SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1034 Rel. No. 39999 / May 18, 1998 Admin. Proc. File No. 3-9188 __________________________________________________ : In the Matter of the Application of : : CASTLE SECURITIES CORPORATION : 45 Church Street, Suite 25 : Freeport, NY 11520 : : and : : MICHAEL T. STUDER : 410 McDermott Road : Rockville Centre, NY 11570 : : 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 Violations of Rules of Fair Practice Manipulation Excessive and Fraudulent Markups Failure to Supervise Member firm of registered securities association engaged in a manipulation and charged excessive and fraudulent markups. The firm and its president failed to establish adequate supervisory procedures and supervisory system to detect and prevent manipulation and excessive markups. Held, association's findings of violation and the sanctions it imposed are sustained. APPEARANCES: Robert C. Beers, P.C., for Castle Securities Corp. and Michael T. Studer. Alden Adkins and Norman Sue, Jr., for NASD Regulation, Inc. Appeal Filed: November 15, 1996 ======END OF PAGE 1====== Briefing Completed: March 20, 1997 ======END OF PAGE 2====== I. Castle Securities Corporation ("Castle" or the "Firm"), a member of the National Association of Securities Dealers, Inc. ("NASD"), and Michael T. Studer, its president and treasurer, appeal from NASD disciplinary action. <(1)> The NASD found that Castle manipulated the market in the common stock of Reshone International Investment Group, Ltd. ("Reshone") in violation of Article III, Sections 1 and 18 of the NASD's Rules of Fair Practice ("NASD Rules") <(1)> and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Exchange Act Rule 10b-5. The NASD further found that Castle charged excessive and fraudulent markups in violation of Article III, Sections 1, 4, <(1)> and 18 of the NASD Rules, and Exchange Act Section 10(b) and Rule 10b-5. The NASD also found that Studer and the Firm failed to establish, implement, and enforce reasonable supervisory procedures designed to prevent the manipulation and markup violations, in violation of Article III, Sections 1 and 27 of the NASD Rules. <(1)> The NASD censured and fined Castle and Studer $25,000, jointly and severally, and required them, jointly and severally, to make restitution of $13,686.05, plus interest. <(1)> In addition, Studer was suspended for 30 days in all capacities and required to requalify by examination as a general securities principal. We base our findings on an independent review of the record. II. Manipulation and Markups A. Reshone was a newly-formed "blind pool" company with no operating history, inexperienced management, and no business plan other than the proposed acquisition of an unspecified business. Beginning on May 13, 1991, Castle acted as exclusive underwriter of an initial public offering ("IPO") of Reshone, on a "best efforts, all or none" basis, for a minimum offering amount of 7,000 units, and on a "best efforts" basis for the <(1)>/ Castle is wholly owned by Castle Holding, Inc., a publicly traded company. Studer is a 33% owner of Castle Holdings. He is also a financial operations principal, a general securities principal, and registered representative of the Firm. <(1)>/ Now Conduct Rules 2110 and 2120. <(1)>/ Now Conduct Rule 2440. <(1)>/ Now Conduct Rules 2110 and 3010. <(1)>/ The NASD also assessed costs, jointly and severally, on Applicants. ======END OF PAGE 3====== remaining 33,000 units. <(1)> Studer directly negotiated the offering price of $6 per unit with Reshone. Castle completed the Reshone IPO on November 7, 1991, selling a total of 8,290 units to fifteen customers, twelve of whom had been referred by Reshone. In November 1991, Kevin Malone, a Castle branch manager, <(1)> asked Studer to list Castle as a market maker in Reshone common stock on the NASD's over-the-counter ("OTC") Bulletin Board and in the "Pink Sheets" published by National Quotation Bureau, Inc. Although Studer agreed to list Castle as a market maker for Reshone, Castle did not publish any price quotations for that security. Between November 7, 1991 and May 31, 1992, Castle was the only broker-dealer listed as a market maker in Reshone common stock. There is no evidence that any firm made a market or acted as a dealer in either Reshone's units or warrants. The first secondary market transaction in Reshone occurred on December 9, 1991, when Castle began selling Reshone common stock to retail customers. Malone's office was the only Castle office that effected any transactions in Reshone. Castle charged customers $9 per share, although there had not been sufficient demand at the IPO's price of $6 per unit to close the entire offering and there had been no trading activity for the first month of the aftermarket. Castle continued to sell Reshone stock to retail customers at $9 per share through March 1992. From April 15 to May 31, 1992, Castle increased the retail price for Reshone to $10 and then to $11 per share. There was little or no investor or dealer interest in the stock and no favorable news or developments concerning the Company. Although the Firm held itself out as a market maker in Reshone common stock, the record reveals that it never in fact acted as a market maker in that security. <(1)> Castle never provided price quotations for Reshone and made no sales of the security to other broker-dealers. In fact, there was only one inter-dealer trade during the entire period. On <(1)>/ Each unit consisted of one share of common stock, six Class A warrants, and three Class B warrants. Each of the warrants was immediately detachable and was redeemable at exercise prices of $5 and $9, respectively, for one share of common stock. <(1)>/ Malone was charged by the NASD with manipulation and fraudulent and excessive markups. Pursuant to a settlement, he was censured, suspended for three months in all capacities, fined $40,000, and required to make restitution to customers in the amount of $9,686, with interest. Our findings with respect to Malone are based on this record and are solely for the purpose of this proceeding. <(1)>/ See Adams Securities, Inc., 51 S.E.C. 311, 313 (1993); Century Capital Corp. of South Carolina, 50 S.E.C. 1280, 1281 n.5 (1992), aff'd, 22 F.3d 1184 (D.C. Cir. 1994) (Table). ======END OF PAGE 4====== December 19, 1991, a customer sold units that she had purchased from Castle to another broker-dealer. On the same day, that broker-dealer sold the units to Castle at $8 per unit. In connection with the Firm's activities in Reshone common stock, Castle (with Malone) charged markups of 16% to 66% in 28 of the Firm's 36 retail sales of these securities. When Castle first entered the Pink Sheets and the OTC Bulletin Board for Reshone, Malone's branch office was located in the office space adjacent to the Firm's main office in Freeport, New York, where Studer worked. Studer allowed Malone independently to establish the prices for all the Firm's retail transactions in Reshone, although the Firm had a trading desk in the main office. In February 1992 Malone's office was relocated to Long Beach, New York. Studer had no direct involvement in Castle's pricing of Reshone in the secondary market and did not actively supervise Malone's activities at either location. The NASD found that Castle (with Malone) violated Article III, Sections 1 and 18 of the NASD Rules and Section 10(b) of the Exchange Act and Rule 10b-5. The NASD concluded that they manipulated the price of Reshone common stock by using the Firm's dominant and controlling position to establish, maintain, and then increase, an artificial and inflated price. The NASD also concluded that this dominating and controlling position enabled Castle (with Malone) to charge customers unfair and fraudulent markups in retail sales of Reshone common stock. The NASD found that Castle (with Malone) charged markups of 16% to 66% in 28 of the Firm's 36 retail sales of Reshone common stock and thereby violated Article III, Sections 1, 4, and 18 of the NASD Rules and Section 10(b) of the Exchange Act and Rule 10b-5. B. Castle does not deny that the manipulation or markup violations occurred. Rather, Castle asserts that it is not liable for these violations. "Manipulation is the deceptive movement of a security's price, accomplished by an intentional interference with the forces of supply and demand." <(1)> We conclude that Reshone's market exhibited the hallmarks of manipulation: a rapid price surge dictated by the firm that controlled the security's market, little investor interest, an abundant supply, and the absence of any known prospects for the issuer or favorable development affecting it. <(1)> Castle, as the exclusive underwriter of Reshone, knew the identity of the customers who had purchased Reshone units in the offering. Castle was the only dealer in Reshone in the aftermarket. There was little investor interest in Reshone. Indeed, Castle was responsible for almost all the <(1)>/ Patten Securities Corp., 51 S.E.C. 568, 572 (1993). <(1)>/ Patten Securities Corp., 51 S.E.C. at 573 and cases cited therein. ======END OF PAGE 5====== transactions in the secondary market. <(1)> The Firm, by virtue of its control of the supply of Reshone and of the secondary market, dominated and controlled the market for Reshone. <(1)> There were no known prospects for the issuer or favorable developments affecting it. <(1)> Nonetheless, Castle sold Reshone common stock to its customers at ever- increasing, arbitrary prices. <(1)> The Firm does not dispute that the markups charged to its retail customers in the Reshone sales were excessive. We conclude that they were also fraudulent, given their size, the Firm's domination and control of the Reshone market, and its manipulative pricing. <(1)> Castle argues that Malone committed these violations and contends that Malone was acting outside the scope of his authority. Castle also claims that the transactions in Reshone constituted an extremely small percentage <(1)>/ Castle purchased 1,146 shares of Reshone common stock from retail customers, accounting for 100% of the volume in the common stock. Castle also made two purchases of Reshone units during the period, one from a retail customer (at $7.50) and one, as noted, from another broker-dealer (at $8). Castle also sold 6,746 shares of Reshone common stock to retail customers in 36 transactions at prices ranging from $9 to $11. These sales accounted for 100% of the market in the common stock. <(1)>/ See, e.g., Meyer Blinder, 50 S.E.C. 1215, 1221 (1992). <(1)>/ See Patten Securities Corp., 51 S.E.C. at 573; Pagel, Inc., 48 S.E.C. 223 (1985), aff'd, 803 F.2d 942 (8th Cir. 1986). <(1)>/ Indeed, Malone, in investigative testimony, stated that the initial $9 price in the aftermarket was an arbitrary number. <(1)>/ We note that the NASD measured the markups over Reshone's cost of acquisition. Some of these acquisitions occurred substantially before the retail sales at issue. Applicants do not suggest that another measure of prevailing market price would be appropriate, and there is no evidence in the record of independent market activity. Given Castle's domination and control, its manipulation of Reshone's price, and the absence of any market activity in Reshone, we conclude that the markups here were properly measured against Castle's cost of acquisition. ======END OF PAGE 6====== of Castle's overall volume. <(1)> It asserts that Castle therefore "could not have had actual or constructive knowledge" of Malone's violations. We conclude that Castle was responsible for the manipulation and markup violations. A corporation necessarily acts through individuals. <(1)> Castle listed itself as a market maker in the pink sheets and the OTC Bulletin Board and thereby represented to the public that the Firm would act as a market maker in Reshone common stock. As discussed above, Studer authorized Malone to effect trades in Reshone common stock. The transactions were effected and cleared on the Firm's behalf. Castle notes that the Market Surveillance Committee ("MSC") found that Castle committed these violations "through Studer." The National Business Conduct Committee ("National Committee"), however, dismissed the allegations that Studer had directly engaged in the manipulation or markup violations. Castle concludes that it was therefore necessarily exonerated. The NASD's complaint charged that Castle, Studer, and Malone committed these violations. The National Committee explained that Castle was liable for these violations by virtue of its domination and control of the market for Reshone and its use of that control to manipulate the price of Reshone. As discussed above, we agree. We have, moreover, upheld NASD discipline against a broker-dealer although the firm's president was not liable for the broker-dealer's violations. <(1)> In those instances, we concluded that other individuals who were associated with the broker-dealer took actions on the broker-dealer's behalf. Here, we have found that Malone effected the violative transactions on Castle's behalf and with the Firm's acquiescence. We find that Castle violated Article III, Sections 1, 4, and 18 of the NASD Rules and Section 10(b) of the Exchange Act and Rule 10b-5. <(1)>/ Castle ascribes Malone's violations to supervisory failures by Castle's compliance officer. We discuss these contentions in Section III below. <(1)>/ Stuart K. Patrick, 51 S.E.C. 419, 421 (1993), aff'd, 19 F.3d 66 (2d Cir. 1994), cert. denied 115 S.Ct. 54 (1994). <(1)>/ Universal Heritage Investments Corp., 47 S.E.C. 839, 840, 842-44 (1982). Cf. Thomas F. White & Co., Inc., 51 S.E.C. 932, 935-36, and n.2 (1994), aff'd, 68 F.3d 482 (9th Cir. 1995)(Table). ======END OF PAGE 7====== III. Supervision A. Article III, Section 27 of the NASD Rules requires that a member firm establish, maintain, and enforce with respect to the activities of each registered representative and associated person a system of supervision, including written procedures, that is reasonably designed to achieve compliance with applicable securities laws and regulations. We have long emphasized the importance of such supervision: [I]t is not sufficient for the person with overarching supervisory responsibilities to delegate supervisory responsibility to a subordinate, even a capable one, and then simply wash his hands of the matter until a problem is brought to his attention. . . . Implicit is the additional duty to follow-up and review that delegated authority to ensure that it is being properly exercised. <(1)> Studer had been responsible for the Firm's compliance since Castle began business in 1985. In early 1991, he assigned to Michael P. Galterio the responsibilities of Castle's compliance officer. <(1)> Galterio had no prior experience in compliance. Initially, Studer continued to handle compliance, and Galterio was responsible only for reviewing the trading tickets. Beginning in March 1991, Castle designated Galterio in its compliance manual as the registered principal responsible for review of trading tickets, for prevention and detection of pricing violations, and for compliance. Castle's written supervisory procedures did not address the determination of fair prices and markups in a dominated and controlled market. The procedures also did not provide for prevention or detection of manipulation. Because Studer was concerned about possible net capital problems, he continued to review, almost daily, inventory reports prepared by the Firm's clearing broker detailing the Firm's trading positions. The Firm also received from its clearing broker trading journals for the previous day's <(1)>/ Rita H. Malm, Securities Exchange Act Rel. No. 35000 (Nov. 23, 1994), 58 SEC Docket 121, 134, quoting Stuart K. Patrick, 51 S.E.C. at 422 (discussing NYSE supervisory rule). See also Patrick v. SEC, 19 F.3d 66, 68-69 (2d Cir.), cert. denied, 115 S.Ct. 54 (1994) (affirming Commission decision). <(1)>/ Galterio was charged by the NASD with inadequate supervision. Pursuant to a settlement, he was censured, suspended for 10 business days in all capacities, barred from acting in any principal or supervisory capacity, and fined $7,500. Our findings here with respect to Galterio are based on this record and are solely for the purposes of this proceeding. ======END OF PAGE 8====== trading. Studer testified that he did not review the portions of these reports indicating the prices customers were paying. The NASD determined that there were serious deficiencies in both the Firm's written supervisory procedures and supervisory system that failed to prevent or detect the manipulation and markup violations. The NASD concluded that Studer, as president of Castle, was responsible for the establishment of supervisory procedures to prevent or detect manipulation and excessive markups and that there was no evidence that Studer either satisfied this responsibility or properly delegated it to another. Accordingly, the NASD found that Castle and Studer (with Galterio) violated Article III, Sections 1 and 27 of the NASD's Rules. B. Studer claims that he performed as a reasonable supervisor. He contends that he believed that he had properly delegated these compliance functions to Galterio and there were no indications that Galterio was not properly carrying out his responsibilities. However, he put Galterio, an inexperienced compliance director, in charge of compliance and supervision and did not monitor his performance. <(1)> Moreover, it appears that Galterio did not understand the extent of his responsibilities. <(1)> Studer also allowed Malone to make a market in Reshone in a branch office, but failed to take any steps to monitor Malone's performance of thatfunction. In such circumstances, heightened supervision was required. <(1)> The Firm did not normally permit a branch office to trade. Rather, the Firm's trading desk in the main office was responsible for effecting Castle's trades. Malone was initially located next door to Studer, but Studer did not take steps to oversee Malone's pricing or to assure that another Castle employee provided such supervision. That failure was exacerbated when Studer permitted Malone's office to relocate to another <(1)>/ See Rita H. Malm, 58 SEC Docket at 133-34 and n.34 and cases cited therein. Cf. Stuart K. Patrick, 51 S.E.C. at 422. <(1)>/ Studer and Galterio both testified at the hearing before a panel of the Market Surveillance Committee ("MSC"). The MSC recognized that Studer may have honestly believed that he had delegated his supervisory responsibilities to Galterio. The MSC, however, credited Galterio's testimony that he understood that he had limited responsibilities for compliance. This credibility determination by the initial decision maker is entitled to considerable weight. Jonathan G. Ornstein, 51 S.E.C. 135, 137 (1992). <(1)>/ See Universal Heritage Investment Corp., 47 S.E.C. at 845. See also Donald T. Sheldon, 51 S.E.C. 59, 83-84 (1992). ======END OF PAGE 9====== town. <(1)> Studer, moreover, had available to him the reports from the clearing broker that revealed the increasing prices for Reshone. We agree with the NASD's conclusion that Castle's and Studer's supervision was deficient. We have long stressed the importance of proper supervision. <(1)> Applicants did not establish procedures to detect these manipulation and markup violations. They permitted a registered representative to trade securities away from the Firm's trading desk and without adequate supervision. They installed an inexperienced compliance officer, and neither monitored the compliance officer's performance nor assured that he understood the scope of his duties. These failures were serious and permitted the manipulation and markup violations to occur. We find Applicants thereby violated Article III, Sections 1 and 27 of the NASD's Rules. <(1)>/ See, e.g., SECO Securities, Inc., 49 S.E.C. 873, 876 (1988); Wedbush Securities, Inc., 48 S.E.C. 963 (1988). <(1)>/ See, e.g., Michael H. Hume, Securities Exchange Act Rel. No. 35608 (Apr. 17, 1995), 59 SEC Docket 347; Rita H. Malm, 58 SEC Docket at 134, n.34 and cases cited therein. ======END OF PAGE 10====== IV. Applicants contend that there is "the possibility of bias" against Castle on the part of the MSC and the National Committee because Castle is a Nasdaq Small Order Execution System ("SOES") firm. Applicants cite this Commission's Report pursuant to Section 21(a) of the Exchange Act Regarding the NASD and the NASDAQ Market. <(1)> Applicants further assert that, like SOES firms cited in our Report, a sister corporation of Castle had an application for membership pending for approximately four years because the NASD perceived that the applicant would likely be trading on SOES. Applicants' unsubstantiated suggestion of "possible unfairness" is insufficient to undercut the NASD's decision. Applicants' violations had no relation to their use of the SOES system, and Applicants have no disciplinary history involving SOES. They have made no showing that any different standard applied to them than to others or that there was discrimination. <(1)> V. Applicants assert that the sanctions are excessive. They base their argument on the fact that the National Committee dismissed the manipulation and markup charges as to Studer because there was insufficient evidence of Studer's direct participation in or intent to further any scheme to defraud to hold him individually responsible for those violations. They complain that the National Committee nonetheless affirmed the majority of the MSC's sanctions as to Castle and Studer. <(1)> The National Committee found that these sanctions reflected the gravity of the Firm's manipulation and markup violations and the serious supervisory failures for which Castle and Studer were responsible. The National Committee concluded that the supervisory deficiencies alone fully justified the sanctions imposed by the MSC. The National Committee viewed the sanctions as "relatively moderate . . . in recognition of the serious nature of the violations." There is no question that the National Committee had the authority to <(1)>/ Securities Exchange Act Rel. No. 37542 (Aug. 8, 1996), 62 SEC Docket 1375. <(1)>/ See Hibbard, Brown & Co., Inc. Securities Exchange Act Release No. 35476 (Mar. 13, 1995), 58 SEC Docket 2769, 2789 n.67, aff'd, 92 F.2d 1172 (3d Cir. 1996)(Table). <(1)>/ The MSC had ordered that Studer and Castle make restitution of $19,373.56, which included prejudgment interest of $5,687.51 at the rate of 12.5% from May 31, 1992 through December 31, 1994. The National Committee stated the amount of restitution as $13,686.05, and reduced the prejudgment interest to 9%. ======END OF PAGE 11====== modify the MSC's findings and impose these sanctions. <(1)> The National Committee considered Applicants' efforts to reduce the extent of the Firm's business <(1)> and the lack of significant relevant prior disciplinary history and viewed the sanctions as appropriately moderate. These sanctions are well within the NASD's Sanction Guidelines. <(1)> We agree, moreover, with the National Committee that these are serious violations. We also reject Applicants' contention that the NASD improperly considered the settlements with Malone and Galterio in sanctioning Castle and Studer. There is nothing in the record that indicates that these settlements were prejudicial to Castle and Studer or that they affected the sanctions imposed on Applicants, except that the NASD directed that the Firm's and Studer's restitution be reduced by any amount paid by Malone. <(1)> <(1)>/ The NASD Rules clearly authorize the National Committee to impose sanctions (Rule 8310), dismiss findings, and "affirm, increase, or reduce any sanction, or impose any other fitting sanction" (Rule 9313). <(1)>/ Studer testified that, since August 1992, the Firm had not engaged in any solicited OTC retail activity and that all the branch offices in existence in August 1992 had been closed. In February 1992, in response to the NASD's concerns, Castle changed its restriction letter to refrain from undertaking any future blind pool underwritings. Only 48 (or .34%) of a total of 14,177 trades Castle reported during this six-month review period involved Reshone. <(1)>/ The NASD Sanction Guidelines (1993) provide, for supervision violations, for a monetary fine of $5,000 to $25,000 (substantially higher where there is a pattern of multiple violations) and suspension of the responsible individual for 10 to 30 business days. For excessive markups the Guidelines provide for a monetary fine of $5,000 to $50,000. <(1)>/ We have previously recognized that proceedings may be settled on different terms than cases are litigated. See, e.g., Eric M. Diehm, 51 S.E.C. 938, 942 (1994). We have not considered these settlements in our assessment of the propriety of these sanctions. ======END OF PAGE 12====== We do not find that the sanctions imposed are either excessive or oppressive. An appropriate order will issue. <(1)> By the Commission (Chairman LEVITT and Commissioners JOHNSON, HUNT, CAREY, and UNGER). Jonathan G. Katz Secretary <(1)>/ All of the arguments advanced by the parties have been considered. They are rejected or sustained to the extent that they are inconsistent or in accord with the views expressed in this opinion. ======END OF PAGE 13====== UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. Admin. Proc. File No. 3-9188 _______________________________________________________ : In the Matter of the Application of : CASTLE SECURITIES CORPORATION : 45 Church Street, Suite 25 : Freeport, NY 11520 : : and : : MICHAEL T. STUDER : 410 McDermott Road : Rockville Centre, NY 11570 : : 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 Castle Securities Corporation and Michael T. Studer, and the Association's assessment of costs, be, and they hereby are, sustained. By the Commission. Jonathan G. Katz Secretary ======END OF PAGE 14======