SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40647 / November 9, 1998 Admin. Proc. File No. 3-9555 __________________________________________________ : In the Matter of the Application of : : JAMES S. PRITULA : : 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 Conduct Inconsistent with Just and Equitable Principles of Trade Failure to Comply with Net Capital, Recordkeeping, and Reporting Requirements Financial and operations principal was responsible for failure of member firm of registered securities association to comply with net capital, recordkeeping and reporting requirements. Held, association's findings of violations and the sanctions it imposed sustained. APPEARANCES: James S. Pritula, pro se. Alden S. Adkins, Norman Sue, Jr., Susan L. Beesley, and Shirley H. Weiss, for NASD Regulation, Inc. Appeal filed: March 9, 1998 Last brief filed: July 1, 1998 I. James S. Pritula, formerly the financial and operations principal ("FINOP") of Fin-Atlantic Securities, Inc. ("FAS" or the "Firm"), a member of the National Association of Securities Dealers, Inc. ("NASD"), appeals from NASD disciplinary action. The NASD found that Pritula permitted the Firm to conduct a securities business, on November 30 and December 16, 1994, while it failed to maintain the minimum net capital required under Rule 15c3-1 under the Securities Exchange Act of 1934 ("Exchange Act"). [1] The NASD also found that Pritula failed on behalf of FAS to give prompt notice to the Commission and NASD of the Firm's November 30, 1994 net capital deficiency as required by Exchange Act Rule 17a-11. [2] Pritula further caused FAS to fail to maintain a current and accurate general ledger trial balance and net capital computations as of November 30 and December 16, 1994, as required by Exchange Act Rule 17a-3. [3] Additionally, the NASD found that Pritula caused FAS to file a materially inaccurate Financial and Operational Combined Uniform Single ("FOCUS") report, Part I for the month ending November 30, 1994. The NASD concluded that Pritula thereby violated Article III, Sections 1 and 21 of the Rules of Fair Practice. [4] The NASD censured Pritula, fined him $3,000, and required him to requalify as a FINOP before again acting in that capacity. We base our findings on an independent review of the record. II. At the time of the events at issue, Exchange Act Rule 15c3-1 required FAS to maintain a minimum of $50,000 net capital. As FINOP for FAS, Pritula prepared the Firm's November 1994 FOCUS report, in which the Firm reported a net capital of $64,779 as of November 30, 1994. Pritula filed this report on December 14, 1994. Pritula included in the Firm's capital calculation a $20,000 capital infusion purportedly made during the month by the Firm's president, Jerry Surman. [5] Upon receipt of the FOCUS report, the NASD staff observed that Surman's capital infusion was required to enable the Firm to meet its minimum net capital requirement. The NASD staff therefore conducted an examination of the Firm's calculations and requested FAS to provide a copy of the corporate minutes authorizing the infusion of capital, as well as proof of deposit of the funds. FAS provided a check dated November 15, 1994, written on the joint account of Surman and his wife. The deposit slip, however, indicated that the check was not actually deposited until December 12, 1994, two weeks after the end of the reporting period. According to Surman and Pritula, a clerk inadvertently failed to take the check from the cash receipt blotter for deposit. Surman found the check and deposit slip in a folder in a drawer at the Firm. The NASD's review of the Surmans' bank account, moreover, showed that there were not sufficient funds in that account to cover the check. In fact, when the check was deposited on December 12, it was returned for insufficient funds. On December 19, 1994, Surman deposited $25,000.70 into his and his wife's bank account, and, on December 20, $20,000 was wired to FAS's bank account from the Surman account. The NASD determined that the capital infusion could not be included in the capital calculation and that the Firm therefore did not meet its net capital requirement for November. The NASD staff also determined that other errors had been made in the Firm's capital computation as reflected in its November FOCUS report and adjusted Pritula's calculations as follows: 1) a $118.40 credit for unbooked funds on deposit at its clearing firm; 2) a $2,163.48 debit for unbooked accounts payable; [6] 3) a $213.20 debit for unaccrued commissions payable; 4) a $273.45 credit for excessive haircuts taken; 5) a $6.56 debit for additional haircuts on securities with no activity; 6) a $28.95 debit for an additional haircut on a security that the NASD valued higher than the Firm; and 7) a $5,434.00 credit for an undue concentration charge on mutual funds that was not required. As a result of these adjustments, the NASD found that the Firm had net capital of only $48,193.66 as of November 30, 1994. The Firm did not give timely telegraphic notice of this net capital deficiency. As part of its examination, NASD staff also requested that the Firm perform a net capital computation as of December 16, 1994. [7] By letter dated January 31, 1995, Pritula transmitted to the NASD a computation that showed the Firm's net capital as $72,152. According to the NASD's calculations, however, the Firm had capital of only $48,902.35 on December 16, 1994. The NASD concluded that the Firm improperly included Surman's $20,000 check. The Firm also did not accrue accounts payable of $2,019.09 or commissions payable to its registered representatives in the amount of $1,295.08. [8] It is undisputed that FAS conducted a securities business on both November 30 and December 16, 1994. III. A. The net capital rule is designed to ensure liquidity. A broker or dealer must have sufficient assets that are readily convertible to cash to cover its indebtedness to customers and other broker-dealers in case of financial difficulty. [9] 1. Pritula contends that he properly included Surman's $20,000 check as an allowable asset in both the November 30th and December 16th, 1994 net capital computations and included it properly as an allowable asset on the Firm's November 30 FOCUS report. He asserts that the "rules" do not specify that a check deposited into a firm's account must clear before it can be considered an allowable asset. Moreover, he contends that, because Surman previously had infused capital into the Firm on four occasions in the same manner, Pritula had no reason to doubt that the check would clear. Pritula should not have included the $20,000 in his calculation of the Firm's capital on November 30 and December 16, 1994. Money that has not been tendered for deposit into a firm's account cannot be considered good capital for purposes of calculating the firm's net capital. The funds were not available to the Firm until deposited. [10] Moreover, the check was not backed by sufficient funds. Pritula argues that he thought Surman had sufficient resources to cover any obligations. However, funds that might in the future become available to a firm cannot be considered assets of the firm for net capital purposes. [11] As FINOP, given the importance of the deposit to the Firm's net capital, Pritula should have ascertained whether the check had been deposited. **FOOTNOTES** [1]: 17 C.F.R. 240.15c3-1. [2]:17 C.F.R. 240.17a-11. [3]:17 C.F.R. 240.17a-3. [4]:The NASD recently revised and renumbered its Rules of Fair Practice; no substantive changes were made to the particular rules at issue here. Article III, Section 1 [new Rule 2110] requires members to "observe high standards of commercial honor and just and equitable principles of trade." Article III, Section 21 [new Rule 3110] requires members to keep and preserve books and records. [5]:Surman was also the Firm's compliance officer and owner. [6]:The Firm had an agreement with its parent company, Fin- Atlantic Corporation, under which the parent agreed to pay certain fixed expenses of the Firm. The NASD determined, however, that for several months the Firm routinely had been paying most of these expenses. Moreover, the Firm was booking these bills as expenses but not as liabilities. [7]:According to NASD staff, this was the last day during which the Firm did business before the $20,000 capital infusion cleared. [8]:The District Business Conduct Committee originally calculated FAS's net capital as of December 16 as only $38,842. The National Business Conduct Committee determined that the Firm had properly used trade date reporting to calculate its net capital, which resulted in an additional credit of $10,060.35 to the Firm's capital as of that date. [9]:See Kirk L. Ferguson, 51 S.E.C. 1247, 1249 (1994). See also Lowell H. Listrom, 50 S.E.C. 883, 886 (1992) ("The primary purpose of Rule 15c3-1 is to ensure that broker- dealers have sufficient liquid capital to protect the assets of customers and to meet their responsibilities to other broker-dealers."), aff'd, 975 F.2d 866 (8th Cir. 1992) (Table). [10]:Ferguson, 51 S.E.C. at 1249 (check cannot be considered good capital until it is actually deposited into firm's account). See also Lowell Niebuhr & Co., Inc., 18 S.E.C. 471, 474-75 (1945) ("mere receipt by the corporation of [the president's] personal checks -- drawn on a bank in which he had practically no funds -- could not justify an entry on the books . . . increasing the company's cash position.") Pritula suggests that the check was a receivable to the firm. However, our net capital rule generally requires the exclusion of unsecured receivables. Exchange Act Rule 15c3- 1(c)(2)(iv)(B). [11]:Wallace G. Conley, 51 S.E.C. 300, 303 (1993) (funds of the parent company that were available to cover debts the broker-dealer could not pay but had not been credited to the broker-dealer did not represent receivables and should not have been considered an allowable asset). Pritula included Surman's check as good capital in the November FOCUS report, which he filed on December 14, 1994. At that time, Pritula knew that Surman's check had not actually been deposited until December 12, two weeks after the end of the reporting period. Pritula claims that the check was properly included as a "deposit in transit." A "deposit in transit," however, indicates that a check has been transmitted for deposit but that the deposit has not yet appeared on a bank statement. [12] A check that is left in a desk drawer is not a "deposit in transit." When Pritula discovered that the check had not been deposited by the end of November, he should not have included the check as capital in the FOCUS report. [13] Pritula also incorrectly included the check as capital for the December 16 net capital computation. Pritula claims that Surman was responsible for the December 16 net capital violation because the check had been deposited, but Surman allegedly hid the bank's notice that the bank had returned the check for insufficient funds. [14] This December 16 capital calculation, however, was transmitted to the NASD by letter dated January 31, 1995. Pritula received the Firm's December bank statement around January 10. This statement reflects the $20,000 check's having been returned on December 15, 1994 and the subsequent wire transfer into the account on December 20, 1994 of $20,000. 2. Pritula also claims that he did not need to book commissions payable to the Firm's registered representatives. Broker-dealers must keep their books in accordance with generally accepted accounting principals ("GAAP"). Thus, among other things, broker-dealers are required to use the accrual method of accounting. A broker-dealer therefore must recognize revenues when earned and liabilities when incurred. [15] FAS should have accrued the commissions payable to FAS' registered representatives at the time that the transactions occurred. Pritula notes that each registered representative at FAS executed an "Attestation" that waived his or her right to commissions owed until "such time as the Firm has received the commission in cleared funds." Therefore, Pritula argues, while the Firm could include the commissions receivable as part of net capital without deducting the part of the commission receivable that would be owed to the registered representatives, the commissions payable did not become obligations of the firm until "such time as the Firm has received the commission in cleared funds." [16] We have previously rejected a similar argument. In Troy Wetter, we concluded that, although a firm's registered representatives agreed to delay the time of payment of the commissions to the succeeding month, the commissions payable should have been accrued when the transactions that generated them took place. [17] In very limited circumstances, this Commission's staff has permitted agreements waiving payment of commissions payable until the broker-dealer receives its commissions or concessions from a third party. Under Exchange Act Rule 15c3-1(c)(2)(iv)(C), only those commissions from other broker-dealers that the broker- dealer will receive within thirty days generally are allowable assets for net capital purposes. In other words, if the broker-dealer expects a commission or concession from another broker-dealer arising from a transaction with a third party that will not be paid to the broker-dealer within thirty days, the broker-dealer must deduct that commission or concession receivable from net worth. At the same time, if the broker-dealer owes commissions to its registered representatives with respect to the transaction, under GAAP, it would have to deduct that amount from net capital. Under limited conditions, however, our staff has not required firms to deduct certain commissions or concessions that the broker-dealer will receive outside the thirty-day period allowed by Exchange Act Rule 15c3-1. Thus, no deduction is required, provided certain conditions are met, to the extent that those commissions or concessions are offset by the amount of commissions payable to the broker-dealer's registered representatives in connection with the particular transaction. [18] This relief prevents a broker- dealer from having to take a double charge to net capital for a liability to the extent that the liability is matched by a receivable. Pritula, however, attempts to turn this exemption on its head. He seeks to record commissions receivable as an asset to the Firm's net capital without being obligated to book the corresponding commissions payable as liabilities. This interpretation would improperly inflate the Firm's net capital. Pritula further asserts that he relied on an opinion by counsel suggesting that, because of the agreements with the representatives waiving payment of the commissions until the funds were received, FAS was not required to reflect the liability for the commissions payable to the registered representatives but could credit the commissions receivable as an asset. That opinion is in error. FINOPs are required to calculate net worth in accordance with GAAP. The Commission's opinion in Wetter was published in October 1993, a year before the matters at issue here, and the staff opinions discussed above also predated Pritula's actions. Pritula should have been aware that the agreements with the representatives could not be used to enhance the Firm's net capital. [19] 3. Pritula challenges the adjustments made by the NASD to the Firm's net capital for certain expenses. Pritula notes that FAS's parent firm in writing had agreed to assume certain of FAS's liabilities, such as rent, utilities, and administrative expenses. Pritula argues that, because of this agreement, he did not need to book these obligations as liabilities. Nevertheless, despite the agreement with its parent firm, FAS appears to have paid these expenses itself, and Pritula booked these payments as FAS expenses. He therefore should have booked these items as liabilities and deducted them from net capital. * * * * * We conclude that the Firm violated Exchange Act Rule 15c3-1 on November 30 and December 16, 1994. FAS also filed a materially inaccurate November 1994 FOCUS report reflecting Pritula's November 30, 1994 net capital computation. For the reasons discussed below, we find Pritula responsible for these violations. B. Exchange Act Rule 17a-3 requires broker-dealers to keep and maintain current books and records. [20] By failing to provide an accurate statement of the Firm's trial balances and net capital computations, Pritula caused the Firm to violate Exchange Act Rule 17a-3(a)(11). [21] As discussed above, Pritula failed to both debit and credit a wide range of adjustments in performing the Firm's trial balances and net capital computations. [22] Moreover, Exchange Act Rule 17a-11 requires broker-dealers whose net capital declines below its minimum amount to notify this Commission as well as the designated examining authority of the broker-dealer's membership organization. [23] Pritula, however, failed to notify this Commission and the NASD that the Firm did not have sufficient capital on November 30, 1994 to operate in compliance with its minimum net capital requirement as required by Exchange Act Rule 17a-11. C. As FINOP, Pritula's duties included "supervision of and responsibility for individuals who are involved in the actual maintenance of the member's books and records from which [the firm's] reports are derived" and the "supervision and/or performance of the member's responsibilities under all financial responsibility rules promulgated pursuant to the provisions of the Act." [24] As FINOP, Pritula was also responsible for complying with the net capital rule provisions. [25] A FINOP must be especially vigilant in ensuring compliance with the net capital rule when, as was the case here, his firm has been experiencing financial difficulties or is operating near the permissible limits. [26] Pritula testified at the District Business Conduct Committee hearing that he was aware that capital was "tight." He also knew that Surman had made four prior capital infusions since the previous spring. He failed, however, to make the required inquiries and adjustments. We conclude that Pritula was responsible for the Firm's failure to comply with Exchange Act Rule 15c3-1, for its filing of a materially inaccurate FOCUS report, and for the Firm's violation of Exchange Act Rules 17a-3 and 17a-11. Pritula thereby violated Article III, Sections 1 and 21 of the NASD Rules. IV. Pritula argues that the sanctions -- a censure, $3,000 fine, and costs -- are excessive. [27] Pritula points out that he spent 17 years in the business with no disciplinary actions or customer complaints. Net capital violations are serious offenses. By failing to maintain sufficient capital, FAS subjected its customers to the risk that it would not have sufficient liquid assets to satisfy its indebtedness. Additionally, Pritula was responsible for allowing the Firm to violate recordkeeping and reporting requirements. The fine assessed is at the low end for a single violation of the net capital rules, recordkeeping rules, or for filing a false FOCUS report. [28] In reviewing the propriety of the sanctions against Pritula, we have not considered the Firm's December 16, 1994 net capital violation. Had Pritula been correct in his treatment of the commissions, the Firm would not have been in violation on that date. Given the Firm's receipt of an opinion of counsel, we do not think sanctions against Pritula are appropriate for this aspect of his conduct. [29] For these reasons, we do not conclude that the fine and costs are excessive or oppressive. An appropriate order will issue. [30] By the Commission (Chairman LEVITT and Commissioners JOHNSON, HUNT, CAREY and UNGER). Jonathan G. Katz Secretary **FOOTNOTES** [12]:See Vincent Musso, 48 S.E.C. 1, 3 (1984) ("a deposit in transit normally reflects a bank deposit that has been made but has not yet appeared on the company's most recent bank statement"). See also, NASD Guide to Rule Interpretations (1996) (reporting an April 1986 Commission staff interpretation that a "[b]roker-dealer that, as part of its normal business practice, promptly mails deposits to its bank may include such deposits in transit as allowable assets in its computation of net capital.") [13]:Pritula argued before the NASD that he relied on the Firm's certified public accountant ("CPA") in making his determination that the check was a "deposit in transit." He has abandoned this claim before us and now contends only that he consulted a CPA. As FINOP, Pritula was responsible for ensuring net capital compliance. See James Michael Brown, 50 S.E.C. 1322, 1326 (1992) (president of firm, who signed FOCUS report and provided information to NASD examiners, could not shift responsibility to outside accountants for recordkeeping and reporting violations), aff'd, 21 F.3d 1124 (11th Cir. 1994) (Table). [14]:Before the NASD, Pritula claimed that Surman did not give him access to incoming mail. Pritula now appears to argue that he had access to all incoming mail but that Surman hid the bank's notification that the check had been returned for insufficient funds. [15]:Clinger & Co., Inc., Securities Exchange Act Rel. No. 39390 (December 3, 1997), 65 SEC Docket 3060, 3063, n.7; Securities Exchange Act Rel. No. 18737 (May 13, 1982), 25 SEC Docket 468, n.4. [16]:The NASD found that the Attestations were limited to certain specified transactions. While we agree that the second part of the document is so limited, the initial portion of the document would appear to apply to any commission. [17]:Troy A. Wetter, 51 S.E.C. 763, 765 (1993) (where firm's representatives signed agreement stating that their commissions were not payable until the 15th of the following month, those commissions were a liability at the prior month end). [18]:These conditions have included: 1) the representative agrees in writing to waive payment of the commission until the broker-dealer is in receipt of the commission; 2) an opinion of counsel is obtained that states that such a contract is enforceable in the state where the broker-dealer and representative reside; 3) the broker-dealer's liability for the commission payable is limited solely to the proceeds of the concession or commission receivable; and 4) the entire amount of the commission payable is included in the aggregate indebtedness at the time of the accrual. Commission staff letter to the NASD, 1984 SEC No-Act. LEXIS 2936 (July 24, 1984). See also, Jerry W. Markham and Thomas Lee Hazen, Broker-Dealer Operations Under Securities and Commodities Law: Financial Responsibilities, Credit Regulation and Customer Protection, at 5.07[10], n.6 and letters cited therein. Our staff no longer requires an opinion of counsel. [19]:In reviewing the appropriateness of the sanctions against Pritula, we have not considered the Firm's December 16, 1994 net capital violation. See infra Section IV. [20]:Palm State Equities, Securities Exchange Act Rel. No. 35873 (June 20, 1995), 59 SEC Docket 1812. [21]:Exchange Act Rule 17a-3(a)(11) requires broker-dealers to maintain a record of "the proof of money balances of all ledger accounts in the form of trial balances, and a record of the computation of aggregate indebtedness and net capital, as of the trial balance date." 17 C.F.R. 240.17a-3(a)(11). Dillon Securities, 51 S.E.C. 142, 147 (1992) ("To reliably ascertain the accuracy of a firm's net capital computation, examiners need an accurate statement not only of net worth but also of all deductions to net worth and other line items"). [22]:See text accompanying n.6. [23]:17 C.F.R. 240.17a-11. [24]:Membership and Registration Rule 1022(b) (formerly Schedule C to the NASD By-Laws). [25]:Gilad J. Gevaryahu, 51 S.E.C. 710, 712-13 (1993) (FINOP cannot simply accept word of firm's president in calculating net capital for firm); George Lockwood Freeland, 51 S.E.C. 389, 392-93 (1993) (where owner of firm withheld information, FINOP cannot shift responsibility for net capital rule compliance to him). [26]:Hutchison Financial Corp., 51 S.E.C. 398, 404 (1993). [27]:The NASD also required Pritula to requalify as a FINOP by passing the Series 27 qualification examination. Pritula does not dispute this requirement. Pritula states that his Series 27 license has expired, and, thus, he is already required to requalify in order to become relicensed. [28]:The Sanction Guidelines suggest a fine of $2,500 to $20,000 for a single violation of each of these provisions. NASD Sanction Guidelines at 21, 30, and 33 (1993). [29]:In our review of the NASD's sanctions, we have considered Pritula's failure to maintain an accurate general ledger trial balance and net capital computation as of December 16, 1994, given the matters discussed in Sections III.A.1. and 3. above. [30]:All of the contentions 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 herein. UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40647 / November 9, 1998 Admin. Proc. File No. 3-9555 : In the Matter of the Application of : : JAMES S. PRITULA : : 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 James S. Pritula, and the Association's assessment of costs, be, and it hereby is, sustained. By the Commission. Jonathan G. Katz Secretary