SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
INVESTMENT ADVISERS ACT OF 1940
Rel. No. 1774 / November 18, 1998
Admin. Proc. File No. 3-8854
__________________________________________________
:
In the Matter of :
:
VALICENTI ADVISORY SERVICES, INC. :
100 Baldwin Street :
Elmira, New York 14901 :
:
and :
:
VINCENT R. VALICENTI :
__________________________________________________:
OPINION OF THE COMMISSION
INVESTMENT ADVISER PROCEEDINGS
Ground for Remedial Action
Fraudulent Sales Literature
Registered investment adviser and its president distributed
two pieces of fraudulent sales literature to prospective
clients. Held, it is in the public interest to censure and
fine respondents, to issue a cease and desist order, and to
require respondents to send a copy of the Commission's
opinion and order to clients and, for one year, to
prospective clients.
APPEARANCES:
Michael R. Wolford and Steven E. Cole, of Wolford & Leclair
LLP, for Valicenti Advisory Services, Inc. and Vincent R.
Valicenti.
Carmen J. Lawrence, Henry Klehm III, Daniel J. Goldstein,
Samuel C. Watkins, Brian H. Fortune, and Daniel C. Feldman, for
the Division of Enforcement.
Appeal filed: July 30, 1997
Briefing completed: October 22, 1997
Oral argument: July 7, 1998
I.
Valicenti Advisory Services, Inc. ("VAS" or "the firm"), a
registered investment adviser, and our Division of Enforcement
appeal from the initial decision of an administrative law judge.
The law judge found that VAS willfully violated Sections 206(2)
and 206(4) of the Investment Advisers Act ("Act") and Rule
206(4)-1(a)(5) thereunder by negligently misrepresenting certain
facts in two pieces of promotional literature. [1] The law judge
also found that, although Vincent R. Valicenti ("Valicenti"),
VAS's president and sole owner, was a "cause" of the firm's
violations within the meaning of Section 203(k)(1) of the Act, he
did not aid and abet the violations. The law judge concluded
that VAS should be censured, and that the proceedings against
Valicenti should be dismissed.
VAS argues that the law judge's findings of violation are
erroneous, and that the proceedings against the firm should also
be dismissed. The Division contends that VAS and Valicenti
("respondents") acted with scienter in issuing four pieces of
fraudulent sales literature; that respondents made material
misrepresentations in addition to those found by the law judge;
and that a cease and desist order as well as significant
sanctions and penalties should be imposed on respondents. Our
findings are based on an independent review of the record.
II.
In early 1992, Valicenti decided to prepare materials
advertising VAS's past performance for distribution to
prospective clients. Peter Marchese, VAS's marketing manager,
was assigned the task of preparing the necessary materials
subject to Valicenti's specifications and close supervision. The
law judge's findings of violation are based on the two pieces of
sales literature that resulted, both of which were distributed to
VAS prospects in 1992. The literature consisted of the chart and
bar graph that are described below.
**FOOTNOTES**
[1]: Section 206(2)(15 U.S.C. 80b-6(2)) prohibits any
transaction, practice, or course of business that operates
as a fraud on any client or prospective client. Section
206(4)(15 U.S.C. 80b-6(4)) prohibits engaging in any act,
practice, or course of business that is fraudulent,
deceptive, or manipulative. Rule 206(4)-1(a)(5)(17 C.F.R.
275.206(4)-1(a)(5)) prohibits the distribution of any
advertisement that contains any untrue statement of a
material fact or is otherwise false or misleading.
A. The 1991 Chart
The 1991 Chart ("Chart") purported to show the rates of
return realized by a "composite of [VAS] discretionary accounts
with a balanced objective" over the five-year period 1987 through
1991. [2] According to Valicenti, in order to be considered
"balanced," and therefore included in the Chart, an account's
objectives "could not be at the extremes of high income or...
growth," which he defined as any account with equity or bond
holdings in excess of 70% of the total portfolio.[3] Under
Valicenti's definition, the assets of a balanced account had to
be a mix consisting of between 30% and 70% equities and 30% and
70% bonds.
In 1987, VAS had approximately 74 balanced accounts meeting
Valicenti's definition, in 1988 about 112 such accounts, and in
each of the years 1989 through 1991 more than 120 such accounts.
However, very few of these accounts were reflected in the 1991
Chart. Indeed, the Chart's rates of return reflected only 13
accounts for 1987, 17 accounts for 1988, and 19 accounts for each
of the years 1989 through 1991. These accounts were selected
from an original list of 22 chosen by Valicenti (from the more
than 400 under VAS management in 1991) and assigned to Marchese
for the calculation of performance results.
We agree with respondents that, in the present context, the
term "composite" simply means "compound" [4] or "combination".
However, we consider that, when, as here, an adviser's sales
literature states that the rates of return it is advertising are
based on the combined performance of certain specified accounts,
the plain meaning of that statement is that the rates reflect the
performance of all accounts falling within the stated criteria,
not merely a few chosen by the adviser. Our conclusion is
supported by expert testimony in the record.
Dr. Robert Hagin testified that it is a clear convention in
the advisory industry that, when the term "composite" is used, it
means all accounts that meet the stated criteria, an established
practice in the industry since at least 1973. There must be "no
sampling" and "no selectivity." Dr. Scott Lummer agreed with
Hagin. Lummer stated that, in 1992, the word "composite" had a
specific, well understood meaning in the investment adviser
community -- the average of all accounts that met the specified
criteria. Lummer stated, moreover, that a large percentage of
investors who focus on performance numbers understand the meaning
of the term "composite." Even Dr. Jeffrey Lessard, one of
respondents' experts, conceded that respondents' use of the term
"composite" to describe their results "may have been technically
inaccurate." [5]
Respondents argue that, in any event, the Division did not
show that respondents misrepresented VAS's performance; i.e., the
Division did not establish that the actual performance of VAS's
discretionary, balanced accounts for the years in question was
materially different from that depicted in the 1991 Chart. We do
not agree. In our view, the evidence is more than sufficient to
justify the conclusion that the results reported in the Chart
were materially misleading. Most significant is the following
evidence concerning the firm's performance for 1991.
In the course of the Division's investigation, respondents
were asked to supply a list of all accounts for the years 1987
through 1991 that met Valicenti's criteria for inclusion in the
Chart. Since pre-1991 data were not available in VAS's computer
system, respondents only supplied a list of such accounts for
1991. That list totaled 122 accounts and disclosed that the
accounts' combined 1991 rate of return was only 20.629%, a figure
more than 7% lower than the rate of 27.89% shown on the Chart for
1991.
Respondents now question the accuracy of the information
they themselves submitted to our staff. They claim that
Valicenti did not know how the 122 accounts were selected; that
the list improperly included accounts that were opened during
1991; and that the rate of return calculated for the accounts was
not "market-weighted" like the other rates on the 1991
Chart. [6] These contentions are without merit. The record
contains a letter from Valicenti to our staff describing in
detail the criteria used in selecting the 122 accounts.
Moreover, Joseph Valicenti ("J. Valicenti"), a VAS portfolio
manager (and Valicenti's son), recalculated the rate of return
for the accounts on the list leaving out those that assertedly
were improperly included. The result was a 21.76% rate of
return, only 1.1% higher than the rate originally supplied to our
staff. J. Valicenti also calculated the market-weighted rate of
return for the 122 accounts and arrived at a figure of 22.70%,
still more than 5% lower than the 27.89% rate shown on the 1991
Chart.
A wealth of other evidence demonstrates that respondents
were intent on presenting a misleading portrayal of VAS's past
performance. While purporting to be a composite of all balanced
accounts managed by VAS, the Chart, as noted above, was based on
only 13 to 19 accounts, although the number meeting Valicenti's
definition ranged from about 74 to more than 120 during the years
in question. Moreover, as the law judge found, Valicenti
rejected all of Marchese's suggestions that would have provided
more disclosure. [7] Thus, Valicenti rejected proposed disclosure
that, among other things, would have revealed that the cited
rates of return only reflected "a sample of discretionary
accounts". Valicenti also chose not to disclose the actual
number of accounts reflected in the Chart for each of the years
in question.
Although the percentage of VAS balanced accounts with less
than $100,000 in assets ranged from about 28% to 45% of all such
accounts during the years 1987 through 1991, Valicenti determined
that the Chart should only include accounts with more than
$100,000 in assets. He stated that accounts with less than that
figure were very difficult to manage on a performance basis
because of their very high transaction costs. No disclosure of
the $100,000 requirement was made in the Chart. In fact,
Valicenti rejected proposed disclosure that would have revealed
the size of included accounts.
The record does not show, and respondents do not claim, that
the Chart was shown only to prospective clients with more than
$100,000 to invest. We agree with Dr. Lummer that the Chart was
materially misleading to VAS prospects who wanted to invest less
than $100,000.
The record further reveals that Valicenti tinkered with the
results calculated by Marchese in order to show higher rates of
return. At Valicenti's direction, Marchese prepared, and showed
to Valicenti, a number of interim spreadsheets showing five-year
performance figures for various combinations of the 22 accounts
initially selected by Valicenti. One of the spreadsheets
calculated the combined performance of 17 of those accounts for
the year 1987. The calculation showed that the combined accounts
had suffered a loss for the year, resulting in a -0.84% negative
rate of return. Valicenti didn't like what he saw, and indicated
to Marchese that the spreadsheet "didn't look like a good
representation." Thereafter, Valicenti directed Marchese to make
changes with respect to six of the 17 accounts in his
computation, all six of which had had a negative 1987
performance. Valicenti ordered that three of the accounts be
dropped completely from the Chart, and that the other three be
omitted for the year 1987. At the same time, he directed
Marchese to add two other accounts to the Chart, both of which
had had a positive 1987 performance.
By these expedients, Valicenti transformed a negative rate
of return for 1987 (-0.84%) into a positive 2.60% rate for the
year, the rate that appeared in the 1991 Chart. As noted above,
the 2.60% rate that Valicenti achieved was based on only 13 of 74
accounts that met Valicenti's criteria. Valicenti claimed that
the three accounts that were totally dropped were eliminated
because they did not meet those criteria. However, he did not
explain why the other three accounts apparently met his criteria
for 1988 through 1991, but not for 1987. The 2.60% rate of
return engineered by Valicenti not only improved the picture
presented for 1987, but also boosted the cumulative rates of
return shown in the 1991 Chart for the subsequent two to five-
year periods. [8]
Other aspects of the Chart were also misleading. Although
the Chart purported to report the performance of the same group
of accounts over a five-year period, that was not the case.
Instead, as Valicenti was aware (and as noted above), differing
numbers of accounts were reflected for different years.
Moreover, despite the fact that the Chart was purportedly limited
to balanced accounts, not all of the included accounts fit that
description. Indeed, as Dr. Hagin pointed out, 6 of the 13
accounts reflected in the Chart for 1987 did not meet Valicenti's
definition.
Valicenti conceded that individual accounts in the Chart did
not "necessarily" fall within his definition of "balanced". He
stated, however, that, regardless of whether each individual
account met his definition, his intent was to lump the assets of
all the accounts in the Chart together and have the total reflect
the appropriate mix of equities and bonds. This was clearly
contrary to the Chart's representation that it reflected a
composite of balanced accounts.
**FOOTNOTES**
[2]: Rates of return were shown separately for the accounts'
total portfolio, the bond component of that portfolio, and
the equity component of the portfolio. The Chart also
showed cumulative rates of return for two, three, four, and
five-year periods.
[3]:All of VAS's accounts were "discretionary."
[4]:The American Heritage Dictionary, Second College Edition
(1985).
[5]:We find contrary testimony by respondents' other experts
unconvincing. One of them, John Piccione, went so far as to
claim that the actual performance of a single account could
be a composite.
[6]:Market-weighted rates of return take into account the
size of an individual portfolio in relation to the total of
all portfolios.
[7]:As noted above, Peter Marchese was VAS's marketing
manager.
[8]:See n.2, supra.
B. The 1991 Bar Graph
The 1991 Bar Graph ("Bar Graph") was also prepared by
Marchese at Valicenti's direction. It purported to compare the
five-year cumulative rates of return appearing in the Chart with
the five-year performance of a sample of money managers.
Valicenti instructed Marchese to order data from CDA Investment
Technologies, Inc. that showed the performance results achieved
by about 1135 money managers for accounts with a ratio of 50%
equities to 50% bonds. The rates of return achieved by the money
managers were shown in three columns; one showing the rates
earned on a total portfolio equally divided between equities and
bonds, the second showing the rates achieved for the portfolio's
equity component, and the third showing the rates earned on the
bond component. An asterisk was placed in each column indicating
where VAS stood vis-a-vis the money managers.
The assets reflected in the Chart were composed of about 54%
equities. Since equities outperformed bonds during the relevant
period, comparing the rates of return appearing in the Chart with
the rates achieved for accounts with only 50% equities resulted
in a somewhat more favorable portrayal of VAS's performance than
was warranted. However, the record does not show that this
circumstance improved the depiction of that performance in any
material amount. Nevertheless, the Bar Graph was materially
misleading since it compared the rates of return achieved by
other money managers with the materially distorted VAS rates
appearing in the Chart.
The Chart and the Bar Graph presented a false portrayal of
VAS's past performance and a misleading comparison of that
performance with the performance of other money managers. Both
of these items were materially misleading to prospective clients
of the firm. We cannot agree with the law judge that, in
creating these documents, Valicenti acted in good faith. On the
contrary, the record shows that, in an effort to win new clients,
he deliberately distorted the truth. [9] Valicenti rejected all
disclosure that would have revealed that, contrary to the Chart's
stated coverage, it reflected only a small sampling of accounts
that differed in number in different years. He excluded accounts
under $100,000 because of their higher costs but refused to
disclose that fact. He manipulated the narrow range of accounts
included in the Chart in order to achieve better results. He
improperly included non-balanced accounts in the Chart. And,
finally, he created a misleading comparison of the Chart's
distorted rates of return with the rates of other money managers.
We accordingly conclude that VAS, willfully aided and
abetted by Valicenti, willfully violated Sections 206(1), [10]
206(2), and 206(4) of the Act and Rule 206(4)-1(a)(5) thereunder.
We further conclude, pursuant to Section 203(k)(1) of the Act,
that Valicenti was a cause of his firm's violations. [11]
As indicated above, the Division argues that respondents
issued two additional pieces of fraudulent sales literature: 1992
updates of the Chart and the Bar Graph. The law judge concluded
that the record did not establish that the updates had ever been
distributed to clients or prospective clients. On the basis of
our review of the record, we are unable to conclude that the law
judge erred in this regard. Accordingly, we make no findings
with respect to these two items.
III.
Respondents argue that no sanctions are warranted. They
assert, among other things, that their record in the advisory
business is otherwise unblemished, that the advertisements at
issue were an isolated occurrence, that no one was harmed by
their actions, and that there is no basis for a cease and desist
order since there is no reasonable likelihood of further
violations on their part.
We take a less sanguine view of respondents' violations.
Investment advisers are fiduciaries whose actions must be
governed by the highest standards of conduct. [12] However,
respondents chose to ignore those standards, and perpetrated a
serious fraud on prospective clients of the firm. Contrary to
the claim made by respondents, their actions demonstrate a
substantial likelihood of further misconduct on their part.
Under all the circumstances, we have determined that it is
appropriate in the public interest to censure respondents, to
issue a cease and desist order, and to fine VAS $50,000 and
Valicenti $25,000. We shall also require that respondents send a
copy of our opinion and order to all of their existing clients
and, for one year, to all prospective clients.
An appropriate order will issue. [13]
By the Commission (Chairman LEVITT and Commissioners JOHNSON
and HUNT); Commissioners CAREY and UNGER not participating.
Jonathan G. Katz
Secretary
**FOOTNOTES**
[9]: As we have previously stated, credibility determinations can
be overcome "only where the record contains `substantial
evidence' for doing so." See Anthony Tricarico, 51 S.E.C.
457, 460 (1993), and the authorities there cited. We find
such evidence here.
[10]:Section 206(1)(15 U.S.C. 80b-6(1)) prohibits the
employment of any device, scheme, or artifice to defraud any
client or prospective client.
[11]: We have found that Valicenti acted with scienter. A
respondent is a "cause" of another's violation if the
respondent "knew or should have known" that his act or
omission would contribute to such violation. Section
203(k)(1).
[12]:See, e.g., SEC v. Capital Gains Research Bureau, Inc.,
375 U.S. 180, 191-192 (1963); Rosenfeld v. Black, 445 F.2d
1337, 1342-1344 (2d Cir. 1971).
[13]: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
INVESTMENT ADVISERS ACT OF 1940
Rel. No. 1774 / November 18, 1998
Admin. Proc. File No. 3-8854
__________________________________________________
:
In the Matter of :
:
VALICENTI ADVISORY SERVICES, INC. :
100 Baldwin Street :
Elmira, New York 14901 :
:
and :
:
VINCENT R. VALICENTI :
__________________________________________________:
ORDER IMPOSING REMEDIAL SANCTIONS
On the basis of the Commission's opinion issued this day, it
is
ORDERED that Valicenti Advisory Services, Inc. (VAS) and
Vincent R. Valicenti (Valicenti) be, and they hereby are,
censured; and it is further
ORDERED that VAS and Valicenti cease and desist from
committing or causing any violation and committing or causing any
future violation of Sections 206(1), 206(2), and 206(4) of the
Investment Advisers Act and Rule 206(4)-1(a)(5) thereunder; and
it is further
ORDERED that, within 30 days of the entry of this order, VAS
shall pay a civil money penalty in the amount of $50,000, and
Valicenti shall pay a civil money penalty in the amount of
$25,000, to the United States Treasury. Such payment shall be:
(i) made by United States postal money order, certified check,
bank cashier's check, or bank money order; (ii) made payable to
the Securities and Exchange Commission; (iii) hand-delivered or
mailed to the Comptroller, Securities and Exchange Commission,
Operations Center, 6432 General Green Way, Stop 0-3, Alexandria,
VA 22312; and (iv) submitted under cover letter which identifies
VAS and Valicenti as respondents in this proceeding, and the file
number of this proceeding. A copy of the cover letter and check
shall be sent to Daniel J. Goldstein, counsel for the Division of
Enforcement, Securities and Exchange Commission, Northeast
Regional Office, 7 World Trade Center - 13th floor, New York,
N.Y. 10048; and it is further
ORDERED that VAS and Valicenti (respondents) shall mail a
copy of this opinion and order, together with a cover letter in a
form acceptable to the staff of the Commission, to each of their
existing clients by certified mail, return receipt requested,
within thirty (30) days from the date of this order. From the
effective date of this order until the expiration of twelve (12)
months, respondents shall provide a copy of this opinion and
order to all prospective investment advisory clients not less
than forty-eight (48) hours prior to entering into any written or
oral investment advisory contract (or no later than the time of
entering into such contract if the client has the right to
terminate the contract without penalty within five (5) business
days after entering into the contract). Also, within thirty (30)
days from the date of this order, respondents shall execute and
deliver to Daniel J. Goldstein at the Commission's Northeast
Regional Office an affidavit that they have provided this opinion
and order to their existing clients in accordance with the terms
of this order. Finally, within thirteen (13) months from the
date of this order, respondents shall execute and deliver to
Daniel J. Goldstein at the Commission's Northeast Regional Office
an affidavit that they have provided this opinion and order to
their prospective clients in accordance with the terms of this
order.
By the Commission.
Jonathan G. Katz
Secretary