SECURITIES AND EXCHANGE COMMISSION
In the Matter of the Application of
A.S. GOLDMEN & CO., INC.,
STUART E. WINKLER
For Review of Disciplinary Action taken by the
NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.
OPINION OF THE COMMISSION
REGISTERED SECURITIES ASSOCIATION -- REVIEW OF DISCIPLINARY PROCEEDING
Violations of Rules of Conduct
Conduct Inconsistent with Just and Equitable Principles of Trade
Excessive and Fraudulent Markups
Violation of Prohibition Against Trading by Person Interested in Distribution
Failure to Establish, Maintain, and Enforce an Adequate Supervisory System
Member firm of registered securities association and its vice president and registered principal charged excessive and fraudulent markups and engaged in violation of Exchange Act Rule 10b-6. The firm and its vice president also failed to establish adequate supervisory procedures and supervisorysystems to detect and prevent excessive markups and manipulation. Held, association's findings of violation and the sanctions it imposed are sustained.
Wilmer Parker, III, of Kilpatrick Stockton LLP, for A.S. Goldmen & Co., Inc.
Carole R. Bernstein, of the Law Offices of Carole R. Bernstein, for Stuart Winkler.
Alden S. Adkins, Susan L. Beesley, and Carla J. Carloni, for NASD Regulation, Inc.
Appeal filed: June 14, 1999
Last brief received: October 22, 1999
A.S. Goldmen & Co., Inc. ("Goldmen" or the "Firm"), a former member of the National Association of Securities Dealers, Inc. ("NASD"), and Stuart E. Winkler ("Winkler"), a registered general securities representative, general securities principal, and a limited principal -- financial and operations, as well as Goldmen's vice president in charge of investment banking, sales, trading, and compliance, appeal from NASD disciplinary action. The NASD found that Goldmen and Winkler: (1) charged fraudulently excessive markups in violation of NASD Conduct Rules 2110,1 2120,2 and 24403; (2) engaged in manipulative trading practices in violation of NASD Conduct Rules 2110, and 2120, Section 10(b) of the Securities Exchange Act of 1934,4 andExchange Act Rule 10b-6;5 and (3) failed to establish, maintain, and enforce an adequate supervisory system in violation of NASD Conduct Rule 3010. The NASD censured Goldmen; fined it $150,000, jointly and severally with Anthony J. Marchiano, the Firm's president;6 ordered the Firm to pay restitution in the amount of $549,903, plus interest; and required the Firm to retain an independent consultant to review the Firm's policies, procedures, and practices, with particular attention to markups and manipulation during a distribution. The NASD censured Winkler, fined him $36,000, and suspended him for two years.7 We base our findings on an independent review of the record.
Innovative Tech Systems, Inc. ("ITSY"), an Illinois corporation, designed, developed, and marketed proprietary software used by businesses and the facilities management industry to oversee and manage the costs associated with the design, construction, and management phases of particular buildings, plants, or other facilities. On or about April 15, 1994, Goldmen, acting through Winkler, agreed to act as a managing underwriter of a firm-commitment ITSY offering of $6,950,000, consisting of 1.3 million shares of common stock at $5 per share and 1.8 million redeemable warrants at $0.25 per warrant (the "offering warrants"). The warrants, which were immediately tradeable, entitled the registered holder to purchase one share of common stock at an exercise price of $7 for a period of 60 months, beginning one year after the effective date of the offering. On or about May 13, 1994, ITSY filed a registration statement with the Commission to register the 1.3 million shares of common stock and the 1.8 million offering warrants.
Prior to filing the registration statement, ITSY raised $1.3 million through bridge financing. Under the terms of the bridge loans, ITSY provided each lender with a seven percent promissory note, together with one redeemable warrant for every dollar loaned to ITSY (the "bridge warrants"). These bridge warrants, which were issued in addition to the offering warrants being underwritten by Goldmen, were redeemable on the same terms as the offering warrants.
On May 11, 1994, ITSY completed the bridge financing and issued the notes and the 1.3 million bridge warrants to 21 investors (the "Selling Security Holders") in return for $1.3 million in financing. The registration statement for the ITSY offering that Goldmen filed on May 13, 1994 also provided for "shelf-registration" of the 1.3 million bridge warrants held by the Selling Security Holders and 1.3 million shares of common stock issuable by ITSY pursuant to those warrants. The registration statement represented that Goldmen was not "underwriting" the bridge warrants or the underlying common stock and that the bridge warrants and underlying common stock were not being offered as part of the public offering.
Each of the 21 Selling Security Holders held accounts at Goldmen. Winkler testified that he identified these potential investors by providing existing Goldmen customers with bridge financing booklets from ITSY that contained information about the financing. Winkler further testified that, in his experience, bridge warrant holders generally "flipped" out of the security in a short period of time in order to recover their original investment and a profit, thereby providing a ready supply of warrants.
On July 26, 1994, the Commission declared the registration statement effective. Goldmen did not allocate any ITSY offering warrants to other broker-dealers when it underwrote the ITSY public offering. When the Firm distributed the 1.8 million offering warrants, it placed most of them with its own customers.
Aftermarket trading in the ITSY offering warrants commenced on the Nasdaq SmallCap Market at approximately 12:00 p.m. on July 26, 1994.8 Goldmen set the first offer for ITSY warrants in the aftermarket at $1 and it set the first bid at $0.375. During the first two hours and eleven minutes of trading, Goldmen increased its offer six times, resulting in an increase in the inside offer from $1 to $1.9375, although there were no favorabledevelopments affecting ITSY and the market for the common stock was inactive.
Within the first hour of secondary trading in the offering warrants, Goldmen purchased approximately 950,000 of the bridge warrants from 14 of the 21 Selling Security Holders. By the close of trading on July 26, Goldmen, through Winkler, purchased a total of 1,250,000 ITSY bridge warrants from 19 of the 21 Selling Security Holders. The prices that Goldmen paid for these warrants ranged from $0.75 to $1.25. The inside bid for ITSY warrants during the period on July 26 when Goldmen was purchasing bridge warrants from the Selling Security Holders ranged from $1.375 to $1.75. On the morning of July 27, Goldmen purchased the remaining 50,000 bridge warrants from two Selling Security Holders at a price of $1.25 per warrant. The inside bids for ITSY warrants at the time of these two purchases were $1.75 and $1.625. Accordingly, Goldmen's purchases from the Selling Security Holders were all below the prevailing inside bid. Winkler alone represented Goldmen in negotiating its purchase of the warrants from the Selling Security Holders on July 26 and 27. Goldmen did not report its purchases from the Selling Security Holders to the Nasdaq SmallCap Market.
Goldmen, having accumulated a substantial inventory of ITSY warrants through its unreported purchases from the Selling Security Holders, sold ITSY warrants to its customers at prices that included a five percent markup over the inside offer quotation that the Firm had established. Between July 26 and July 29, 1994, Goldmen sold 2,504,435 warrants to its customers in 592 transactions.9 According to Goldmen's stock record for the week ending July 29, 1994, Goldmen, including its customers, held 3,357,845 of the 3,550,000 outstanding ITSY warrants.10 Thus, Goldmen controlled the supply of ITSY warrants.
Winkler testified that he directed Stacy Meyers, the Firm's head trader, to calculate the retail price it charged its customers by including a markup of five percent from the inside offer price.11 The NASD found that, in 500 retail sales ofITSY warrants, Goldmen charged markups in excess of 5% of its contemporaneous costs. In 309 of those trades, the markups exceeded 10% and ranged as high as 140%. The NASD determined that the total amount of excessive markups charged was $549,903.
A. Goldmen and Winkler Charged Customers Fraudulently Excessive Markups in the Sale of ITSY Warrants
The prices that a broker-dealer charges retail customers for securities must be reasonably related to the prevailing market price of the security.12 We further have held that markups of more than 10 percent over the prevailing market price are evidence of scienter and have held such markups to be fraudulent.13 The prevailing market price typically is the current inter-dealer price, that is, the price at which dealers trade with one another.14 Where an integrated dealer, like Goldmen, so dominates and controls the market for a security that it effectively can set wholesale prices, however, the best evidence of the security's market price is the firm's contemporaneous cost in acquiring the security, rather than the inter-dealer price.15 If there are no contemporaneous purchases from other dealers, purchases from retail customers may be used to determine prevailing market price, subject to an imputed markdown being added to the purchase price.16
Goldmen and Winkler argue that the Firm did not dominate and control the market for ITSY warrants and, therefore, properly calculated its retail prices from the inside offer. In determining whether a firm dominates and controls a market for a security, we have considered several factors, including whether the firm underwrote the security and sold a substantial percentage of the offering to its own customers, whether the firm was responsible for significant trading in the aftermarket, and whether the remaining amount of aftermarket trading was fragmented among other dealers.17
Goldmen had "unique access to its customers to obtain its supply of [securities] for secondary market activities."18 The Firm did not allocate any of the 1.8 million ITSY offering warrants to other broker-dealers and placed most of these offering warrants with its own customers. Goldmen had access to an additional supply of ITSY warrants, the 1.3 million bridge warrants held by the 21 Selling Security Holders, all of whom had accounts at Goldmen. During aftermarket trading of the offering warrants, Winkler negotiated Goldmen's purchase of all of the bridge warrants held by the 21 Selling Security Holders.
Goldmen traded a significant amount of the total aftermarket volume in ITSY warrants.19 During the markup review period, all broker-dealers, including Goldmen, purchased a total of 2,971,388 ITSY warrants. Goldmen purchased 2,785,688 warrants, 93.8% of the total purchase volume. All broker-dealers sold a total of 2,686,535 ITSY warrants during the review period. Goldmen sold 2,528,935 warrants, 94.1% of the total sales volume. Goldmen traded 93.9% of the 5,314,623 ITSY warrants traded during the markup review period.
The remaining secondary market in ITSY warrants was fragmented among several broker-dealers. Goldmen and Winkler maintain that the Firm could not have controlled the market for ITSY warrants because 12 other market makers posted bona fide quotations for ITSY warrants on the Nasdaq SmallCap Market and traded within the posted quotes. Therefore, applicants argue, quotations represented reliable evidence of the prevailing market price and the Firm was justified in using them as the basis for calculating markups on ITSY warrants.20 It is well-established, however, that quotations merely propose a transaction and that, standing alone, they generally are notaccurate indications of price.21 Moreover, where an integrated dealer dominates and controls the market for a security, it is able to set non-competitive quotations and spreads, as other market makers have no significant competitive influence in pricing the security.22 That other dealers adopted Goldmen's quotations and spreads does not make them independent or indicative of the current market.23 Goldmen's purchase of the bridge warrants well below the inside bid when other market makers were unaware of these transactions is further evidence that the spreads were artificial.24
Contrary to applicants' argument, the mere existence of a number of market makers in a security also does not itself ensure that an independent market exists for that security.25 Goldmen had unique access to its customers and the Selling Security Holders, which allowed it to obtain its supply of securities for secondary market activities.26 Goldmen's control of the supply of warrants enabled it "to control wholesale pricing to such an extent as to preclude an independent, competitive market from arising, notwithstanding the presence of other dealers who may [have been] entering quotations."27 The meager activity by market makers other than Goldmen supports our conclusion that a viable independent market away from Goldmen did not exist during the markup review period.
Goldmen also controlled the wholesale pricing of ITSY warrants by increasing the inside offer for ITSY warrants six times during the first two hours and eleven minutes of trading, at a time when there were no developments with respect to ITSY, and the market for the underlying securities was stagnant. Goldmen, through Winkler, set the first offer in the aftermarket in ITSY warrants at $1. After Goldmen's six increases, the inside offer stood at $1.9375.28 Based on these factors, we conclude that Goldmen controlled the market for ITSY warrants during the markup review period, and that, therefore, the NASD correctly calculated Goldmen's markups based on the Firm's contemporaneous cost.29 We find that all of the allegedmarkups over five percent of Goldmen's contemporaneous cost are excessive.
The record establishes that Winkler was responsible for the markups of ITSY warrants. Winkler was a principal and vice president of Goldmen. Winkler testified that in this role he was responsible for all aspects of the Firm's operation and that he reported to no one, including the Firm's president. Winkler testified that it was his job to ensure that pricing of the ITSY warrants complied with NASD requirements. Winkler made all trading decisions for the Firm with respect to ITSY warrants, including setting the Firm's quotations for the warrants and establishing the Firm's procedures for setting the price at which the warrants would be sold to retail customers.
Moreover, Winkler was responsible for the actions that resulted in Goldmen's domination and control of the market for ITSY warrants. He located the bridge lenders for ITSY, directed Goldmen's purchase of bridge warrants from the Selling Security Holders, and directed Goldmen's placement of ITSY warrants with and purchases from its customers, all of which contributed to Goldmen's control of the supply of ITSY warrants. Indeed, Winkler testified that he made all of the decisions for the Firm regarding ITSY warrants.
The NASD determined that Goldmen charged markups in excess of 10% of the prevailing market price in 309 trades and that the markups ranged as high as 140%. Winkler's scienter is amply demonstrated. At a minimum, Winkler was reckless in not knowing that Goldmen dominated and controlled the market for ITSY warrants. Winkler further was reckless in charging Goldmen's customers markups based on unsubstantiated ask quotations when he knew the Firm's contemporaneous costs. We find that these 309 markups were fraudulent.
* * *
Accordingly, we find that Goldmen and Winkler violated NASD Conduct Rules 2110, 2120, and 2440.
B. Goldmen and Winkler Bid for and Purchased ITSY Warrants While Engaged in a Distribution of ITSY Warrants
At the time of the conduct here, Exchange Act Rule 10b-6 prohibited any person engaged in a distribution of securities from purchasing or bidding for the security until that person had completed its participation in the distribution.30 Rule 10b-6 was intended to prevent persons participating in the distribution of a security from artificially conditioning the market in order to facilitate the distribution, and to protect the integrity of the securities trading markets as independent pricing mechanisms.31
The registration for the underwritten offering of 1.3 million shares of ITSY common stock and the 1.8 million ITSY offering warrants, as well as for the 1.3 million ITSY bridge warrants, went effective on July 26, 1994. Goldmen distributed all of the 1.8 million ITSY offering warrants, selling most of them to the Firm's retail customers. Secondary trading in ITSY warrants began on the Nasdaq SmallCap Market around 12:00 p.m. At this time, Goldmen, as a market maker in ITSY warrants, began displaying bids for ITSY warrants. The Firm continuously displayed bids for ITSY warrants during the remainder of July 26 and on July 27. During this time, Goldmen also purchased ITSY warrants from retail customers.
Between 12:00 p.m. on July 26 and 12:00 p.m. on July 27, Goldmen purchased, in a series of transactions, all 1.3 million bridge warrants from the 21 Selling Security Holders.32 Between 12:00 p.m. on July 26 and the close of trading on July 27, the Firm sold at least 2.1 million ITSY warrants to its retail customers.
Rule 10b-6 prohibits a respondent from purchasing or bidding for securities while participating in a distribution of thosesecurities.33 As the foregoing makes clear, it is undisputed that Goldmen bid for and purchased ITSY warrants from its retail customers during the same period that the Firm purchased all of the ITSY bridge warrants from the 21 Selling Security Holders and then sold those bridge warrants to its retail customers. We must determine, therefore, whether Goldmen's sale of those bridge warrants to retail customers was a distribution.
As used in Rule 10b-6, the term distribution "means an offering of securities, whether or not subject to registration under the Securities Act of 1933, that is distinguished from ordinary trading transactions by the magnitude of the offering and the presence of special selling efforts and selling methods."34 Relevant factors in evaluating the magnitude of an offering are the number of shares for sale, and the percentage of outstanding shares, of the public float, and of the trading volume that those shares represent.35 Providing greater than normal sales compensation arrangements pertaining to the distribution of a security is indicative of special selling efforts and selling methods.36
The 1.3 million warrants purchased from the Selling Security Holders by Goldmen on July 26 and 27 represented more than 36% of the total number of ITSY warrants issued and outstanding at that time, and more than 38% of the public float of the ITSY warrants.37 Goldmen's sale of the 1.3 million ITSY bridgewarrants from the Selling Security Holders satisfies the magnitude requirement of Rule 10b-6.
Applicants argue that the NASD improperly combined individual purchases from the 21 Selling Security Holders in determining the magnitude of the offering. Whether an offering of securities constitutes a distribution depends not on the source of the stock, but on the magnitude of the offering to investors. The sources of the securities are not required to act in concert in order to establish that a distribution has occurred. Moreover, while applicants argue that the Selling Security Holders sold their warrants at different times for different prices, all 21 of the Selling Security Holders sold all of their warrants to Goldmen within the first 24 hours after the registration became effective.
Goldmen employed special selling efforts by providing its salespersons with greater compensation for selling ITSY warrants than for selling other securities. We have stated that one indication of special selling efforts is providing greater than normal sales compensation arrangements pertaining to the distribution of a security.38 Although Goldmen generally paid its salespersons 50% of the gross commission the Firm earned on all sales of securities, by determining the amount of Goldmen's gross commissions, Winkler effectively could change the compensation level for a given security. Winkler testified that at times he calculated Goldmen's gross commission to include the spread -- he would calculate the Firm's gross commission from the inside bid and pay the Firm's brokers 50% of that amount. Winkler stated that at other times he used a higher number for the Firm's cost basis -- thereby reducing the gross commission calculation -- in order to reduce the amount paid to salespersons. Winkler testified that he was responsible for setting the cost basis from which broker commissions were calculated and used his ability to alter the commissions to motivate and punish brokers. In this way, Winkler was able toset Goldmen's gross commissions so as to promote the sale of ITSY warrants.
Winkler set the gross commission level for ITSY warrants substantially higher than for other securities Goldmen sold during the same time period. Winkler set the cost basis of ITSY warrants so that the average commission earned by Goldmen through the sale of warrants on July 26 and 27 was 24.31% of the total sale price. On the same two days, Goldmen earned average commissions of 5.93% of the total sales price of ITSY common stock and average commissions of 8.65% of the total sales price of the other securities it sold. Thus, while Goldmen paid its brokers 50% of the gross commissions for all sales of securities, the average percent of the sales price that brokers received for selling ITSY warrants was nearly three times what they received for selling other securities.
Goldmen's sales results for July 26 and 27 also indicate that the Firm engaged in a major sales campaign with respect to the ITSY warrants. Goldmen's sales force sold far more ITSY warrants than any other security on July 26 and 27. Goldmen sold over 2.1 million ITSY warrants on those two days. In contrast, Goldmen sold only 5,200 shares of ITSY common stock and only 181,830 shares in entities other than ITSY.
Goldmen and Winkler argue that they could not have manipulated the market for ITSY warrants in violation of Rule 10b-6 because the Firm did not report its purchases of the bridge warrants from the 21 Selling Security Holders. Applicants allege that they could not have used these unreported purchases to condition artificially the market for ITSY warrants. Whether Goldmen reported its purchases of ITSY warrants from the 21 Selling Security Holders is not relevant to determining that those purchases constituted a distribution. Based on the magnitude of the offering and the Firm's special selling efforts, we have determined that Goldmen's purchases from the 21 Selling Security Holders was a distribution. The Firm violated Rule 10b-6 when it bid for and purchased ITSY warrants before it completed that distribution.39
Winkler does not challenge the Division's contention that he acted with scienter when he violated Rule 10b-6. Assuming, without deciding, that a finding of scienter is necessary,40 it is clear that Winkler acted with scienter. Winkler testified that he made all decisions for the Firm with regard to ITSY warrants. Winkler negotiated the Firm's purchase of ITSY warrants from the Selling Securities Holders on July 26 and 27. Winkler also was responsible for setting the Firm's bids for, and directing the Firm's purchases of, ITSY warrants at the same time the Firm was distributing warrants from the Selling Securities Holders. We find that Winkler knew or was reckless in not knowing that the Firm was engaged in a distribution of ITSY warrants and therefore violated Exchange Act Section 10(b), and Exchange Act Rule 10b-6, and NASD Conduct Rules 2110, and 2120 when it bid for and purchased ITSY warrants during the distribution.
C. Supervisory Failings
NASD Conduct Rule 3010 requires that a member firm establish, maintain, and enforce with respect to the activities of each registered representative and associated person a system of supervision, including written procedures, that is reasonably designed to achieve compliance with applicable securities laws and regulations. The Firm's written procedures regarding pricing and manipulation were inadequate.
Goldmen's compliance manual contained a section concerning NASD markup policy that briefly summarized some of the requirements relating to the pricing of securities. The compliance manual failed to discuss the concept of domination and control, gave no guidance as to how to determine whether an independent market existed, and did not address how to determine fair prices in a dominated and controlled market.41 The Firm'swritten procedures concerning Rule 10b-6 also were inadequate. While the manual warned that Rule 10b-6 was a complex rule, it provided only general information about compliance with the rule. Moreover, the only concern highlighted in the manual with respect to a violation of Rule 10b-6 was that a violation could force the Firm to drop out of its participation in an underwriting. There was no specific discussion in the section on how to detect or prevent violation of Rule 10b-6 or manipulation in the context of a distribution of securities.42
In addition to the inadequacy of the Firm's written procedures, Goldmen and Winkler failed reasonably to supervise Meyers, the Firm's head trader, with respect to the manipulation and markup violations. Meyers testified that she did not receive the Firm's compliance manual or procedures manual until 1996. Meyers also stated that at the time of the events in question she had never been given any written procedures concerning the impact of market domination and control. Thus, she had not received NASD Notice to Members 92-16, which addressed monitoring the nature and volume of trades to determine whether a firm was in a dominant and controlling position with respect to a security and how to price a security in such a market.
Winkler was Goldmen's director of compliance. The compliance manual identified Winkler as one of the registered principals responsible for prevention and detection of pricing violations in customer transactions. Furthermore, Winkler testified that he was responsible for all of the Firm's compliance policies and for its trading department. Winkler also admitted that he supervised Meyers and that she reported to him. Winkler was responsible for the serious deficiencies in the Firm's written supervisory procedures. He further was responsible for a supervisory system that failed to prevent or detect the markup and manipulation violations and he failed reasonably to supervise Myers.
Goldmen, though Marchiano, also failed to establish, maintain, and enforce a system to supervise the activities of Winkler and Meyers. Marchiano was Goldmen's president and as such he had the ultimate individual responsibility for assuringthat the Firm's compliance procedures were adequate.43 Marchiano delegated many of his responsibilities to Winkler.44 Marchiano failed, however, to comply with his duty to follow-up and review the authority that he delegated to Winkler to assure that it was being exercised properly.45 Indeed, Winkler testified that no one supervised him and he reported to no one. Therefore, Goldmen, through Marchiano, also was responsible for the serious supervisory failures that permitted the markup and manipulation violations to occur. Accordingly, we find that Goldmen and Winkler violated NASD Conduct Rule 3010.
Applicants raise various procedural objections, arguing that they did not have a fair hearing and were denied due process. Specifically, applicants argue that they were not allowed to call as witnesses representatives of 12 other market makers in ITSY warrants. Applicants sought to introduce this testimony to refute the charge that Goldmen dominated and controlled the market for ITSY warrants from July 26 through July 29. Goldmen and Winkler maintain that other market makers would have testified that they were not controlled by Goldmen and that their quotes were bona fide. The District Business Conduct Committee refused to compel this testimony, concluding that it would not be relevant because a determination as to domination and control must be made based upon actual market transactions, not the recollections and perceptions of traders. The National Adjudicatory Council agreed with this determination. We conclude that, under the circumstances presented here, testimony of other market makers as to their perception of the marketplace or the bona fides of their quotes is not probative of the issue of Goldmen's domination and control of the market for ITSY warrants.46 Goldmen controlled the supply of ITSY warrants, and only it could satisfy the demand for those warrants, at whatever price the Firm chose to set. Evidence that other firms may have agreed to this price is not probative of the issue ofwhether Goldmen dominated and controlled the market for ITSY warrants because those firms had no reason to believe the price set by Goldmen was manipulated, nor were they aware that Goldmen had purchased the bridge ITSY warrants from the Selling Security Holders, increasing the Firm's control of the supply of ITSY warrants.47
Goldmen and Winkler also argue that they were prejudiced by the panel's refusal to allow them to call a former NASD employee who participated in the NASD's investigation and who prepared many of the markup schedules used by the NASD. Applicants argue that this former employee is the only witness with personal knowledge of the investigation. However, another NASD employee who reviewed, verified, and updated the former employee's work testified regarding the NASD's investigation and the markup schedules. In addition, the underlying documents used to prepare the schedules were provided to applicants and, therefore, they had in their possession all information necessary to challenge the schedules. Goldmen and Winkler failed to point to any defect in the data that would have required explanation by the testimony of the former NASD employee. Under these circumstances, Goldmen and Winkler were not prejudiced by the absence of the former employee.48
We may cancel, reduce, or require remission of a sanction imposed by the NASD if we find, having due regard for the public interest and the protection of investors, that the NASD's sanction is excessive or oppressive or imposes an unnecessary burden on competition.49 We make no such finding here.
Winkler argues that the $36,000 monetary penalty and the two-year suspension imposed by the NASD are excessive.50 Winkler claims that these sanctions exceed those recommended in the NASD's sanction guidelines and those imposed in other cases involving comparable facts. He urges that his conduct was not egregious or pervasive because it was limited to one security over a four-day period. Winkler also points to his lack of a prior disciplinary history relating to improper pricing and manipulative conduct as a further mitigating factor.
The NASD's Sanction Guidelines state that the monetary sanction for markup violations should be a fine of "$5,000 to $100,000 plus (if restitution is not ordered) the gross amount of the excessive markup . . . ."51 The guidelines also provide for a suspension of up to two years or a bar in egregious cases. Winkler was responsible for Goldmen's domination and control of the market for ITSY warrants and for the excessive markups. We believe these markups, which ranged as high as 140%, were egregious.52
In addition, we are troubled by Winkler's reckless disregard for the principles governing the pricing of securities and by his responsibility for the Firm's violation of Rule 10b-6. Winkler also neglected his supervisory responsibilities which resulted in Goldmen's customers being charged unfair and fraudulent markups. Thus, we find that the sanctions imposed by the NASD are neither excessive nor oppressive.53
An appropriate order will issue.54
By the Commission (Acting Chairman UNGER and Commissioners HUNT and CAREY).
Jonathan G. Katz
Admin. Proc. File No. 3-9917
In the Matter of the Application of
A.S. GOLDMEN & CO., INC.,
STUART E. WINKLER
For Review of Disciplinary Action taken by the
NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.
ORDER SUSTAINING DISCIPLINARY ACTION TAKEN BY REGISTERED SECURITIES ASSOCIATION
On the basis of the Commission's opinion issued this day, it is
ORDERED that the disciplinary action taken by the National Association of Securities Dealers, Inc. against A.S. Goldmen & Co., Inc. and Stuart E. Winkler be, and it hereby is, sustained.
By the Commission.
Jonathan G. Katz
|1||NASD Conduct Rule 2110 requires members to observe "high standards of commercial honor and just and equitable principles of trade."|
|2||NASD Conduct Rule 2120 states that no member "shall effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive or other fraudulent device or contrivance."|
|3||NASD Conduct Rule 2440 requires a member who buys or sells for his own account to his customer to "buy or sell at a price which is fair, taking into consideration all relevant circumstances . . . ."|
|4||15 U.S.C. § 78j(b) (1999).|
|5||17 C.F.R. § 240.10b-6 (1994).|
|6||The NASD found that Marchiano failed adequately to establish, maintain, and enforce a supervisory system. The NASD censured Marchiano; fined him $150,000, jointly and severally with Goldmen; and required him to requalify as a principal. The NASD also found that the Firm's head trader, Stacy Meyers, was responsible for Goldmen's excessive markups, although it did not find that she acted fraudulently. The NASD censured Meyers, fined her $5,000, and required her to requalify as a general securities representative. Marchiano and Meyers have not appealed the NASD's decision.|
|7||The NASD also assessed hearing costs in the amount of $13,520, jointly and severally as to Goldmen, Winkler, and Marchiano.|
|8||There was almost no activity in ITSY common stock in the immediate aftermarket. For example, Goldmen sold no shares of ITSY common stock to its customers on July 26 and sold only 5,200 shares of common stock to its customers in seven transactions on July 27.|
|9||In contrast, the record indicates that Goldmen sold fewer than 25,000 warrants to other broker-dealers in approximately 10 trades between July 26 and 29.|
|10||The total outstanding warrants included the 1.8 million offering warrants, the 1.3 million bridge warrants, 270,000 over-allotment warrants, and 180,000 restricted warrants provided as underwriter's compensation.|
|11||Meyers also reviewed order tickets, supervised other traders, and executed most of the Firm's trades. Although Winkler set the Firm's pricing policies, Meyers primarilywas responsible for trading ITSY warrants in July 1994.|
|12||C. James Padgett, 52 S.E.C. 1257, 1260 (1997), aff'd sub nom., Sullivan v. SEC, 159 F.3d 637 (D.C.Cir. 1998) (Table); Alstead, Dempsey & Co., 47 S.E.C. 1034, 1035-36 (1984).|
|13||See Frank L. Palumbo, 52 S.E.C. 467, 478 (1995); George Salloum, 52 S.E.C. 208, 214 (1995) Sacks Inv. Co., 51 S.E.C. 492, 496 (1993); Adams Sec., Inc., 51 S.E.C. 311, 315 (1993).|
|14||Padgett, 52 S.E.C. at 1260; Meyer Blinder, 50 S.E.C. 1215, 1217 (1992).|
|15||Padgett, 52 S.E.C. at 1260; Pagel, Inc., 48 S.E.C. 223, 226 (1985), aff'd, 803 F.2d 942 (8th Cir. 1986); Alstead, 47 S.E.C. at 1035-36. Goldmen was an integrated dealer in ITSY warrants, both making a market and simultaneously selling to retail customers. See Frank L. Palumbo, 52 S.E.C. at 472.|
|16||Robert A. Amato, 51 S.E.C. 316, 318 (1993) (citing Meyer Blinder, 50 S.E.C. at 1218), aff'd, 18 F.3d 1281 (5th Cir. 1994). The use of an imputed markdown reflects the factthat the price at which a dealer purchases a security from its customer generally will be less than the dealer would have paid for that security in the inter-dealer market. Id. at 318 (citing Meyer Blinder, 50 S.E.C. at 1219).|
|17||See, e.g., Michael A. Leeds, 51 S.E.C. 500, 503 (1993) (finding domination and control where the firm sold 82% of an offering to its own retail customers because the firm had "control of most of the available supply"); Meyer Blinder, 50 S.E.C. at 1218 n.14 (identifying these factors as probative of whether a market is dominated); Pagel, 48 S.E.C. at 225-26 (holding that where a dealer sells 90% of an offering to its own customers and the remainder is fragmented among other dealers, "trading in the aftermarket is necessarily contingent on the underwriter's customers furnishing the supply"). See also Steven P. Sanders, Exchange Act Rel. No. 40600 (Oct. 26, 1998), 68 SEC Docket 982, 986 n.7.|
|18||Alstead, 47 S.E.C. at 1035-36 (94% of the IPO placed with firm's customers). See also Pagel, 48 S.E.C. at 226 ("Because the identity of those customers is known only to the underwriter, tapping that supply for resale lies uniquely within the underwriter's control.").|
|19||See, e.g., George Salloum, 52 S.E.C. at 211; Padgett, 52 S.E.C. at 1260 (holding that a firm dominates and controls the market for a security when that firm sells all or a substantial percentage of an offering to retail customers, and then, as a market maker in the secondary market, trades a significant amount of the total aftermarket volume); see also Meyer Blinder, 50 S.E.C. at 1218 n.14.|
|20||Goldmen and Winkler argue further that the NASD erred because our holding in Peter J. Kisch, 47 S.E.C. 802 (1982), allows market makers to use ask quotations as the prevailing market price. Their reliance on Kisch as justification for their markup policy is misplaced. Although the Kisch firm was the dominant market maker in the stock at issue in that case, the other 13 market makers in the stock accounted for more than half the trading volume during the period in question. Accordingly, the Commission found that Kisch did not control the inter-dealer market and that use of representative ask quotations was appropriate. See the discussion of Kisch in Alstead, supra, 47 S.E.C. at 1036. Where a dominating integrated dealer "asserts such control over the market for the security that it effectively controls wholesale prices, the best evidence of the interdealer market is the price the market maker in the position of establishing the prices is willing to pay." Richfield Securities, 51 S.E.C. 797, 800-01 (1993) (citing Meyer Blinder, 50 S.E.C. at 1222).|
|21||George Salloum, 52 S.E.C. at 211; Richfield Securities, 51 S.E.C. at 801 n.19. In addition, Goldman sold only 21,500 warrants to other broker-dealers on July 26 and sold no warrants to broker-dealers on July 27 through 29. Many of Goldmen's inter-dealer sales were at prices below the inside offer, which is further evidence that the quotations were not validated. See Palumbo, 52 S.E.C. at 473.|
|22||Richfield Securities, 51 S.E.C. at 801 n.19. Goldmen and Winkler also attempt to distinguish securities listed in the Pink Sheets, where quotes constitute transaction proposals, from securities traded on the Nasdaq SmallCap Market, where quotes represent commitments to trade at the quoted price. NASD Conduct Rule 3320's requirement that quotations be bona fide, however, does not mean that the quotations are reliable evidence of the current market. Id. As an initial matter, even bona fide quotations are negotiable. See Salloum, 52 S.E.C. at 211; G.K. Scott & Co., 51 S.E.C. 961, 965 (1994). Moreover, given Goldmen's control of the supply of ITSY warrants, other dealers' quotations and any transactions resulting therefrom necessarily reflected the firm's presence in the market. Salloum, 52 S.E.C. at 211.|
|23||Richfield Securities, 51 S.E.C. at 801 n.19 (citing Meyer Blinder, 50 S.E.C. at 1218-19).|
|24||Goldmen and Winkler maintain that they could not have controlled the market for ITSY warrants because Goldmen increased only the offer price and never set or increased the inside bid. Applicants are correct that insertion of increasingly higher bids is one way to support the price of a security at an inflated level. Goldmen, however, controlled the supply of ITSY warrants. Accordingly, Goldmen had no need to increase its bid and was able to achieve its manipulative intent by increasing the offer. Moreover, five of the Firm's six increases occurred when Goldmen alone held the inside offer. Other market makers followed Goldmen's lead and, as the inside offer price increased, so did Goldmen's profits when it sold from its substantial inventory.|
|25||Michael A. Leeds, 51 S.E.C. at 504; George Salloum, 52 S.E.C. at 211.|
|26||Alstead, 47 S.E.C. at 1035-36.|
|27||Pagel, 48 S.E.C. at 225-26; see also Michael A. Leeds, 51 S.E.C. at 503-04.|
|28||Goldmen then sold the ITSY warrants that it had accumulated in inventory to its retail customers at prices that included a five percent markup over the inside offer quotation that the Firm itself had established.|
|29|| We have held that, where a dealer dominates and controls the market for a particular security, the price a dealer pays other dealers in contemporaneous transactions is the best evidence of the prevailing market price. Amato, 51 S.E.C. at 318 (citing Meyer Blinder, 50 S.E.C. at 1218). If there are no contemporaneous purchases from other dealers, purchases from retail customers may be used, subject to the addition of an imputed markdown. Id. (citing Meyer Blinder, 50 S.E.C. at 1219).
For each sale of ITSY warrants by Goldmen, the NASD calculated the Firms's contemporaneous cost by using the most recent previous purchase by Goldmen, whether wholesale or retail. When the NASD used a retail purchase to determine the Firm's contemporaneous cost, it imputed a five percent markdown. Applicants have not challenged the NASD's method of determining the Firm's contemporaneous cost.
|30||The conduct at issue occurred in July 1994. In December 1996, the Commission adopted Regulation M to replace Rules 10b-6, 10b-6A, 10b-7, 10b-8, and 10b-21. Exchange Act Rel. No. 38,067 (Dec. 20, 1996), 63 SEC Docket 1374. Regulation M did not change the substance of the requirements at issue here.|
|31||Review of Antimanipulation Regulation of Securities Offerings, Securities Act Rel. No. 7057 (Apr. 26, 1994), 56 SEC Docket 1442, 1445.|
|32||Goldmen purchased 950,000 bridge warrants during the first hour of aftermarket trading.|
|33||17 C.F.R. § 240.10b-6 (1994).|
|34||17 C.F.R. § 240.10b-6(c)(5) (1994); see also Bruns, Nordeman & Co., 40 S.E.C. 652, 660 (1961); Prohibitions Against Trading by Persons Interested in a Distribution, Securities Act Rel. No. 6456 (Mar. 4, 1983), 27 SEC Docket 656, 669.|
|35||Review of Antimanipulation Regulation of Securities Offerings, 56 SEC Docket at 1445.|
|36||Id. at 1445-46. Delivering a sales document, such as a prospectus or market letters, and conducting "road shows" also generally are indicative of special selling efforts and selling methods. Id. at 1446.|
|37|| Cf. Collins Sec. Corp., 46 S.E.C. 20, 35 (1975) (holding that offering constituting more than 30% of outstanding stock was of sufficient magnitude to qualify as a distribution pursuant to Rule 10b-6), rev'd on other grounds, 502 F.2d 320 (D.C. Cir. 1977).
In addition, the activity in ITSY warrants by other market makers on July 26 and 27 was insubstantial in comparison to Goldmen's sales; there were transactions in only 81,700warrants away from Goldmen over the course of these two days. Cf. Theodore C. Landau, 40 S.E.C. 1119, 1125 (1962) (holding that a broker-dealer can be engaged in a distribution even where the number of shares involved represents only "a small part of the total number of shares outstanding" when there is no evidence of substantial activity in a stock by others).
|38||Prohibitions Against Trading by Person Interested in a Distribution, 27 SEC Docket at 658 n.13 ("The presence of special selling efforts and selling methods may be indicated in a number of ways, including the payment of compensation greater than that normally paid in connection with ordinary trading transactions.").|
|39||Applicants also argue that the NASD failed to establish that Goldmen, through its bids for, and purchases of, ITSY warrants, created a false appearance of market activity, thereby artificially inflating the price of the warrants. Such a showing is not required to establish a violation of Rule 10b-6. While Rule 10b-6 contains several exceptions and exemptions for activities considered necessary to conduct an offering, the rule expressly prohibits bids and purchases because those are the most obvious means of influencing market activity. See Review of Antimanipulation Regulation of Securities Offerings, 56 SEC Docket at 1445. Thus, Goldmen violated Rule 10b-6 when it bid for and purchased ITSY warrants while engaged in a distribution of those warrants, regardless of whether it was successful in creating a false appearance of market activity.|
|40||See Swartwood, Hesse, Inc., 50 S.E.C. 1301, 1304 (1992) (citing SEC v. Burns, 614 F. Supp. 1360, 1363 (S.D. Cal. 1985)), aff'd on other grounds, 816 F.2d 471 (9th Cir. 1987).|
|41||See Steven P. Sanders, Exchange Act Rel. No. 40600 (Oct. 26, 1998), 68 SEC Docket 982, 993 (finding inadequate supervision where compliance manual gave no guidance as to how to determine whether an independent market existed or how to comply with NASD pricing requirements in a dominatedand controlled market); Castle Sec. Corp., Exchange Act Rel. No. 39523 (Jan. 7, 1998), 66 SEC Docket 796, 803 (finding inadequate supervision where firm's written procedures did not address the determination of fair prices and markups in a dominated and controlled market).|
|42||See Castle Sec. Corp., 66 SEC Docket at 803 (finding inadequate supervision where the firm did not provide written procedures to detect and prevent manipulation).|
|43||Kochcapital, Inc., 51 S.E.C. 241, 248 (1992). See also Kirk A. Knapp, 50 S.E.C. 858, 862 (1992) ("The president of a brokerage firm is responsible for the firm's compliance with all applicable requirements unless and until he reasonably delegates a particular function to another person in the firm, and neither knows nor has reason to know that such a person is not properly performing his duties.").|
|44||Nevertheless, Marchiano, along with Winkler, was listed as a registered principal responsible for preventing and detecting pricing violations.|
|45||Rita H. Malm, 52 S.E.C. 64, 73 (1994).|
|46||Patten Sec. Corp., 51 S.E.C. 568, 576 (1993).|
|47||As for applicants' objection that they were not allowed to introduce evidence as to trading in ITSY warrants after July 29, 1994, such evidence is irrelevant to the issues herein. Michael A. Leeds, 51 S.E.C. at 507 (holding that evidence regarding trading after the period of domination and control is irrelevant).|
|48|| See DMR Sec., Inc., 47 S.E.C. 180, 183 (1979). Goldmen and Winkler also argue that their attempt to establish a claim of selective prosecution was prejudiced when they were not allowed to call this former NASD employee and another current NASD employee, an analyst in the NASD's Corporate Finance Department, who had been involved in the investigation of a cause of action that the NASD subsequently dismissed. To demonstrate selective prosecution, Goldmen and Winkler must establish that they were singled out for enforcement action while others who were similarly situated were not and that their prosecution was motivated by arbitrary or unjust considerations such as race, religion, or the desire to prevent the exercise of a constitutionally protected right. See, e.g., United States v. Huff, 959 F.2d 731, 735 (8th Cir. 1992)
Goldmen and Winkler have failed to present any theory of selective prosecution that meets the elements of such a claim nor have they indicated what evidence the two witnesses would provide other than that they "quite possiblycould have assisted . . . in demonstrating selective prosecution." Applicants are not entitled to go on a fishing expedition in the hopes that some evidence might turn up to support an otherwise unsubstantiated claim. See G.K. Scott & Co., 51 S.E.C. 961, 973 (1994). Accordingly, their claim of prejudice is without merit.
|49||See Exchange Act § 19(e)(2), 15 U.S.C. § 78s(e)(2).|
|50||Goldmen has not challenged specifically the sanctions imposed on it by the NASD, but we find, that given the Firm's conduct, the sanctions are neither excessive nor oppressive.|
|51||NASD Sanction Guidelines (1998 ed.) at 82 ("Pricing -Excessive Markups/Markdowns and Excessive Commissions").|
|52||Of the 500 excessive markups, 191 sales occurred at markups of more than 5 but not more than 10 percent of the prevailing market price. The remaining 309 sales occurred at markups greater than 10 percent of the prevailing market price, and we have found these trades to be fraudulent. Goldmen's violative markups generated a total of $549,903 in illegal profits for the Firm.|
|53||Winkler also argues that the sanctions are excessive when compared with other cases which he argues involved larger markups over a longer duration. As we have previously noted, appropriate remedial action depends on the facts and circumstances of each case and cannot be precisely determined by comparison with the actions taken in other proceedings. See Butz v. Glover Livestock Comm'n Co., 411 U.S. 182, 187 (1973); Heller v. SEC, 429 F.2d 856, 858-59 (2d Cir. 1970). Particularly given the gravity of his conduct, we find that the two year suspension imposed on Winkler is neither excessive nor oppressive.|
|54||We have considered all of the parties' contentions. We have rejected or sustained these contentions to the extent that they are inconsistent or in accord with the views expressed herein.|