SECURITIES AND EXCHANGE COMMISSION
In the Matter of the Application of
For Review of the Action Taken by the
OPINION OF THE COMMISSION
REGISTERED SECURITIES ASSOCIATION - REVIEW OF DISCIPLINARY PROCEEDINGS
Fraudulent offering documents
Misleading sales literature
General solicitation in connection with private offering
Failure to list member's name in advertisement
Unwarranted claim in advertisement
Failure to disclose account at non-employer member
Failure to provide information
Former associated person of former member firm of registered securities association fraudulently used offering document that contained material misstatements and omitted material facts; fraudulently used proceeds of private placement in a manner inconsistent with offering documents; used misleading sales literature; engaged in general solicitation in connection with a private securities offering; failed to list in an advertisement the broker-dealer with which he was associated; used unwarranted claim in an advertisement; failed to disclose account at non-employer member to employing member; and failed to provide information to association staff in connection with investigation. Held, association's findings and sanctions sustained.
Brian Prendergast, pro se
Alden S. Adkins, Susan L. Beesley, and James S. Wrona, for NASD Regulation, Inc.
Appeal filed: July 29, 1999
Last brief filed: November 10, 1999
Brian Prendergast, formerly a general securities representative with AmeriNational Financial Services, Inc. ("AmeriNational"), a former member of the National Association of Securities Dealers, Inc. ("NASD"), appeals from NASD disciplinary action. The NASD found that Prendergast violated NASD rules in his 1994 sale of shares in and management of a hedge fund.1 The NASD determined that Prendergast used a private placement memorandum ("PPM") containing materially misleading statements and omitting material facts, and that Prendergast fraudulently used the offering proceeds inconsistently with the PPM.2 The NASD also concluded that Prendergast used misleading sales literature, engaged in an improper general solicitation in connection with a private placement of unregistered securities, failed to name in an advertisement the NASD member with which he was associated, made an unwarranted claim in an advertisement, failed to notify the NASD member with which he was associated regarding a securities account at another NASD member firm, and failed to provide on-the-record testimony to NASD staff in connection with an investigation.3 The NASD censured Prendergastand barred him from association with any NASD member in any capacity.4 We base our findings on an independent review of the record.
Prendergast was a general securities representative with AmeriNational from September 1993 through November 1994. Beginning in January 1994, Prendergast sold investors interests in a hedge fund ("Hedge Fund") operated by Prism Financial Limited Liability Company ("Prism"), a new enterprise. The sales were made pursuant to a PPM prepared by Prendergast and his counsel, which attached Prism's Operating Agreement. The securities offered by the PPM were described as securities exempt from the registration requirements of the Securities Act of 1933. During the one-year offering period, the PPM offered a maximum of 50 "units" at $25,000 each. Prendergast and Joel DeAngelis were identified as co-managers of Prism.5 The PPM stated that Prendergast had earned consistent "top-20" rankings in the "Money Managers' Championship," a contest administered by Norm Zadeh of Beverly Hills, California, even though Prendergast oftenfinished out of the top 20. Prendergast competed in the contest before the Prism investment program had been developed.6
According to the PPM, the key component of Prism was a proprietary Standard & Poors ("S&P") 500 Index computer trading program ("the Program") developed by Prendergast. The PPM stated that the units were speculative securities and referred potential investors to a list of "risk factors," only two of which were relevant to investment in a hedge fund such as this. The first of these began by saying that the Program was untested, but immediately contradicted itself, stating that, "[a]lthough Prism has spent the last two years developing and testing this proprietary computerized investment program, it has not been tested within the parameters of the . . . hedge fund . . ." (emphasis added). The "parameters" were not defined.7
Elsewhere, the PPM stated that the Program had been "publically [sic] tested and audited over a four-year period of time." Prendergast's testimony established, however, that the testing covered less than four years. Moreover, the testing routine used the Program to direct hypothetical trades based on hypothetical market conditions; it did not encompass actual use in a securities market. The PPM included other statements suggesting that Prism, a new enterprise, had a successful track record and had achieved trading results that exceeded those that investors could expect from other types of investments. For example, the PPM stated that the Prism product "enhances historical yields by as much as 100% per year." Similarly, illustrations in the PPM referred to "actual program performance."
The PPM also projected extremely high returns for investors. As noted above, the PPM claimed that Prism's product could double the "historic yields" of unidentified investments. It claimed elsewhere that the Hedge Fund's "actual program performance" produced gains of almost seven "S&P points" per month.8 In another reference, the PPM stated that the trades listed in the "actual program performance" would have produced a 278 percent investment return. The PPM implied that Hedge Fund investors could expect their investment to outperform 95 percent of mutual funds. The PPM "conservatively" projected that the Program would return three "S&P points" per month profit. As a new investment product, the Hedge Fund had no history to support these claims. The PPM also claimed that the Hedge Fund took advantage of a money-management system that limited the investor'srisk of loss while maximizing his or her ability to achieve high rates of return. There was no money-management system that minimized investors' risks.
The PPM also implied that the Hedge Fund was a mutual fund or was in material respects operated like a mutual fund. For example, the PPM stated that Prism's hedge fund was "unusual and high yielding compared to other mutual fund products." Prism was not registered as a mutual fund and did not operate in the way that mutual funds operate. Of most relevance in this case, Hedge Fund investors did not purchase an undivided interest in the Hedge Fund's assets. Instead, Prism assigned investments to investors based upon the transactions made with the funds provided by those investors. Prism allocated profits and losses according to that assignment.
The PPM advised investors that Prism's managers would invest 60 percent of the offering proceeds in the Hedge Fund. The PPM accounted for the remaining 40 percent of the offering proceeds as follows:9
|General and Administrative:||10%|
|Legal and Accounting:||1|
The stated purpose of the "Bank Reserve" and "Bank Discount" items was to enable prospective investors to finance their purchases of Hedge Fund units. As it happened, all of the investors paid cash. The PPM did not provide for the disposition of the "Reserve" and "Discount" funds in such a circumstance. NASD examiners determined that these funds were used to pay management fees.
The PPM claimed that the Hedge Fund offered diversification, safety of principal, automatic "internal profit dispersion," and a great deal of flexibility in asset allocation. The Operating Agreement, which governed the operation of the Prism enterprise, granted the managers authority, among other things, to purchase and sell securities owned by Prism. The "Asset Matrix" was the heart of the Hedge Fund. The Asset Matrix specified that the allocation of the assets in the Hedge Fund would be 60 percent "in the S&P stock index futures" and 40 percent in "load and no-load mutual funds to be market timed." The PPM then projected investment returns in the Asset Matrix. The Asset Matrix projections were based on the following assumptions:
1. The S&P 500 projected performance is based upon the assumption that the S&P 500 trading program will average at least 3 S&P points per month profit . . .. Prism's four year, back tested program has averaged over 5 S&P points per month although this is no guarantee of future success.
2. The mutual fund timing segment is projecting an annual return of at least 16%. Prism's past 7 year track record has averaged over 16.5% per year on a compound return basis.
The PPM then added the following "disclaimer:"
DISCLAIMER: Prism cannot guarantee that [sic] the projections illustrated in this spreadsheet and cannot guarantee the final ending balance will be achieved. Prism has taken a conservative approach to projecting a compound rate of return that is below its historical trading record but cannot guarantee results. There are many factors beyond the control of Prism that could affect the Company's trading results.
(italics and underlining in original). There was no "historical trading record." The spreadsheet to which the disclaimer referred projected a 226.9 percent "internal rate of return" on an investment of $745,000 over 10 years.
Elsewhere, the PPM claimed that Prism was also marketing other products to institutional investors. Prism, however, never had any institutional clients or institutional investment products.
Between March and November, 34 investors bought units in the Hedge Fund worth approximately $920,000. Prendergast invested approximately 63 percent of the total proceeds in the Hedge Fund. Of this amount, he deposited approximately $540,500 in three successive commodities accounts and spent $40,300 on the purchase of low-priced Canadian securities through several different brokerage accounts. Although the PPM specifically represented that mutual funds were a key component of the Hedge Fund, Prism never purchased any mutual funds.
In March 1994, the Hedge Fund suffered a realized trading loss of approximately $72,000. By April, Prendergast had begun investing the proceeds in investments other than those identified in the PPM. In April 1994, Prism invested in Chicago Board of Trade ("CBOT") Treasury Bond futures. In May, Prism invested in foreign currency options. From May 1 through May 10, less than half of the transactions involved S&P 500 Index futures transactions; the remainder involved foreign currency options and CBOT Treasury Bond futures positions. From May 11 through the end of June, most of the Hedge Fund's transactions involved the S&P 500 Index futures market as the PPM represented they would. In July, approximately one-third of the transactions involved foreign currency positions. By November 30, the Hedge Fund's trading activity had realized losses of approximately $476,000; Prism's November 30 ending position was $64,000.
From April through November 1994, while Prendergast was directing the Hedge Fund's investments as described, he corresponded with the Hedge Fund investors by form letters describing its performance. Prendergast's letter of April 16 encouraged investors to look beyond the recent losses the Hedge Fund had suffered because of the Hedge Fund's record of rebounding from poor market performance. The Hedge Fund, as a new enterprise, had no record, successful or otherwise. The letter also informed investors that the Hedge Fund's mutual fund holdings would soften the impact of future market swings. The Hedge Fund owned no mutual funds at that, or any other, time.
A June 6, 1994, letter told investors that because of the mutual funds' performance they could expect to recoup their losses within 7.4 years regardless of the Program's performance. The letter also described the Canadian stocks Prendergast purchased in lieu of money-market funds as having a "contained risk factor," a term the letter left undefined. In response to inquiries from investors who had compared their results among themselves, the letter tried to explain why investors who bought Prism units at the same time had widely varying results. In an attempt at explanation that avoided the question raised by the investors, the letter implied that Prism's accounting system was similar to that used by mutual funds and represented that profits and losses would be redistributed to "equalize" the results between earlier and later investors. In fact, the Hedge Fund's accounting system was materially different from that used by mutual funds. Moreover, Prendergast testified that Prism's and the Hedge Fund's accountant had told him in the course of preparing the first account statements that equalizing the investment results could not be done. In fact, the Hedge Fund never equalized the results.
A July 20, 1994, letter predicted a nearly fourfold price increase in one Canadian mining stock from $0.64 (Canadian) per share to $2.50 (Canadian) by mid-September. A September 21, 1994, letter advised investors that they were not doing as badly as their statements reflected and assured them that the Hedge Fund had not, and would not, run out of money with which to trade. In fact, the statements accurately reflected the state of the investors' accounts, and the Hedge Fund ran out of trading capital shortly after the letter was written. A November 1, 1994, letter advised the investors that the Hedge Fund was buying mutual funds, which never happened.
On September 9, Prendergast opened an account at Rocky Mountain Securities & Investments ("RMSI"). Prendergast did not notify AmeriNational in writing that he had opened a securities account at another NASD member firm, although he claimed that AmeriNational was aware of the account through its President's knowledge of the Prism enterprise. In late September, Prendergast placed the following advertisement in the San Jose Mercury-News inviting the general public to a seminar regarding hedge funds:
"Today's Hottest Investment"/ Hedge Funds/ WHAT THEY ARE / HOW TO INVEST / WHEN: Thurs., Sept. 29th 2:00 - 3:30 PM / 4:00 -5:30 PM / WHERE: Silicon Valley Capital Club / Fairmont Plaza/ 50 West San Fernando - Suite 1700 / San Jose, CA (408) 971-9300 / Gentlemen: Coat and Tie required / SPONSORED BY [LOGO] PRISM Financial Corporation C.T.A. / RSVP 1-800-915-2945
The advertisement did not list AmeriNational as Prendergast's employing broker-dealer. Prendergast testified without contradiction that the San Jose seminar explained only what hedge funds did.10
On December 1, 1995, NASD staff requested, pursuant to Article IV, Section 5 of the Rules, that Prendergast submit to an on-the-record interview regarding Prism; on December 2, 1995, Prendergast refused. On December 15, 1995, the staff repeated the request. On December 21, 1995, Prendergast offered to speak to the staff off the record, but the staff did not respond to this offer. Prendergast gave no on-the-record testimony until he testified at the NASD hearing in May 1997.
A. Prendergast Defrauded Investors in Connection With the Sale and Management of the Prism Hedge Fund.
1. Mischaracterization of the Prism Hedge Fund
The PPM misrepresented the nature of the Hedge Fund to potential investors particularly the degree of risk involved. Specifically, the PPM misled investors concerning the track record of the Fund. Although the PPM stated that the investment was speculative and the Program was untested, the significance of that statement was obscured by other multiple claims that the Program had been tested and had a successful performance history. In fact, the Program, the key component of the Hedge Fund, had never been used in the market, and, therefore, had no "historical yields" nor any record against which to compare its performance with the yields of other trading programs. We have held that the false claim that an investment has a track record is misleading.11
Prendergast's contention that he worked hard to show the development and history of the Program "to include past historical returns based upon past historical market conditions," misses the point. The PPM falsely described the Program as an investment vehicle with a successful trading history. The efforts spent developing the Program are not relevant to whether it had ever been used to trade in an actual market, as the PPM implied. The statement buried in the PPM that the Hedge Fund's track record was actually attributable to predecessor firms failed to correct the misleadingimpression created throughout the PPM that the Hedge Fund had the successful history with the Program that was described in the PPM. Throughout, the PPM couched crucially important disclosures regarding the Program's lack of history in obfuscatory language while contrary, and false, claims were clearly and plainly expressed. This pattern of calculated deceit violates Article III, Section 18 of the Rules.12
The PPM also was replete with false claims of high yields and projections, such as the claim that the Hedge Fund would outperform 95 percent of mutual funds. The PPM's "conservative" projections that the Program would return three "S&P points" per month profit; the similar claims for the mutual fund segment of the Hedge Fund; and the claim that the Asset Matrix would produce a 226.9 percent "internal rate of return" were all without foundation.13 Such predictions of specific and substantially above-market returns for a speculative security are a "hallmark of fraud" and violate Article III, Section 18 of the Rules.14 Similarly, the PPM's assertion that the Hedge Fund's money-management system "limit[ed] downside risk and maximiz[ed] upside potential," misled investors. The Asset Matrix's generic disclaimer that "markets are unpredictable" failed to cure specific misleading aspects of the PPM.15 The boilerplate declaration concerning the possible impact of uncontrollable events was not sufficient to cure the PPM's misleading statements; it was just a "vague or blanket (boilerplate) disclaimer which merely warns the reader that the investment has risks."16
The PPM's repeated comparison of the Hedge Fund to mutual funds led potential investors to believe that they were investing in a mutual fund, when, in fact, they were investing in somethingdifferent.17 The Hedge Fund investors' inquiries to Prendergast regarding their statements indicate that some investors believed they had invested in an investment vehicle that operated like a mutual fund. Most importantly, unlike mutual fund investors, Hedge Fund investors did not purchase an undivided interest in the assets of the Hedge Fund.
Taken as a whole, these mischaracterizations of the Hedge Fund obscured the nature of the product that potential investors were asked to purchase, and were material. We have held that misrepresenting the nature of an investment violates Article III, Section 18 of the NASD Rules.18
We are not convinced by Prendergast's defense that the PPM's description of the Program may have been confusing, but was not misleading. Offering document disclosures must be clear and organized so that their significance is readily understood.19 Prendergast insists that he clarified the PPM's "ambiguities" regarding the Program, and the Hedge Fund, through personal meetings and telephone conversations. Prendergast does not substantiate his purported verbal communications with prospective investors.
Moreover, the representations in the PPM that the Program had a successful history were false, not ambiguous. The PPM also falsely claimed that Prendergast used his trading programs to achieve consistent rankings as one of the top 20 contestants in the "Money Managers' Championship." Such a claim is material because Prendergast's financial acumen is a fact that would be important to a potential investor. The claim was false because more often than not, Prendergast failed to achieve a "top-20" ranking. Other facts regarding the contest were omitted and the facts the PPM provided were "not presented so clearly that they [would] be plainly evident to the ordinary investor."20 This mischaracterization and the material omissions violate Article III, Section 18 of the Rules.
Prendergast prepared most of the PPM himself and was closely involved in the drafting of those parts than he did not prepare onhis own. As the developer of the Program around which the Hedge Fund was built, he knew full well that the PPM described the Hedge Fund to potential investors in a false and misleading manner. We find, therefore, that Prendergast acted with scienter in using the inaccurate and misleading PPM to sell Prism units.
2. Prendergast's Fraudulent Misrepresentations Concerning Use of Offering Proceeds
The disposition of the proceeds of a securities offering is material information, and issuers must adhere strictly to the uses for the proceeds described in the PPM.21 Prendergast's disposition of the proceeds was inconsistent with the disclosures in the PPM both as to the investment strategy and the so-called "Bank Reserve" and "Bank Discount."
Prendergast admits that, from the beginning, he abandoned the investment strategy disclosed in the PPM. His defense is that: the PPM disclosed that the asset allocation formula for the Hedge Fund allowed a great deal of flexibility; the Operating Agreement gave him broad investment authority; and Prendergast's fiduciary duty to Hedge Fund investors required him to avoid unsuitable investments.
Prendergast's arguments are fundamentally flawed. First, in offering documents, specific statements control more general language such as that an allocation plan is "flexible."22 No reasonable investor reading the strongly phrased, mandatory language in the PPM's description of the Asset Matrix would anticipate that he or she would eventually own the type of investments Prendergast purchased for Prism. It was therefore misleading to include such specific language describing asset allocation when Prendergast intended to rely on more general language to authorize a departure from the Asset Matrix.
Second, the language of the Operating Agreement does not override the specific promises regarding the disposition of the offering's proceeds.23 Finally, whether motivated by concerns regarding fiduciary duty or not, Prendergast's investment decisions were inconsistent with the PPM's specific disclosures regarding the allocation of the offering proceeds. Simply put, the Hedge Fund wasa bait-and-switch scheme. It is irrelevant that some of the improper investments were profitable.24
The PPM did not disclose accurately the disposition of 11 percent of the offering proceeds to be set aside as the "Bank Reserve" and the "Bank Discount" to allow Prism to finance investors' unit purchases. No investors financed their purchases. The NASD's analysis of Prism's bank records disclosed that most of the "Reserve" and "Discount" amounts were paid in management fees, a use of the proceeds that was not disclosed in the PPM. The actual disposition of 11 percent of the proceeds was a material fact that should have been disclosed.
As we found above, Prendergast was actively involved with preparation of the PPM and knew of its provisions regarding the use of the offering proceeds. The record shows, and he does not dispute, that he made the decision to change the disposition of the proceeds and did not disclose this decision to the investors. Accordingly, we find that Prendergast acted with scienter.25 Prendergast's argument that his hard work developing the Program precludes a finding of scienter is a non sequitur. The allegations concern fraudulent conduct, not the merits of the Program.
Accordingly, we find that Prendergast used the proceeds of the offering inconsistently with the representations made in the PPM, in violation of Article III, Section 18 of the Rules.26
B. Prendergast Distributed Misleading Sales Literature.
Article III, Section 35 of the Rules defines "sales literature" as written communications distributed to customers, such as performance reports or summaries.27 Prendergast denies that the letters he sent to all Hedge Fund investors reporting on Prism's performance were sales literature and, resting on that denial, does not respond to the NASD's charges regarding their content. However, Prendergast's letters were distributed to all Hedge Fund investors and included reports or summaries of the Hedge Fund's performance. They fall squarely within the definition in Section 35. The Rules require that sales literature must provide "a sound basis for evaluating the facts in regard to any particular security . . ." and must not omit any material fact or qualification if to do so would make the sales literature misleading.28 The Rules also prohibit "[e]xaggerated, unwarranted or misleading statements or claims" in sales literature.29 Prendergast's letters violated these standards.
The April 16 letter's references to Prism's nonexistent track record and to the performance of its nonexistent mutual fund component were false and misleading. The June 6 letter's prediction that investors would recover their losses was (like guarantees of profit and predictions of sharp increases in the price of speculative stocks) inherently fraudulent.30 Its implication that the Hedge Fund was subject to the same accounting principles as mutual funds was also highly misleading. The June 6 letter represented that the Hedge Fund would "equalize" the profits and losses among the investors. However, Prendergast had been told by the Hedge Fund's accountant months earlier that the equalization he described was not possible. The July 20 letter fraudulently predicted the quadrupling (in less than two months) of the price of the speculative Canadian mining securities Prendergast purchased for the Hedge Fund.31 The September 21 letter's statements that "things are not as bad as they appear on your statement" and that the Hedge Fund "has not and will not run out of money to trade with" were false and designed to deceive the investors regarding the true state of their Hedge Fund investment.32 Finally, the November 1 letter falsely stated that the Hedge Fund had begun to purchase mutual funds.
Accordingly, we find these misrepresentations and misleading statements violate Article III, Section 35 of the Rules.
C. The September 25, 1994 Newspaper Advertisement
1. Article III, Section 35(e) violation
Article III, Section 35(e) of the Rules requires that NASD members comply with all applicable Commission rules in their public communications.33 The PPM stated that the Prism offering was being made in reliance on the Commission's Regulation D, exempting the "units" from registration subject to conditions in Securities Act Rule 502. Subpart (c) of Rule 502 prohibits issuers, or those acting on their behalf, from offering or selling the exempt securities by newspaper advertisements or seminars whose attendees have been invited by a general solicitation or advertising.34 Rule 502(c) defines "general solicitation" as "[a]ny advertisement . . . published in any newspaper . . . ; and [a]ny seminar or meeting whose attendees have been invited by any general solicitation or general advertising."35 In late September, Prendergast placed an advertisement in the San Jose Mercury-News announcing the Prism seminar on hedge funds. The NASD found that the advertisement violated Securities Act Rule 502(c) and consequently determined that Prendergast had violated Article III, Section 35(e) of the Rules, which requires that NASD members' public communications conform with Commission rules.
To prove a violation of Rule 502(c), the NASD had to establish that the advertisement was placed by an issuer or person acting on its behalf, offered or sold securities and was a general solicitation. There is no dispute that Prendergast acted on behalf of Prism when he placed the advertisement. The advertisement and the seminar met the definition of "general solicitation" contained in Rule 502(c). Prendergast asserts, however, that neither the advertisement nor the seminar were used to offer or sell securities.
During the period Hedge Fund units were being sold, the advertisement announced a seminar regarding hedge funds and specified its date, time, and location. The September 21 letter from Prendergast to Hedge Fund investors stated Prendergast's intention to use seminars in California to obtain new investment capital for the Hedge Fund. Although the only record evidence regarding the content of the San Jose seminar is Prendergast's testimony that the seminar content was "generic," the September 21 letter states that the purpose of the planned seminars was to attract investors to Prism. Further, there was no reason other than marketing considerations for Prendergast to hold the free seminars.
Our 1964 decision in Gearhart & Otis, supports this broad view of "offer or sell."36 In that case we found that the respondent offered unregistered securities for sale in violation of sections 5(a) and (c) of the Securities Act of 1933 by sending to broker-dealers copies of articles regarding lithium, its uses, availability and commercial prospects. The articles did not mention any particular security. Nonetheless, we found that sending the articles to the broker-dealers was part of a scheme to "awaken an interest" in securities related to lithium before the offering of securities in National Lithium Corporation. Here we have a more direct link. The September 21 letter refers to a series of seminars intended to attract new Hedge Fund investors, and the seminar itself is advertised and held shortly thereafter. Prendergast's intentions expressed in the September 21 letter lead us to conclude that the advertisement and the seminar itself were general solicitations used to offer or sell Prism units.37
We therefore find that Prendergast violated Article III, Section 35(e) of the Rules.
2. Article III, Section 35(d)(2)(A) violation.
The Mercury-News advertisement did not identify the NASD member with which Prendergast was associated. Accordingly we find that Prendergast violated the provisions of Article III, Section 35(d)(2)(A) of the Rules which requires that the member be identified.38
3. Article III, Section 35 (d)(1)(B) violation.
Prendergast's use of the phrase "Today's Hottest Investment" in the Mercury-News advertisement was unfounded. Accordingly, we find that Prendergast's use of the statement in an advertisement violated Article III, Section 35(d)(1)(B) of the Rules which prohibits making unwarranted statements in advertisements.39
D. Prendergast Did Not Notify AmeriNational That He Had Opened an Account at RMSI.
Article III, Section 28(c) of the Rules provides that "[a] person associated with a member, prior to opening an account or placing an order for the purchase or sale of securities with another member, shall notify both the employer member and the executingmember, in writing of his or her association with the other member."40 Prendergast does not dispute that on September 9 he opened an account for Prism at RMSI without giving prior written notice to AmeriNational; Prendergast signed the account application.41 Prendergast argues that he should not be found in violation because AmeriNational had actual knowledge of the account. Even if Prendergast had established that AmeriNational knew of the account (and he did not establish that fact), that would not excuse his failure to notify AmeriNational in writing as required by the Rule.42 Therefore, we find that Prendergast violated Article III, Section 28 of the Rules.
E. Prendergast Failed to Provide Information to NASD Staff Regarding Prism.
NASD staff twice requested that Prendergast submit to an on-the-record interview regarding Prism and the Hedge Fund. As an associated person of an NASD member, Prendergast had a duty to comply with the NASD request under Article IV, Section 5 of the Rules.43 Prendergast refused the first request and offered to give an off-the-record interview in response to the second. He argues that he could not testify on the record because he anticipated litigation with Hedge Fund investors. He also argues that he had provided enough information to the NASD. Neither of these considerations relieves Prendergast of his duty. He did not have the right to determine unilaterally that NASD staff did not need the information or to set conditions on his compliance.44 Nor did Prendergast's desire to deprive potential litigants of the transcript of the requestedinterview justify his refusal.45 We find that Prendergast violated Article IV, section 5 of the Rules.
Prendergast alleges several procedural improprieties. First, he claims that the NASD erred in denying his motion to adduce additional evidence after the close of the hearing: a letter from an investor and the audit report regarding the Program. Prendergast did not offer the two items in evidence at the hearing, even though he had them in his possession. He did not file his motion to adduce additional post-hearing evidence with the NASD until after the deadline for such motions had passed.46 Moreover, the motion did not establish that the documents were material or that good cause excused his failure to present them at the hearing, as required by NASD Procedural Rule 9346(b).47 Prendergast argues that the investor letter established that the PPM provided sufficient information to enable investors to understand the operation of the Program. The NASD found, however, that the letter reflected only that the investor, a college mathematics instructor, could perform a series of mathematical operations based on Prism's assumptions. The accuracy of the PPM's mathematical demonstrations was never in dispute. In short, the letter was irrelevant to the issues the NASD had to decide. Similarly, the audit report reflected only that there had been an audit, a fact that the NASD had not disputed. Our review of the two documents supports the NASD's conclusion that neither document was sufficiently material to justify their inclusion in the record after the close of the hearing. Accordingly, we find no impropriety in the NASD's denial of the motion to adduce additional evidence.
Prendergast asserts that he is the victim of improper selective prosecution. To succeed on this claim, Prendergast must establish that he was singled out for enforcement action while others who were similarly situated were not, and that his prosecution was motivated by arbitrary or unjust considerations such as his race, religion or the desire to prevent his exercise of a constitutionally protectedright.48 Prendergast has failed to allege, much less substantiate, any of these elements of improper selective prosecution. Accordingly, we find that Prendergast was not the victim of impermissible selective prosecution.
Prendergast objects vehemently to an alleged conspiracy between the NASD and the Commodity Futures Trading Commission aimed at depriving him of his professional licenses. No evidence supports that allegation, and we reject it.
In light of our independent review of the record we find that the NASD's proceedings against Prendergast were conducted fairly.
Our review of the NASD's sanctions is governed by Section 19(e)(2) of the Exchange Act, which requires us to determine whether a self-regulatory organization's sanctions are excessive or oppressive or impose an unnecessary or inappropriate burden on competition.49 The proper sanctions depend on the facts and circumstances of each case.50 We conclude, in light of the substantial and deliberate nature of Prendergast's misconduct, that the sanctions imposed by the NASD upon him, censure and a bar from association with any member firm in any capacity, are appropriate. The applicable NASD sanction guidelines suggest that a bar is appropriate in egregious cases for each of the following violations: the fraudulent use of offering proceeds, use of a fraudulently misleading PPM, use of misleading sales literature, failure to notify AmeriNational of the RMSI account and his failure to provide on-the-record testimony to NASD.51 There are no mitigating factors. The NASD concluded, we believe correctly, that the violations were sufficiently egregious in this case to justify a bar. In these circumstances, we conclude that the NASD's sanctions are neither excessive, oppressive nor an unnecessary or inappropriate burden on competition.
An appropriate order will issue.52
By the Commission (Acting Chairman UNGER and Commissioners HUNT and CAREY).53
Jonathan G. Katz
Admin. Proc. File No. 3-9964
In the Matter of the Application of
For Review of the Action Taken by the
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., ("NASD") against Brian Prendergast, and the NASD's censure and bar, be, and they hereby are, sustained.
By the Commission.
Jonathan G. Katz
|1||Between 1994, when the charged conduct allegedly took place, and 1996 when the NASD filed its complaint, the NASD revised and renumbered its rules and changed their name from "Rules of Fair Practice" to "Conduct Rules" or "Procedural Rules." There are no relevant substantive changes in the rules at issue here. Although the complaint and the NASD decision use the new nomenclature and numbering, we will refer to the Rules of Fair Practice ("Rules"), which applied to Prendergast's conduct in 1994.|
|2||The NASD found that this conduct violated Article III, Section 18 of the Rules (now Conduct Rule 2120), which provided that "[n]o 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||The NASD found that this conduct violated (1) Article III, Section 35 of the Rules (now Conduct Rule 2210), whichregulated NASD members' communications with the public through sales literature; (2) Article III, Section 35(e) of the Rules (now Conduct Rule 2210(e)), which required that all NASD members' public communications conform to applicable Commission rules(here, Rule 502(c), 17 C.F.R. § 230.502(c) (1994), which forbade using general solicitations to offer or sell unregistered securities); (3) Article III, Section 35(d)(2)(A) of the Rules (now Conduct Rule 2210(d)(2)(A)), which required that advertisements list the name of the NASD member with whom a representative is associated; (4) Article III, Section 35(d)(1)(B) (now Conduct Rule 2210(d)(1)(B)), which prohibited use of unwarranted claims in advertisements; (5) Article III, Section 28 of the Rules (now Conduct Rule 3050), which required that persons associated with an NASD member provide written notice to the employing member before opening an account with another NASD member; and, (6) Article IV, Section 5 of the Rules (now Procedural Rule 8210), which required associated persons to provide NASD staff, when asked, with on-the-record testimony regarding investigations.|
|4||The NASD did not assess monetary sanctions against Prendergast because he had declared personal bankruptcy. Presumably for the same reason, the NASD did not assess costs against him.|
|5||The NASD did not proceed against DeAngelis; he was not registered with the NASD.|
|6||Articles regarding the Money Managers' Championship were among the attachments to the PPM. Neither the PPM nor the articles disclosed that entrants paid an entry fee.|
|7||The other relevant risk factor was a boilerplate declaration that uncontrollable events could damage Prism's performance.|
|8||The PPM did not define this performance measure.|
|9||These percentages are derived from the PPM, which expresses these allocations in dollars based on the assumption that the offering achieved the maximum proceeds of $1,250,000. All percentages are rounded to the nearest whole percentage.|
|10||The September 21 letter to investors had referred to this seminar explaining that the purpose of this and other prospective seminars would be to attract new Prism investors.|
|11||Del Consol. Indus., Inc., 42 S.E.C. 682, 684 (1965).|
|12||Coastline Financial, Inc., Exchange Act Rel. No. 41989 (Oct. 7, 1999), 70 SEC Docket 2444, 2447-48.|
|13||See Gabriel A. Arcuri, Jr., 50 S.E.C. 977, 978 (1992).|
|14||Alfred Miller, 43 S.E.C. 233, 235 (1966); see also, C. James Padgett, 52 S.E.C. 1257, 1265 (1997), aff'd sub nom., Sullivan v. SEC, 159 F.3d 637 (D.C. Cir. 1998) (table), cert. denied, 525 U.S. 1070 (1999); Lester Kuznetz, 48 S.E.C. 551, 553 (1986); Irving Friedman, 43 S.E.C. 314, 320 (1967).|
|15||See In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 371-72 (3d Cir. 1993)(legally effective cautionary statements must be specific and tailored to specific portions of offering document alleged to be misleading), cert. denied, 510 U.S. 1178 (1994).|
|16||Id., at 371. See also, Blatt v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 916 F. Supp. 1343, 1356 (D. N.J. 1996).|
|17||See e.g., Prime Investors, Inc., 53 S.E.C. 1, 11-12 (1997) (comparison to better known investment vehicle violates Rules when investments are not comparable).|
|18||See e.g., Coastline Financial, Inc., 70 SEC Docket 2447-48 (representation that unsecured promissory notes are "secured" violates Rules).|
|19||Del Consol. Indus., Inc., 42 S.E.C. at 684; Mon-O-Co Oil Corp., 38 S.E.C. 833, 840 (1959).|
|20||See Del Consol. Indus., Inc., 42 S.E.C. at 684; see also Mon-O-Co Oil Corp., 38 S.E.C. at 840.|
|21||Riedel v. Acutote of Colorado LLP, 773 F. Supp. 1055, 1068 (S.D. Ohio 1991) (materiality); Joseph P. Tufo, Exchange Act Rel. No. 41340 (Apr. 28, 1999), 69 SEC Docket 2002, 2003. Prime Investors, Inc., 53 S.E.C. at 11 (strict adherence to disclosed uses of proceeds); DWS Sec. Corp., 51 S.E.C. 814, 817-18 (1993); Wilshire Discount Sec., Inc., 51 S.E.C. 547, 550 (1993).|
|22||See e.g, DWS Sec. Corp., 51 S.E.C. at 817-19.|
|24||See Shaw, Hooker & Co., 46 S.E.C. 1361, 1366 (1977).|
|25||See DWS Sec. Corp., 51 S.E.C. at 821.|
|26||Prendergast argues that AmeriNational, as a member and "agent" of the NASD, approved the Prism offering including the PPM. Therefore, he concludes, the NASD should not be allowed to proceed against him, or, in the alternative, should have proceeded against AmeriNational. No evidence supports Prendergast's argument that AmeriNational was an agent of the NASD, and we reject it.|
|27||NASD Rules of Fair Practice, Art. III, § 35(a)(2) (1994) (now Conduct Rule 2210 (a)(2)).|
|28||NASD Rules of Fair Practice, Art. III, § 35(d)(1)(A) (1994) (now Conduct Rule 2210(d)(1)(A).|
|29||NASD Rules of Fair Practice, Art. III, § 35(d)(1)(B) (1994) (now Conduct Rule 2210(d)(1)(B).|
|30||See Irving Friedman, 43 S.E.C. at 320.|
|31||See Donald A. Roche, 53 S.E.C. 16, 18-19 (1997); Alfred Miller, 43 S.E.C. at 235; Irving Friedman, 42 S.E.C. at 320.|
|32||Cf. Donald T. Sheldon, 51 S.E.C. 59, 70 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995).|
|33||NASD Rules of Fair Practice, Art. III, § 35(e) (1994) (now Conduct Rule 2210(e))|
|34||17 C.F.R. § 230.502(c) (1994).|
|35||17 C.F.R. § 230.502(c)(1) - (2).|
|36||Gearhart & Otis, Inc, 42 S.E.C. 1 (1964), aff'd, 348 F.2d 798 (D.C. Cir. 1965).|
|37||17 C.F.R. § 230.502(c) (1994).|
|38||NASD Rules of Fair Practice, Art. III, § 35(d)(2)(A) (1994).|
|39||NASD Rules of Fair Practice, Art. III, § 35(d)(1)(B) (1994).|
|40||NASD Rules of Fair Practice, Art. III, § 28(c) (1994) (now Conduct Rule 3050(c)).|
|41||From our review of the record, it appears that Prendergast also failed to notify RMSI as required. The NASD, however, did not charge him with any violation regarding that failure.|
|42||John M. W. Crute, Jr., 53 S.E.C. 870, 878 (1998), aff'd, 208 F.3d 1006 (5th Cir. 2000).|
|43||NASD Rules of Fair Practice, Art. IV, § 5 (1994).|
|44||See Mark Allen Elliott, 51 S.E.C. 1148, 1151 (1994) (associated person may not withhold compliance on grounds that NASD does not need requested information); Richard J. Rouse, 51 S.E.C. 581, 585-86 (1993); Michael David Borth, 51 S.E.C. 178, 181 (1992) (associated person may not set conditions on compliance with NASD information request).|
|45||See Darrell Jay Williams, 50 S.E.C. 1070, 1072 (1992).|
|46||NASD Procedural Rule 9346(b) (1998) requires that the moving party must file its motion no later than 30 days after noting its appeal to the National Adjudicatory Council ("NAC") of the NASD. Prendergast noted his appeal to the NAC no later than December 27, 1997, and moved to adduce additional evidence on February 8, 1998, more than 30 days after he noted his appeal.|
|47||NASD Procedural Rule 9346(b) (1998) ("The motion shall . . . demonstrate that there was good cause for failing to introduce it below [and] demonstrate why the evidence is material to the proceeding . . ..")|
|48||See United States v. Huff, 959 F.2d 731, 735 (8th Cir.), cert. denied, 506 U.S. 855 (1992); Barry C. Wilson, 52 S.E.C. 1070, 1074 (1996).|
|49||15 U.S.C. § 78s(e)(2).|
|50||Donald R. Gates, Exchange Act Rel. No. 41777 (Aug. 23, 1999), 70 SEC Docket 1228, 1236 and cases cited therein.|
|51||See NASD Sanction Guidelines (1993 ed.) at 5, 22, 34.|
|52||We have considered all of the parties' contentions. We rejector sustain these contentions to the extent that they are inconsistent or in accord with the views we express here.|
|53||This opinion was submitted to Commissioner Carey, and he voted on it before he died.|