SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40600 / October 26,1998 Admin. Proc. File No. 3-9195 _________________________________________________ : In the Matter of the Applications of : : STEVEN P. SANDERS : 13-28 208th Place : Bayside, New York 11360 : : and : : DANIEL M. PORUSH : Two Bayclub Drive : Bayside, New York 11360 : : 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 Excessive and Fraudulent Markups Failure to Supervise Head trader of member firm of registered securities association was responsible for excessive and fraudulent markups, and firm's president failed to comply with supervisory requirements. Held, association's findings of violation and sanctions it imposed sustained. APPEARANCES: Andrew M. Zeitlin and Martin P. Unger, of Tenzer Greenblatt LLP, for Steven Sanders. Charles A. Stillman and Michael J. Grudberg, of Stillman & Friedman, P.C., for Daniel M. Porush. Alden S. Adkins and Norman Sue, Jr., for NASD Regulation, Inc. Appeal filed: December 6, 1996 Last brief filed: May 6, 1997 I. Steven P. Sanders, the former manager of the trading department at Stratton Oakmont, Inc. ("Stratton" or the "Firm"), which was at the time a member of the National Association of Securities Dealers, Inc. ("NASD"), and Daniel M. Porush, Stratton's president, appeal from NASD disciplinary action. [1] The NASD found that Stratton, acting through Sanders, charged excessive and fraudulent markups in violation of Article III, Sections 1, 4, and 18 of the NASD's Rules of Fair Practice (the "NASD Rules") [2] The NASD further found that Stratton and Porush violated Article III, Sections 1 and 27 of the NASD Rules as a result of the Firm's deficient supervisory system and written supervisory procedures. [3] Sanders was censured, fined $25,000, and barred in all capacities. Porush was censured, fined $250,000 and barred in all capacities. [4] We base our findings on an independent review of the record. II. Pricing Violations. A. This case concerns Stratton's sales to retail customers of warrants issued by Master Glazier's Karate International, Inc. ("Glazier"), the operator of five martial arts and fitness centers in Pennsylvania and New Jersey, during the period October 18, 1993 to November 17, 1993. Stratton was the sole underwriter for Glazier's initial public offering ("IPO") of its units on October 15, 1993. Each unit consisted of one share of common stock, one Class A warrant, and one Class B warrant, each of which was separately transferable immediately. The warrants were exercisable one year after the offering date and entitled the holder, within the following four years, to purchase one share of Glazier common stock at $4.75 per share (in the case of the Class A warrants) and at $5.50 per share (in the case of the Class B warrants). Glazier's prospectus stated that Stratton might "become a dominating influence in the market for the units or the common stock and warrants contained therein." In the IPO, Glazier sold 2,070,000 units, at a price of $4 per unit. Stratton sold 1,623,500 of the Glazier units, 78% of the total number of units issued, to the Firm's own retail customers. Porush, who shared responsibility for allocating the Glazier IPO to Stratton's sales personnel, apparently allocated to himself the largest block of Glazier units. [5] Certain of Porush's customers "flipped," i.e., immediately sold, over 300,000 units acquired in the IPO back to the Firm at the start of aftermarket trading at prices of $4-15/16 to $5-1/16. Additional units were flipped shortly after trading in the aftermarket began at prices of between $8 and $9. In addition to obtaining units from its retail customers, the Firm, during the first five minutes of aftermarket trading, acquired 360,000 additional units from two other firms that had been members of the selling group, at prices of $5 and $5-1/8. Sanders, as Stratton's head trader, was responsible for executing these trades. As a result, Stratton soon controlled, either through holdings in its own proprietary accounts or through the holdings of its retail customers, over 95% of all the Glazier units that had been sold. Stratton then used its control over the supply of Glazier units, which it subsequently broke into their component parts, to dominate trading in the warrants. Stratton bought both units and warrants in both the wholesale and retail markets. From October 18, 1993 to November 17, 1993, Stratton bought or sold 2,942,500 Class A warrants in wholesale and retail transactions, roughly 95% of all Class A warrants traded in those markets during this period. In the interdealer market, 154,220 Class A warrants were traded during this period. Stratton was on one side of interdealer trades for all but 20,520 warrants. Stratton bought or sold 4,829,650 Class B warrants in wholesale and retail transactions, close to 96% of all Class B warrants traded during this period. In the interdealer market, 204,510 Class B warrants were traded, and Stratton was on one side of the trade involving all but 66,810 warrants. The record also reflects that Stratton controlled approximately 87% of the float for the Class A warrants on October 25, 1993, the regular settlement date for the first day of trading during the review period, and 89% of the float on November 24, 1993, the regular settlement date for the last day of trading. For the Class B warrants, the Firm controlled approximately 87% of the float on October 25 and over 80% on November 24, 1993. The NASD found that the Firm dominated and controlled the market for both the Class A and Class B warrants. The NASD further found that, in 85 retail sales of Class A warrants, at prices ranging from $2 to $2-6/16, Stratton charged markups in excess of 5% over its contemporaneous costs. In 21 of those trades, the markups exceeded 10% and ranged as high as 22%. In 73 retail sales of Class B warrants, ranging in price from $1-1/8 to $1-9/16, the NASD found that Stratton charged markups in excess of 5%. In 64 of those trades, the markups ranged from 10% to 33%. The total amount of excessive markups charged was $416,528 on 158 trades. B. Applicants do not dispute the NASD's calculations but, instead, whether the markups should be calculated based on the Firm's wholesale contemporaneous cost. It is well established that, "if an integrated dealer dominates the market to such a degree that it controls wholesale prices for the security, then the dealer should use its contemporaneous purchase price as the basis for computing markups, rather than its quotations or its sales prices." [6] In determining whether that degree of domination exists, we have considered several factors including whether the firm at issue was an underwriter of the initial public offering of the security and whether it sold a substantial percentage of the offering to its own customers; whether the firm was responsible for a significant portion of trading in the aftermarket; and whether the remaining amount of aftermarket trading was fragmented among other dealers. [7] Based on these factors, we conclude that Stratton controlled the Glazier market and that, therefore, the NASD correctly calculated Stratton's markups based on the Firm's contemporaneous cost. As discussed, the Firm sold the bulk of the IPO to its own retail customers, and then quickly bought in the aftermarket most of the remaining units that had been allocated to other firms in the IPO. Although several other dealers identified themselves as market makers in Glazier warrants, applicants concede that Stratton dominated secondary trading in the securities during the relevant period. [8] **FOOTNOTES** [1]: Stratton also appealed the NASD's decision against it. Stratton subsequently notified us that it had filed a petition in bankruptcy and that an order of relief on its petition was entered on January 24, 1997 by the United States Bankruptcy Court for the Southern District of New York. Under 11 U.S.C.  362, Stratton's bankruptcy filing triggered an automatic stay of these proceedings as to Stratton. Our findings with respect to Stratton, therefore, are made only for the purposes of this proceeding and are binding only with respect to Sanders and Porush. [2]:The NASD has revised and renumbered its rules, but no substantive changes were made to the particular rules at issue here. Section 1 (new NASD Conduct Rule 2110) requires adherence to "high standards of commercial honor and just and equitable principles of trade." Section 4 (new Conduct Rule 2440) requires that prices charged in transactions with customers be "fair, taking into consideration all relevant circumstances. . . ." Section 18 (new Conduct Rule 2120) provides that "[n]o member shall effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive or other fraudulent device or contrivance." [3]:Section 27 (new Conduct Rule 3010) mandates the establishment and maintenance of a system to supervise the activities of registered representatives that "is reasonably designed to achieve compliance with applicable securities laws and regulations, and with the rules of [the NASD]." [4]:The NASD also assessed costs against each of the applicants. [5]:Although he did not state explicitly that he took the largest allocation of Glazier units, Porush testified that allocations were generally determined based upon "how big a broker [someone was], how many assets they had of clients, how many active accounts they had." Porush also stated that "at that time I was still the biggest broker in the firm, so I would take a lot of allocations." Sanders also testified that Porush usually took the largest allocation of new issues. [6]:Meyer Blinder, 50 S.E.C. 1215, 1218 (1992). [7]:See, e.g., Michael Alan Leeds, 51 S.E.C. 500, 503 (1993) (finding domination and control where firm sold 82% of offering to its own retail customers because the firm had "control of most of the available supply"); Meyer Blinder, 50 S.E.C. at 1218 n.14 (identifying these factors as probative of whether market is dominated); Pagel, Inc., 48 S.E.C. 223, 225-6 (1985)(holding that, where dealer sells 90% of an offering to its own customers and the remainder is fragmented among other dealers, "trading in the aftermarket is necessarily contingent on the underwriter's customers furnishing the supply"), aff'd, 803 F.2d 942 (1986). [8]:Although the NASD found that Stratton dominated and controlled the market for Glazier warrants, it found that the Firm was not a market maker in the warrants "due to a low level of warrant sales by Stratton to dealers during the review period." Because we find that Stratton was the dominant firm in the secondary market, and because no other firm exercised nearly the influence of Stratton, we need not determine whether Stratton was a market maker under Section 3(a)(38) of the Securities Exchange Act of 1934. See Adams Securities, Inc., 51 S.E.C. 311 (1993) (declining to characterize firm as market maker where firm evidenced no willingness to buy and sell the security at issue to other dealers during the review period). Applicants' Contentions Whether Stratton Controlled Market for Glazier Units. While applicants concede that the Firm dominated trading in the warrants, they contend that they did not control the pricing of these securities because, they argue, there was an active and competitive market during this period for the Glazier units, from which the warrants were derived. They note that Stratton was neither a buyer nor a seller in 212 out of a total of 289 interdealer transactions, involving 579,730 units out of a total of 1,219,160 units traded (approximately 48%). We conclude that trading in the units away from the Firm did not represent an accurate reflection of the prevailing market price for the warrants. We note initially that, even with respect to the units, Stratton was involved in over 52% of the trades by volume and the remaining volume was divided among many firms. In any event, Stratton had "unique access to its customers to obtain its supply of [Glazier units and, in turn, Glazier warrants] for secondary market activities." [9] Such control of the supply of the Glazier units enabled the Firm "to control wholesale pricing [of the Glazier warrants] to such an extent as to preclude an independent, competitive market from arising, notwithstanding the presence of other dealers who [were] entering quotations." [10] In addition, on October 28, 1993, Stratton broke up close to 1.6 million units then in its inventory, thereby reducing the float for the units by over 70%. We conclude that Stratton was, as a result, "empowered `to set prices arbitrarily.'" [11] Whether Markups Should Be Based on Retail Not Wholesale Costs. Applicants contend that, even assuming that Stratton was required to calculate its markups on the warrants based on its contemporaneous cost, these costs should be based on purchases from the Firm's retail customers, not interdealer transactions. They note that a 1992 NASD Notice to Members "stated that it may be `far more appropriate to use retail purchase prices as the prevailing market price in lieu of . . . wholesale cost' where wholesale transactions are isolated and could be called into question due, inter alia, to size or frequency." However, this same Notice to Members further states that "the actual cost to the dominant and controlling market maker based on prices it paid to other broker/dealers . . . is the best indicator of the prevailing market price." The Notice, moreover, advises that interdealer trades should be rejected only if the trades' "size, frequency, price or other features . . . suggest that [they] are not bona fide trades but rather are designed to artificially establish a particular prevailing market price." Although we occasionally have declined to use interdealer purchases to establish a firm's contemporaneous cost, we have done so because of concerns about the legitimacy of the interdealer trades in question. [12] There is nothing in the record that leads us to conclude that the interdealer trades at issue here (while fewer in number than the retail trades) were "artificial." We therefore consider those interdealer trades to be a better indication of the prevailing market price than Stratton's purchases from retail customers. [13] Whether NASD Failed to Show that Markups Were Unfair. Applicants argue that the NASD impermissibly shifted to them the burden of proving that these markups were appropriate. We disagree. Once the NASD presented evidence that the Firm's markups exceeded 5% over its contemporaneous cost, the burden properly shifted to the applicants to show that the facts surrounding these transactions justified higher markups. [14] The NASD's Mark-Up Policy acknowledges the possibility that, under certain circumstances, markups above 5% may be justified. The factors listed in the Mark-up Policy include: the type of security involved; its availability and price of the security in the market; disclosure of pricing information; the amount of money involved in the transaction; pattern of markups; and nature of the firm's business. [15] It is entirely appropriate that applicants bear the burden of coming forward with evidence justifying markups above 5% because they were in the best position to know about any of these special circumstances surrounding these trades. Applicants nonetheless assert that the NASD should bear the burden of establishing that the prices Stratton charged were not "fair, taking into consideration all relevant circumstances . . . ." [16] They cite their expert witness, Lee Pickard, who testified that the NASD failed to demonstrate, based on the factors identified in the Mark-Up Policy, [17] that markups above 5% were excessive under the circumstances of this case. Pickard did not give an opinion on what would have constituted fair prices for these warrants or that the prices Stratton charged were fair. Rather, Pickard identified four factors that, in his view, might have justified higher markups in this case: the type of securities involved; the prices charged for the securities; the amount of money involved in the transactions; and the level of customer service provided in connection with the transactions. Based on these factors and the record here, we find no justification for the markups charged by Stratton. On cross examination, Pickard admitted that the NASD had in fact considered the amount of the transactions when it excluded each transaction in which Stratton's markup, although above 5%, failed to exceed $100 above the Firm's cost. We also believe that the NASD's decision to exclude trades in which the markups did not exceed $100 reflects consideration of the fact that these transactions involved lower-priced securities. [18] In any event, we have held that markups above 5% generally are not justified even in the sale of lower-priced securities. [19] In addition, neither Pickard nor either of the applicants presented evidence that the Firm provided any special services to its customers in connection with these transactions or that the securities were not readily available. To the contrary, Stratton's control of a large supply of Glazier warrants meant that the Firm had to expend minimal effort to obtain the securities, a factor weighing in favor of lower rather than higher markups. Whether Prices Charged Were Justified by Common Stock Prices. Applicants assert that the prices customers paid Stratton "were eminently fair and reasonable" because, among other reasons, they correlated directly with the contemporaneous market prices of the Glazier common stock and units. They support this assertion with a report written by James Ohlson, a professor at Columbia University. In the report, Ohlson concluded that Compared to the contemporaneous prices in the underlying stock . . . the prices paid by the retail customers for the warrants were low rather than high. Further, there is no evidence, nor has it been claimed, that the trading prices in [the Glazier common stock and units] deviated from their intrinsic values. **FOOTNOTES** [9]: Alstead, Dempsey & Company, Incorporated, 47 S.E.C. 1034, 1035-36 (1984)(94% of the IPO placed with firm's own customers). See also Pagel, 48 S.E.C. at 226 ("Because the identity of those customers is known only to the underwriter, tapping that supply for resale lies uniquely within the underwriter's control."). [10]:Pagel, 48 S.E.C. at 225-26. See also Leeds, 51 S.E.C. at 503-04 (citing Pagel). [11]:George Salloum, Securities Exchange Act Release No. 35563 (April 5, 1995), 59 SEC Docket 43, 47 (quoting Pagel, 48 S.E.C. at 226). [12]:See, e.g., George Salloum, 59 SEC Docket at 50. [13]:See, e.g., George Salloum, 59 SEC Docket at 49 ("prices paid in wholesale trades are a more reliable indication of the prevailing market price [than retail trades] because they occur between informed market professionals . . . ."). See also Robert A. Amato, 51 S.E.C. 316, 317-18 (1993) ("the best evidence of the prevailing market price is the price that the dealer pays other dealers . . . . If there are no contemporaneous purchases from other dealers, purchases from retail customers may be used . . . ."), aff'd, 18 F.3d 1281 (5th Cir.), cert. denied, 115 S.Ct. 316 (1994). [14]:See First Honolulu Securities, Inc., 51 S.E.C. 695, 701 n.23 (1993) ("Once the NASD presented evidence of the markups, the burden shifted to Applicants to refute this evidence."); Investment Planning, Inc., 51 S.E.C. at 596 (burden shifts to applicants to produce evidence establishing the fairness of markups after NASD showed a pattern of high markups); Richard R. Perkins, 51 S.E.C. 380, 383 n.16 (1993) ("Once the NASD presented its prima facie case, it was incumbent on Applicants to explain why, notwithstanding the evidence to the contrary, their pricing was fair."). See also NASD Notice to Members 92-16. at 91 ("markups exceeding 5% . . . are generally viewed as excessive . . . unless the member can show the markup/markdown charged to be fair under the unique circumstances of the trade."). [15]:See Interpretation of the NASD Board of Governors, Article III, Section 4 of the NASD Rules, NASD Manual  2154 (April 1993). [16]:See Article III, Section 4 of the NASD Rules. [17]:See Interpretation of the NASD Board of Governors accompanying Article III, Section 4, NASD Manual (April 1993)  2154. [18]:Our analysis should not be construed as suggesting that minimum transaction charges of $100 or less, under all circumstances, are appropriate. [19]:See Century Capital Corp. of South Carolina, 50 S.E.C. 1280, 1283-84 n.10 (1992) (holding that a markup higher than 5 percent may be appropriate for transactions in low-priced securities stocks "only if the size of the total transaction is small and the total compensation charged is equal to or less than a reasonable minimum ticket charge"), aff'd, 22 F.3d 1184 (D.C. Cir. 1994). This report was submitted as part of applicants' appeal of the decision of the NASD's District Business Conduct Committee ("District Committee") to the NASD's National Business Conduct Committee (the "National Committee"). Ohlson did not appear at any NASD hearing, and his views were not subject to cross- examination. The NASD did not allege improper pricing by Stratton in the sale of the Glazier units or stock. However, it introduced evidence indicating that the markets for those securities, like those for the Glazier warrants, were dominated and controlled. As discussed, Stratton controlled over 95% of all the Glazier units that had been sold in the IPO. The NASD also introduced evidence showing that Stratton was responsible for 95% of all trading that occurred in Glazier common stock. Sanders, moreover, conceded before the NASD that the market for Glazier stock was not active and that Stratton dominated the markets for Glazier stock and warrants. Under the circumstances, it does not appear that the market for the Glazier common was active and competitive. Any correlation between the stock and warrant prices, therefore, was irrelevant to a consideration of the fairness of Stratton's pricing of the warrants. Confirming the unreliability of this correlation is the fact that Stratton, in contemporaneous interdealer transactions, was able to acquire the warrants at prices that were substantially below what Ohlson hypothesized was the warrants' "fair value." Whether NASD Provided Inadequate Guidance. Applicants also contend that the NASD provided inadequate guidance regarding the pricing of what they describe as derivative securities, e.g., the Glazier warrants that were separated from the Glazier units. They point to differences in the analysis of the pricing used by the District Committee and that used by the National Committee. [20] We do not agree that there was a lack of guidance regarding the applicable markup rules. The appropriate method for calculating markups in a non- competitive market is well established, [21] and this method was employed by the National Committee. [22] Finally, applicants note that the NASD examined the Firm during the period at issue and failed to identify any deficiency in Stratton's approach to pricing securities. However, the responsibility for complying with regulatory requirements cannot be shifted to regulatory authorities. [23] C. The record fully supports the NASD determination that Sanders, as the manager of the Firm's trading department, was responsible for these markups. Sanders testified that he was responsible for pricing these trades and ensuring that pricing complied with NASD requirements. Sanders admitted before the NASD that, in determining whether the Firm exercised a controlling influence over the market for a security, he never considered the extent to which the Firm's customers held that security in their Stratton accounts. He further admitted that he did not consider the Firm's interdealer cost -- the appropriate basis for calculating markups where a market is dominated and controlled -- in determining the prevailing market price for the Glazier warrants. Sanders claimed that he generally set prices for the warrants based on the inside ask quotations and continually compared the Firm's prices for the warrants with the Glazier common to determine whether they were "in parity," i.e., that the price of the warrants plus the exercise price of the warrants roughly equalled the quotes for the common stock although the warrants could not be exercised for a year. Sanders conceded, however, that he knew of no other firm that employed this pricing methodology. He further conceded, as mentioned above, that the Glazier common stock, with which he was purportedly seeking pricing parity, was trading in an inactive market dominated by Stratton. We accordingly find that Sanders violated Article III, Sections 1 and 4 of the NASD Rules. We further find that Sanders knew or was reckless in not knowing that the Firm dominated and controlled the market for these warrants and that customers would be charged excessive markups if those markups were not based on the Firm's contemporaneous cost. Given the number and size of these markups and Sanders' reckless disregard for the rules and principles governing the retail pricing of securities, the requisite degree of scienter has been shown to support a finding that Sanders also violated Article III, Section 18 of the NASD Rules. [24] III. Supervisory Failings. We now turn to the question of whether Porush should be held liable for supervisory failings in connection with the pricing violations found above. Firm Procedures. A. The record establishes that the Firm's procedures regarding pricing were totally inadequate. Its compliance manual [25] contained a section titled "Fair Prices" which briefly summarized some of the rules relating to the pricing of securities. This section correctly discussed the pricing situation "[w]here no independent market exists for" a security, i.e., the situation presented here, by stating that, in such a situation, "the most reliable evidence of the prevailing market price is the contemporaneous prices . . . paid other dealers . . . ." However, the compliance manual gave no guidance about how to determine whether an independent market existed. Moreover, there were no written procedures governing the manner in which Firm personnel were to make such a determination or, more generally, to ensure that Stratton's pricing practices were in compliance with NASD pricing requirements. Sanders testified that he was unaware that the Firm even had any written procedures relating to such pricing requirements. Beyond its inadequate written procedures, it is clear that the Firm in practice lacked adequate supervisory procedures to avoid the pricing violations at issue. For example, it appears the Firm had an unwritten policy of setting markups up to 5% above the inside quotations, regardless of whether these quotations were validated. In addition, the testimony of Sanders showed that the individual with primary responsibility for setting the Firm's retail prices seriously misunderstood the principles governing pricing in a dominated and controlled market. For the reasons set forth below, we believe that Porush was responsible for these inadequate procedures. B. Every firm is required to assign supervisory responsibilities in writing, including names of the responsible personnel and date assigned. [26] The record contains competing but undated written compliance bulletins that purport to assign these responsibilities. Record Exhibit 11 is comprised of a compliance manual and a series of numbered compliance bulletins. Record Exhibit 11 was produced by Stratton's compliance director, Paul Byrne, in response to an NASD request for the manual in effect during the period October 1993 to February 1994. Although Byrne later testified that he could not remember whether the NASD had specified a particular time period, an NASD examiner, Hannah Huynh, testified that an NASD representative had made the request for that period and, despite vigorous cross-examination on this point, Huynh never wavered in her testimony. Record Exhibit 11 contains two different documents entitled "Compliance Bulletin # 1." Neither version is dated, and both versions purport to assign supervisory responsibility to Firm personnel. The first version of Compliance Bulletin # 1 (the "Porush Bulletin") identifies Sanders as being responsible for Stratton's trading and Porush, along with two other Firm principals, as responsible for "review[ing] the Firm's supervisory procedures and recommend[ing] appropriate action reasonably designed to achieve Stratton's compliance with applicable securities laws and regulations and with the rules of the NASD." Record Exhibit 11 also contains a second version of Compliance Bulletin # 1 (the "Belfort Bulletin"), which purports to assign supervisory responsibility to Jordan Belfort, Porush's predecessor as Firm president. Apparently at the time it was copied, the Belfort Bulletin had been partially covered over with a "post-it" marked "leave out . . . ." As a result, certain of the information on the Belfort Bulletin was blocked out on the copy provided to the NASD. The NASD made a second written request specifically for the Stratton compliance manual in effect from October 1993 through February 1994. In response to this second request, the Firm produced a different compliance manual, Record Exhibit 12. Record Exhibit 12 contains only a single version of Compliance Bulletin # 1, which assigned Belfort supervisory responsibility as Firm president and which in all other respects appears to be identical to the Belfort Bulletin blocked out in Record Exhibit 11. Porush argues that the NASD failed to establish that Record Exhibit 11 was in effect during the period at issue. We conclude that Record Exhibit 11 was the Firm's compliance manual during this time and that the Porush Bulletin reflects the then-current assignments of supervisory responsibility. Byrne testified before the District Committee that the Belfort Bulletin was not in effect during this period. This view is confirmed by the fact that the Belfort Bulletin contains information that is not current as of the relevant period. For example, the Belfort Bulletin lists Belfort as president of the Firm, although Porush admittedly assumed that title in August 1993. The Belfort Bulletin further states that Frank Casillo is compliance director, although Casillo had left the Firm in 1992. In contrast, the Porush Bulletin's supervisory assignments correspond to Stratton's supervisory personnel during the time at issue. The Porush Bulletin correctly identifies Porush as president (a position that he assumed in August 1993) and Byrne as compliance director. It also identifies one William Mooney, who was associated with the Firm during the relevant period but who left Stratton in February 1994, as sharing supervisory responsibilities with Porush. Additionally, the Porush Bulletin assigns supervisory responsibilities to Porush that were inconsistent with a supervisory bar that Porush became subject to in March 1994. [27] Thus, we conclude that the Porush Bulletin was in effect for a period between August 1993 and February 1994. Applicants have suggested below that there might have been an interim Compliance Bulletin # 1 between the Belfort Bulletin and the Porush Bulletin. Applicants have not produced any such document, nor suggested what it contained. Given the limited period that Porush was able to act in a supervisory capacity as president (August 1993 to March 1994) and the fact that Mooney left the Firm in early 1994, we question the likelihood that a different set of supervisory documents would have been in effect during October and November 1993. Porush's Supervisory Role at the Firm. A. It is undisputed that Porush was president of the Firm during the period at issue. Porush asserts that he became president only because his predecessor was then subject to disciplinary proceedings brought by this Commission. [28] Porush further asserts that, while he was president, Belfort remained as the Firm's "chief executive officer" and retained all supervisory responsibility for regulatory compliance, including the pricing of securities. The record refutes Porush's assertion that Belfort retained exclusive supervisory responsibility for regulatory compliance. During the NASD investigation, Paul Byrne, Stratton's compliance director, stated that he and Porush met on a daily basis and discussed "market surveillance, regulatory inquiries, customer complaints, arbitrations, the general function of the compliance department." Byrne also stated during the investigation that Sanders reported to Porush during the period at issue. Although Byrne subsequently testified before the District Committee that Belfort was his supervisor and was responsible for Firm compliance, he conceded that he also reported to Porush as "president" of the Firm. [29] Sanders also testified before the District Committee that he reported to Belfort as his supervisor. During the NASD investigation, however, Sanders stated that he consulted with Porush when Belfort was unavailable regarding the advisability of making certain significant trades. Assuming, as Porush contends, that Belfort continued to exercise supervisory authority at the Firm after Porush became president, this fact would not preclude a finding that Porush also had such authority. As we have held, even where supervisory responsibility is shared between firm executives, each can be held liable for supervisory failure. [30] B. While Porush now claims that Belfort was the senior executive at the Firm during the period at issue, Porush downplayed Belfort's role in a contemporaneously filed registration form. On September 30, 1993, Porush executed on behalf of the Firm an amendment to Stratton's Form BD -- Uniform Application for Broker-Dealer Registration. The Form BD's instructions expressly require that a firm list its chief executive officer. While Stratton's 1993 amendment to Form BD did not explicitly identify any person at the Firm as chief executive officer, the amendment lists Porush as "Director & Pres." and Belfort as merely a "Director." In executing the Form BD, Porush represented that the information contained therein was "current, true and complete." In light of Porush's representation to regulatory authorities in the amendment to the Firm's Form BD, we consider it appropriate to regard him as the Firm's president and senior executive, and to consider that he had the corresponding supervisory responsibilities. [31] As we have held, The president of a brokerage firm is responsible for the firm's compliance with all applicable requirements unless and until he reasonably delegates a particular function to another person in the firm, and neither knows nor has reason to know that such person is not properly performing his duties. [32] Porush's Direct Involvement with the Glazier Offering. A. The record establishes that Porush knew that it was the Firm's policy to charge a markup of up to 5% over the offer quotation, although we have previously voiced our disapproval of such a practice. [33] He also typically was in the trading room during the initial aftermarket for the Firm's new offerings. Additionally, Porush had access to a Nasdaq terminal which gave him information about pricing. As Porush conceded, he "knew what prices customers were getting, because you could see prints on the NASDAQ machine." Significantly, Porush testified that his compensation from Stratton, which in 1993 was roughly $3.4 million, was tied to the Firm's profitability, and that 80% of the Firm's revenue was derived from its trading activity. Porush, therefore, had a strong incentive to follow closely those securities, like the Glazier warrants, in which the Firm had taken a stake. B. The record further establishes that Porush was directly involved in the Glazier offering. Because he admittedly shared supervisory responsibility for the Firm's retail sales force as well as responsibility for allocating the distribution of the Glazier units among salespersons in the IPO, he was aware that the Firm had retained close to 80% of the IPO for its own customers. He also "probably knew the next day" that Stratton had repurchased most of the Glazier units that the Firm had allocated to other firms in the selling group. Porush's customers, who typically flipped new issues, sold a significant number of their Glazier units in the aftermarket, and Porush was aware of the prices those customers received for their units. Additionally, Porush admitted that he knew that the Firm was responsible for the majority of trading in the Glazier warrants and common stock. Also, as mentioned, the Glazier prospectus expressly warned that Stratton might become a dominating influence in the market for the warrants. All things considered, it is inconceivable that Porush was unaware of the circumstances that made the Firm's normal pricing policy problematic. C. The NASD's District Committee, which heard him testify, found "incredible" Porush's claim that he was uninvolved in the pricing of the Glazier warrants. The District Committee further described his effort to pin all supervisory responsibility on Belfort as a "transparent attempt to avoid blame." We have consistently held that "credibility determinations of an initial fact finder are entitled to considerable weight [and] can be overcome only where the record contains `substantial evidence' for doing so." [34] As discussed herein, the record here confirms the District Committee's credibility determination. We conclude that Stratton's procedures were inadequate to ensure compliance with NASD pricing requirements. Porush was aware of the Firm's approach to pricing, including its practice of basing prices on quotations, which led directly to the markups violations found herein. We further conclude that it is appropriate, based on the evidence in this case, to hold Porush liable for violating the NASD's supervisory requirements in connection with the pricing violations at issue. III. Applicants raise various procedural and constitutional objections. They argue that the NASD's disciplinary structure violates due process requirements set forth in the Securities Exchange Act of 1934 (the "Exchange Act") and the Constitution because it fails to separate prosecutorial and adjudicatory functions, i.e., the same body that initially decides whether a complaint should be issued -- the District Committee -- also has responsibility for adjudicating the merits of that complaint. It is well established, however, that the NASD "may combine investigatory, prosecutorial, and quasi-judicial functions without violating due process." [35] Applicants further claim that they were prevented from calling witnesses and introducing evidence related to their contention that the NASD's procedures denied them due process. Applicants sought to establish that there was inappropriate contact between the NASD staff and the members of the District Committee during the investigation and consideration of this matter. There is, however, nothing in the record to suggest that there was anything unusual or inappropriate about the interaction between the NASD staff and the District Committee. [36] We previously have held that such interaction is permissible because the decision that is ultimately issued by the District Committee "is reviewed and must be accepted by the DBCC before the opinion is issued." [37] We also have held that, "even if there had been inappropriate procedures, the de novo review of the record by both the NASD Board of Governors and the Commission dissipates any harm that may have resulted from any such impropriety." [38] As discussed above, the NASD's findings of violation are amply supported by the record. Applicants further complain about the appointment of an NASD enforcement staff member as attorney-advisor to the District Committee's hearing panel that presided over the hearing. Sanders has identified no basis for the disqualification of this individual -- such as personal bias -- other than that the attorney-advisor's other NASD responsibilities involved the prosecution of unrelated complaints in a different NASD district. We do not consider these facts disqualifying. [39] IV. Respondents complain that the sanctions are excessive. Sanders claims that the sanctions exceed those recommended in the NASD's own sanction guidelines and those imposed in other cases involving comparable facts. In addition, Sanders states that he has no prior disciplinary history regarding excessive pricing. According to the NASD's Sanction Guidelines, the monetary sanction for markup violations should equal "[t]he gross amount of the excessive markup . . . plus $5,000 to $50,000." The guidelines also provide for a suspension of up to three years or bar of the responsible employee "[w]here . . . [the] excessive markups/markdowns are egregious." We believe that these markups, which in some cases exceeded 20% and which generated several hundred thousand dollars of illegal profits, were egregious. In addition, we are troubled by Sanders' reckless disregard for the principles governing the pricing of securities. Although he was the Firm's head trader, he apparently had made virtually no effort to familiarize himself with these principles or the manner in which they are to be applied in particular situations. Sanders' disregard for regulatory requirements in this case augurs poorly for his fitness generally to remain in the industry. We also observe that, while Sanders has no prior disciplinary record relating to excessive pricing, this is not the first time the NASD has brought proceedings against him. [40] Under the circumstances, we do not consider the sanctions imposed on Sanders to be excessive or oppressive. [41] Porush complains that the sanctions imposed on him are so grossly disproportionate to the single violation found that the NASD must have improperly considered matters wholly separate from the instant proceeding in assessing them. We are deeply troubled by Porush's neglect of his supervisory responsibilities, which resulted in Stratton's customers being charged unfair and fraudulent markups. As discussed, Porush personally profited from Stratton's excessive pricing because his compensation, which as mentioned exceeded $3 million during 1993, was tied to the Firm's trading profits. In addition, like Sanders, this is not the first time Porush has run afoul of regulatory requirements. [42] As with Sanders, Porush's behavior in this case causes us to doubt his fitness to remain in the securities industry. We further believe that a substantial fine is necessary here to impress upon Porush and others in the industry the seriousness with which we view such supervisory failures. [43] Thus, we find that the sanctions imposed by the NASD are neither excessive nor oppressive. [44] An appropriate order will issue. [45] By the Commission (Chairman LEVITT and Commissioners JOHNSON, HUNT and CAREY); Commissioner UNGER not participating. Jonathan G. Katz Secretary **FOOTNOTES** [20]:The District Committee evaluated the fairness of Stratton's pricing by looking at the prices it paid to acquire Glazier units in an apparent attempt to respond to applicants' argument that the fairness of its pricing of the warrants should be judged by reference to the contemporaneous price of the units. Based on this analysis, the District Committee concluded that Stratton charged excessive markups of $1,876,205. The National Committee did not use the District Committee's analysis. [21]:See, e.g., Alstead, Dempsey & Company, Incorporated, 47 S.E.C. at 1037 (markups calculated based upon wholesale contemporaneous cost where market dominated and controlled). [22]:The National Committee has the power to affirm, modify, or reverse the District Committee (which it properly did here). Its opinion, if not modified by the NASD's Board of Governors, is subject to appeal to the Commission. See Article III of the NASD's Code of Procedure, NASD Manual 3041 et seq. (April 1993). [23]:See Richard R. Perkins, 51 S.E.C. at 384 n.20, and the cases there cited. [24]:See, e.g., G.K. Scott & Co., Inc., 51 S.E.C. 961, 968 (1994) (firm trader is charged with "knowing fundamental standards for charging fair prices to the public," including those governing a dominated and controlled market, and his reckless disregard for these standards satisfies the scienter requirement), aff'd, 56 F.3d 1531 (D.C. Cir. 1995) (Table). [25]:As discussed below, applicants contend that the NASD failed to establish that a compliance manual contained in the record was in effect during the period at issue. We reject that contention. [26]:See Article III, Section 27(b) of the NASD Rules. [27]:See n.28, infra. [28]:On November 2, 1992, this Commission filed an injunctive action against the Firm, Belfort, Porush, and other Firm personnel. On March 17, 1994, the Firm, Belfort, and Porush settled Commission proceedings, without admitting or denying the allegations. Pursuant to this settlement, the Firm agreed, among other things, to pay disgorgement, interest and a civil penalty of over $2.5 million, to appoint an independent consultant to review the Firm's policies, and to prepare a supervisory procedures and compliance manual. Belfort agreed to be permanently enjoined from further violations of the antifraud provisions of the securities laws, to pay a civil penalty of $100,000, and to be barred from association with any broker, dealer, investment company, investment adviser or municipal securities dealer. Porush agreed to be suspended from acting in a supervisory capacity with any broker, dealer, investment company, investment adviser, or municipal securities dealer for 12 months and to pay a civil penalty of $100,000. On July 31, 1998, Porush's attorney informed this Commission that Porush settled unrelated NASD disciplinary proceedings on July 23, 1998. Pursuant to this settlement agreement, Porush consented, for the purpose of that proceeding only, without admitting or denying the allegations of the NASD's complaint, to findings that he failed to supervise Stratton salespersons who "engaged in widespread fraudulent sales practices and other egregious misconduct." Porush agreed to be censured, barred from association with any NASD member in any capacity and fined $500,000. Porush also acknowledged that the settlement would become part of his permanent disciplinary record and may be considered in any future NASD proceedings. [29]:Byrne explained the apparent inconsistencies in his testimony by stating that, before the District Committee hearing, he viewed documents showing that Belfort remained at the Firm as a director until March 1994. As noted, however, before the District Committee he conceded that he reported to Porush as president of the Firm. [30]:Cf. Houston A. Goddard, 51 S.E.C. 668 (1993) (compliance director and principal both held liable under NASD rules for failure to supervise salesperson). See also John H. Gutfreund, 51 S.E.C. 93, 111-12 (1992) (settled case) (finding supervisory failure by both president and chief executive officer of firm); Robert J. Check, 49 S.E.C. 1004, 1008 (1988) ("The fact that other officials . . . shared responsibility for supervising the firm's salesmen did not relieve [respondent] of his supervisory obligations.") (citation omitted). [31]:Cf. William S. Mentis, Securities Exchange Act Rel. No. 37952 (November 15, 1996), 63 SEC Docket 661, 664 (principal violated NASD supervisory requirements by failing properly to designate supervisor for firm's trading activities where principal was identified in firm documents as having the designation responsibility and where he provided such documents to the NASD as reflecting the firm's supervisory system); Kirk A. Knapp, 50 S.E.C. 858, 862 (1992) (president of firm violated NASD supervisory requirements even though barred firm owner continued to exercise managerial control). [32]:Kirk A. Knapp, 50 S.E.C. at 862. [33]:Frank L. Palumbo, Securities Exchange Act Rel. No. 36427 (Oct. 26, 1995), 60 SEC Docket 1736 (firm president, chief executive officer and vice-president each violated NASD supervisory requirements where they knew that firm's policy was to charge retail prices of up to 5% above the inside offer quotation). See also D.E. Wine Investments, Inc., Securities Exchange Act Rel. No. 39517 (Jan. 6, 1998), 66 SEC Docket 763, 770 (quotations constitute "a less reliable measure of the market" than actual trades); Alstead, Dempsey & Company, Incorporated, 47 S.E.C. at 1036 ("[b]y their very nature, quotations only propose a transaction; they do not reflect the actual result of a completed arms-length sale"). [34]:Anthony Tricarico, 51 S.E.C. 457, 460 (1993). See also Universal Camera v. NLRB, 340 U.S. 474 (1950). [35]:David A. Gingras, 50 S.E.C. 1286, 1292 (1992). See also Withrow v. Larkin, 421 U.S. 35, 52 (1975) ("our cases . . . offer no support for the bald proposition . . . that agency members who participate in an investigation are disqualified from adjudicating."); Austin Municipal Securities, Inc. v. NASD, 757 F.2d 676, 689 (1985) ("There is nothing constitutionally infirm about the [District Committee] performing both prosecutorial and adjudicatory functions."); Stratton Oakmont, Inc., Securities Exchange Act Rel. No. 38390 (March 12, 1997), 64 SEC Docket 164; Daniel C. Adams, 47 S.E.C. 919, 922 (1983) ("While the NASD as a whole, like this Commission, exercises investigatory, prosecutory and quasi-judicial functions, the combination of such functions in one agency does not violate due process of law."); Richard W. Perkins, 47 S.E.C. 847, 849-50 (1982). We note that the NASD has modified its disciplinary procedures. Under current procedures, the members of the hearing panel are not responsible for investigating possible misconduct or instituting disciplinary proceedings. See Rule 9144 of the NASD's Code of Procedure. [36]:In this connection, we note that the District Committee's analysis of the Firm's pricing differed markedly from that proposed by the NASD staff. See n.20, supra. [37]:David A. Gingras, 50 S.E.C. at 1292. [38]:Frank J. Custable, Jr., 51 S.E.C. 855, 862 (1993) (rejecting claim that the NASD staff, through prosecutorial zeal, improperly influenced the NASD's district committee). See also Frank J. Custable, Jr., 51 S.E.C. 643, 650 (1993) (commission's independent de novo review of the record and that of the NASD's National Committee "`dissipates the possibility of abuse.'"). [39]:See Stratton Oakmont, Inc., 64 SEC Docket at 171 (rejecting similar due process challenge). [40]:The NASD notes that, in April 1996, it accepted an Offer of Settlement from Stratton and Sanders to resolve allegations that, among other things, Stratton had effected sales in an IPO before the offering had been declared effective, had failed to notify customers of its market maker status, and had "given customers arbitrary prices in purchases from customers in violation of SEC Rule 10b-5 . . . ." Sanders was censured, fined $50,000 and suspended for 45 days in all capacities and thereafter for 5 additional days in any capacity related to trading. Sanders also settled two other NASD proceedings in 1990 and 1991, but the NASD expressly declined to consider these earlier settlements in assessing a sanction. [41]:As we have previously noted, appropriate remedial action depends on the facts and circumstances of each particular case and cannot be precisely determined by comparison with the actions taken in other proceedings. See Butz v. Glover Livestock Commission Co., 411 U.S. 182, 187 (1973); Hiller v. SEC, 429 F.2d 856, 858-59 (2d Cir. 1970). [42]:See n.28, supra. [43]:Porush notes that the sanctions imposed exceed those called for in the NASD's Sanction Guidelines. As we have previously pointed out, however, the NASD's guidelines are not meant to prescribe fixed penalties but merely to provide a "starting point" in the determination of remedial sanctions. Peter W. Schellenbach, 50 S.E.C. 798, 803 (1991) (noting that there are "instances where the particular case facts and circumstances justify sanctions other than those suggested" in the guidelines), aff'd, 989 F.2d 907 (7th Cir. 1993). [44]:Porush moves to strike an exhibit attached to the NASD brief purporting to summarize the Firm's disciplinary record, noting that it was not part of the record below nor the subject of a motion to adduce additional evidence before us. We have not considered this "exhibit" and grant Porush's motion. [45]: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. UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40600 / October 26, 1998 Admin. Proc. File No. 3-9195 _________________________________________________ : In the Matter of the Applications of : : STEVEN P. SANDERS : 13-28 208th Place : Bayside, New York 11360 : : and : : DANIEL M. PORUSH : Two Bayclub Drive : Bayside, New York 11360 : : 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 Steven P. Sanders and Daniel M. Porush, and the Association's assessment of costs, be, and they hereby are, sustained. By the Commission. Jonathan G. Katz Secretary