UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION Securities Exchange Act of 1934 Release No. 38150 / January 10, 1997 Administrative Proceeding File No. 3-9217 ------------------------------- : In the Matter of : ORDER INSTITUTING PROCEEDINGS : PURSUANT TO  15(b)(4) AND NATIONAL FINANCIAL SERVICES :  21C OF THE SECURITIES CORPORATION, : EXCHANGE ACT OF 1934, : MAKING FINDINGS : AND IMPOSING REMEDIAL Respondent. : SANCTIONS : ------------------------------- I. The Securities and Exchange Commission (the "Commission") deems it appropriate and in the public interest that proceedings be, and they hereby are, instituted against National Financial Services Corporation ("NFSC" or "Respondent") pursuant to Section 15(b)(4) and Section 21C of the Securities Exchange Act of 1934 (the "Exchange Act"). II. In anticipation of the institution of these administrative proceedings, NFSC has submitted an offer of settlement which the Commission has determined to accept. Solely for the purposes of these proceedings and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, NFSC, without admitting or denying the findings and matters set forth herein (except as to jurisdiction, which NFSC admits), consents to the issuance of this Order Instituting Proceedings Pursuant to Section 15(b)(4) and Section 21C of the Exchange Act, Making Findings And Imposing Remedial Sanctions ("Order"), and to the entry of the findings and imposition of the sanctions set forth below. ==========================================START OF PAGE 2====== III. FINDINGS On the basis of this Order and Respondent's Offer of Settlement, the Commission finds-[1]- the following: A. FACTS 1. Respondent NFSC is a Massachussetts corporation with its principal place of business in New York, New York. Its principal business is the execution, settlement and financing of correspondent and correspondents' customer securities transactions, and it acts as a clearing firm for more than 200 correspondent firms. At all times relevant to these proceedings, NFSC was registered with the Commission as a broker-dealer pursuant to Section 15(b) of the Exchange Act and was a member of the New York Stock Exchange and other exchanges. 2. NFSC's Extension of Credit on a Nonmargin Security This matter involves violations of the margin requirement provisions of the Exchange Act by NFSC. NFSC extended and maintained approximately $3,000,000 of credit on purchases of approximately 900,000 shares of the common stock of Vertex Industries, Inc. ("Vertex"), held in approximately ninety-eight retail accounts between March 2, 1993, and November 26, 1993. Vertex stock was not a margin security under Regulation T during this period. As a result, NFSC violated Section 7(c) of the Exchange Act and Section 18(e) of Regulation T thereunder (original version at Section 19(e)). On or about March 2, 1993, NFSC erroneously designated the common stock of Vertex Industries, Inc. ("Vertex") as a margin security in NFSC's computer system. At the time, Vertex stock, which was traded over-the-counter, was not designated as qualified for trading in the NASDAQ National Market System, and was not included in the list of margin securities published by the Board of Governors of the Federal Reserve System (the ---------FOOTNOTES---------- -[1]- The findings herein are made pursuant to NFSC's Offer of Settlement and are not binding on any other person or entity named as a respondent in this or any other proceeding. ==========================================START OF PAGE 3====== "Federal Reserve"). NFSC's records do not identify who made this change or the reasons for it.-[2]- Beginning in March 1993, NFSC extended credit on purchases of Vertex stock to retail customers of certain of NFSC's correspondent firms in approximately ninety-eight accounts. Between March 2, 1993, and September 1, 1993, when NFSC discovered its error, these customers purchased approximately 900,000 shares of the common stock of Vertex (approximately 20% of the number of shares issued and outstanding) in margin accounts. The amount of credit extended by NFSC on these retail accounts in connection with these purchases was approximately $3,000,000. Most of these accounts were customers of one of NFSC's former correspondent firms ("Correspondent"), which was a market maker in Vertex stock at all relevant times. After discovering the error, NFSC officials treated the continued extension and maintenance of credit on Vertex securities as a house margin maintenance matter, and not as a situation implicating Regulation T.-[3]- NFSC initially contacted the principals of Correspondent and asked Correspondent to require its customers with margined holdings of Vertex stock to reduce their margin debits by selling securities or depositing additional collateral. NFSC never issued Regulation T margin calls to Correspondent's customers. As of September 24, 1993, more than three weeks after discovering the error, NFSC was still maintaining at least $2,800,000 in margin credit extended on purchases of Vertex. Furthermore, on September 14 and September 15, 1993, customers of Correspondent made three additional purchases of Vertex stock totalling 15,500 shares in cash accounts. When the customers did not pay for these cash account purchases by settlement date, NFSC obtained Regulation T extensions of the payment date for these purchases. On September 29, 1993, these positions were sold. As of November 25, 1993, NFSC had failed to bring the Correspondent's customer accounts into compliance with the credit extension requirements of Regulation T. On November 26, 1993, Vertex stock was registered on the Boston Stock Exchange and became a margin ---------FOOTNOTES---------- -[2]- After the events described here, NFSC adopted new procedures for designating margin securities and for documenting changes in designation. -[3]- NFSC officials did not consult with an NFSC compliance officer to determine whether NFSC was complying with Regulation T. NFSC also could have consulted the staff of the Commission, the Federal Reserve or any self-regulatory organization on the issue. They did not do so. ==========================================START OF PAGE 4====== security as defined in Section 2 of Regulation T, 12 C.F.R.  220.2. B. APPLICABLE LAW Section 7(c) of the Exchange Act provides in part: It shall be unlawful for any member of a national securities exchange or any broker or dealer, directly or indirectly to extend or maintain credit or arrange for the extension or maintenance of credit to or for any customer -- (1) on any security (other than an exempted security), in contravention of the rules and regulations which the Board of Governors of the Federal Reserve System shall prescribe ... . Regulation T, promulgated by the Federal Reserve, 12 C.F.R.  220.1, et seq., regulates matters relating to the extension and maintenance of credit by and to brokers and dealers. Among other things, Regulation T sets forth initial margin requirements and rules concerning the maintenance of credit extended on securities transactions. "Margin securities" are defined in Section 2, 12 C.F.R.  220.2, and include any over-the-counter ("OTC") stock appearing on the Federal Reserve's periodically published list of OTC margin stocks, any stock registered on a national securities exchange, and any OTC security designated as qualified for trading in the NASDAQ National Market System. OTC stocks which do not meet one of these requirements are not margin securities. Vertex stock did not meet one of these requirements until November 26, 1993. Section 18(e) of Regulation T, 12 C.F.R.  220.18(e) (original version at Section 19(e) of Regulation T, 12 C.F.R.  220.19(e) (1996)), requires a margin of one hundred percent on positions of non-margin securities. By extending and maintaining credit on Vertex stock to customers prior to November 26, 1993, NFSC allowed margins which were lower than one hundred percent. NFSC continued to do so for some twelve weeks after discovering that Vertex was not a margin security. As a result, NFSC willfully violated Section 7(c) of the Exchange Act and Section 18(e) of Regulation T by extending and maintaining credit on an ==========================================START OF PAGE 5====== OTC equity security that was not a "margin security" under Section 2 of Regulation T.-[4]- IV. ORDER In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer of Settlement of Respondent and impose the sanctions specified therein. Accordingly, IT IS ORDERED that Respondent: 1. Be, and hereby is, censured; 2. Pay a civil money penalty, pursuant to Section 21B(a) of the Exchange Act, in the amount of $50,000 to the United States Treasury. Such payment shall be made within five business days of the date of this Order and shall be: (a) made by United States postal money order, certified check, bank cashier's check or bank money order; (b) made payable to the U.S. Treasury; (c) hand-delivered to the Office of the Comptroller, Securities and Exchange Commission, 450 5th Street, N.W., Washington, D.C. 20549; and (d) submitted under cover letter which identifies NFSC as the Respondent in these proceedings, the file number of these proceedings and the Commission's case number (HO-2872), a copy of which cover letter and money order or check will be sent to Gary N. Sundick, Associate Director, Division of Enforcement, Securities and Exchange Commission, 450 5th Street N.W., Mail Stop 4-1, Washington, D.C. 20549; and 3. Cease and desist from committing or causing any violations and any future violations of Section 7(c) of the Exchange Act and Regulation T thereunder. By the Commission. ---------FOOTNOTES---------- -[4]- "Willfully" as used in this Order means intentionally committing the act which constitutes the violation. There is no requirement that the actor also be aware that he is violating one of the Rules or the Acts. See Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965). ==========================================START OF PAGE 6====== Jonathan Katz Secretary