SECURITIES AND EXCHANGE COMMISSION
In the Matter of
ABRAHAM AND SONS CAPITAL, INC.
OPINION OF THE COMMISSION
INVESTMENT ADVISER PROCEEDINGS
Grounds for Remedial Action
Fraud in the Purchase and Sale of Securities
Violating, Aiding and Abetting, and Causing Violations of Recordkeeping Requirements
Violating, Aiding and Abetting, and Causing Violations of Requirement to Have Independent Public Accountant Verify, by Examination, Customer Funds and Securities.
Registered investment adviser and its president, who was also president of registered broker-dealer, made fraudulent misrepresentations in connection with the purchase and sale of securities. Investment adviser violated, and president aided and abetted and was a cause of violations of, recordkeeping requirements and requirement to have independent public accountant verify, by examination, customer funds and securities. Held, it is in the public interest to bar president from association with any broker, dealer, or investment adviser subject toa right to apply for such association after five years; revoke investment adviser's registration; order investment adviser and president to cease and desist from committing or causing any violation, and from committing or causing any future violation, of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Sections 204, 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 and Rules 204-2(a)(2) and 206(4)-2 thereunder; and order respondents to pay a civil money penalty of $50,000 each.
Brett G. Brubaker, pro se, and for Abraham and Sons Capital, Inc.
Mary E. Keefe, Robert J. Burson, and Jane E. Jarcho, for the Division of Enforcement.
Appeal filed: February 11, 1999
Last brief received: May 10, 1999
Abraham and Sons Capital, Inc. ("ASCI"), a registered investment adviser, Brett G. Brubaker, ASCI's president (collectively with ASCI, "Respondents"), 1 and the Division of Enforcement appeal from the decision of an administrative law judge. The law judge found that Respondents violated Section 17(a) of the Securities Act of 1933, 2 Section 10(b) of the Securities Exchange Act of 1934 3 and Rule 10b-5 thereunder, 4 and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940, 5 in connection with representations they made to investors in a private, pooled hedgefund Respondents managed, Abraham and Sons Limited Partnership (the "Fund"). The law judge further found that ASCI violated Sections 204 and 206(4) of the Advisers Act, 6 and Rules 204-2(a)(2) and 206(4)-2 thereunder 7 as a result of recordkeeping failures related to the Fund and a failure to have an independent public accountant conduct a examination of the Fund's assets. Additionally, the law judge found that Brubaker caused, and aided and abetted, ASCI's violations of these latter provisions as well as ASCI's violation of Section 206(1) of the Advisers Act.
The law judge ordered Respondents each to pay a civil money penalty of $50,000; to cease and desist from further violations of the securities laws they violated; and to disgorge $11,600 (plus interest). Additionally, the law judge suspended, for six months each, Brubaker from association with any broker, dealer, or investment adviser, and ASCI from acting as an investment adviser.
Respondents challenge certain of the law judge's findings of violation, and contend that the sanctions imposed are excessive. The Division does not challenge the law judge's findings but argues that the sanctions are too lenient. We base our findings on an independent review of the record, except with respect to those findings not challenged on appeal.
We turn first to Respondents' violations of the antifraud provisions. We then address Respondents' violations of examination and recordkeeping requirements.
Background. The Fund was established by Brubaker in 1991 as a limited partnership and had, during the period at issue, approximately fifty limited partners. It grew substantially during 1994 and the first half of 1995. In January 1994, the Fund was valued at $819,257; by May 1995, its value had reached $11,508,601. By the end of 1995, however, the Fund's value had declined to $6,742,384. As compensation for its services, Respondents charged the limited partners an annual fee equal to 2% of net asset value, plus a percentage of profits.
Brubaker's primary strategy in managing the Fund during the period at issue was to "sell short" securities, particularly technology stocks, that he deemed overvalued. 8 Writing to investors in July 1995, Brubaker stated that "[s]tock prices are more stretched today than they have been at any time during my career . . . . We are likely experiencing a bubble in the technology stocks." Brubaker's strategy was unsuccessful, producing large losses for the Fund.
Brubaker, who was ASCI's sole officer, was responsible for making all investment decisions for the Fund, which was ASCI's sole client. Brubaker also was responsible for maintaining the Fund's records. All of the Fund's trading was through Abraham and Sons, Inc., an affiliated broker-dealer, 9 which cleared its trades through the firm of Spear, Leeds & Kellogg ("SLK"). During the period at issue, ASCI's only employee other than Brubaker was Timothy Christiansen, who assisted Respondents with administrative matters and market research. 10
Overstating Fund Performance. Between June and December 1995, Respondents, as co-managing general partners of the Fund, prepared and distributed to the Fund's limited partners a series of letters that materially misrepresented the Fund's performance and the value of each limited partner's interest. In monthly correspondence, Respondents overstated the Fund's performance to the limited partners as follows:
|Letter||Represented Performance||Actual Performance|
|June 23, 1995||.74%||-8.4%|
|July 14, 1995||-11.2%||-27.0%|
|Aug. 24, 1995||-2.7%||-26.9%|
|Sept. 6, 1995||9.2%||3.2%|
|Oct. 4, 1995||.4%||-10.3%|
|Nov. 1, 1995||2.5%||-5.4%|
|Dec. 4, 1995||7.5%||-5.9%|
On a cumulative basis, for the period May through November 1995, Respondents represented the Fund's performance as a 5.1% increase in value, while it actually suffered a 59.7% loss.
Respondents also sent the limited partners letters in which the value of their individual partnership interests was vastly overstated. In correspondence dated July 14, 1995, Respondents reported to the limited partners, for the quarter ending June 30, 1995, the value of each of their interests based upon a total net asset value for the Fund of $12.3 million. In fact, however, the Fund's net asset value at this time was only $8.7 million. Similarly, in correspondence dated November 22, 1995, Respondents reported to the limited partners the value of their interests based on a total net asset value for the Fund of $12.5 million for the quarter ending September 30, 1995, when the Fund's actual total net asset value at that time was just $5.9 million. During this period, existing limited partners made additional contributions to the Fund to increase their partnership interests and at least one new investor purchased a partnership stake for the first time.
There were two primary causes of the Fund's overvaluation. First, Respondents failed to calculate accurately the effects of stock splits on the Fund's short positions. In a stock split, the aggregate value of outstanding shares remains the same, but the number of shares is increased. Hence the value of each share is proportionately lower. 11 For example, in a 2:1 stock split, the number of shares outstanding is doubled, reducing the value of each share by half. Thus, a stock split should have no direct effect on the economic value of the ownership interests of stockholders. Here, however, Respondents apparently calculated the Fund's short positions by using the new lower, post-stock split share price (which reduced their short sale liability), without accounting for the fact that the number of shares (for which they were liable) had increased.
Second, although Respondents were bound by the partnership agreement to value the Fund's securities based on the price paid in the last transaction of the day or, if no sales occurred on that day, based on the mean between the bid and ask quotations for the security, Respondents did not always do so. Rather, according to the Division's expert, Robert Conner, who examined the valuation calculations Respondents performed for the Fund for a portion of the period at issue, the Fund's numbers conform neither to the mean between bid and ask nor to last sale . . . instead . . . the numbers significantly vary and . . . do so at an unrandom pattern so that, in each instance, the valuation of the position is in Mr. Brubaker's favor in that if it is a long position, the number is higher. If it's a short position, the number is lower. In each instance, it makes the valuation look better than it really is.
Disclosure of Calculation Errors. According to Brubaker, he first noticed in late December 1995 "a significant difference" between ASCI's internal records regarding the Fund and the monthly account statements for the Fund he received from SLK. Brubaker testified that, between June and late December 1995, he never reviewed the Fund's monthly account statements because he "didn't have the time at that point . . . ." Before June 1995, Brubaker had performed a monthly reconciliation between ASCI's records and the SLK account statements. Brubaker testified that, during the course of these monthly reconciliations, he had discovered discrepancies between his records and SLK's statements. 12 Christiansen also discovered at least six errors in ASCI's internal records regarding the Fund's holdings, which he communicated to Brubaker. 13 Notwithstanding his knowledge that the reconciliation process had detected errors, Brubaker concluded in June 1995 that the monthly reconciliation of ASCI's records with the SLK account statement was unnecessary. 14
Brubaker claims that shortly after discovering the gap between ASCI's and SLK's records in late December 1995, he attempted to ascertain its cause by redoing his own calculations of the Fund's performance, using ASCI's computer. He further asserts that, while performing these new calculations, he deleted his former calculations without making any backup copies. 15 By so doing, Brubaker eliminated much of the evidence regarding the basis for his miscalculations.
On January 9, 1996, Brubaker informed the Fund's limited partners by letter about "some unintentional errors that impact performance and account balances." At that time, Respondents offered investors the opportunity to withdraw from the partnership as of the end of 1995. Between January 11 and February 15, 1996, limited partners holding approximately 85% of the Fund's value withdrew.
Respondents Acted with Scienter. Respondents concede that they materially misrepresented the Fund's performance and value. They also concede that their actions violated Sections 17(a)(2) and 17(a)(3) of the Securities Act and 206(2) of the Advisers Act. Respondents deny, however, that they acted with intent or a lesser degree of scienter, including recklessness. Respondents claim that,until late December 1995, they were unaware of the Fund's true performance -- i.e., that it was accumulating large losses -- or of the fact that they were misrepresenting that performance to the Fund's limited partners. Hence, they claim that they lacked the level of intent necessary to support a violation of the antifraud provisions requiring scienter. As discussed below, we find that Respondents made their misrepresentations knowing that they were false or, at a minimum, with reckless disregard for whether they were false.
At the hearing before the law judge, Brubaker admitted that he knew (i) the stock positions the Fund held during the second half of 1995, (ii) the approximate number of shares the Fund held in each stock, (iii) the approximate price of each stock held by the Fund, (iv) whether the Fund's position was long or short, and (v) whether the stock had experienced a stock split and, if so, the date of the stock split, the factor of the split, and the readjusted price for the stock after the split. Brubaker also admittedly knew the extent of the Fund's approximate cash position. Based on Brubaker's testimony regarding his knowledge of the Fund's equity and cash positions, the Division's expert Conner opined that he did not "find it at all believable" that Brubaker was unaware of the Fund's declining value. According to Conner, "you add up the valuation of your securities. You add up your cash. And the two equal your total portfolio value. It's that simple." 16
Respondents Blame Misrepresentations on Computer Error. In a June 13, 1996 letter to the limited partners, Brubaker blamed much of the Fund's overvaluation on failures by ASCI's computer software to account properly for stock splits that were entered into the computer system several days after the split occurred. At the hearing, he stated that a "large . . . but not substantial" portion of the reasonfor the overvaluation of the Fund was the miscalculation of stock splits in short positions held by the Fund. Christopher Flynn, an official with Advent Software, Inc., which developed and serviced the computer system used by Respondents, was qualified as an expert witness without objection. Flynn testified that "user error," not computer error, was responsible for the Fund's overvaluation. Flynn further stated that, contrary to Brubaker's assertion, it makes no difference when the user enters stock split information, provided that he generates the valuation report after entering the information. After Flynn's testimony, Brubaker testified that he was no longer confident that the Advent system was responsible for the errors.
Respondents now challenge the law judge's finding that "[t]he date the split information is entered is not relevant to any calculation the system makes as long as the performance report is run after correct information is entered." Respondents assert, in challenging this finding by the law judge, that Flynn testified "that it was critical that correct information was entered." We do not see any conflict between the law judge's finding and the quoted testimony. It is undisputed that the Advent system produced erroneous results if the user entered flawed data. What was challenged by Flynn was Brubaker's initial claim that late but not erroneous entry of data into the system could produce erroneous results.
Respondents further argue that Flynn's conclusions rest on the assumption that ASCI's computer system was operating properly during the period in question, without any verification that this was so. There is no evidence, however, that the system had any role in producing the faulty results Respondents reported or that it was not operating properly. Moreover, even assuming that ASCI's computer miscalculated the Fund's performance, the evidence establishes that Respondents were aware of the Fund's true performance, regardless of the results calculated by the Advent system.
Respondents Apprised of Fund's Performance by SLK. As indicated above, SLK sent Respondents monthly account statements for the Fund, which Respondents failed to review until late December 1995. Respodents' failure constitutes recklessness with respect to the misrepresentations it was making to the Fund's investors.
Brubaker also requested and received, by facsimile transmission, a daily "exception status report" for the Fund. These reports contained information regarding activity in the account, a summary of account positions, cash available, total equity, and thevalue of the account. They also disclosed, in three separate places, whether the account was subject to SLK house margin calls. 17
Generally, SLK issued a house margin call when the percentage of equity to the value of the account fell below 40%. This house margin requirement was higher than those set by regulatory authorities, and consequently SLK had discretion as to how to enforce it. Nevertheless, a house margin call can -- and those at issue here did -- signal a sharp decline in an account's equity.
During the second half of 1995, the Fund was frequently subject to house margin calls. These margin calls should have alerted Brubaker to apparent losses caused by his trading strategy. The record contains copies of exception status reports for the Fund dated July 13, 1995, August 14, 1995, and November 29, 1995, which reflected margin calls against the Fund's account for $509,277, $568,485, and $866,683, respectively. For example, in July Respondents were notified that the Fund's equity had declined to the extent that SLK was seeking $509,277 in additional equity -- either through the sale of securities held by the Fund or the injection of new capital -- to return the equity in the Fund's account to an acceptable level.
Brubaker denies receiving the exception status reports, but his denial is not credible. 18 Angelo Gonzalez, a supervisor in SLK's margin division, testified that Brubaker had requested in 1994 that the exception status reports be sent to him, and that in any event it was SLK's practice to provide such reports to customers, such as hedge funds, that engaged in heavy trading. Gonzalez further stated that, when he checked with SLK's data processing department in preparation for his appearance as a witness in this proceeding, he learned that the Fund's account was set up so that Respondents should have been sent the reports. Moreover, Gonzalez stated that he hadconversations with Brubaker in which Brubaker referred to information that he would have received only from the exception status reports.
Aside from the evidence supporting the conclusion that Respondents received regular written reports from SLK regarding the Fund's holdings, two witnesses (Gonzalez and Christiansen), testified that they personally discussed with Brubaker SLK margin calls against the Fund during the period at issue. Gonzalez also testified that members of his staff spoke to Brubaker on other occasions regarding the Fund's margin calls. Supporting Gonzalez' assertion that Respondents knew about SLK's margin calls is the fact that, on three separate occasions in July, August, and November 1995, Respondents wired additional funds to SLK at the time of, and apparently in response to, SLK's margin calls. 19
Christiansen stated that he spoke to SLK personnel about margin calls affecting the Fund "several" times during late spring and summer 1995. 20 Christiansen then relayed the information about the margin calls to Brubaker and, on at least one occasion, Brubaker had the Fund execute "orders to cut back some of the [the Fund's] positions." 21
Brubaker flatly denies receiving any margin calls or discussing the Fund's troubling margin status with SLK. Although conceding that SLK's records reflect that the Fund fell below the 40% equity requirement on the dates in question and that the Fund made the three capital contributions at issue to its SLK account, Respondents claim that those contributions "had nothing to do with a response by Mr. Brubaker to a margin call, but were simply the addition of new capital." Brubaker supports this claim by pointing out that the amounts of the capital contributions did not equal those of the margin calls.
The law judge credited the testimony of Gonzalez and Christiansen that Brubaker was aware that the Fund was subject to margin calls during the second half of 1995. He found Brubaker's denials not credible. As we have consistently held, "credibility determinations of an initial fact finder are entitled to considerable weight [and] can be overcome only where the record contains 'substantial evidence' for doing so." 22 This record provides no reason to reject the law judge's credibility determinations.
The fact that the amounts Respondents contributed to SLK did not equal the margin calls does not undermine our finding that they were made in response to those calls. As Respondents conceded in an offer of proof they submitted, "[b]ecause the 40% equity requirement is in excess of any exchange minimum maintenance requirement, [SLK] has discretion as to how to enforce it." Gonzalez stated that SLK's policy was to seek at least a portion of the margin call amount as a show of "good faith" by the customer and then "work out the differences" with the customer.
Respondents further assert that SLK records show that the Fund was "in violation of margin requirements for months," and had a margin call for over $2 million in early November 1995. They claim that it "defies rational thinking" that the Fund would meet margin calls on some dates but not others, and argue that the margin calls were not met because "Mr. Brubaker was never aware that he was in violation of margin requirements. . . . because the calls were never made." We find Respondents' reasoning unpersuasive. The fact that the Fund did not satisfy certain of the margin calls does not establish that they were not made. Even assuming that SLK failed to notify Respondents every time the Fund fell below required margin levels, the credible testimony of two different witnesses directly contradicts Brubaker's assertions that he was unaware of any margin calls affecting the Fund. 23
Moreover, Gonzalez indicated that, as a general matter, SLK was somewhat lenient in enforcing "house" margin requirements. Thus, it appears that, to the extent the Fund was able to operate in a fairly normal manner despite serious margin problems, it did so because of SLK's accommodating approach, and not because Respondents were ignorant of those problems.
We therefore conclude that Respondents knew that the reports they were making to the Fund's investors were false or, at a minimum, that they acted with reckless disregard for whether those reports were false. Accordingly, we find that Respondents willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. In addition to these violations, ASCI was charged with violating, and Brubaker was charged with aiding and abetting and causing ASCI's violations of, Sections 206(1) and 206(2) of the Advisers Act. To establish aiding and abetting by Brubaker requires: (a) wrongdoing by ASCI; (b) a general awareness or reckless disregard by Brubaker of the wrongdoing and of his role in furthering it; and (c) that Brubaker substantially assisted the wrongdoing. 24 The record clearly establishes ASCI's violations of Sections 206(1) and 206(2), Brubaker's responsibility for those violations, and his reckless disregard. Because we find that Brubaker aided and abetted these violations, he was necessarily a cause of those violations. 25 Accordingly, we find that ASCI willfully violated, and Brubaker willfully aided and abetted and caused ASCI's violations of, Sections 206(1) and 206(2) of the Advisers Act.
Failure to Have Fund Examined
Advisers Act Rule 206(4)-2(a)(5), adopted pursuant to Advisers Act Section 206(4), 26 requires investment advisers to have customer funds and securities "verified by actual examination at least once during each calendar year by an independent public accountant at a time that shall be chosen by such accountant without prior notice to the investment adviser." It is undisputed that the Fund was not examined during 1995.
In the proposed findings of fact they filed before the law judge, Respondents conceded that, "[b]ecause scienter is not required for violation of Section 206(4) of the Advisers Act and Rule 206(4)-2 thereunder, Respondents' conduct constitutes violation of those provisions." Respondents claim that their failure to comply with the examination requirement was "inadvertent."
ASCI was charged with violating Rule 206(4)-2, and Brubaker was charged with causing and aiding and abetting that violation.
The record establishes that ASCI violated Rule 206(4)-2 and that Brubaker, as ASCI's president, was responsible for that violation. 27 Even if we accept that the failure to comply with Rule 206(4)-2was not deliberate, 28 we still find that it was reckless. Securities professionals are required to be knowledgeable about, and to comply with, the regulatory requirements to which they are subject. 29 Failure to meet this requirement constitutes an "extreme departure from the standards of ordinary care . . ." 30 and establishes recklessness. We therefore find, based on our consideration of the record, that ASCI willfully violated, and Brubaker caused and willfully aided and abetted ASCI's violation of, Advisers Act Rule 206(4)-2(5).
Violation of Recordkeeping Rules
Advisers Act Rule 204-2(a) requires that investment advisers maintain "true, accurate and current . . . General and auxiliary ledgers (or other comparable records) reflecting asset, liability, reserve, capital, income and expense accounts." 31 The records Respondents maintained for the Fund clearly were inaccurate in that they misstated the Fund's income and assets in violation of Rule 204-2(a). Respondents do not dispute that they violated the Rule but claim that they did so inadvertently. We disagree. Respondents' faulty recordkeeping was closely linked to their fraudulent misrepresentations. Respondents therefore acted, at a minimum, with recklessness. We therefore find that ASCI willfully violated, and Brubaker caused and willfully aided and abetted ASCI's violation of, the aforementioned recordkeeping requirements.
Denial of Respondents' Request to Call Expert Witness. Respondents claim that they were denied a fair hearing because they were not permitted to call, as an expert witness on margin, Margaret Wiermanski. The law judge's decision to deny this testimony was based on the Respondents' failure to identify Wiermanski as an expert witness on their witness list. At a prehearing conference held on November 5, 1997, the parties agreed that witness lists and expert testimony summaries would be exchanged in mid-December, several weeks before the hearing. Respondents neither identified Wiermanski on their witness list nor provided a summary of her testimony by the appointed dates. 32
The law judge further ruled that Wiermanski's proposed testimony was irrelevant because the Division did not allege a substantive violation of the margin requirements. The issue, instead, was whether or not Respondents were aware of the Fund's margin status during the period at issue.
Commission Rule of Practice 320 authorizes the exclusion of evidence that is "irrelevant, immaterial or unduly repetitious." 33 According to Respondents' Offer of Proof, Wiermanski would have testified that the SLK documents entered into the record "provide no support for the Division's claim that margin calls were ever made on [the "Fund's] securities account and that deposits into that account were in response to margin calls." More specifically, Respondents' counsel indicated at the hearing that Wiermanski would have testified that SLK was required to make its margin calls in writing, and that there was no evidence in the record of any written communication between SLK and Respondents regarding margin calls. However, whether or not SLK met the technical requirements for margin calls here is irrelevant to whether Respondents were notified of the Fund's margin status and, ultimately, whether Respondents knew or were reckless in not knowing that the reports they were making to Fund investors were false --factual matters about which Wiermanski had no knowledge. In light of Respondents' failure timely to identify Wiermanski before the hearing and the irrelevance of her proposed testimony, we believe that the law judge acted within his discretion in denying the opportunity for Wiermanski to testify.
Failure to Introduce SLK's "Margin Logs". Respondents suggest that they were deprived of a fair hearing because SLK failed to produce certain internal records known as "margin logs." According to Respondents, those records should disclose the amount of the margin call, date on which the call was made, and how it was paid. They claim that "[t]he fact that [SLK] didn't produce these documentsis evidence that Mr. Brubaker never received the alleged margin calls."
We begin by noting that it appears to have been the Division, rather than Respondents, who initially sought to obtain SLK's margin logs. Although SLK stated that it was unable to locate them, there is no basis to believe that SLK intentionally withheld the logs or that the logs would have assisted Respondents' defense. More important, as discussed above, evidence independently establishes that Brubaker was well aware of the Fund's margin deficiencies.
Respondents challenge the sanctions imposed as excessive, asserting that, "[e]ven if the charges were held to be proven, they do not warrant sanctions as severe as meted out." Brubaker states that he has been in the investment business for nearly thirty years without any prior complaints and that "[h]is character qualities, as testified by two limited partners, are assets to the industry."
Respondents engaged in serious misconduct. For roughly half a year, they made material misrepresentations regarding the performance and value of the Fund to its limited partners. These misrepresentations were made by Respondents with knowledge of their falseness or with extreme recklessness. In addition, Respondents violated important and related recordkeeping and auditing requirements. Respondents' behavior represents a serious abuse of the trust placed in them by the Fund's investors and by the securities industry.
The law judge, after observing Brubaker throughout the hearing, concluded that Brubaker failed to appreciate the seriousness of these offenses. As a result, the law judge questioned Brubaker's assurances that he would not violate the securities laws in the future. We share the law judge's concern about the continuing threat Respondents pose to the investing public.
We conclude that Respondents' conduct warrants their exclusion from the securities industry. While the law judge concluded that a six-month suspension was sufficient, we believe that it is in the public interest to bar Brubaker from association with any broker, dealer or investment adviser, with the proviso that Brubaker may apply to become so associated after a period of five years. We also believe that it is in the public interest to revoke ASCI'sregistration as an investment adviser. 34 Respondents' conduct evidences a fundamental misunderstanding of the obligations securities professionals owe the investing public and demonstrates their unfitness to remain in the industry. We also conclude that it is in the public interest to impose a cease and desist order against future securities law violations.
Additionally, we agree with the law judge's decision to impose a civil money penalty of $50,000 on each of the Respondents. 35 Section 21B of the Exchange Act and Section 203(i) of the Advisers Act authorize the imposition of civil money penalties where it is in the public interest to do so. 36 Those sections authorize a money penalty of $50,000 for each violative act or omission if it involved "fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement." Respondents' misconduct amply satisfies the standards set by those provisions.
Although we agree with law judge's determination to impose civil penalties, we disagree with his decision to order disgorgement. The law judge ordered Respondents to disgorge the administration fee they charged withdrawing partners for January 1996, because it was taken in contravention of the Fund's limited partnership agreement. Although these limited partners were, pursuant to the partnership agreement, supposed to receive the value of their interests as of the end of December 1995, Respondents valued their holdings as of the end of January 1996. Valuing the interests in this way, according to Respondents and without challenge by the Division, benefitted the limited partners because the Fund "realized well over a 20% gain during January, 1996 -- raising the value of the Fund to well over $1 million in gains." Respondents assert that, had they not considered the limited partners' best interests, they could have "pocketed" the gains from January and paid the limited partners the value of their interests as of the end of 1995. In return for valuing the withdrawing partnership interests as of the end of January rather than December, Respondents assessed a management fee for the additional month. 37
The Division argues that Respondents should be required to disgorge the January management fee. The Division contends that disgorgement of the fee amount is appropriate because of Respondents'fraud during the preceding half year and because assessment of the management fee contravened the partnership agreement.
Our disgorgement authority is intended to deprive a wrongdoer of "ill-gotten gains" from his violations of the securities laws. 38 The Division, however, has not alleged any violation of the securities laws in connection with Respondents' conduct in January 1996, including their assessment of a fee for that period. Consequently, we have no basis for ordering disgorgement of the fee amount. In reaching this conclusion, we offer no opinion regarding whether the limited partners might have a valid private claim against Respondents for breach of the partnership agreement.
An appropriate order will issue. 39
By the Commission (Acting Chairman UNGER and Commissioners CAREY and HUNT).
Jonathan G. Katz
INVESTMENT ADVISERS ACT OF 1940
Rel. No. 1956 / July 31, 2001
Admin. Proc. File No. 3-9448
In the Matter of
ABRAHAM AND SONS CAPITAL, INC.
ORDER IMPOSING REMEDIAL SANCTIONS
On the basis of the Commission's opinion issued this day, it is
ORDERED that Brett G. Brubaker be, and he hereby is, barred from association with any broker, dealer, or investment adviser provided that, after five years, he may apply to become so associated, such application to be made to the appropriate self-regulatory organization or, if there is none, to the Commission; and it is further
ORDERED that the investment adviser registration of Abraham and Sons Capital, Inc. be, and it hereby is, revoked; and it is further
ORDERED that Brett G. Brubaker and Abraham and Sons Capital, Inc. cease and desist from committing or causing any violation and committing or causing any future violation of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, Sections 204, 206(1), 206(2) and 206(4) of the Investment Advisers Act of 1940, and Rules 204-2(a)(2) and 206(4)-2 thereunder; and it is further
ORDERED that Brett G. Brubaker and Abraham and Sons Capital, Inc. each pay to the United States Treasury a civil money penalty of$50,000, pursuant to Section 21B of the Securities Exchange Act of 1934, within 21 days of the issuance of this Order. Such payment shall be: (i) made by United States postal money order, certified check, bank cashier's check, or bank money order; (ii) made payable to the Securities and Exchange Commission; (iii) delivered by hand or courier to the Comptroller, Securities and Exchange Commission, 450 5th Street, N.W., Washington, D.C. 20549; and (iv) submitted under cover letter which identifies the respondent in these proceedings, and the file number of these proceedings. A copy of this cover letter and check shall be sent to Mary E. Keefe, Counsel for the Division of Enforcement.
By the Commission.
Jonathan G. Katz
|1||Brubaker was also president of Abraham and Sons, Inc., a registered broker-dealer.|
|2||15 U.S.C. § 77q(a).|
|3||15 U.S.C. § 78j(b).|
|4||17 C.F.R. § 240.10b-5.|
|5||15 U.S.C. §§ 80b-6(1) and (2).|
|6||15 U.S.C. §§ 80b-4 and 80b-6(4).|
|7||17 C.F.R. §§ 275.204-2 and 275.206(4)-2.|
|8||A "short sale" is "any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller." 17 C.F.R. § 240.3b-3. See also Glenn G. Munn, Encyclopedia of Banking & Finance 941-944 (1991). Thus a short seller "gambl[es] that the price of the securities [will] decline substantially before he [is] required to deliver them . . . . [His profit being] the difference between the price at which he sold and the price at which he covered." U.S. v. Naftalin, 441 U.S. 768, 770 (1979).|
|9||See n.1, supra.|
|10||According to Christiansen, Brubaker's wife also was on ASCI's payroll, but never came into the office.|
|11||See Glen G. Munn, Encyclopedia of Banking & Finance, 981 (1991).|
|12||These errors, which Brubaker blamed on SLK, included SLK's failing properly to reflect stock dividends and listing in the Fund's account statements stocks it did not own.|
|13||Christiansen further testified that, during the fall of 1995, Brubaker informed Christiansen that the Fund was up approximately 8%. After receiving that information, Christiansen noticed that "there were two or three stocks that it didn't seem that the share quantities were right . . ." because of stock splits. Upon being told by Christiansen of this error in share quantities, Brubaker performed some additional calculations and then told Christiansen that theFund was up just 6%.|
|14||Shortly before this time, Brubaker also stopped supplying Christiansen with computer printouts summarizing the Fund's performance. Christiansen was given different printouts showing the Fund's long and short positions, without disclosing the value of those positions.|
|15||Brubaker claims that he was advised by an accountant with the firm of Ernst & Young to write over the computer files containing his original and erroneous calculations with the correct data. Brubaker further claims that the accountant never advised Brubaker to make copies of the original files before writing over and deleting them. The law judge expressly stated that he did "not credit Brubaker's testimony on this issue."|
|16||Brubaker challenges the Division's assertion that Brubaker must have known the Fund was in trouble because "his prediction of an imminent market downturn did not occur and the Fund had to cover most [of its] short positions at losses." Brubaker notes that, while the Dow Jones Industrial Average rose during this period, an index of technology stocks declined significantly. Thus, Brubaker contends that it was not immediately apparent during the period at issue that Brubaker's trading strategy was not working. Regardless, however, of whether technology stock prices generally were declining, it is clear that the Fund's holdings were, for the most part, suffering losses during this time, a fact Brubaker knew or was reckless in not knowing.|
|17||Division expert Conner doubted that a fund manager in Brubaker's position would need SLK's help in tracking the Fund's performance, comparing such an approach to "driving a car looking through the rear view mirror for direction."|
|18||The record does not contain the actual reports that were sent to Respondents; it appears that neither SLK nor Respondents retained them in their records. The copies of the reports contained in the record were generated by SLK's computers in response to a Division request in connection with this proceeding.|
|19||The record indicates that the Fund's November deposit was related to the discussion Gonzalez had with Brubaker in late November regarding the Fund's margin status.|
|20||Christiansen noted that, because ASCI had just two employees in its offices, all telephone calls were answered by either Christiansen or Brubaker during the period in question.|
|21||Christiansen explained that the Fund could respond to a margin call either by "put[ting] in more money or . . . cut[ting] back the positions and Brett [Brubaker] said that he would have to cut back the position -- positions, or some of them."|
|22||Anthony Tricarico, 51 S.E.C. 457, 460 (1993). See also Universal Camera v. NLRB, 340 U.S. 474 (1951).|
|23||Respondents also assert that the Fund engaged in a series of transactions that effectively increased its market exposure on two of the dates (July 14 and August 15, 1995) on which the Division contends Respondents were responding to margin calls. Respondents claim such trading is "completely inconsistent" with a finding that Respondents traded out of the Fund's margin call. We disagree. The fact that the Fund, on two occasions,may have been permitted to increase its market exposure following substantial capital contributions is not inconsistent with a finding that Respondents, on other occasions, decreased the Fund's market exposure by selling off positions when it lacked additional capital, as testimony by Gonzalez and Christiansen established.|
|24||See, e.g., Graham v. SEC, 222 F.3d 994, 1000 (D.C. Cir. 2000) (setting forth elements for aiding and abetting liability); Levine v. Diamanthuset, Inc., 950 F.2d 1478, 1483 (9th Cir. 1991). See also Sharon M. Graham, 53 S.E.C. 1072, 1080 (1998); Donald T. Sheldon, 51 S.E.C. 59, 66 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995).|
|25||Sharon M. Graham, 53 S.E.C. 1072, 1085 n.35 (1998); (noting that a respondent is a "cause" of another's violation if the respondent "knew or should have known" that his or her act or omission would contribute to such violation), aff'd, 222 F.3d 994 (D.C. Cir. 2000); Richard D. Chema, 53 S.E.C. 1049, 1059n.20 (1998),; Dominick & Dominick, Incorporated, 50 S.E.C. 571, 578 n.11 (1991) (settled case).|
|26||Section 206(4) prohibits investment advisers from "engag[ing] in any act, practice, or course of business which is fraudulent, deceptive, or manipulative." It further authorizes the Commission to adopt rules and regulations to "define, and prescribe means reasonably designed to prevent, such acts, practices, and courses of business . . . ."|
|27||There is no evidence that Brubaker delegated compliance responsibility to anyone else. See, e.g., Thomas F. White, 51 S.E.C. 1194, 1196-97 (1994) (president has compliance responsibility unless he reasonably delegates thatresponsibility and has no reason to know that the performance of the person to whom he delegated is deficient).|
|28||Lack of intent is no defense. See SEC v. Steadman, 967 F.2d 636, 646-647 (D.C. Cir. 1992) (scienter need not be found to support a violation of Rule 206(4)-2(a)(5)). Cf. Clinger & Co., Inc., 53 S.E.C. 358, 363 (1997), (rejecting defense that failure to comply with customer protection provisions of Exchange Act Rule 15c3-3 was inadvertent); Mark James Hankoff, 48 S.E.C. 705, 708 (1987) (lack of intent no defense to finding that president was responsible for firm's customer protection, recordkeeping, reporting, and net capital violations); Butcher & Singer Inc., 48 S.E.C. 640, 644 n.9 (1987).|
|29||See Jacob Wonsover, Exchange Act Rel. No. 41123 (March 1, 1999), 69 SEC Docket 694, 712 (noting that "[m]embers of the securities industry agree to be subject to the statutes, rules, and regulations administered by the Commission and self-regulatory organizations, and, before entering the business, generally must apply for registration and pass examinations demonstrating their knowledge of the securities laws."), petition denied, 205 F.3d 408 (D.C. Cir. 2000); but see Steadman, 967 F.2d at 647 (declining to find president aided and abetted firm's violation of examination requirement based on president's acknowledgment that he had "ultimate supervisory responsibility" for the firm).|
|30||Steadman, 967 F.2d at 641-42 (defining recklessness) (quoting Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1045 (7th Cir.) (citation omitted), cert. denied, 434 U.S. 875, 98 S.Ct. 224, 54 L.Ed.2d 155 (1977)).|
|31||17 C.F.R. § 275.204-2(a).|
|32||Respondents assert that the witness list had to be produced long before "they were informed that the Division of Enforcement thought margin calls were an issue." The Division's witness list, which was filed on December 8, 1997, stated that Gonzalez would testify "regarding correspondence and conversations he had, during the second half of 1995, with Mr. Brubaker regarding the Hedge Fund's trading losses and margin calls made by Spear Leeds and Kellogg." Respondents' witness list, which was also due on December 8, did notidentify Wiermanski, and they never subsequently sought to disclose their intention to call her by filing an amended witness list or a summary of her testimony. Summaries were not due until December 22, 1997, two weeks after the Division disclosed that it planned to question Gonzalez about margin calls.|
|33||17 C.F.R. § 201.320.|
|34||The Division also seeks a collateral bar against Brubaker. However, since briefing was completed in this case, the United States Court of Appeals for the District of Columbia Circuit determined that the Commission lacks the authority to impose collateral bars. Teicher v. SEC, 177 F.3d 1016 (D.C. Cir. 1999), cert. denied, 120 S.Ct. 1267 (2000).|
|35|| Respondents assert that, "even if the Commission believes the fine and disgorgement order appropriate, Mr. Brubaker does not have the resources to pay." However, Rule of Practice 17 C.F.R. §201.410(c) requires that such claims of inability to pay must be supported by "a sworn financial disclosure statement containing information specified in Section 201.630(b), i.e., "the respondent's assets, liabilities, income or other funds received and
expenses . . . ." 17 C.F.R. §201.630(b). Respondents have filed no such document.
|36||15 U.S.C. §§ 78u-2(a) and 80b-3(i).|
|37||Respondents also assessed a separate administrative fee as of December 31, 1995 based on the Fund's net asset value at that time, $6.7 million. We note that Respondents further assert, without Division challenge, that any over-assessment of administrative fees based on inflated Fund values was repaid to the Fund.|
|38||See, e.g. Laurie J. Canady, Exchange Act Rel. No. 41250 (April 5, 1999), 69 SEC Docket 1468, 1486-87, petition denied, 230 F.3d 362 (D.C. Cir. 2000).|
|39||We have considered all of the arguments advanced by the parties. We reject or sustain them to the extent that they are inconsistent or in accord with the views expressed herein.|