SECURITIES AND EXCHANGE COMMISSION
In the Matter of the Application of
WENDELL D. BELDEN
For Review of Disciplinary Action Taken by the
NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.
OPINION OF THE COMMISSION
REGISTERED SECURITIES ASSOCIATION -- REVIEW OF DISCIPLINARY PROCEEDING
Violations of Conduct Rules
Registered representative of member firm of registered securities association made unsuitable recommendations to a customer. Held , association's findings of violation and the sanctions it imposed are sustained .
Steven L. Hunt, for Wendell B. Belden.
Marc Menchel, Alan B. Lawhead, Nancy C. Libin, and Brian J. Woldow, for NASD Regulation, Inc.
Appeal filed: September 12, 2002
Last brief received: December 13, 2002
Wendell D. Belden, an investment company products/variable contracts limited principal, an investment company products/variable contracts limited representative, and the sole owner of Southmark, Inc., a member of the National Association of Securities Dealers, Inc. ("NASD"), appeals from NASD disciplinary action. The NASD found that Belden violated NASD Conduct Rules2110 and 2310 by making unsuitable recommendations to a customer.1
The NASD suspended Belden in all capacities for one year and fined him $40,000. The NASD further ordered that he pay restitution of $55,567.03 and that he requalify as a principal by examination.2 We base our findings on an independent review of the record.
In mid-1997, John R. Book, a retired pilot, approached Belden about investing Book's retirement savings of approximately $2.1 million. In the Customer Information Form he executed for Southmark, Book stated that his investment objectives were safety of principal and long-term growth.
Belden discussed with Book the possibility of diversifying Book's investments over several mutual funds. Belden recommended that Book purchase the Class B shares of five different mutual funds with two fund families, MFS Investment Management ("MFS"), and Van Kampen American Capital ("Van Kampen"). As a result of these discussions, in July 1997, Book invested more than $2 million in the five funds recommended by Belden.3
At Belden's recommendation, Book also entered into a Managers Client Investment Agreement and a Mutual Fund Timing agreement in June 1997 with Four Seasons Asset Management ("Four Seasons"), a money management company controlled by D. J.Kadagian. Southmark had entered into an investment advisory services agreement with Four Seasons. Under Four Seasons' mutual fund timing service, Kadagian periodically exchanged a customer's investments between equity mutual funds and money market mutual funds.4
Each of the MFS and Van Kampen mutual funds that Book purchased offered both Class A shares and Class B shares. The Van Kampen Class A shares were subject to an initial sales charge. For an initial purchase of less than $500,000 in Class A shares, the sales charge was 5.75 percent. On investments of more than $500,000, it was 2 percent. The sales charge was waived for purchases of $1 million or more. The Van Kampen Class B shares did not have an initial sales charge. However, the Class B shares were subject to higher annual operating charges, sometimes referred to as internal expenses, than the Class A shares.5 The annual operating expenses for the Class A shares of the two Van Kampen funds at issue here ranged between .94% and 1.01% of the net asset value. The internal expenses for the Class B Shares ranged between 1.75% and 1.82%.
Moreover, the Van Kampen Class B shares were subject to a Contingent Deferred Sales Charge ("CDSC"). A CDSC is a charge paid to the investment company by the customer if the customer sells shares of the mutual fund before the end of a designated period. Van Kampen Class B shares were subject to a CDSC of 5 percent in the first year after purchase, 4 percent in the second year, 3 percent in the third year, 2-1/2 percent in the fourth year, 1-1/2 percent in the fifth year, and none thereafter. Van Kampen limited purchase of Class B shares in each of its funds to no more than $500,000 because above that amount it was "more advantageous for an investor making such an investment to purchase Class A Shares."
While the MFS Class A shares were subject to an initial sales charge, there was no sales charge for an investment in excess of $1 million. The vice president of MFS testified that investments in more than one MFS mutual fund could be aggregated to reach the $1 million amount. MFS had a written policy that itwould reject orders to purchase more than $1 million in Class B shares.
The internal expenses of the MFS Class A shares ranged between .72% and 1.22%; the internal expenses for the MFS Class B shares ranged between 1.51% and 1.97%. MFS Class B shares were subject to a CDSC of 4 percent in the first and second years after purchase, 3 percent in the third and fourth years, 2 percent in the fifth year, 1 percent in the sixth year, and none thereafter.6
Belden admitted in his Answer that the Class B shares generally had higher internal expenses than the Class A shares. However, despite their higher expenses, Belden testified that he generally recommended to his clients that they purchase the Class B shares, instead of the Class A, because he received greater commissions on the sales of these shares. He stated that he "couldn't stay in business" with lower commissions.
Belden stated that he used the higher commissions generated on the Class B shares to offset the low revenues he claimed he received on small accounts. Belden testified, "[Y]ou can say that that's . . . soaking the rich to pay for the poor if you want to, but that's the way it is." Belden further testified that he recommended that Book structure his purchases in the MFS and Van Kampen funds so as to avoid the fund limits imposed by the mutual fund companies on individual purchases of Class B shares. Book followed this recommendation.
At the beginning of the business relationship between Southmark and Four Seasons, Kadagian had advised Belden to use Class A shares for all accounts serviced by Belden. Kadagian testified that he preferred to purchase Class A shares for several reasons. Although Class A shares generally had initial sales charges, they had lower internal expenses and did not cause the investor to incur a CDSC when the shares were sold. Kadagian was particularly concerned about the CDSC because, as a market timer who continually switched his clients in and out of funds, he knew that clients could be forced out of a specific mutual fund, or family of funds, should those funds decide to end their relationships with market timers. Any client forced out of a Class B mutual fund would have to pay the CDSC, which varied with the number of years the client had been in the fund.7
Kadagian also testified that he favored Class A shares because his large volume of business with certain mutual funds had given him rights-of-accumulation privileges, and therefore he could offer Class A shares to all his clients without a front-end load, regardless of the amount of the initial investment. Kadagian did not like to use Class B shares because he aggregated the accounts that he managed when he changed funds. If one client elected to sell shares of a Class B mutual fund, then that client would incur a CDSC. Because Kadagian aggregated accounts, it would be difficult for him to identify properly the account and impose the applicable charge.
Kadagian did not deal directly with Book. Kadagian testified that, prior to Book's purchase of the Class B shares, Kadagian had discussed the prospective investment with Scott Pilgrim, an employee at Southmark who served as the point of contact between Southmark and Kadagian. Kadagian told Pilgrim that an investment as large as Book's should be placed in Class A shares rather than in Class B shares as Belden had proposed because the expenses to Book would be substantially lower. Pilgrim discussed Kadagian's concerns about Class B shares with Belden. However, notwithstanding Kadagian's concerns, Belden recommended that Book purchase Class B shares.
Book's investment in Van Kampen funds totaled $805,189.45, which was not enough to qualify for a waiver of the entire initial sales charge on a purchase of Class A shares. It was large enough, however, to reach the most favorable breakpoint for initial sales charges. As noted, Book's investment in Van Kampen Funds Class B shares resulted in commissions to Southmark of $32,207.85. The same investment in Class A shares would have resulted in commissions of $15,640.82 (approximately $16,000 less than Southmark received for Book's purchase of Class B shares) if Southmark had aggregated Book's purchase, or $18,116.76 if it had not requested the discount.
If Book's funds had been invested in Class A shares of the three MFS funds, his purchases would have qualified for investment at net asset value, with no sales charge, because the total value of the investment exceeded $1 million. Book's investment in MFS Class B shares resulted in commissions to Southmark of $52,000, while the same investment in Class A shares would have resulted in commissions of approximately $16,000 if Southmark had aggregated Book's purchase.
On August 11, 1998, Book wrote a letter to the NASD complaining that Belden had improperly handled his account bypurchasing Class B shares instead of Class A shares. Book explained that he had relied upon Belden's advice in purchasing the Class B shares because he did not know the normal practice associated with large dollar investments and that, when he became aware of the normal practice, he wanted to change his investment to Class A shares. In April 1999, when Book exchanged his Class B shares for Class A shares, he incurred a CDSC of $84,421.58.8
Before recommending a transaction, NASD Conduct Rule 2310 requires that a registered representative have reasonable grounds for believing, on the basis of information furnished by the customer, and after reasonable inquiry concerning the customer's investment objectives, financial situation, and needs, that the recommended transaction is not unsuitable for the customer.9 As we have frequently pointed out, a broker's recommendations must be consistent with his customer's best interests.10 The test for whether Belden's recommended investments were suitable is not whether Book acquiesced in them, but whether Belden's recommendations to him were consistent with Book's financial situation and needs.11
Book's initial complaint letter states that he was not aware of "normal" mutual fund practice and that he trusted Belden. On appeal, Belden asserts that he did not recommend the purchase of Class B shares to Book. However, Belden testified that he "probably" told Book that the firm's accounts were only Class B shares. Moreover, during the NASD's investigation, Belden admitted in a letter that "All the funds presented to [Book] were B funds." In a taped conversation between Belden and Pilgrim, Belden confirmed that he had recommended that Book either invest in the Class B shares of a single, unspecified Van Kampen fund orspread his investment among the Class B shares of several funds. He also agreed with Pilgrim that Belden did not mention Class A shares to Book, adding, "I don't deal in A shares." We find that Belden made recommendations to Book and that those recommendations were limited to the purchase of Class B shares.12
Belden also asserts that "[p]resenting alternatives does not necessarily imply recommendation." As discussed above, Belden did not present alternatives. All his recommendations involved Class B shares. Moreover, he admits that he structured Book's transactions to avoid the investment companies' limitations on the purchase of Class B shares.
Belden chose not to have Book take advantage of Kadagian's rights-of-accumulation privileges, which would have allowed Book to purchase Class A shares without paying a front-end load. Belden recommended that Book structure his purchases in the MFS and Van Kampen funds in plain disregard of the companies' express policies stating that it would be more advantageous for an investor making a large investment to purchase Class A Shares, and the NASD's directions to its members to consider all of the expenses charged, and discounts offered, by a mutual fund in determining whether thepurchase of that fund's shares is suitable.13 Belden also caused Book to incur unnecessary CDSCs.
As a result of Book's purchase of Class B shares, Belden received significantly greater commissions than he would have received had Book purchased the Class A shares. Indeed, as Belden testified, this is the precise reason that he recommended the Class B shares instead of the Class A shares. In short, Belden put his own interest before that of his customer.14 We thus conclude that the securities that Belden recommended to Book were unsuitable in the circumstances of this case. Belden's conduct also was inconsistent with Conduct Rule 2110, which requires observance of "high standards of commercial honor andjust and equitable principles of trade."15 We accordingly find that Belden violated NASD Conduct Rules 2110 and 2310.
Exchange Act Section 19(e)16 provides that we will sustain the NASD's sanctions unless 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 or inappropriate burden on competition.17 The appropriate sanctions depend on the facts and circumstances of each case.18
We find that the NASD's sanctions are neither excessive nor oppressive. Belden placed Book in Class B shares in order to generate commissions for Southmark. His actions demonstrate a lack of appreciation for his responsibility to make suitable recommendations. The NASD properly considered in determining its sanctions that Belden placed the paying of his firm's expenses above the interests of his customer.19
Moreover, Belden has a prior disciplinary history. In 1993, the NASD accepted Belden's consent, without admitting or denying the allegation of the complaint, to the entry of findings that he disseminated sales literature that was misleading and was not approved.
Belden asserts that, for purposes of the settlement, the NASD found only that he failed to obtain approval of the sales literature. The 1993 NASD complaint charged that Belden had disseminated both misleading and unapproved sales literature dealing with SunAmerica Capital Services and Keystone Distributor Fund. A review of the settlement shows that, while the NASD dismissed all the allegations with respect to sales literature dealing with SunAmerica Capital Services, the NASD sustained the remaining allegations of the complaint, including allegations that the Keystone sales literature was misleading, as well as unapproved.20
Belden claims that, by ordering restitution to Book's estate, the NASD conferred an unjustified "boon" on the estate because mutual fund companies, not the customers, pay commissions to brokers on the purchase of Class B shares. Restitution seeks to require the wrongdoer to restore the victim to the status quo ante , i.e. , to return customers to their prior positions by restoring the funds of which they were wrongfully deprived.21 Restitution requires payment that would restore the customer's position before the wrong-doing. At times, that amount may exceed the amount by which the wrong-doer was unjustly enriched.22 Here, the NASD required Belden to make restitution to Book only to the extent of Belden's commissions. While it appears that Book's losses caused by the increased internal expenses and CDSC resulting from Belden's recommendation of Class B shares may have exceeded that amount, we believe that this amount is a reasonable approximation of the harm Book suffered.23
In light of all of these factors and our review of the record, we find that the sanctions imposed on Belden are neither excessive nor oppressive.
An appropriate order will issue.24
By the Commission (Chairman DONALDSON and Commissioners GLASSMAN, ATKINS and CAMPOS); Commissioner GOLDSCHMID not participating.
Jonathan G. Katz
Adm. Proc. File No. 3-10888
In the Matter of the Application of
WENDELL D. BELDEN
For Review of Disciplinary Action Taken by the
NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.
ORDER SUSTAINING DISCIPLINARY ACTION TAKEN BY REGISTERED SECURITIES ASSOCIATION
On the basis of the Commission's opinion issued this day, it is
ORDERED that the disciplinary action taken by the National Association of Securities Dealers, Inc. against Wendell D. Belden, and the Association's assessment of costs, be, and they hereby are, sustained.
By the Commission.
Jonathan G. Katz
1 Rule 2110 requires the observance of "high standards of commercial honor and just and equitable principles of trade." Rule 2310 requires that, in recommending the purchase or sale of any security to a customer, a member must have reasonable grounds for believing that the recommendation is suitable for that customer based on the facts, if any, disclosed by the customer as to his other securities holdings and the customer's financial situation and needs.
2 The NASD also assessed costs.
3 Book purchased the following amounts in the following funds:
|MFS Emerging Growth Fund B||$495,000.00|
|MFS Research Fund B||310,000.00|
|MFS Mass. Investors Growth Stock Fund B||495,000.00|
|Van Kampen Amer. Capital Enterprise Fund B||495,189.45|
|Van Kampen Amer. Capital Pace Fund B||310,000.00|
4 Four Seasons received a fee of two percent of the account value per year for its management of the account but did not receive commissions for the sale of the mutual fund shares.
5 The annual operating charges included management fees, custodial fees, and so-called 12b-1 fees. Rule 12b-1 under the Investment Company Act of 1940, 17 C.F.R. § 270.12b-1, permits an investment company to use its funds to distribute securities if the shareholders and a majority of the board, including a majority of the independent directors, adopt a written plan of distribution that complies with the rule.
6 Both the MFS Class B shares and the Van Kampen Class B shares would convert into MFS and Van Kampen Class A shares, respectively, after eight years.
7 In fact, in June or July 2000, Van Kampen terminated its relationship with Four Seasons and Belden's clients wereforced out of Van Kampen funds for that reason.
8 Book died before the NASD hearing.
9 James B. Chase , Securities Exchange Act Rel. No. 47476 (Mar. 10, 2003), 7_ SEC Docket ____, ____; J. Stephen Stout , Exchange Act Rel. No. 43410 (Oct. 4, 2000), 73 SEC Docket 1441, 1460; Maximo Justo Guevara , Exchange Act Rel. No. 42793 (May 18, 2000), 72 S.E.C. Docket 1281, 1287, petition for review denied , No. 00-1681 (3d Cir. Sept. 30, 2002).
10 See , e.g. , Jack H. Stein , Exchange Act Rel. No. 47355 (Feb. 10, 2003), 7_ SEC Docket ____, ____; Daniel Richard Howard , Exchange Act Rel. No. 46269 (July 26, 2002), 78 SEC Docket 427, 430; John M. Reynolds , 50 S.E.C. 805, 809 (1992).
11 Stein , 7_ SEC Docket at ____; Howard , 78 SEC Docket at 430; Gordon Scott Venters , 51 S.E.C. 292, 295 n.8 (1993).
12 Belden notes that Kadagian testified that, if Book had invested all his funds in a single mutual fund, the mutual fund company automatically would have converted the investment into Class A shares. From this testimony, Belden argues that the "only credible evidence is that [Belden] asked Mr. Kadagian for an alternative and presented both alternatives to" Book. However, the record shows that Belden presented only recommendations involving Class B shares.
13 See , e.g. , NASD Notice to Members 95-80 (Sept. 1995) (reminding members that, in determining whether a fund is suitable for an investor, a member should consider the fund's expense ratio and sales charges as well as its investment objectives). The NASD issued a release to its members specifically advising against recommending that large investors purchase Class B shares because of the lower sales charges and discounts that are frequently available to the purchasers of Class A shares. Suitability Issues for Multi-Class Mutual Funds , NASD Regulatory and Compliance Alert (Summer 2000) ("[M]embers generally should not recommend Class B or C shares to investors who seek to purchase in large amounts and who would incur significantly lower sales charges for Class A share purchases due to the availability of breakpoints, rights of accumulation, or letters of intent.").
14 See Robert L. Den Herder , 53 S.E.C. 329, 331-32 (1997); Kenneth C. Krull , 53 S.E.C. 1101, 1110-11 (1998) (the respondent "ignored his fundamental obligation of fair dealing by . . . plac[ing] his own interests in garnering commissions above those of his customers"), aff'd , 248 F.3d 907 (9th Cir. 2001). As we have previously observed, "where a broker-dealer or representative is aware of large amounts of money being invested in a mutual fund over a relatively short period of time, . . . it is incumbent upon them to obtain the lowest possible price for the customer [and a] failure to do so results not only in the customer being deprived of a benefit to which he or she is entitled, but also in the broker-dealer and representative receiving increased commissions at the customer's expense." Harold R. Fenocchio , 46 S.E.C. 279, 282 (1976).
15 Chase , 7_ SEC Docket at ____ n.28; Guevara , 72 SEC Docket at ____; Larry Ira Klein , 52 S.E.C. 1030, 1031 (1996); Clinton Hugh Holland, Jr. , 52 S.E.C. 562, 566 n.20 (1995), aff'd , 105 F.3d 665 (9th Cir. 1997) (Table).
16 15 U.S.C. § 78s(e)(2).
17 Id . Belden does not claim, and the record does not show, that the NASD's action imposed an undue burden on competition.
18 Michael Flannigan , Exchange Act Rel. No. 47142 (Jan. 8, 2003), 7_ SEC Docket ____, ____; Donald R. Gates , Exchange Act Rel. No. 41777 (Aug. 23, 1999), 70 SEC Docket 1228, 1236.
19 These sanctions are within the NASD Sanction Guidelines. The NASD Sanction Guideline for unsuitable recommendations recommends a fine of $2,500 to $75,000 and a suspension of 10 business days to one year (up to 2 years or a bar in egregious cases). NASD Sanctions Guidelines (2001 ed.) at 99. The Guideline recommends that the NASD increase the amount of the fine by adding the amount of a respondent's financial benefit or require respondent to offer rescission to the injured customers. Id . at n.2.
20 Even if Belden had no disciplinary history, we believe that Belden's conduct merits the sanctions imposed by the NASD.
21 Krull , 53 S.E.C. at 1109-10; Charles E. French , 52 S.E.C. 858, 864 (1996).
22 Toney L. Reed , 51 S.E.C. 1009, 1014 (1994).
23 Compare SEC v. First Jersey Sec., Inc. , 101 F.3d 1450, 1474-75 (2d Cir. 1996), quoting , SEC v. Patel , 61 F.3d 137, 139 (2d Cir. 1995) (disgorgement "need only be a reasonable approximation of profits causally connected to the violation").
We note that, under Section 19(e)(2) of the Securities Exchange Act of 1934, 15 U.S.C. § 78s(e)(2), we may not increase sanctions imposed by a self-regulatory organization.
24 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 in this opinion.