SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 38570 / May 5, 1997 Admin. Proc. File No. 3-9023 --------------------------------------------------- In the Matter of the Application of : : WILLIAM K. CANTRELL : 2250 Cove Avenue : Los Angeles, California 90039 : : For Review of Disciplinary Action Taken by the : : NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. : --------------------------------------------------- OPINION OF THE COMMISSION REGISTERED SECURITIES ASSOCIATION -- REVIEW OF DISCIPLINARY PROCEEDINGS Violation of Rules of Fair Practice Failure to Comply with Net Capital Requirements Limited principal-financial and operations of member firm of registered securities association was responsible for firm's failure to comply with net capital requirements. Held, association's finding of violation and the sanctions it imposed are sustained. APPEARANCES: William K. Cantrell, pro se. Alden S. Adkins, Norman Sue, Jr., and Shirley H. Weiss, for NASD Regulation, Inc. Appeal filed: June 10, 1996 Last brief filed: September 18, 1996 I. William K. Cantrell, who, during the relevant period, was the limited principal-financial and operations ("FINOP") of Cartwright & Walker Securities, Inc. ("CWS" or the "Firm"), formerly a member of the National Association of Securities Dealers, Inc. ("NASD"), appeals from NASD disciplinary action. The NASD found that Cantrell was responsible for net capital ==========================================START OF PAGE 2====== violations by the Firm and thereby violated Article III, Section 1 of the NASD's Rules of Fair Practice ("Rules"). 1/ The NASD censured Cantrell, fined him $2,500, suspended him for ten calendar days from association with any NASD member as a FINOP, and ordered him to requalify by examination as a FINOP. 2/ Our findings are based on an independent review of the record. II. Our Rule 15c3-1 under the Securities Exchange Act of 1934 ("Exchange Act") establishes net capital requirements for brokers and dealers. Rule 15c3-1(a)(2)(vi), in pertinent part, permits a broker-dealer to operate with net capital of $5,000 if that broker-dealer does not receive or hold customer funds or securities, or carry customer accounts (hereinafter referred to as a "$5,000 broker-dealer"). 3/ Rule 15c3-1(a)(2)(iii), however, defines a "dealer" to include any broker-dealer that effects more than ten transactions in any one calendar year for its own investment account and requires any such dealer to maintain net capital of at least $100,000. We imposed this higher requirement on dealers, in part, in recognition of the risks of a dealer's business, including the potential for severe 1/ The NASD recently revised and renumbered the Rules. No substantive changes were made to the provision at issue here. Article III, Section 1 of the Rules [new Rule 2110] requires compliance with high standards of commercial honor and just and equitable principles of trade. 2/ The NASD further ordered that, in the event that Cantrell failed to requalify as a FINOP during his suspension, he would remain suspended until he requalified. CWS and Everett Scoville Walker, its president during the relevant period, were also respondents in the proceedings before the NASD. Before the NASD District Business Conduct Committee ("District Committee") issued the decision in this matter, disciplinary action was taken against CWS and Walker in another NASD proceeding. In that proceeding, CWS was expelled from membership in the NASD, and Walker was barred from association with any member firm. The NASD dismissed the charges in this proceeding against CWS and Walker. 3/ The NASD's opinion states that a $5,000 broker-dealer is subject to our Rule 15c3-1(a)(2)(ii). However, the record reflects that Cantrell was aware of the issues involved and cited the correct provision before the NASD. ==========================================START OF PAGE 3====== market volatility. 4/ It is undisputed that CWS purported to operate as a $5,000 broker-dealer. However, the Firm maintained a so-called "error account" (hereinafter referred to as "the Oxford Account") with its clearing firm, J.B. Oxford & Company ("Oxford"). At issue are approximately 42 transactions in the Oxford Account in July 1994, and approximately 159 transactions in the Oxford Account the following month. The bulk of these trades involved the stock of Metro Wireless Interactive Corp. ("MWIC"). 5/ During this period, customer transactions were cancelled for non-payment and placed in the Oxford Account. They were held for a period of time and then resold. The level of activity in the Oxford Account during the relevant period was significant. For example, on July 14, 1994, a total of 6,900 MWIC shares were transferred into the Oxford Account in eight purchase transactions. The 6,900 MWIC shares remained in the Oxford Account until July 21, when all those shares were sold in ten trades. The Oxford Account acquired 8,630 MWIC shares in 20 transactions between July 22 and July 29, and four sales totalling 1,900 shares were effected on July 29, leaving a balance of 6,730 shares. On August 2 and 3, 8,040 MWIC shares were purchased through the Oxford Account in eight trades, and on August 3, 11,410 MWIC shares were sold from the Oxford Account in 40 trades, leaving a balance of 3,360 shares in the account. The Oxford Account held 4,860 shares of MWIC on August 5; 7,810 shares on August 8; 25,140 shares on August 15; and 26,340 shares on August 18. CWS effected more than ten transactions in 1994 in the Oxford Account. The NASD found that the Oxford Account was used by CWS to establish substantial positions in MWIC stock and functioned as CWS' investment account. 6/ Accordingly, the NASD concluded that, pursuant to Rule 15c3-1(a)(2)(iii), CWS was required to maintain at least $100,000 in net capital. The NASD found that CWS operated a securities business on July 29, 1994, when it had $60,558 in net capital, and on August 31, 1994, when it had $73,469 in net capital. The NASD concluded that the Firm thus had operated with net capital deficiencies of $39,441 on 4/ Securities Exchange Act Rel. No. 31511 (November 24, 1992), 52 SEC Docket 4148, 4152. 5/ There were also trades in Health & Wealth, Inc. and in a security identified in the record as "Stet Ord-Sta Financeria Tel." 6/ The NASD found that the Oxford Account was also used to establish smaller positions in Health & Wealth, Inc. stock and "Stet Ord-Sta Financeria Tel" stock. ==========================================START OF PAGE 4====== July 29, 1994, and $26,530 on August 31, 1994. The NASD further found that Cantrell, the Firm's FINOP, prepared the Firm's net capital computations without considering the impact that the Oxford Account had on CWS' required net capital, and thereby violated Article III, Section 1 of the Rules. III. Cantrell does not dispute either that, as FINOP, he was responsible for CWS' net capital computations or that the transactions described above occurred in the Oxford Account. Rather, he argues that there were no criteria to determine whether to treat the Oxford Account as an error account or as an investment account and questions whether in fact the Oxford Account operated as an investment account. 7/ In its decision, the NASD described the purpose and operation of an "error account" as follows: When a mistake is made in filling a customer order, . . . the erroneous trade is entered into an "error account." The erroneous trade is generally allocated to the party responsible for the error, and the stock is liquidated . . . by an offsetting trade to "the Street." Once an erroneous trade is liquidated, it is transferred out of the error account. Erroneous trades are generally liquidated as soon as possible, ideally within a day of the transfer into the error account. Failure to liquidate these trades promptly may place the broker/dealer at risk, since realized and unrealized losses in the account affect the firm's net capital. Cantrell notes that the NASD has not cited any rule that defines an error account and asserts that the NASD's description "is the first and only definition of an error account" that he has seen. Where an issue involves an NASD panel's collective experience and its knowledge of trade practice in the securities industry, we 7/ Cantrell asserts that the NASD has attempted "to create Rules [sic] and impose sanctions 'ex post facto'." The Ex Post Facto Clause of the United States Constitution generally prohibits laws that retroactively make a previously innocent action criminal or increase the penalty for a crime. Calder v. Bull, 3 U.S. 386, 390 (1798). Such prohibitions are not applicable to the issues in this proceeding. Cantrell also characterizes the issue here as whether he failed to report the Firm's net capital "based on standards, rules, or guidelines known to me, or which should have been known to me." We have considered that argument here. ==========================================START OF PAGE 5====== give substantial weight to the determination of that issue by the panel. 8/ The NASD's description of an error account is, moreover, consistent with other discussions of these accounts. 9/ Cantrell was aware that an error account was a "place to liquidate a DK trade." 10/ We believe that Cantrell ignored several indications that the Oxford Account was not functioning as an error account. Unlike a typical error account, the Firm amassed positions in the Oxford Account, held those positions for a period of time, and then sold out the positions in a series of trades. Cantrell, moreover, was aware of the activity in the Oxford Account and that the volume of transactions in the account was high. According to Cantrell, he advised Everett Scoville Walker, CWS's president, that there was a large volume of transactions and that customers were rejecting many trades as unauthorized. He also recognized that CWS would be at risk for these transactions until Oxford liquidated the trades. Although Cantrell claims that he could not discern that the Oxford Account was functioning as an investment account, the Firm's clearing broker noted that the Oxford Account showed "a pattern of customer buy transactions . . . being cancelled for 'non-payment' and . . . being re-billed to other customers." The Firm was at risk with respect to those positions. We have previously held that, where trades were placed in an "error account" in order to permit their subsequent sale, that account was, in fact, a proprietary account chargeable to the broker- dealer for purposes of the net capital rule. 11/ Cantrell also argues that the Oxford Account did not constitute CWS' investment account because, he asserts, Oxford, 8/ See J.V. Ace & Company, Inc., 50 S.E.C. 461, 465-466 (1991); Hamilton Bohner, Inc., 50 S.E.C. 125, 130 (1989). 9/ John Gordon Simek, 50 S.E.C. 152, 154-155 (1989) (operation of error account under New York Stock Exchange Rules); Merrill Lynch Futures, Inc. v. Kelly, 585 F. Supp. 1245, 1249-1250 (S.D.N.Y. 1984) (commodity futures error account). 10/ A "DK trade" is a trade that the customer or the contra- party "does not know." DK trades can occur, for example, when the purchase and sell orders do not agree as to price or number of shares or, as was apparently the case in some instances here, the customer asserts that the trade was not authorized. John Gordon Simek, 50 S.E.C. at 154-155. See also Securities Exchange Act Rel. No. 27543 (December 15, 1989), 45 SEC Docket 197, 198 n. 16. 11/ Carrol P. Tieg, 46 S.E.C. 615, 618 (1976). ==========================================START OF PAGE 6====== not CWS, controlled the Oxford Account. Cantrell asserts that clearing brokers, not introducing brokers, determine whether particular trades are placed in an error account and when those trades will be liquidated. Cantrell further asserts that the Oxford Account functioned in this manner. These assertions, however, appear to be based primarily on Cantrell's own opinions. 12/ Cantrell admits that he never discussed the activity in the Oxford Account with Oxford, and did not know Oxford's procedures for the operation of an error account, generally, or the Oxford Account, in particular. Cantrell's contentions, moreover, are contradicted by a memorandum, dated December 20, 1994, submitted by Oxford to the NASD ("Oxford Memorandum"). The Oxford Memorandum states, in relevant part: [a] Correspondent may request his customer [sic] purchase or sale be canceled and placed in his error account. Simultaneously with such request, the error account position should be liquidated by (1) replacing the transaction with the correct client or (2) liquidated to the street. In the case of Cartwright & Walker a pattern of customer buy transactions were being canceled for "non-payment" and were being rebilled to other customers. 13/ The NASD also noted that, "on the basis of [its] industry experience, . . . it is the introducing firm, and not the clearing firm, which is responsible for 'correcting' erroneous trades in an error account." We conclude that CWS was responsible for the activity in the Oxford Account. We agree with the NASD that the Oxford Account served as an investment account for the Firm. It is clear that CWS effected 12/ Cantrell testified that he asked individuals who worked at "a couple" of clearing firms about "why they don't liquidate immediately," and those individuals gave him certain business reasons why a trade might not be immediately liquidated from an error account. Cantrell admitted that his questions about error accounts were general, and that he did not ask about this particular pattern of transactions. It is also not clear at what point Cantrell had these conversations. 13/ Oxford further reported that it subsequently restricted CWS' customer accounts that failed to pay. No representative of Oxford appeared at the District Committee hearing. However, counsel for the NASD represented that the author of the Oxford Memorandum was available by telephone for the hearing. Cantrell did not request to have Oxford contacted. ==========================================START OF PAGE 7====== far more than ten transactions for its own account during July and August 1994. We accordingly conclude that CWS was a dealer that improperly failed to maintain net capital of at least $100,000 pursuant to Rule 15c3-1(a)(2)(iii). As FINOP for a $5,000 broker-dealer, Cantrell knew, or should have known, that the Firm was not allowed to effect more than ten transactions in one year on its own behalf. 14/ It is undisputed that approximately 42 transactions were entered in July 1994, and approximately 159 transactions in August 1994. These transactions were held for a period of time. Cantrell limited his examination of the Oxford Account to a determination of the account's balance. 15/ We conclude that Cantrell, as CWS' FINOP, failed properly to recognize that the nature and level of activity in the Oxford Account made CWS a "dealer" required to maintain $100,000 in net capital under our net capital rule. We accordingly sustain the NASD's findings that Cantrell violated Article III, Section 1 of the Rules. IV. By permitting CWS to operate with substantial net capital deficiencies, Cantrell deprived CWS' customers of the protection afforded them by the net capital requirements and subjected them to undue risk. Under the circumstances, the sanctions imposed by the NASD are neither excessive nor oppressive. An appropriate order will issue. 16/ By the Commission (Chairman LEVITT and Commissioners WALLMAN, JOHNSON, and HUNT). 14/ Cantrell complains that the NASD did not advise him to monitor the Oxford Account to determine whether it became an investment account. However, a securities professional cannot shift his responsibility for compliance with applicable requirements to a regulatory authority. See, e.g., W.N. Whelen & Co., Inc., 50 S.E.C. 282, 284 (1990); Melvin Y. Zucker, 46 S.E.C. 731, 733 (1976). 15/ Cantrell stated that, as far as he knew, CWS had no intention of owning stock in the Oxford Account. However, he admittedly conducted no examination "to see how long the transactions stayed in the account." 16/ All of the arguments advanced have been considered. They are rejected or sustained to the extent that they are inconsistent or in accord with the views expressed herein. ==========================================START OF PAGE 8====== Jonathan G. Katz Secretary UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. Admin. Proc. File No. 3-9023 --------------------------------------------------- : In the Matter of the Application of : : WILLIAM K. CANTRELL : 2250 Cove Avenue : Los Angeles, California 90039 : : 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 William K. Cantrell, be, and it hereby is, sustained. By the Commission. Jonathan G. Katz Secretary