SECURITIES AND EXCHANGE COMMISSION
In the Matter of the Application of
PACIFIC ON-LINE TRADING & SECURITIES, INC.
For Review of Action Taken by the
OPINION OF THE COMMISSION
REGISTERED SECURITIES ASSOCIATION -- REVIEW OF DISCIPLINARY PROCEEDING
Failure to Comply with Advertising Rules
A member firm and a general securities principal who was, among other things, the firm's president and chief compliance officer, failed to file an internet website with NASD as advertising material when the firm became an NASD member, and the advertising was misleading. Held, association's findings of violation and sanctions imposed are sustained.
Timothy A. McAdams, pro se and for Pacific On-Line Trading & Securities, Inc.
Marc Menchel, Alan Lawhead, and Deborah F. McIlroy, for NASD.
Appeal filed: December 27, 2002
Last brief received: March 27, 2003
Pacific On-Line Trading & Securities, Inc. ("Pacific On-Line"), an NASD member firm functioning as an online trading broker-dealer, and Timothy A. McAdams, a general securities principal who served as Pacific On-Line's president, chief executive officer, chief financial officer, chief operating officer, and chief compliance officer (together, the "Applicants"), appeal from NASD disciplinary action. NASD found that the Applicants violated NASD Conduct Rules 2210(c)(4)(A)1and 21102 by failing to file, before use, an internet website with NASD's Advertising/Investment Companies Regulation Department ("Advertising Department"). For these violations, NASD fined the Applicants, jointly and severally, $2,500. NASD further found that the Applicants' website was misleading and thus violated NASD Conduct Rules 2210(d)3 and 2110. For these violations, NASD censured McAdams and ordered him to requalify by examination as a general securities principal, and fined the Applicants, jointly and severally, $20,000.4 We base our findings on an independent review of the record.
McAdams first became involved in the securities industry in May 1997, when he became a registered general securities representative with Terra Nova Trading, L.L.C. ("Terra Nova"), a member firm not the subject of this appeal.5 At that time, McAdams incorporated two entities: (1) Pacific On-Line,6 the member firm at issue in this proceeding; and (2) Electronic Day Trading Services Incorporated ("EDT"), a company formed to teach the fundamentals of online trading to potential Pacific On-Line customers.
In the fall of 1997, McAdams created a website (the "Original Website") for Pacific On-Line and EDT. McAdams drafted the Original Website language and then submitted it to Terra Nova for approval. Terra Nova approved the Original Website, which subsequently became operational in October or November 1997, albeit without pre-use filing with NASD.7 The Original Website was maintained through at least a portion of 1999, including the period January 7 through March 18, 1999. The Original Website contained the following allegedly misleading statements at issue in this proceeding:
With [Pacific On-Line] there is less risk because you control your own buy and sell by the second.
Do The Math
1 Point on 1000 shares = $1000.00
1 Point average per day = 240,000.00 Annually
8 Hours of Professional Instruction, Supervised by NASD Series 24 Registered Principal.
The fastest Access to the Market today.
Stock Brokers and Market Makers have made money doing this for years, many times at your expense.
In April 1998, Pacific On-Line became a branch office of Terra Nova. McAdams, by this time a registered securities principal at Terra Nova, updated the Original Website to include the following statement, also charged here as misleading:
Pacific [On-Line] is a Branch of Terra Nova Trading, L.L.C.
In June 1998, McAdams submitted to NASD a broker-dealer application for Pacific On-Line. On January 7, 1999, Pacific On-Line became an NASD member, and McAdams executed an NASD membership agreement on behalf of Pacific On-Line. McAdams then proceeded to register Pacific On-Line as a broker-dealer in the states in which it had customers. Pacific On-Line also filed FOCUS reports and established its requisite $5,000 net capital position. It is undisputed that the Applicants did not file the Original Website with NASD when Pacific On-Line was admitted to NASD membership and that the Original Website was available online from January 1999 to March 1999.
NASD learned of the Original Website in March 1999, during its routine, new-member-firm examination of Pacific On-Line. At that time, Christopher LeVasseur, an NASD Regulation examiner, used an internet search engine to identify the public communications Pacific On-Line posted on the Internet. LeVasseur located and downloaded the Original Website and sent it to the Advertising Department for its review.
On March 22, 1999, shortly before the exit conference concluding the initial examination, McAdams submitted to the Advertising Department a revised version of the Original Website (the "Revised Website"). This website differed significantly from the Original Website, as it included risk disclosures concerning on-line trading and omitted all of the allegedly misleading statements at issue here. On April 13, 1999, NASD approved the Revised Website with certain requested changes. The Revised Website should have been posted at this time.
In August 1999, LeVasseur participated in a conference call with Advertising Department staff to discuss Pacific On-Line's Original Website that he had forwarded to the Advertising Department during the March 1999 initial examination. LeVasseur testified that, during the conference call, he again used aninternet search engine to locate the Pacific On-Line website. LeVasseur testified that what he discovered was a website substantially similar to the Original Website, rather than the Revised Website approved in April 1999. McAdams denies that the Original Website was posted that day, and LeVasseur did not download the website he viewed. The NASD complaint does not allege a violation based on the website as it appeared in August 1999.
In a letter dated August 31, 1999, NASD wrote to McAdams requesting information regarding the creation and approval of the Original Website provided to it during NASD's initial examination. Through correspondence with McAdams and with Terra Nova, NASD concluded that McAdams created the Original Website and that Gerald Putnam, as president of Terra Nova, had approved its use.
On October 5, 1999, McAdams participated in a conference call with NASD advertising and enforcement staff, including LeVasseur. LeVasseur again used an internet search engine to locate the Pacific On-Line website and, as had happened in August, accessed a website that the Applicants concede was substantially similar to the Original Website. During this call, NASD advised McAdams to take down the website within forty-eight hours or face disciplinary action. McAdams complied with these instructions. Although McAdams gave no explanation during this call for the fact that the Original Website, or something very close to it, was displayed at this late date, he later claimed that the web host had erroneously posted the Original Website after its server crashed.8
Conduct Rule 2210(c)(4)(A) requires any member that has not previously filed advertisements with NASD to file its "initial advertisement" at least ten days prior to use. Article I(q) of NASD's By-laws defines a member as any "broker or dealer admitted to membership in the NASD."
As indicated above, the Applicants do not deny that they failed to file the Original Website with NASD.9 Instead, they contend that the Original Website was not Pacific On-Line's "initial advertisement." The Applicants claim that the Original Website was Terra Nova's advertisement and note that it had been in use for many months prior to Pacific On-Line's NASD membership.10 The Applicants argue that it was Terra Nova's responsibility to submit the advertisement to NASD, and in fact, they believed that Terra Nova had done so when the Original Website was created.
We conclude, as did NASD, that as of January 7, 1999, when Pacific On-Line became an NASD member, the Original Website was an "initial advertisement" of the new member firm, which the Applicants were required to file with NASD. We find that the Applicants, by failing to file the Original Website with NASD, violated Conduct Rule 2210. Even if McAdams believed that the Original Website had been submitted by Terra Nova, McAdams as president, sole principal, and chief compliance officer of Pacific On-Line, was responsible for ensuring that, once Pacific On-Line was admitted to NASD membership in January 1999, Pacific On-Line itself complied with all NASD rules and requirements that accompany NASD membership, including Conduct Rule 2210.11 We further find that the Applicants, by violating Conduct Rule 2210, also violated Conduct Rule 2110. It is a "long-standing and judicially-recognized policy that a violation of another Commissionor NASD rule or regulation . . . constitutes a violation of Conduct Rule 2110."12
Alternatively, the Applicants contend that Pacific On-Line continued to operate as a branch office of Terra Nova during the period from January 7, 1999, when Pacific On-Line first became an NASD member, through March 18, 1999, a period during which Pacific On-Line awaited registration as a broker-dealer in certain states. The Applicants reason that the Original Website remained under the control of Terra Nova during that period and posit that, accordingly, only Terra Nova was responsible for submitting the Original Website to NASD. McAdams testified that an outside compliance consultant advised him that Pacific On-Line could maintain its status as a branch office pending receipt of state registrations.13 In further support of this claim that Pacific On-Line was merely a branch office during the January through March 1999 period, the Applicants point to the fact that Pacific On-Line did not open customer accounts or claim revenues on its FOCUS reports during this period.
We reject the Applicants' "branch office" defense. In doing so, we rely on McAdams' statements and conduct with respect to his own belief as to whether Pacific On-Line was operating as a branch, or independently, during this period. Directly to the point at issue, McAdams wrote in a November 1, 1999, letter to NASD staff that "[f]rom January 1999 to the present, [Pacific On-Line] has been using the website and all other sales literature referenced as a separate broker/dealer and not as a branch office of Terra Nova." Moreover, in additional correspondence to NASD dated September 13 and October 15, 1999, McAdams asserted that Pacific On-Line became a separate broker-dealer in January 1999 and at that time ceased operating as a branch of Terra Nova. Further, during this period, Pacific On-Line fulfilled obligations required of broker-dealers, not branch offices, including the filing of FOCUS reports and maintaining requisite net capital.
We find that the advertising at issue included misleading, exaggerated and unwarranted statements, and failed to disclose potential risks, in violation of Conduct Rule 2210 and, thus, of Conduct Rule 2110.
As NASD concluded, the advertising highlighted the purported benefits of online securities trading but failed to provide essential risk disclosures regarding such trading. The statements "With [Pacific On-Line] there is less risk because you control your own buy and sell by the second," "Do The Math, 1 Point on 1000 shares = $1000.00, 1 Point average per day = 240,000.00 Annually," and "Stock Brokers and Market Makers have made money doing this for years, many times at your expense," suggested to potential investors that online trading with Pacific On-Line would increase profits and minimize market risk, neither of which Pacific On-Line established was true. The Original Website omitted disclosure of the risk of loss of funds used in such securities trading and the risks of investing in volatile stocks.14
The other statements at issue were also misleading and violative of NASD rules. The statement, "The fastest Access to the Market today," was misleading because it did not provide a basis for investors to evaluate the assertion as required by Conduct Rule 2210(d)(1). The statement, "8 Hours of Professional Instruction, Supervised by NASD Series 24 Registered Principal," was misleading because it suggested, erroneously, that passing an NASD Series 24 examination qualifies a principal to instruct others in online trading and could be viewed as indicating NASD endorsement of the seminar. Implying NASD endorsement violates Conduct Rule 2220(d)(2)(J). The final statement, "Pacific [On-Line] is a Branch of Terra Nova Trading, L.L.C.," was misleading because from it a reasonable investor would infer that Pacific On-Line was not itself a broker-dealer.
The Applicants contend to us, as they did to NASD, that Pacific On-Line's advertising should not be viewed on its own, as we have done, but rather in conjunction with the disclaimers of the risks of online trading provided to customers at EDT seminars and when these customers opened new accounts. However, in determining whether an advertisement is misleading, we look to the content of the advertisement. As we have previously stated,"Advertisements must stand on their own when judged against the standards of [Conduct Rule 2210]."15
This advertising appeared on the Original Website during the period January 7 through March 18, 1999. Because we have found that the Applicants were responsible for complying with NASD rules once Pacific On-Line became an NASD member on January 7, 1999, we find the Applicants responsible for the violations of Conduct Rules 2210 and 2110 during the period January 7, 1999, through March 18, 1999.
The Applicants contest their responsibility for the identical statements that NASD employee LeVasseur downloaded via an internet search engine on October 5, 1999. The Applicants contend that the fact that these statements appeared on the Internet on that date was the result of a technical error made by the web host when it restored files after a server crash.16 NASD responds that the Applicants' delay in blaming the web host for the October 5 posting of the Original Website indicates, as NASD found, that their belated explanation is false.
The Applicants are responsible for the Internet availability on October 5, 1999, of the advertising at issue. As Pacific On-Line's president and chief compliance officer, McAdams is responsible for Pacific On-Line's failure to comply with NASDrules.17 McAdams seeks to avoid responsibility by claiming that, on October 5, the web host inadvertently posted an obsolete back-up tape of the Original Website. No evidence supports this, other than McAdams' testimony.18 In fact, McAdams did not even mention to NASD investigators the "web host" defense until December 1999, and he subsequently failed to assert the defense again, or to set forth the argument in any written response, until the Applicants filed their pre-hearing brief on June 22, 2001. We conclude, as did the NASD, that Pacific On-Line and its president McAdams were responsible for the advertising as it appeared on October 5, 1999.19
The Applicants make a variety of procedural claims which we reject for the reasons set forth below.
The Applicants, pointing to Conduct Rule 2361 (Day-Trading Risk Disclosure Statement) which took effect on October 16, 2000, claim that they effectively are being held liable for violating rules that were not in place at the time of their alleged misconduct. The cited rule requires firms promoting a day-trading strategy to furnish a risk disclosure statement to non-institutional customers prior to opening accounts for them. It does not address, as does this matter, the content ofadvertising. Prior to the adoption of Conduct Rule 2361, Rule 2210 required advertisements to present balanced statements of risks and benefits of any products and services being advertised.
We further reject the Applicants' claim that NASD's acceptance of a settlement offer with Terra Nova and Putnam forecloses this proceeding. Terra Nova and Putnam settled charges that they maintained the Original Website, with its misleading communications, during the period November 1997 through January 7, 1999.20 Subsequent time periods are at issue here. In any event, more than one individual or firm can be responsible and thus held liable for the same violation.21
We may reduce or lift sanctions imposed by 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.22 We do not make such a finding on this record. The Applicants contend that the sanctions imposed by NASD are "too severe" in comparison to those imposed in other NASD disciplinary proceedings. We have repeatedly explained, however, that the appropriate remedial action depends on the facts and circumstances of each particular case, andcannot be precisely determined by comparison with action taken in other cases.23
The NASD Sanction Guidelines with respect to failure to file advertisements suggest a fine ranging from $1,000 to $15,000 and call for the consideration of, among other factors: (1) whether the failure to file was inadvertent; (2) whether the advertisement was widely circulated; and (3) whether the respondent failed to notify a supervisor, in addition to NASD, about the advertisement. NASD considered as mitigative that McAdams submitted the Original Website to Terra Nova for approval and that McAdams believed that Terra Nova had filed the Original Website with the Advertising Department. NASD further noted as mitigative that McAdams relied on the advice of an outside consultant who told him that the Original Website did not have to be filed, and that McAdams believed that, for the period January 7 through March 18, 1999, Pacific On-Line operated as a branch office. NASD accordingly censured Pacific On-Line and imposed a joint and several fine, at the low end of the Sanction Guidelines, of $2,500. We find these sanctions are neither excessive nor oppressive.
As for the violations involving misleading advertising, the Sanction Guidelines provide for a fine ranging from $1,000 to $20,000 for the inadvertent use of misleading communications and for a fine ranging from $10,000 to $100,000 for intentional or reckless use of misleading communications. The Sanction Guidelines provide that the principal consideration in determining sanctions is whether the violative advertisements were circulated widely. NASD concluded that McAdams' dissemination of misleading communications was inadvertent, rather than intentional, and observed that McAdams demonstrated that he provided more complete information to potential customers at seminars and prior to opening new customer online accounts. NASD identified as aggravating factors that the omissions and misleading statements were serious and had the potential to be widely viewed by the public over the Internet. On balance, NASD imposed a $20,000 joint and several fine and censured McAdams. We view these sanctions as neither excessive nor oppressive and view favorably NASD's further determination to require McAdams to requalify as a general securitiesprincipal, given what NASD viewed as "McAdams' continued refusal to appreciate that the Original Website he drafted was misleading."24
An appropriate order shall issue.25
By the Commission (Chairman DONALDSON and Commissioners GLASSMAN, GOLDSCHMID and ATKINS); Commissioner CAMPOS not participating.
Jonathan G. Katz
In the Matter of the Application of
PACIFIC ON-LINE TRADING & SECURITIES, INC.
For Review of 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 NASD against Pacific On-Line Trading & Securities, Inc. and Timothy Alan McAdams, and NASD's assessment of costs, be, and they hereby are, sustained.
By the Commission.
Jonathan G. Katz
|1|| Since the issuance of the NASD's complaint, Conduct Rule 2210 has been amended and the applicable subsection has been renumbered (without change to text) from Rule 2210(c)(3)(A) to 2210(c)(4)(A). We will refer to the rule as 2210(c)(4)(A) in this opinion.
Conduct Rule 2210(c)(4)(A) requires that new members file their initial advertisements with the Adverting Department at least ten days prior to their use.
|2||Conduct Rule 2110 requires members to "observe high standards of commercial honor and just and equitable principles of trade."|
|3||Conduct Rule 2210(d) sets forth standards for member communications with the public. Rule 2210(d)(1)(A) requires that such communications "provide a sound basis for evaluating the facts in regard to any particular security or securities or type of security, industry discussed, or service offered" and prohibits the omission of facts if such omissions would cause the communication to be misleading. Rule 2210(d)(1)(B) prohibits "[e]xaggerated, unwarranted or misleading statements or claims" in public communications. Rule 2210(d)(2)(J) prohibits references to NASD in communications to the public where such references could imply endorsement or approval by NASD.|
|4||NASD also assessed hearing and appeal costs.|
|5||Prior to his involvement in the securities business, McAdams owned a commercial printing company for 20 years.|
|6||Pacific On-Line's original business name was Pacific Day Trading, Inc.|
|7||Terra Nova did not submit the Original Website to the Advertising Department. NASD's complaint here also included allegations that Terra Nova and its former president were responsible for misleading statements that appeared in the Original Website from November 1997 through January 7, 1999. Charges against the two were settled by an offer of settlement accepted by NASD's National Adjudicatory Council ("NAC") on September 6, 2001.|
|8||McAdams first provided this explanation in writing in the Applicants' June 2001 prehearing submission to NASD. Previously, McAdams mentioned the web host error in a conversation with an NASD staff member in June 1999 but did not include the explanation in the Applicants' answer to the complaint submitted in January 2001.|
|9||Supra at 4.|
|10||The Applicants, relying on Conduct Rule 2210(c)(1), contend that members are not required to file advertising and sales literature that has previously been filed and is used without change. This section of Rule 2210 involves advertisements and sales literature of registered investment companies; it is not applicable here. In any event, as noted above, supra n.7, Terra Nova did not in fact file the Original Website with NASD.|
|11||See Gary E. Bryant, 51 S.E.C. 463, 470-71 (1993) ("It is a firm's president who is responsible for compliance with all of the requirements imposed on his firm unless and until he reasonably delegates particular functions to another person in that firm . . . .").|
|12||Stephen J. Gluckman, Securities Exchange Act Rel. No. 41628 (July 20, 1999), 70 SEC Docket 418, 428.|
|13|| In reaching an appropriate sanction, NASD took into consideration as a "mitigating circumstance" McAdams' alleged reliance on the consultant. See discussion infra
|14||Compare Jay Michael Fertman, 51 S.E.C. 943, 950 (1994) (finding sales literature at issue misleading where it failed to "disclose in a balanced way the risks and rewards of the touted investments").|
|15||Sheen Financial Resources, Inc., 52 S.E.C. 185, 191 (1995).|
|16|| The Applicants contend that they should have been permitted to supplement the record before the NAC with a live demonstration of the operation of Pacific On-Line's current website to show the "mechanics of the website" and "how an end user customer would look at it."
The NAC Subcommittee denied the motion to supplement on the grounds that the record contains a downloaded and printed copy of the Original and Revised Websites and that a live demonstration would have been cumbersome and cumulative but not material. We find no prejudice to the Applicants, as a demonstration of the website's operation would not have shed light on the issue of whether the Applicants are responsible for the posting of the Original Website, or its close equivalent, on October 5.
|17||Compare Sheen, 52 S.E.C. at 189 (finding "as Firm president, chief executive officer, and registered principal, Sheen is responsible for the Firm's compliance failures" and rejecting Sheen's attempt to blame others for his own misconduct).|
|18||McAdams offered into evidence a termination of service letter he sent to the web host, dated October 8, 1999. The termination letter explained that EDT would "not be using your services anymore as a result of the hosting problem that occurred over the weekend of October 2." This letter is not probative since it did not identify that the "hosting problem" was an erroneous posting of the Original Website.|
|19||We note that NASD found "credible" NASD examiner LeVasseur's testimony that LeVasseur had viewed virtually the same misleading website in August 1999 that he had first downloaded in March 1999 and, subsequently, in October 1999. We make no finding here as to whether the Original Website, and the misleading advertising it included, were posted on days other than those charged in the complaint.|
|20||See supra n.7.|
|21||The Applicants suggest that the double-jeopardy clause is implicated by this proceeding. The double jeopardy clause prohibits successive governmental criminal prosecutions and successive criminal punishments for the same conduct. U.S. Const. amend. V. See also Hudson v. United States, 522 U.S. 93, 98-99 (1997). NASD's disciplinary proceedings are not criminal matters. Further, the double-jeopardy clause does not apply to NASD disciplinary proceedings because NASD is not a government actor. See William F. Lincoln, 53 S.E.C. 452, 462-63 (1998). See also D.L. Cromwell Inv., Inc. v. NASDR, 279 F.3d 155, 161-62 (2d Cir. 2002); Jones v. SEC, 115 F.3d 1173, 1182-83 (4th Cir. 1997); Graman v. NASD, 1998 WL 294022, *3 (D.D.C. 1998) (collecting cases) ("Every court that has considered the question has concluded that NASD is not a governmental actor").|
|22||See Exchange Act Section 19(e)(2), 15 U.S.C. § 78s(e)(2). The Applicants do not claim, and the record does not show, that NASD's action has imposed an undue burden on competition.|
|23||John R. D'Alessio, Exchange Act Rel. No. 47627 (Apr. 3, 2003), 79 SEC Docket 3627, 3651, appeal filed, 03-4883 (2d Cir.). See also Butz v. Glover Livestock Comm'n Co., 411 U.S. 182, 187 (1973).|
|24||NASD Sanction Guidelines, in General Principles Applicable to All Sanction Determinations, provide that requiring a respondent to requalify in any or all capacities is appropriate when the respondent's actions have demonstrated a lack of knowledge or familiarity with the rules and laws governing the securities industry. Compare Harry Gliksman, Exchange Act Rel. No. 42255 (Dec. 20, 1999), 71 SEC Docket 892, 908-09, aff'd, No. 00-70258 (Gliksman)(9th Cir. 2001) (finding the requirement to requalify as a general securities principal is appropriate to remind applicant of his obligations).|
|25||We have considered all of the parties' contentions. We have rejected or sustained them to the extent that they are inconsistent or in accord with the views expressed in this opinion.|
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