (stating that defendant must establish that "he (1) made a complete disclosure to counsel; (2) requested counsel's advice as to the legality of the contemplated action; (3) received advice that it was legal; and (4) relied in good faith on that advice" to obtain this limited defense).
|39|| The prospectuses stated that the Fund would not pay any of WMM's general or administrative overhead. WMM undertook to pay the fees and expenses of the Fund's independent directors. However, Respondents charged the Fund's 12b-1 plan for travel for Coxon and Sergy to locations where Fund Board meetings were held, including London and Hong Kong.
Respondents assert that Coxon and Sergy engaged in marketing activities on these trips and that marketing expenses could be paid under the 12b-1 plan. However, the prospectus does not disclose that, under certain circumstances, the Fund might pay Coxon or Sergy's travel expenses.
|40||One of the independent directors, Martin Tier, testified that, if he had been told that reimbursement was aggressive, he would have asked if it was illegal or unethical. Coxon's and Sergy's failure to disclose this information prevented that discussion from occurring.|
|41||The Division argues that, because WMM agreed to pay certain ordinary operating expenses of the Fund but instead charged such expenses to the Fund's 12b-1 distribution plan, Respondents willfully aided and abetted and were causes of violations of IC Act Section 12(b) and IC Act Rule 12b-1. Section 12(b) generally prohibits an investment company from using company funds to distribute its shares, absent compliance with a Commission rule like IC Act Rule 12b-1. Because we find that WMM, aided and abetted by Coxon and Sergy, violated the terms of its advisory agreement that required it to pay the Fund's ordinary operating expenses, and that WMM's conduct thereby violated Advisers Act Section 206(2), we do not reach the Division's remaining allegations that Respondents thereby also aided, abetted and were causesof the Fund's IC Act Section 12(b) and 12b-1 violations.|
|42||A third independent director of the Fund resigned in August 1990.|
|43||See Green v. Brown, 398 F.2d 1006, 1010 (2d Cir. 1968) (noting Commission position that "advance shareholder approval gives minority shareholders both an opportunity to dissuade the majority, and a chance to dispose of their holdings before the change occurs").|
|44||The Fund's prospectus, dated May 31, 1990, was issued afterexecution of the Symantec agreement. The prospectus merely states that Permanent Portfolio will engage "in the same types of investments in which the Aggressive Growth Portfolio may invest." The Aggressive Growth Portfolio's investment policy states that the portfolio invests in "stock and stock warrants of U.S. companies," and explains that stock warrants "are long-term options to purchase shares of stock at a fixed price."|
|45||The Division's expert testified that it would be unlikely for a warrant to include a cash settlement provision because a warrant "is ultimately a source of capital for the corporation."|
|46||In the pamphlet, entitled, "Using Warrants: Safe Investment Programs Using Stock Warrants in Dual-Purpose Funds," Coxon states that warrants are issued "by the company whose stock is involved" The pamphlet added, "Warrants differ from call options, which can be written (issued) by any investor." Coxon agreed at trial that this was "reasonable" as a "general description."|
|47||The Fund's SAI disclosed that the Permanent Portfolio would purchase put options or sell call options for hedging purposes. Reading the prospectus, which stated that the portfolio would be "stock warrants of U.S. companies" and the SAI, an investor would not understand that the Permanent Portfolio might purchase a call option from a third-party individual.|
|48|| At the hearing, Division counsel asked Coxon what would happen if, hypothetically, (a) Symantec stock increased in price; (b) the Permanent Portfolio exercised its option; and (c) Layman elected to tender cash to the Portfolio rather than the stock.
Coxon opined that, as a result, the Permanent Portfolio would have an immediate capital gain on the cash. However according to Coxon, "Layman's exercise of the right of prevention would constitute a repurchase of an option being sold, and he would be repurchasing it for more than he sold it for. So he would have a capital loss." Coxon also agreed that, if the price of Symantec rose further during the 14-day period provided for settlement under the Right of Prevention, Layman would receive the benefit of that increase.
The Division's expert explained that, if the Permanent Portfolio received Symantec stock, rather than cash, it would not have a taxable event until it sold that stock. Moreover, the expert stated that the Permanent Portfolio would "inherit the cost basis of the option."
|49||The Division's expert also expressed the opinion that it would be difficult to hedge the Permanent Portfolio's risk during the period between exercise and Layman's election under the Right of Prevention. The Division further argued that, if the Permanent Portfolio exercised the option, it would have been exposed in the event of Layman's bankruptcy to the bankruptcy court's setting the option aside as an executory contract. See, e.g., In re Robert L. Helms Constr. & Dev. Co., 139 F.3d 702, 705 (9th Cir. 1998) (holding that option may be executory contract if holder has exercised option before bankruptcy); In re Riodizio, Inc., 204 B.R. 417, 423 (Bankr. S.D.N.Y. 1997) (determining that stock warrant is executory by weighing relative benefits and burdens to the debtor's estate of assuming or rejecting performance under warrant).|
|50|| At argument, respondents counsel suggested that the Symantec option had been profitable. There is nothing on the record from which we can determine whether this is a reference to realized or unrealized gains and whether the Fund might have profited more or less employing a different strategy.
In any event, whether a transaction involving a potential conflict of interest ultimately proves profitable is irrelevant to respondents' obligation to disclose the potential conflict. SEC v. Capital Gains Research Bureau, 375 U.S. at 200 (holding that "actual inequitable conduct" is irrelevant because the Advisers Act is "directed not only at dishonor, but also at conduct that tempts dishonor.")
|51||See, e.g., SEC v. Advance Growth Capital Corp., 470 F.2d at 43 n.2. See text accompanying note 34 supra.|
|52||Sergy's brief adopted Coxon's arguments. To the extent that Sergy also asserts that he should not be held responsible for actions approved by the Fund's Board, we note that Sergywas secretary-treasurer of the Fund, WMS' president, and secretary to the Board, as well as a director. As described above, Sergy participated actively in the various violations. We find that Sergy willfully aided and abetted and was a cause of WMM's and the Fund's violations.|
|53||See Steadman v. SEC, 603 F.2d at 1135 (officer's control "is a substantial ground for the inference that he was involved in every important activity of that company").|
|54|| Respondents claim that they cannot be liable for aiding or abetting because the Fund was not charged with primary violations of the Investment Company Act. However, IC Act Section 9(b) authorizes the Commission to bring proceedings against any associated person of an investment company who "has willfully aided, abetted, counseled, commanded, induced, or procured the violation" of any provision of the securities laws or the rules thereunder. We previously rejected the argument that the Commission may not proceed against an aider and abettor unless the primary violator is charged. "Even in a criminal context, it is not necessary to identify, indict, try, or convict a principal wrongdoer in order to convict an aider and abettor." Swartwood Hesse, Inc., 50 S.E.C. 1301, 1304 n.8 (1992), citing United States v. Mann, 811 F.2d 495, 497 (9th Cir. 1987). See also SEC v. Fehn, 97 F.3d at 1294 (finding attorney aided and abetted issuer's disclosure violations).
Rather, the Commission must find that primary violations occurred. Here, the Order Instituting Proceedings gave Respondents notice of the Fund's alleged primary violations, and Respondents vigorously defended against those allegations. As described in this opinion, we conclude that the Division met its burden of demonstrating that the Fund engaged in the violations that we have found.
Moreover, Coxon and Sergy are primary violators of the antifraud provisions, and WMM was a primary violator, aided and abetted by Coxon and Sergy, of Advisers Act Section206(2) and IC Act Section 17(d) and IC Act Rule 17d-1.
|55||From the record, however, it appears that the Board did not approve either the WMM/WMS lease or the Passport transaction. See notes 26, 29 supra. Thus, these transactions would not, in any event, be entitled to protection under the business judgment rule.|
|56||International Ins. Co. v. Johns, 874 F.2d 1447, 1461 (11th Cir. 1989) (business judgment rule protects a director "in the absence of a showing of abuse of discretion, fraud, bad faith, or illegality."); Arthur Lipper Corp. v. SEC, 547 F.2d 171, 180 (2d Cir. 1976), cert. denied, 434 U.S. 1009 (1978) (concluding that "bald diversion" of investment company funds "is quite different" from discretionary transactions entitled to protection under the business judgment rule "after full disclosure to the independent directors"); Yost v. Early, 87 Md. App. 364, 377-78 (1991) (finding that "proof of the lack of good faith defeats both the presumption of the business judgment rule" and the requirements of the Maryland Code of Conduct for directors, Section 2-405.1). See also Parish v. Maryland & Va. Milk Producers Ass'ns Inc., 250 Md. 24, 74 (1968) (finding that business judgment rule does not protect directors acting "with gross or culpable negligence").|
|57||Butz v. Glover Livestock Comm'n Co., 411 U.S. 182, 185 (1973). See also Rizek v. SEC, 215 F.3d 157, 160 (1st Cir. 2000) (same).|
|58|| Respondents assert that the passage of time hampered their defense because Rolnick died in 1994, and Sergy's memory became deficient. Although Respondents assert that Rolnick advised them with respect to various transactions, as discussed in note 38 supra, they failed to establish reliance on the advice of counsel.
Sergy's testimony at the hearing was consistent with that of Coxon and other witnesses. It was also confirmed by various documents in the record, including minutes of board meetings, the office leases, and the disclosure documents.
|59|| On the record before us, we have determined not to impose bars, suspensions, or civil penalties. Respondents argue that we could not impose such remedies in this case because they are time-barred under 28 U.S.C. § 2462, as interpreted by Johnson v. SEC, 87 F.3d 484 (D.C. Cir. 1996). Section 2462 requires the federal government to bring an action for enforcement of a "civil fine, penalty, or forfeiture" no later than five years after the claim accrues. We do not address Respondents' argument, other than to note that it overlooks the fact that, while much of the misconduct here occurred more than five years before the institution of these proceedings, payments under the WMM and WMS leases and the Passport Financial offering did not.
Section 2462 does not constitute an evidentiary bar. Evidence of matters that occurred before the applicable limitations period may be admitted. Joseph J. Barbato, 53 S.E.C. 1259, 1278 n.26 (1999), citing United States v. Gavin, 565 F.2d 519, 523 (8th Cir. 1977).
|60||Respondents did not address the applicability of Section 2462 to cease-and-desist proceedings. Because a cease-and-desist order is forward-looking, we believe that Section 2462 does not apply to actions for a cease-and-desist order. The order here requires only that Respondents obey the law, which they must do in any event, and is designed to ameliorate the risk of similar violations occurring in the future.|
|61||Among those factors are, "the seriousness of the violation, the isolated or recurrent nature of the violation, the respondent's state of mind, the sincerity of the respondent's assurances against future violations, the respondent's recognition of the wrongful nature of his or her conduct, and the respondent's opportunity to commit future violations. In addition, we consider whether the violation is recent, the degree of harm to investors or the marketplace resulting from the violation, and the remedial function to be served by the cease-and desist order in the context of any other sanctions being sought in the same proceeding." KPMG Peat Marwick LLP, Exchange Act Rel. No. 43862 (Jan. 19, 2001), 74 SEC Docket 384, 436, petition denied, 289 F.3d 109 (D.C. Cir. 2002).|
|62|| Hately v. SEC, 8 F.3d 653, 655 (9th Cir. 1993); SEC v. Rind, 991 F.2d 1486, 1941 (9th Cir. 1993).
Respondents do not assert that disgorgement is subject to 28 U.S.C. § 2462 although, as discussed below, they assert that certain aspects of the law judge's award constitute a penalty. Johnson v. SEC, 87 F.3d at 1491, stated that "where the effect of the SEC's action is to restore the status quo ante, such as through a proceeding for restitution or disgorgement of ill-gotten profits, § 2462 will not apply." Respondents unlawfully obtained use of the Permanent Portfolio's money, and Respondents have not returned any funds to the Portfolio. The status quo ante is restoration of those funds.
|63||SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1475 (2d Cir. 1996), cert. denied, 522 U.S. 812 (1997), quoting SEC v. Patel, 61 F.3d 137, 139 (2d Cir. 1995).|
|64||See, e.g., SEC v. First Pacific Bancorp, 142 F.3d 1186, 1992 (9th Cir. 1998) (finding that disgorgement by defendant was appropriate where defendant had fraudulently diverted funds into an offering, the infusion of capital put off the enterprise's failure and permitted continued operations, and defendant had paid himself salaries, commissions, and fees.)|
|65|| Respondents also claim that they should be credited with the value of their donation of WMS to the Permanent Portfolio. We disagree. Martin testified that the Fund's counsel had given the opinion that the Fund was prohibited from paying any amount of money for WMS. Respondents were unable to receive compensation for WMS. Moreover, WMM had written off WMS as an asset.
We also reject Respondents' assertion that they are entitled to offset the rent WMM paid on the office suite after WMS was dissolved. As guarantor of WMS's performance under the lease, WMM had the obligation to pay rent.
|66||Respondents and the Division agree that, in the initial decision, the disgorgement amount awarded by the law "double counted" or duplicated Respondents' ill-gotten gains. Thus, she awarded $850,000, plus $182,005 in printing and mailing costs from the 1990 Selling Agreement, the $154,566 in printing and mailing costs from the 1991 Selling Agreement, the $52,137 in rent that WMS paid for the space occupied by WMM, the Fund, and Bullion Security Corp., and the $20,289 in unreimbursed costs that WMS incurred in connection with the Passport Financial offering although each of these expenditures were paid out of the $850,000 excess capitalization of WMS. The $850,000 in disgorgement that weimpose here includes these other expenditures.|
|67||SEC v. First Jersey Sec., Inc., 101 F.3d at 1475.|
|68||SEC v. First Pacific Bancorp, 142 F.3d at 1191, citing SEC v. Hateley, 8 F.3d at 656; SEC v. Hughes Capital Corp. 124 F.3d 449, 455 (3rd Cir. 1997) ("When apportioning liability [for disgorgement] among multiple tortfeasors, it is appropriate to hold all tortfeasors jointly and severally liable for the full amount of the damage unless the liability is reasonably apportioned."); SEC v. First Jersey Sec., Inc., 101 F.3d at 1475|
|69||SEC v. Hughes Capital Corp., 124 F.3d at 455, citing SEC v. First City Financial Corp., 890 F.2d 1215, 1232 (D.C.Cir. 1989).|
|70||15 U.S.C. §77h-1(e); 15 U.S.C. §78u-3(e).|
|71||We have considered all of the parties' contentions. We have rejected or sustained them to the extent that they are inconsistent or in accord with the views expressed in this opinion.|
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