SECURITIES AND EXCHANGE COMMISSION
In the Matter of the Application of
JOHN P. GOLDSWORTHY
For Review of Action Taken by the
NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.
OPINION OF THE COMMISSION
REGISTERED SECURITIES ASSOCIATION -- REVIEW OF DISCIPLINARY PROCEEDING
Violation of Rules of Fair Practice
Failure to Inform Employer of Private Securities Transactions
On remand from Commission to clarify whether promissory notes at issue were securities, registered securities association determined that notes issued by former general securities representative associated with a member firm were securities and that representative engaged in private securities transactions without required written notification to, and approval from, member. Held, association's findings of violation, bar order, and assessment of costs are sustained.
John P. Goldsworthy, pro se.
Jeffrey S. Holik, Norman Sue, Jr., Susan L. Beesley, and Deborah F. McIlroy, for NASD Regulation, Inc.
Appeal filed: November 15, 2000
Last brief received: February 15, 2001
John P. Goldsworthy, formerly a registered general securities representative associated with U.S. Securities Clearing Corporation ("USSCC"), a member of the National Association of Securities Dealers, Inc. ("NASD"), appeals from NASD disciplinary action.
In his first appeal to us, Goldsworthy sought review of the NASD's determination that he engaged in private securities transactions without providing prior written notice to USSCC, in violation of Article III, Sections 1 and 40 of the NASD Rules of Fair Practice, now Conduct Rules 2110 and 3040,1 when he participated in the sale to twelve customers of promissory notes issued by SCF, Inc. ("SCF"). Because it was not clear from the record before us whether the SCF promissory notes were securities and thus whether Goldsworthy violated NASD Rules, we vacated the NASD's decision and remanded the matter to it to determine whether the notes at issue were in fact securities.2 We directed the NASD to marshall evidence concerning the circumstances surrounding the sale of the notes from which the reasonable motivations and expectations of the note holders, as well as the plan of distribution, could be discerned, and further directed the NASD to apply the "family resemblance" test articulated in Reves v. Ernst & Young, 494 U.S. 56 (1990), for determining when a note is a security.
At the remand hearing, three note purchasers testified regarding their decision to purchase the SCF notes. In addition, the NASD introduced into evidence "Investor Questionnaires" from seven of the note purchasers, including the three purchasers who testified.3 Onremand, based on all of the evidence before it, the NASD, guided by Reves, found that the SCF promissory notes were securities. The NASD concluded that Goldsworthy participated in private transactions in those securities without providing prior written notice to, and obtaining written approval from, USSCC. The NASD barred Goldsworthy from association with any member firm in any capacity and assessed costs.
In his current appeal, Goldsworthy, who is pro se, attacks in a general way the NASD's conduct during these proceedings; the NASD's finding that the SCF notes are securities; and the NASD's conclusion that his assertedly minimal participation in the note sales subjects him to the NASD's rules governing private securities transactions. We have considered, and will discuss where appropriate, Goldsworthy's more detailed arguments on these points made before the NASD. We base our findings on an independent review of the record.
In April 1992, while employed with another NASD member firm, Goldsworthy formed SCF4 for the purpose of funding the start-up costs of a mutual fund. SCF's board of directors included Goldsworthy, who also served as President of SCF, Fred Snyder, and Dick Waterman. Goldsworthy formed the contemplated mutual fund, the St. Charles Mutual Fund, Inc., in August 1992. That year, Goldsworthy solicited two loans, later evidenced by promissory notes, to assist in the formation of the new companies.5
In December 1992, Goldsworthy became associated with USSCC and remained associated with USSCC throughout the period covered by this proceeding. From April through December 1993, Goldsworthy maintained an account at the New Orleans, Louisiana branch office of Smith Barney Shearson, Inc. ("Smith Barney") in the name of SCF. Goldsworthy was signatory for the account. During this period, Goldsworthy engaged Bill Ryan, a registered representative of Smith Barney, to solicit investors for SCF.
The circumstances surrounding Ryan's engagement were disputed before the NASD. According to Goldsworthy, Thomas Robinson, the resident manager of the New Orleans branch office of Smith Barney, introduced Goldsworthy and Snyder to Ryan, and the four men discussed the sale of promissory notes for SCF, agreeing that Ryan would market the notes to accredited and institutional investors. Ryan died before the hearing, so the NASD did not have his testimony on these matters. Goldsworthy testified that Robinson suggested that disclaimer letters be prepared for distribution to the note purchasers in order to clarify the non-security status of the notes. Goldsworthy further testified that, in response, he prepared such letters, but Smith Barney and Ryan failed to distribute them. Robinson, as well as other Smith Barney employees, testified that these discussions did not occur and that they did not authorize and had no knowledge of the note sales. According to these employees, a request for a transfer of customer funds raised sufficient concern to trigger an internal investigation which resulted in the discovery of the transactions with Smith Barney customers. The firm was unaware of the SCF note distribution prior to this investigation. The employees further testified that one consequence of learning of the SCF note distribution was that Ryan resigned from the firm.6 Goldsworthy had not signed the form disclaimer letter that he introduced before the NASD, and Robinson disputed before the NASD that disclaimer letters were a subject of discussion. The NASD hearing panel concluded, in response to this testimony and evidence, "[t]here [wa]s no evidence before [it] that any individual at Smith Barney knew [of] or approved the loans."
Ryan offered the SCF notes, signed by Goldsworthy as president of SCF, to his Smith Barney customers. The Investor Questionnaires indicate that the investors solicited were largely inexperienced, interested in safe, income-yielding investments, and relied primarily on Ryan's advice in making investment decisions. The SCF investors testified that they agreed to purchase SCF promissory notes because they understood them to be a safe, short-term investment that guaranteed a return of ten-percent interest.
Ryan purchased the SCF promissory notes on behalf of the investors, in most instances with funds transferred from their Smith Barney customer accounts. Smith Barney then issued checks to Goldsworthy or SCF and deposited the checks into the SCF account. The terms of the promissory notes were that: (1) the aggregate outstanding principal would bear interest at ten percent per annum until paid in full; (2) if written demand for repayment was made by a note holder, SCF would pay the outstanding principal and all accruedand unpaid interest within sixty days of demand and SCF could prepay the note in whole or in part without premium or penalty; (3) all payments and prepayments would be made in dollars or the equivalent value of units in a publicly traded mutual fund; and (4) under no circumstances would the promissory note be deemed to grant to the lender any option to purchase shares of any mutual fund. The notes also provided that note proceeds would be used to "fund certain start-up costs in connection with the formation of an investment advisory firm and an investment company."7 Ultimately, eighteen promissory notes were issued to twelve of Ryan's customers for a total of $499,744.
Goldsworthy testified that he intended to repay the notes with fees generated by operating the mutual fund. Goldsworthy admitted that the notes were not backed by collateral and that the transactions at issue involved considerable risks for note holders. Goldsworthy further admitted that, if the investors demanded repayment before the mutual fund became profitable for the investment adviser, "[t]he entire situation would collapse."
In fact, some investors demanded early repayment of the promissory notes and, despite the repayment-on-demand provisions in the notes, Goldsworthy and SCF did not repay them. Goldsworthy subsequently was indicted by the Louisiana authorities for his role in the note distribution. On September 13, 1995, Goldsworthy pled guilty to selling unregistered securities and to attempted theft in violation of Louisiana statutes.8
Ryan's resignation from Smith Barney triggered the NASD's investigation. The record shows that, shortly after Ryan's resignation, SCF representatives, including Snyder, met individually with some of the note purchasers to assure them that their investment was safe. Goldsworthy attended some of these meetings; the recordindicates that these were his only personal contacts with the Smith Barney customers.9
NASD Conduct Rule 3040 prohibits a person associated with a member firm from participating in any manner in securities transactions outside the regular course or scope of the associated person's employment without providing written notice to the firm. The rule requires that such notice be provided prior to participating in the transaction and describe in detail the contemplated transaction. In order to determine whether Goldsworthy violated this NASD rule, we must first determine, guided by Reves, whether the SCF notes are securities.
Goldsworthy asserts that Ryan's and Smith Barney's marketing of the notes, which purportedly was contrary to his intentions and instructions, "transformed" the notes into securities.10 He claimsthat the notes, at least as he devised them, were not securities. Goldsworthy contends that had the notes been distributed as he had intended, accompanied by the disclaimer he purportedly furnished to Smith Barney, the SCF notes would not be securities, and he would not be subject to this proceeding.
We reject Goldsworthy's contention that our analysis of the status of the SCF notes should be limited to the facts and circumstances as he assertedly intended them. In balancing the Reves factors to determine whether the SCF notes are securities, we and the NASD must be guided by the objective evidence as to the characteristics of the notes as marketed to their purchasers. We also reject Goldsworthy's effort to avoid responsibility for the marketing efforts that Ryan, his agent, undertook on his behalf. Ryan's representations to the note purchasers fairly are attributed to Goldsworthy under established agency law principles, as the record does not demonstrate that Goldsworthy in fact undertook to limit Ryan's sales efforts.11 Even taking at face value Goldsworthy'sfact claims about the purported meeting setting the limits of the agency relationship that are described supra at Section II, these do not establish that Goldsworthy, for example, affirmatively directed Ryan or Smith Barney not to market the notes broadly to retail customers and not to focus customers on the favorable interest rate offered. Further, Goldsworthy's belief that a form-letter disclaimer of security status would have insulated the notes from being deemed securities is misguided; it would not.12
A. The Promissory Notes Issued by SCF Were Securities
The Exchange Act defines the term "security" to include "any note."13 In Reves,14 the Supreme Court, recognizing that not all instruments denominated "notes" are securities, adopted the "family resemblance" test to determine when a note is a security. Under the test, a note is presumed to be a security unless it bears a strong resemblance, based on the consideration of four factors enumerated by the Court,15 to certain types of notes deemed to be outside of the investment market regulated by the securities laws and thus not securities.16 If a note is not similar to an item on this list of non-securities, the same four factors are applied to determine if the note should be added to the list and deemed not to be a security. In balancing these four factors, the courts have determined that all four factors need not be met for a note to be a security.17
Goldsworthy argues that the SCF notes resemble character loans made to bank customers, a category of notes identified in Reves as non-securities.18 We reject Goldsworthy's assertion. There is no "family resemblance" between the SCF promissory notes at issue and character loans extended to bank customers. Typically, character loans are offered by banks "in an attempt to cement or maintain an ongoing commercial relationship with the borrower."19 In determining whether to extend such loans, banks exercise considerable expertise in evaluating potential borrowers and the risks involved. Here, the note holders were merely customers of an associated person of a broker-dealer. They had no commercial relationship with SCF. Nor did the note holders have the means -- access to relevant financial and business information -- to assess adequately the loan to SCF.20
Goldsworthy also argues that, because the SCF notes are short-term notes that may be called immediately, they resemble the types of notes that are not securities under Reves. In fact, Reves found that the demand note at issue in that case, callable at any time, was a security.21 The Reves Court explained that a demand note's term is not necessarily short since "demand could be made many years or decades into the future."22 The Court determined that, given the facts surrounding the note before it, it was appropriate to construe the definition of a security broadly in order to fulfill Congress' intent to prevent fraud and abuse in the securities markets and to conclude that the demand note was a security. In light of that precedent, we believe that the demand feature of the SCF notes does not cause them to resemble instruments that are not considered securities.
We further find that the SCF promissory notes do not bear a family resemblance to any of the other types of notes recognized in Reves as being non-securities. Therefore, we must apply the four-factor analysis set forth in Reves to determine if the SCF promissory notes should be added to this list of non-securities and excluded from regulation under the securities laws. The record evidence marshalled by the NASD on remand, coupled with that before us from Goldsworthy's first appeal, leads us to conclude that the SCF notes are securities.
1. Motivations of Borrower and Lender
Under the first Reves factor, a note is likely to be a security if the borrower's purpose is "to raise money for the general use of a business enterprise or to finance substantial investments" and the lender "is interested primarily in the profit the note is expected to generate."23 Conversely, a note is "less sensibly described as a security" if the borrower intends to use the proceeds to finance the "purchase and sale of a minor asset or consumer good, to correct for the seller's [or borrower's] cash-flow difficulties, or to advance some other commercial or consumer purpose ...."24
The SCF promissory notes state that the proposed use of the funds generated from the promissory notes was to raise money for general business use -- specifically, to "fund certain start-up costs in connection with the formation of an investment advisory firm and an investment company."25 Goldsworthy argues that he in fact intended to use the funds to satisfy specific, "near-term obligations" of SCF and not for general business purposes. Among other things, Goldsworthy claims that the funds were to be used for retiring business debt and for fulfilling the $100,000 capital requirement that mutual funds must meet under the Investment Company Act of 194026 and that these uses prove that the notes are not securities.
We reject Goldsworthy's assumption that these uses of funds do not constitute use for general business purposes. As between an approach that looks to the motivation for soliciting another's investment in a business enterprise that is stated in writing and an approach that looks to the note issuer's undisclosed purported motivation, the former approach tends to fulfill Congressional intent to prevent fraud and abuse in the securities markets. There also is no evidence in the record that reflects Goldsworthy's claimed intention to use the funds raised from the promissory notes for specific, non-business purposes. The record suggests, rather, that the note proceeds were used to pay earlier SCF loans, office expenses, and other general business expenses.27 In sum, we find that the motivation in distributing the notes was to raise money for the general use of the business.
We further find that the customers who purchased the SCF notes were motivated by a desire for profit. Most of the customers identified the promised ten percent interest rate as a primary reason for investing in the SCF notes.28 In terms of promissory notes, desire for profit "undoubtedly includes [desire for interest]."29
2. Plan of Distribution
The second Reves factor looks at the plan of distribution of the notes in order to determine whether there is common trading for speculation or investment. Common trading is established when notes are "offered and sold to a broad segment of the public."30
Goldsworthy contends that the two notes that he sold in 1992 to Duane Cady, a wealthy and sophisticated investor, and to the insurance company, an institutional investor, are part of the plan of distribution and assertedly refute a finding of common trading. Even if we were to consider the 1992 note sales as part of the plan ofdistribution, which we do not, these additional note sales to sophisticated purchasers would not cause us to conclude that there was not common trading. Goldsworthy argues that because there is no record evidence that the customers intended to resell the notes, no finding of common trading may be found here. However, the terms of the SCF notes do not prohibit secondary market trading. The fact that the public offering was not large and that there is no proof of secondary trading in the notes is not determinative. Common trading is indicated here because the note sales were targeted to individual retail customers.31 In determining whether there has been a public distribution, "the focus of inquiry should be on the need of the offerees for the protections afforded by the federal securities laws."32 Here, twelve largely inexperienced investors bought these notes. We previously have found that sales of as few as five notes to members of the general public can constitute a sale of securities.33 We find that the plan of distribution indicates there was common trading in the SCF notes.
3. Reasonable Expectations of the Investment Public
The third Reves factor tests whether the note purchasers reasonably viewed the notes as investments. We find that they did. Although some purchasers referred to the transaction with SCF as a "loan," many of these same persons also referred to the transaction as a "safe investment." Moreover, the customers compared the SCF notes to investment vehicles that incontestably are investments. They responded variously that they viewed the promissory notes as "an alternative to a bond," "as good as a AAA rated bond," and more desirable than "a money market," because of the notes' more favorable interest rate. Many of the note holders testified that the noteswere presented as an investment and as a Smith Barney product.34 Further, most of the note holders purchased the notes with funds held in their investment accounts, acting at the advice of a registered representative that Goldsworthy had engaged to market the notes.35
Goldsworthy would have us find that, because of the notes' demand feature, it was unreasonable for the note purchasers to believe the SCF notes were securities. However, the Reves Court already rejected the argument that the demand nature of such notes is uncharacteristic of a security.36
4. The Existence of Another Regulatory Scheme
The fourth Reves factor requires us to determine whether the existence of another regulatory scheme, because it significantly reduces the risk of the note, renders the application of the securities laws unnecessary.37 Goldsworthy admits that the SCF notes were neither collateralized, insured, nor secured. Goldsworthy asserts that the antifraud provisions of the federal securities laws, to which employees of Smith Barney are subject, provide adequate protection for SCF note holders, who purchased the transformed notes from those employees. Goldworthy would conclude from this proposition that the federal securities laws need not be applied to him through this proceeding. Goldsworthy misses Reves' point: the inquiry under the fourth Reves factor focuses on whether "another regulatory scheme [exists] that significantly reduces the risk of the instrument[s], thereby rendering application of the Securities Acts unnecessary."38 Goldsworthy directs us to no alternativeregulatory scheme, and we conclude that none exists under state39 or federal law.
* * * *
Accordingly, based on our consideration of the Reves factors, we conclude that these instruments do not bear a family resemblance to notes that are not securities, nor should they be added to the list of instruments deemed not to be securities.
B. Goldsworthy Violated NASD Conduct Rules 3040 and 2110
Conduct Rule 3040 provides that no person associated with a NASD member shall participate in any manner in a private securities transaction unless that person complies with the Rule's specific notice provisions. Because Goldsworthy received selling compensation, in the form of the proceeds of the note sales,40 he was required not only to notify his employer in writing of each securities transaction but also to secure its written approval. Goldsworthy admits that he did not give USSCC written notice regarding the distribution of SCF promissory notes.41
Goldsworthy's "participation" included, among other things, signing the SCF notes and making arrangements to sell them. Goldsworthy also received investor and Smith Barney checks payable to him, accepted funds derived from the note sales, and met with customers after Ryan's resignation to discourage them from demanding repayment of the notes. This participation triggered the private securities transaction rule. We have concluded previously that an associated person can be held liable under Conduct Rule 3040 even though a purchaser's decision to invest in a note instrument assertedly resulted from the representations made by third parties.42 We also have found Rule 3040 liability when the associated person's role in a transaction was limited to a client introduction and to eventual receipt of a finder's or referral fee.43
We further find that Goldsworthy, by violating Conduct Rule 3040, also violated Conduct Rule 2110 requiring the observance of "high standards of commercial honor and just and equitable principles of trade." It is a "long-standing and judicially-recognized policy that a violation of another Commission or NASD rule or regulation, including Conduct Rule 3040, constitutes a violation of Conduct Rule 2110."44
Goldsworthy claims that he has been treated unfairly. Among other claims, Goldsworthy contends that he was denied the right to subpoena evidence material to his case. Goldsworthy suggests that this evidence would show that Smith Barney knew of Ryan's involvement in the SCF note distribution and was responsible, through fraudulent conduct, for (purportedly) transforming the notes into securities and thereby triggering the private securities transactions rule.
We find no unfairness. Testimony was adduced before the NASD on these matters and on the central issue -- whether Goldsworthy himself participated in any manner in a private securities transaction. Although the NASD lacks subpoena power, the record does not establishthat Goldsworthy sought the attendance of any person at these proceedings who did not in fact testify. Several Smith Barney employees, including Robinson, appeared as witnesses in the initial NASD hearing, and Goldsworthy had the opportunity to cross-examine these employees. Goldsworthy has failed to specify what additional evidence he would have sought by subpoena.45
Goldsworthy further suggests that the Smith Barney employee witnesses who testified in this proceeding were not truthful, and, without the threat of perjury charges, he allegedly could not garner truthful testimony from them. While the NASD cannot initiate perjury charges, truthful testimony in NASD matters is fostered by NASD rules that permit the imposition of penalties on any persons within the NASD's jurisdiction (such as the testifying Smith Barney employees) who make false statements during disciplinary proceedings.
We may reduce or cancel sanctions imposed by the NASD if we find, having due regard for the public interest and the protection of investors, that the sanctions are excessive or oppressive or impose an unnecessary burden on competition.46 We do not make such a finding on this record. The NASD Sanction Guidelines with respect to violations of the private securities transactions rule call for consideration of, among other factors, the associated person's relevant disciplinary history, whether the misconduct at issue occurred over an extended period of time, whether the associated person was affiliated with the issuer of the securities, and whether the associated person provided verbal notice to his employer about the outside securities transactions.47 The NASD Sanction Guidelines further provide that barring an associated person for violating Conduct Rule 3040 is appropriate "in egregious cases."48
The NASD found Goldsworthy's conduct to be egregious and determined to impose a bar on Goldsworthy, after considering thesespecified factors. The NASD considered Goldsworthy's prior disciplinary history, which included discipline by the NASD for failing to update his Form U-4 to reflect his outside business activities and for failing to notify his member firm in writing that he had opened an account with another firm. The NASD also considered the criminal penalty imposed as a result of Goldsworthy's guilty plea to Louisiana state charges of attempted theft and the sale of unregistered securities. The NASD found that Goldsworthy had participated in securities transactions with twelve customers over a period of almost eight months. The NASD further found that Goldsworthy had received significant compensation from the note proceeds while the note purchasers incurred substantial monetary losses from his misconduct. The NASD also emphasized Goldsworthy's lack of contrition and his refusal to accept responsibility for the consequences of his own misconduct. We also note that Goldsworthy was affiliated with the issuer of the notes as founder and president of SCF and that Goldsworthy did not provide USSCC with verbal notice of the note sales, two additional factors identified in the Sanction Guidelines as appropriate for consideration.
We agree with the NASD that Goldsworthy's misconduct was serious. The associated person's duty to notify his or her employer of outside securities transactions is "long-standing and essential. It protects the firm from exposure to loss and litigation, and investors from the hazards of unmonitored sales."49 Based on this record, we find that the bar and the assessment of costs are neither excessive nor oppressive.
An appropriate order will issue.50
By the Commission (Chairman PITT and Commissioners HUNT and GLASSMAN).
Jonathan G. Katz
Admin. Proc. File No. 3-9339
In the Matter of the Application of
JOHN P. GOLDSWORTHY
For Review of 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 findings of violation made by the National Association of Securities Dealers, Inc. against John P. Goldsworthy, and the bar from association with any member firm in any capacity, and the assessment of costs imposed, be, and they hereby are, sustained.
By the Commission.
Jonathan G. Katz
|1||Section 1 of the Rules [now Conduct Rule 2110] requires the observance of "high standards of commercial honor and just and equitable principles of trade." Section 40 [now Conduct Rule 3040] provides, among other things, that, prior to participating in any securities transaction outside the regular course or scope of his or her employment, a person associated with a member firm must give that firm prior written notice. Section 40 further provides that if the associated person may receive selling compensation as a result of a private securities transaction, he or she must secure written approval from the member firm for each such private securities transaction.|
|2||John P. Goldsworthy, 53 S.E.C. 576 (1998).|
|3||The NASD had distributed these Investor Questionnaires to note purchasers during its initial investigation to solicit information about the SCF transactions. The testimony of thethree testifying note purchasers was consistent with their written responses in the Investor Questionnaires.|
|4||SCF was initially named St. Charles Funds, Inc.|
|5||Goldsworthy personally solicited these loans from an individual investor (Duane Cady) and from an insurance company. The promissory notes, issued in 1992, are not encompassed by this NASD proceeding.|
|6||Ryan committed suicide on March 4, 1994, shortly after his resignation.|
|7||A Schedule of Checking Account Activity in SCF Account dated March 9, 1994, shows that Goldsworthy used the proceeds to repay, among other things, part of the loan from Cady and to pay an NASD disciplinary fine. The Schedule also shows that Goldsworthy drafted checks to pay for office expenses, secretarial services, legal fees, salaries, and regulatory fees. Goldsworthy made out other checks to "cash."|
|8||Smith Barney made all but one of the customers whole. Goldsworthy has made restitution payments to the remaining customer as a result of the order issued in the Louisiana criminal case.|
|9|| Goldsworthy's meeting with investor Charles Walsten was the subject of hearing testimony. During cross examination, Goldsworthy asked if Walsten remembered that Goldsworthy explained at the meeting that the notes would be repaid either from "the securities commissioner or Smith Barney or this company has to get up and running in order to make money to be able to repay these notes." Walsten agreed that this was the substance of Goldsworthy's explanation.
The record reflects that investor Allen Querens also met with Goldsworthy after Ryan's resignation; it is not clear whether this was the same meeting concerning which Walsten testified.
|10|| Goldsworthy claims in his appeal brief that "the best proof of this position" is that, in a prior proceeding, the Commission assertedly found that the 1992 notes, identical in form to the 1993 notes, were not securities. We did not make the claimed finding. From his erroneous premise, Goldsworthy concludes that the 1993 notes cannot be securities unless Smith Barney's marketing of the notes is considered.
The NASD had brought a disciplinary proceeding against Goldsworthy for conduct occurring prior to December 1992, relating to the formation of SCF. The proceeding concluded with a Letter of Acceptance, Waiver and Consent in which Goldsworthy, without admitting or denying liability, accepted and consented to the entry of findings that he: (1) became registered as an investment adviser contrary to a policy of his employer memberfirm prohibiting such registration; (2) formed St. Charles Funds, Inc. and St. Charles Mutual Funds, Inc. and failed to update his form U-4 to reflect this outside business activity; and (3) opened an account in the name of St. Charles Funds, Inc. with Smith Barney without notifying his employer in writing that he was affiliated with another member firm. Contrary to Goldsworthy's assertions, the NASD, in evaluating the 1992 misconduct in connection with that settled proceeding, did not make a determination regarding whether or not the 1992 notes were securities. Indeed, NASD staff involved in the investigation testified explicitly to this effect before the NASD hearing panel in this matter, and the settlement document does not contain allegations regarding the sale of the 1992 notes.
The Commission did not review the NASD's settled proceeding and thus made no determination regarding the 1992 notes. As noted supra at note 5, the proceeding now before us involves only the 1993 note sales.
|11||See LA. CIV. CODE ANN. Bk. III, T. XV, Ch. 2 (2002) (Principal is liable for acts of agent when agent acts within scope of his or her authority and when principal ratifies agent's unauthorized conduct by accepting the benefits of that conduct.). The record reflects that Goldsworthy accepted from Ryan and Smith Barney, without question as to their source, all funds derived from the note sales. Yet, the "Schedule of Checking Activity in SCF,Inc, Account" dated March 9, 1994, furnished Goldsworthy by Smith Barney, reflects a sales campaign broader than that to which the meeting attendees purportedly had agreed.|
|12|| Timmreck v. Munn, 433 F. Supp. 396, 400-01 (N.D. Ill. 1977) (rejecting suggestion that boilerplate language that disclaims statements made in promotional literature should preclude a court from considering such statements in assessing a deal as a securities transaction, on the ground that securities analysis requires inquiry into the substance of the transaction and emphasis upon economic reality rather than mere form).
If a disclaimer in fact had been provided to and understood by customers, this would have been relevant to the third Reves factor, which focuses on note investors' reasonable expectations about a note's securities status. See 494 U.S. at 69, and discussion infra at Section III.3.
|13||15 U.S.C. § 78c(a)(10).|
|14||494 U.S. 56.|
|15||The four factors are: (1) the motivations that would prompt a reasonable borrower and lender to enter into the transaction; (2) the plan of distributing the note to determine whether it is an instrument in which there is common trading for speculation or investment; (3) the reasonable expectations of the investing public; and (4) the existence of another regulatory scheme that significantly reduces the risk of the note and thus renders the application of the securities laws unnecessary. Reves, 494 U.S. at 66-67.|
|16|| The types of notes that are not securities include:
(1) the note delivered in a consumer financing;
(2) the note secured by a mortgage on a home;
(3) the short-term note secured by a lien on a small business or some of its assets;
(4) the note evidencing a character loan to a bank customer;
(5) the short-term note secured by an assignment of accounts receivable;
(6) the note which formalizes an open-account debt incurred in the ordinary course of business (particularly if, as in the case of the customer of a broker, it is collateralized); and
(7) the note evidencing a loan by a commercial bank for current operations.
Reves, 494 U.S. at 65 (citations omitted).
|17||See, e.g., Stoiber v. SEC, 161 F.3d 745, 752 (D.C. Cir. 1998) (finding note to be a security where two of four factors weighedstrongly in favor of a security finding); Nat'l Bank of Yugoslavia v. Drexel Burnham Lambert, Inc., 768 F.Supp. 1010, 1015-1016 (S.D.N.Y. 1991) (finding note to be a security where three of four Reves factors met and "fourth cannot sensibly take this investment transaction outside the federal securities laws").|
|18||Reves, 494 U.S. at 65.|
|19||Stoiber, 161 F.3d at 750.|
|20||Id. at 752.|
|21||Reves, 494 U.S. at 72-73.|
|23||Id. at 66.|
|25||In his solicitation of note purchasers, Ryan told customers that the funds were "seed money."|
|26||15 U.S.C. § 80a-14(a). We note that the capital requirement is not a short-term obligation. The capital requirement, because it must be maintained by a mutual fund company at all times, is a permanent obligation.|
|27||See supra note 7.|
|28||Goldsworthy suggests that at least some of the customers might not have testified entirely truthfully about their motivation because of possible restrictions on their testimony imposed in non-disclosure agreements that are not in the record but that Goldsworthy claims were signed by customers when Smith Barney reimbursed them for their losses from the SCF notes. This is speculation that Goldsworthy failed to test through questioning of the customers on cross-examination.|
|29||Reves, 494 U.S. at 68 n.4.|
|30||Id. at 68.|
|31||Cf. Banco Espanol de Credito v. Security Pacific Nat'l Bank, 973 F.2d 51, 55 (2d Cir. 1992) (finding notes not to be securities where distribution limited to the solicitation of "sophisticated financial or commercial institutions" and where resale was specifically prohibited without written permission).|
|32||Gerald J. Stoiber, 53 S.E.C. 171, 178 (1997), petition for review denied, 161 F.3d 745 (D.C. Cir. 1998) (footnote omitted) (rejecting the contention that a distribution of thirteen notes is insufficient, as a matter of law, to constitute a public distribution).|
|33||William L. Morgan, 51 S.E.C. 622 (1993). See also Robin Bruce McNabb, Securities Exchange Act Rel. No. 43411 (Oct. 4, 2000), 73 SEC Docket 1470, 1477, appeal pending, No. 00-71528 (9th Cir.) (six customers).|
|34||Reves, 494 U.S. at 69 (finding reasonable note purchasers' acceptance of advertisements' characterization of notes as investments).|
|35||Cf. Pollack v. Laidlaw Holdings, Inc., 27 F.3d 808, 814 (2d Cir. 1994) (finding reasonable investors' expectations that note purchase was an investment when purchase made on the advice of a registered representative).|
|36||494 U.S. at 69.|
|37||Id. at 67.|
|38||Reves, 494 U.S. at 67 (emphasis added).|
|39||In our opinion in Stoiber, 53 S.E.C. at 179, we explained that state law provisions allowing for enforcement of promissory notes in the courts do not represent the type of comprehensive regulatory schemes that render unnecessary the need for application of the federal securities laws.|
|40||Conduct Rule 3040 defines selling compensation as any compensation paid directly or indirectly from whatever source as a result of the purchase or sale of a security. The NASD made this definition broad in scope and "intended it to include any item of value received." Morgan, 51 S.E.C. at 627. At the remand hearing, Goldsworthy admitted that there is "legal precedent" that the proceeds he received from the note sales, which he categorizes as "salary," were selling compensation if the underlying notes were securities.|
|41||Specifically, Goldsworthy admits that he did not provide written notice to USSCC regarding his intention to issue the 1993 SCF notes and that, consequently, USSCC did not give him written permission to sell the notes. Goldsworthy further admits that he did not provide USSCC with notice regarding the individual note sales. Goldsworthy contends, however, that USSCC understood that he intended to solicit additional loans because, shortly before his employment with USSCC, he had provided the firm with copies of the two 1992 notes discussed supra at note 5 and accompanying text. His contention is not determinative ofthis appeal since the Conduct Rules require written notice to, and written approval from, USSCC.|
|42||See Stephen J. Gluckman, Exchange Act Rel. No. 41628 (July 20, 1999), 70 SEC Docket 418, 425.|
|43||Gilbert M. Hair, 51 S.E.C. 374, 378 (1993).|
|44||Gluckman, 70 SEC Docket at 428 & n.31.|
|45||See Gateway Stock & Bond, Inc., 43 S.E.C. 191, 195 (1966) (finding that sufficient evidence of applicants' violations was adduced at NASD hearings and rejecting allegation that NASD's lack of subpoena power denied applicants due process).|
|46||See Exchange Act Section 19(e)(2), 15 U.S.C. § 78s(e)(2). Goldsworthy does not claim, and the record does not show, that the NASD's action has imposed an undue burden on competition.|
|47||NASD Sanction Guidelines (1998 ed.) at 8-9 and 15 (Private Securities Transactions).|
|48||Id. at 15.|
|49||Morgan, 51 S.E.C. at 625.|
|50||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.|