SECURITIES AND EXCHANGE COMMISSION
In the Matter of the Application of
AMERICAN INVESTMENT SERVICES, INC.
For Review of Action Taken by the
OPINION OF THE COMMISSION
REGISTERED SECURITIES ASSOCIATION -- REVIEW OF DENIAL OF MEMBERSHIP CONTINUANCE APPLICATION
Registered securities association denied member's application to allow continued association of two general securities representatives, relying on preliminary injunction entered with consent against representatives based on allegations of violations of the Commodity Exchange Act. Held, association's action sustained and appeal dismissed.
Thomas D. Birge, of Birge & Minckley, P.C., for American Investment Services, Inc.
Deborah F. McIlroy, for NASD Regulation, Inc.
Appeal filed: September 7, 1999
Last brief received: January 10, 2000
American Investment Services, Inc. ("AIS"), a member of the National Association of Securities Dealers, Inc. ("NASD"), appeals from the denial of a membership continuance application ("Application") to permit Carolyn F. Munn and Samuel H. Foreman to associate with AIS as general securities representatives. AIS acknowledges that Munn and Foreman are each subject to a statutory disqualification arising as a result of a Consent Order of Preliminary Injunction ("Preliminary Consent Order") entered againstthem on October 9, 1997 in the United States District Court for the Northern District of Illinois. During the pendency of this appeal, the District Court, on March 27, 2000, entered a Consent Order of Permanent Injunction ("Consent Order") against Munn and Foreman.1 We base our findings on an independent review of the record.
The Preliminary Consent Order enjoined Munn and Foreman from, among other things, acting in any capacity for which registration with the Commodity Futures Trading Commission ("CFTC") is required under the Commodity Exchange Act ("CEA").2 The Consent Order enjoins the same conduct as did the Preliminary Consent Order. These orders arose from a complaint filed by the CFTC alleging that Munn, Foreman, and others participated in the business of soliciting, accepting, and pooling money from investors for commodity pools that were not registered under the CEA. The CFTC further alleged that Munn and Foreman had misrepresented and failed to disclose material facts to investors.
Munn and Foreman do not dispute either their conduct or that the investment scheme in which they participated resulted in fraud. Rather, Munn and Foreman argue that they lacked the requisite intent to commit fraud. Thus, the factual record underlying the findings of the Consent Order is largely undisputed.3
Beginning in the fall of 1995, Munn, Foreman, and a third person no longer a participant in this proceeding became involved with an individual named Randall Williams.4 Williams introduced Munn and Foreman to James Crawford, a purported expert futures trader who had allegedly created a profitable investment system for trading commodity interests.5 Although Munn and Foreman visited Crawford's office, reviewed Crawford's investment literature, and engaged in discussions with Williams and Crawford, they did not conduct any investigation into Crawford's background or whether the proposed commodity investments were exempt from registration under the CEA.6 Munn and Foreman simply accepted the assertions of Williams and Crawford that the investments were exempt from registration. In fact, Crawford had a criminal conviction for securities fraud and the proposed investments were commodity pools that were required under the CEA to be registered.
Pursuant to directions from Crawford and Williams, in about June 1996 Munn and Foreman established two investment vehicles.7 Munn and Foreman, together with a third individual, then obtained approximately $1.2 million, mostly from friends and family, and invested the funds in both investment vehicles. Over a ten-month period, the investors lost most if not all of these funds.
In its complaint, the CFTC alleged, among other things, that Munn and Foreman failed to disclose material facts to investors in each of the investment vehicles. As to limited partner investors, the CFTC alleged that Munn and Foreman failed to disclose their agreement to pay Crawford 30% of the realized profits, that the commodity pools would have to achieve substantial minimum earnings before investors would earn any profits, that the accounts were not being traded in conformance with the representations made when the funds were solicited, and that the limited partnership statements sent to investors did not include substantial unrealized losses.
As to Fixed Participation Plan investors, the CFTC alleged that Munn and Foreman failed to disclose that their money would be used to trade commodity interests and was subject to substantial risks. Munn and Foreman also allegedly failed to disclose that investors' principal was being depleted and that "interest" being paid to investors either on an accrued basis or as actual monthly cash payments was not the result of earnings from their invested principal. Further they allegedly failed to disclose that at least $200,000 of invested funds would be used to pay operating and promotional expenses and fees.
In support of its Application, AIS argues that Munn and Foreman were themselves the victims and pawns of a fraudulent scheme perpetrated by Williams and Crawford. It further asserts that Munn and Foreman were duped by the convincing demeanor of Williams and Crawford as to their expertise and history of profitable commodities investments. Moreover, AIS represents that, if Munn and Foreman are permitted to associate, AIS will implement stringent supervision and reporting requirements in order to ensure their compliance with all applicable securities laws, rules, and regulations.8 AIS stressesthat both Munn and Foreman have made restitution payments and will continue to do so to the extent they can generate sufficient income.
The NASD considered the factual record, the gravity of the charges that led to the Preliminary Consent Order, and also reviewed the disciplinary history of AIS.9 The NASD concluded that, on the basis of the entire Application, the public interest required its denial.
Section 19(f) of the Securities Exchange Act of 1934 governs our review of this appeal. In particular, if we find that: (1) the specific grounds on which the NASD based its action exist; (2) the NASD's action is in accordance with its rules; and (3) the NASD ruleswere applied in a manner consistent with the purposes of the Exchange Act; we must dismiss the appeal, unless the NASD's action imposes an undue burden on competition.10
We begin our analysis by examining whether the specific grounds on which the NASD based its action exist in fact. Pursuant to Section 3(a)(39)(F) of the Exchange Act,11 a person is subject to a "statutory disqualification" if, among other things, such person "is enjoined from any action, conduct, or practice" specified in Section 15(b)(4)(C) of the Exchange Act.12 Section 15(b)(4)(C) includes injunctions against acting as a person or entity required to be registered under the CEA or as an affiliated person or employee of such an entity.
The Preliminary Consent Order enjoined, and the Consent Order enjoins, Munn and Foreman from, among other things, acting in any capacity for which registration with the CFTC is required under the CEA.13 Accordingly, Munn and Foreman are each subject to a statutory disqualification under the Exchange Act.14 Based upon the foregoing, we find that the specific grounds on which the NASD based its action exist in fact.
We next determine whether the NASD's action is in accordance with its rules. In its appeal, AIS does not dispute that the denial of the Application was in accordance with the NASD's rules. The NASD's rules permit it to bar a person from associating with a memberwhen that person is enjoined under the CEA.15 The NASD conducted an eligibility hearing during which AIS was afforded a full and fair opportunity to be heard on its Application and to demonstrate why it was consistent with the public interest and protection of investors to permit Munn and Foreman to remain registered representatives with AIS. As such, we are satisfied that the NASD's action was in accordance with both its substantive and procedural rules.
We also find that the NASD's rules were applied in a manner consistent with the purposes of the Exchange Act. The NASD is afforded discretion in considering the circumstances under which a person subject to a statutory disqualification may associate with a member.16 Here, the NASD considered the testimony of Munn and Foreman at the eligibility hearing, the gravity of the charges alleged in the CFTC's complaint, the disciplinary history of Munn, Foreman, and AIS, and the proposed supervision to be accorded to Munn and Foreman. The NASD concluded that Munn and Foreman's failure to act responsibly in their dealings with investor accounts, in addition to their alleged failure to investigate investments sufficiently and to disclose material information to investors, indicated that approval of the Application was not consistent with the public interest and the protection of investors.17
Securities professionals must be held to the highest possible standard of conduct. Munn's and Foreman's own testimony at the NASDhearing and in depositions taken by the CFTC (and admitted into evidence before the NASD) makes clear that their conduct fell far short of this standard.
Although the record contains many examples, we find the following of particular significance. Despite more than 25 years of experience in the securities industry between them, Munn and Foreman marketed and recommended investments about which they admittedly knew nothing and which ultimately caused significant losses to investors. In so doing, Munn and Foreman concede that they relied on the purported expertise and documentation of Williams and Crawford for purposes of marketing investments, without conducting any independent inquiry or investigation into the accuracy of the supplied information.
Under the tutelage of Williams and Crawford, Munn and Foreman caused accounts for each investment vehicle to be opened with a registered futures commission merchant ("FCM") for the purpose of trading commodity interests.18 Munn and Foreman received, on at least a daily basis, statements from the FCM evidencing the trading activity that occurred in the accounts.19 Munn and Foreman admit that they did not understand these statements. Yet, they made no inquiry of the FCM regarding the import of the statements or how to interpret them. Munn and Foreman further admit that, when they asked Williams and Crawford to interpret the account statements, they did not receive an explanation, but rather were told to let Williams and Crawford worry about it.
Foreman claims that he did not believe that he and Munn had any obligation to review the statements, but instead, opted to rely on Williams and Crawford for guidance and instructions. Neither Munn nor Foreman disseminated the statements from the FCM to investors. Instead, they forwarded the statements to Williams and Crawford who in turn generated different statements to be sent by Munn and Foreman to the investors. Munn and Foreman admit that they could not reconcile information contained in the statements generated by Williams and Crawford with the information contained in the statements from the FCM.
Munn and Foreman state that they were told by Williams and Crawford that money obtained from the Fixed Participation Plan investors would be deposited into a bank account earning 6% interest, and that funds would also be placed in non-securities related investments offering a high rate of return with minimum risk in order, collectively, to generate the 12% interest promised in the Secured Investment Agreements. Neither Munn nor Foreman verified with Williams or Crawford that this was being done nor did they ask to see any documentation from the bank where the funds were supposedly deposited. Nonetheless, Munn and Foreman continued to represent to investors that their investments were on deposit in an interest-bearing bank account. Finally, Munn and Foreman, without disclosing it to investors, used approximately $200,000 of Fixed Participation Plan funds for operating and promotional expenses rather than investment.
Although AIS portrays Munn and Foreman as victims, a review of the record, even in a light most favorable to them, demonstrates a troubling lack of understanding by Munn and Foreman of their own role in the events that were at issue in the CFTC's injunctive action. Munn and Foreman, in making representations to their clients, abdicated any responsibility to verify the accuracy of information provided by Crawford and Williams concerning the disposition of money solicited from investors. They sent account statements to their clients that they knew were inconsistent with the statements generated by the FCM that maintained the accounts. They admittedly failed to disclose material information to investors.
These facts, plus the troubled disciplinary history of AIS, lead us to conclude that, notwithstanding the supervisory procedures proposed by the firm, it is appropriate in the public interest and for the protection of investors to deny AIS's Application.20 Accordingly, we find that the NASD's rules were applied in a manner consistent with the purposes of the Exchange Act.
AIS argues that the NASD's denial of its Application imposes a burden on competition that is not necessary or appropriate in furtherance of the purposes of the Exchange Act and therefore must be set aside.21 In support of this argument, AIS states that Munn and Foreman each had a clean disciplinary record prior to the CFTC action, did not intend to harm investors, has cooperated extensivelywith the regulatory authorities, has begun restitution, and will associate with AIS pursuant to strict compliance oversight.22
AIS's argument fails to identify any burden on competition imposed by the NASD's denial of the Application. The NASD, in its brief on appeal, hypothesizes that AIS is arguing that an undue burden on competition arises from the denial of the Application by interfering with Munn's and Foreman's ability to make restitution payments to injured investors. Even assuming this hypothesis is true, it is unclear how a failure to make full restitution burdens competition. In the absence of any identifiable burden on competition, AIS's arguments that the denial of the Application is not necessary or appropriate in furtherance of the purposes of the Exchange Act do not provide a basis for setting aside the NASD's decision.
Finally, AIS contends that the Preliminary Consent Order provides only a "preliminary" injunction, whereas a denial of the Application results in a "lifetime bar" for Munn and Foreman from the securities industry. This is incorrect for two reasons. First, since the time that AIS filed its briefs, the injunction has become permanent. Second, denial of AIS's Application is not a lifetime bar from the industry. The NASD's denial of the Application was based on the totality of the circumstances that existed at that time. A different application at a different time might yield a different result.23
In light of the foregoing considerations, we dismiss this appeal. An appropriate order will issue.24
By the Commission (Acting Chairman UNGER, Commissioners HUNT and CAREY).
Jonathan G. Katz
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 43991 / February 21, 2001
Admin. Proc. File No. 3-10001
In the Matter of the Application of
AMERICAN INVESTMENT SERVICES, INC.
For Review of Action Taken by the
ORDER DISMISSING APPEAL OF DENIAL OF MEMBER'S CONTINUANCE APPLICATION TO REGISTERED SECURITIES ASSOCIATION
On the basis of the Commission's opinion issued this day, it is
ORDERED, that the appeal of the action taken by the National Association of Securities Dealers, Inc. denying the application of American Investment Services, Inc. ("AIS") to permit Carolyn F. Munn and Samuel H. Foreman to associate with AIS as general securities representatives be, and it hereby is, dismissed.
By the Commission.
Jonathan G. Katz
|1||On April 14, 2000, the NASD submitted a copy of the Consent Order. Pursuant to our Rules of Procedure, we may take official notice of any material fact as to which a United States District Court might take judicial notice, including federal district court orders. Rule 323, 17 C.F.R. § 201.323.|
|2||7 U.S.C. §§ 1 et seq. The Preliminary Consent Order made no findings of fact.|
|3|| Pursuant to the Consent Order, the CFTC's complaint against Munn and Foreman was settled without a trial on the merits. Except in limited circumstances not relevant here, the Consent Order provides that neither Munn nor Foreman admits or denies any of the findings of fact (beyond jurisdiction and venue) contained therein. Nonetheless, Munn and Foreman agree that they "will not take any action . . . to create the impression that this Consent Order is without a factual basis." Munn and Foreman reserve, however, "the right to take legal positions in other proceedings to which the [CFTC] is not a party." Consent Order at ¶5.
We need not resolve the effect of this language on whether AIS may challenge in this appeal the facts found by the District Court in the CFTC action. Our findings herein are based upon admissions made by Munn and Foreman in depositions and beforethe NASD, as well as representations by AIS in its briefs.
|4||At that time, Munn and Foreman were associated with an NASD member firm other than AIS; that firm terminated its association with them in June 1997 when it learned of their involvement with the transactions at issue in the CFTC lawsuit. Munn and Foreman were hired by AIS prior to the entry of the Preliminary Consent Order.|
|5||A "commodity interest" is any contract for the purchase or sale of a commodity for future delivery and any contract, agreement or transaction subject to CFTC regulation under section 4c or 19 of the CEA. 17 C.F.R. § 4.10(a).|
|6||Although Munn and Foreman knew that Crawford's investment system involved commodity trading, Munn testified that Crawford, at least initially, didn't refer to his system as a "pool."|
|7||The two investment vehicles were: (1) the sale of limited partnership interests pursuant to a limited partnership agreement; and (2) participation in a "Fixed Participation Plan" pursuant to the use of written agreements entitled "Secured Investment Agreements." Investors participating in the second vehicle received promissory notes providing for interest at a fixed annual rate.|
|8||In its Application AIS states that Munn and Foreman will be: (1) required to conduct all business, including securities, insurance, and financial planning, through AIS; (2) prohibited from participating in any limited partnerships, private placements, or other type of unregistered securities offering without prior written approval from AIS's compliance director; (3) required to make available all checking and savings account records; (4) required to attend specialized continuing education; and (5) supervised daily by one or more senior AIS professionals with supervisory experience. Further, AIS will: (a) maintain a salaried manager in Munn and Foreman's office who, among other things, will make periodic random contacts with customers to determine whether Munn or Foreman is conducting any business away from AIS; (b) perform regular on-site inspections (both scheduled and unscheduled); and (c) have its compliance director perform a monthly review of Munn and Foreman's business. Finally, AIS will submit to and pay for a year-long examination, conducted by an independent consultant, covering all its compliance and supervisory policies, practicesand procedures.|
|9||AIS became an NASD member in 1987. Since that time, AIS and its employees have been the subject of regulatory actions taken by both the NASD and state agencies. Specifically, an NASD proceeding in 1991 resulted in censures and fines against AIS and one of its representatives for net capital and recordkeeping violations. In 1996, a North Dakota action resulted in a cease and desist order against AIS prohibiting it from offering investments in a company and viatical settlement contracts in violation of state registration laws. Similarly, a Maryland action in this same time period resulted in a consent order following AIS's admission that it effected securities transactions while not registered with the State to do so. In 1997, the NASD initiated two disciplinary actions, for, among other things, failure to maintain minimum required net capital, filing inaccurate FOCUS IIa Reports, and failure to maintain and enforce adequate supervisory procedures. These proceedings resulted in censures and fines and, in the case of one individual, a bar from association and a fine in excess of $1 million. In 1998, AIS was again involved in a North Dakota action alleging its failure timely to execute a transaction and its alteration of account documents to conceal the failed execution. AIS was assessed a civil penalty. Also in 1998 the State of Illinois commenced an action alleging that an AIS representative offered and sold securities through another salesperson not registered with the State. AIS was censured in that proceeding.|
|10||Section 19(f) of the Exchange Act, 15 U.S.C. § 78s(f). See, e.g., Jacob Adoni, Exchange Act Rel. No. 41813 (Aug. 31, 1999), 70 SEC Docket 1496, 1499; Gershon Tannenbaum, 50 S.E.C. 1138, 1139 (1992).|
|11||15 U.S.C. § 78c(39)(F).|
|12||15 U.S.C. § 78o(b)(4)(C).|
|13|| In addition to enjoining Munn and Foreman from violating numerous CEA sections, the Consent Order prohibits them from:
[S]eeking registration or claiming exemption from registration with the [CFTC] in any capacity under the [CEA]; acting in any capacity for which registration or exemption from registration with the [CFTC] is required under the [CEA]; and/or acting as a principal, employee, officer or agent of any person registered, exempted from registration or required to be registered under the [CEA].
|14||Although at the time that AIS filed its briefs only the Preliminary Consent Order was in effect, Section 15(b)(4)(C) of the Exchange Act expressly includes "temporary" injunctions within its purview. See Gershon Tannenbaum, 50 S.E.C. 1138, 1140 & n.5 (1992).|
|15||See Article III, Section 4(h) of the NASD By-Laws (person who is enjoined from acting as an entity required to be registered under the CEA is subject to a disqualification); Article III, Section 3(b) of the NASD By-Laws (no person who becomes subject to a disqualification shall continue to be associated with a member); Article III, Section 3(c) of the NASD By-Laws (the NASD may suspend or bar a person from continuing to associate with any member if such person becomes ineligible to associate under Section 3(b)).|
|16||See, e.g., Dennis Milewitz, Exchange Act Rel. No. 40254 (July 23, 1998), 67 SEC Docket 1827, 1832 ("Congress has granted the NASD broad discretion in matters involving the employment of statutorily disqualified individuals"); Halpert and Co., 50 S.E.C. 420, 422 (1990) ("Particularly in matters involving a firm's employment of persons subject to a statutory disqualification, it is appropriate to recognize the NASD's evaluation of appropriate business standards for its members."). See also NASD Code of Procedures Rule 9523(b)(1).|
|17||Because the Consent Order had not been issued at the time of the NASD's decision, the NASD based its findings with respect to the public interest on its own review of the facts rather than any findings by the District Court. Our review of the NASD's action is likewise based on the record actually considered by the NASD in reaching its conclusions.|
|18|| A futures commission merchant is defined as an entity that:
(A) is engaged in soliciting or in accepting orders for the purchase or sale of any commodity for future delivery on or subject to the rules of any contract market; and
7 U.S.C. § 1a(12).
|19||The trading activity in the accounts occurred originally at the direction of Crawford, and later Williams.|
|20||Cf., Halpert and Co., 50 S.E.C. 420, 422 (1990) (the NASD's denial of an application to employ criminally convicted salesman held consistent with purposes of the Exchange Act because "a criminal conviction involving fraud raises a serious question as to whether the perpetrator will engage in similar misconduct in the securities industry, a field that is rife with opportunities for abuse.").|
|21||See 15 U.S.C. § 78s(19)(f).|
|22||AIS also stresses Munn's and Foreman's backgrounds, including that Munn is a former missionary and school principal and Foreman, who has been married to the same woman for 28 years, is a Sunday school teacher and active with his church.|
|23||See Article III, Section (3)(d) of the NASD By-Laws. In considering a new application, the NASD can re-evaluate the recency of the disqualifying event and the seriousness of the misconduct that gave rise to it. See, e.g., Louis A. Frangos, 49 S.E.C. 865, 867 (1988) (recency of conviction is a factor in justifying denial of association); Funding Capital Corp., 50 S.E.C. 603, 606 (1991) (seriousness of misconduct considered). Additionally, factors that might be considered in any new application include the proposed firm, the type of association, and the supervisory arrangements.|
|24||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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