UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. 38673 / May 27, 1997 Admin. Proc. File No. 3-8991 : In the Matter of the Application of : : LITWIN SECURITIES, INC. : 329 Arthur Godfrey Road : Miami Beach, Florida 33140 : : and : : HAROLD A. LITWIN : 2815 Prairie Avenue : Miami Beach, Florida 33140 : : 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 Failure to Comply with Recordkeeping Provisions Failure to Give Telegraphic Notice of Net Capital Deficiency Failure to Comply with Net Capital Requirements Member firm of registered securities association and firm's president and former FINOP filed inaccurate FOCUS reports, failed to give required telegraphic notice of firm's net capital deficiency, and conducted a securities business when firm's net capital was below required minimum. Held, association's findings of violation and sanctions it imposed are sustained. APPEARANCES: Avi J. Litwin, for Litwin Securities, Inc. and Harold A. Litwin. Alden S. Adkins and Norman Sue, Jr., for the National Association of Securities Dealers, Inc. Appeal filed: April 26, 1996 Briefing completed: September 30, 1996 I. Litwin Securities, Inc. ("LSI" or the "Firm"), a member of the National Association of Securities Dealers, Inc. (the "NASD"), and Harold A. Litwin, president, general securities principal, and former financial and operations principal ("FINOP") of LSI, <(1)> appeal from NASD disciplinary action. The NASD found that LSI, acting through Litwin: (a) filed an inaccurate Financial and Operational Combined Uniform Single Report ("FOCUS Report"), Part I, on Securities Exchange Act of 1934 ("Exchange Act") Form X-17A-5, for the month ended November 30, 1994, and also submitted a false and misleading balance sheet and net capital computation to the NASD staff for this time period, in violation of Article III, Section 1 of the NASD's Rules of Fair Practice ("NASD Rules"); <(2)> (b) failed to maintain current and accurate books and records by failing to post certain liabilities, by misclassifying certain assets as allowable, and by overstating LSI's net capital for the month ended December 31, 1994, in violation of Article III, Sections 1 and 21 of the NASD Rules; <(3)> (c) filed an inaccurate FOCUS Report, Parts I and IIA, for the month ended December 31, 1994, in violation of Article III, Section 1 of the NASD Rules; and (d) conducted a securities business without the minimum capital required by Rule 15c3-1 under the Exchange Act, and failed to give notice to the NASD and this Commission of LSI's net capital deficiency as required by Exchange Act Rule 17a-11, in violation of Article III, Section 1 of the NASD Rules. <(1)> On November 11, 1994, in connection with an unrelated NASD disciplinary proceeding, the NASD ordered Litwin to requalify as a FINOP. On August 25, 1995, the NASD terminated Litwin's registration for failure to comply with that requalification order. <(2)> The NASD recently revised and renumbered its Rules of Fair Practice and Code of Procedure; no substantive changes were made to the particular rules at issue here. Article III, Section 1 of the NASD Rules [new Conduct Rule 2110] requires the observance of high standards of commercial honor and just and equitable principles of trade. <(3)> Article III, Section 21 of the NASD Rules [new Conduct Rule 3110] requires each NASD member to keep and preserve books, accounts records, memoranda, and correspondence in conformity with applicable laws, rules, regulations, and statements of policy. ======END OF PAGE 2====== The NASD censured LSI and Litwin, fined them $25,000, jointly and severally, and barred Litwin from acting as a FINOP with any NASD member. <(4)> Our findings are based on an independent review of the record. II. The facts generally are not in dispute. At all relevant times, LSI was required to maintain minimum net capital of $50,000 pursuant to Exchange Act Rule 15c3-1(a). LSI also was required, pursuant to Exchange Act Section 17(a) and the rules thereunder, to keep current and accurate records and to calculate and report its net capital on a monthly basis to this Commission and the NASD on the FOCUS Report. A. Applicants do not dispute that LSI, acting through Litwin, filed an inaccurate FOCUS Report, Part I, for the month ended November 30, 1994 (the "November FOCUS Report"), which overstated LSI's net capital by $1,165, and also furnished to the NASD regional examination staff supporting documentation that reflected that overstatement, in violation of Article III, Section 1 of the NASD Rules. The record supports the NASD's findings of violation, and we accordingly sustain them. <(5)> Applicants, however, strenuously object to "any concern or finding by the [NASD] that the erro[neous overstatement] was not inadvertent." <(6)> Applicants contend that they now can account conclusively for the $1,165 overstatement. <(7)> They accordingly dispute any <(4)> The NASD also assessed costs. <(5)> See Fundclear, Inc., 51 S.E.C. 1316, 1321 (1994) (firm's overstatement of net capital in FOCUS Report, Part I, violated Article III, Section 1 of the NASD Rules). <(6)> The NASD's District Business Conduct Committee ("DBCC") expressed its concern with the facts that (1) applicants could provide no reasoned, consistent explanation for the overstatement; (2) the NASD's examiner testified that, after reviewing LSI's books and records, he could not account for the $1,165 discrepancy; and (3) the amount of the overstatement caused LSI's reported capital to rise above the level that triggers the telegraphic notice requirements of our Exchange Act Rule 17a-11. <(7)> Applicants advise us that the discrepancy resulted when Litwin erroneously failed to post certain payroll expenses to LSI's bank account. Before the DBCC, Litwin initially testified that the $1,165 overstatement may have been due to the fact that he had not yet received LSI's November bank account statement when he prepared LSI's November FOCUS Report, and that he believed the statement reflected unanticipated account debit reversals and bank charges. Litwin (continued...) ======END OF PAGE 3====== suggestion that applicants' previous inability to account for the capital discrepancy is an indication that applicants "made up a number" that raised the firm's capital above the threshold that triggers the telegraphic notice requirements of Exchange Act Rule 17a-11. Whether applicants acted deliberately to evade our Exchange Act Rule 17a-11 is not before us; the NASD did not so charge applicants, and we make no finding in this regard. B. We turn now to the NASD's findings that LSI, acting through Litwin, failed to maintain current and accurate books and records, and thus violated Article III, Section 1 and 21 of the NASD Rules, by: (1) failing to post a $1,670 liability resulting from a prior NASD disciplinary action; (2) failing to post a $470 liability to an advertising vendor; (3) overstating commissions receivable by $1,386; and (4) overstating LSI's net capital by approximately $6,000, as a result of (a) the foregoing errors; (b) the misclassification of order flow receivables as allowable assets; and (c) incorrectly reflecting other account balances not charged as violations of the NASD Rules. The NASD also alleged that LSI, through Litwin, filed an inaccurate FOCUS Report, Parts I and IIA, for the month ended December 31, 1994, that included this overstated net capital figure, in violation of Article III, Section 1 of the NASD Rules. 1. It is undisputed that LSI, through Litwin, in calculating its capital for the covered period, failed to post a $1,670 liability resulting from a previous NASD disciplinary fine and costs imposed in a decision issued November 11, 1994, <(8)> thereby overstating the Firm's net capital by $1,670. The decision became final on December 26, 1994, and should have been "booked" as a liability as of that date, because LSI and Litwin did not appeal the decision and it was not called for review. <(9)> <(7)>(...continued) subsequently testified that the overstatement may have been due instead to the automatic withdrawal of a $555 life insurance premium for a policy that had been cancelled. The DBCC concluded from Litwin's testimony that "Litwin was unable to provide any rational basis whatsoever for the bank balance figure used in the FOCUS report and in the . . . documents provided to the staff." <(8)> District No. 7 v. Litwin Securities, Inc. and Harold A. Litwin, Complaint No. C07930057, (November 11, 1994). <(9)> See Article II, Section 8 of the NASD Code of Procedure [new Procedure Rule 9225] (unless appealed to, or (continued...) ======END OF PAGE 4====== Applicants nonetheless contend that Litwin, based on his prior experience with the NASD's disciplinary process, reasonably believed that the disciplinary fine and costs did not have to be treated as a current liability until the NASD presented applicants with a bill for payment. The NASD counters that any such belief by applicants could not have been reasonable since they were sanctioned in November 1994 for an identical failure to book a disciplinary fine. While it does not appear that the conduct at issue in this case is identical to that at issue in the NASD's 1994 decision, <(10)> we conclude that LSI and Litwin are charged with knowledge of, and obligated to adhere to, the well-established requirement that adverse judgments must be booked as liabilities when they are rendered. <(11)> We therefore sustain the NASD's finding that applicants failed to maintain current and accurate books and records in violation of Article III, Sections 1 and 21 of the NASD Rules in connection with the Firm's failure to book the disciplinary fine as a current liability. <(12)> 2. The record also establishes, as the NASD found, that LSI, through Litwin, overstated the Firm's net capital by failing to book a $470 liability owed to its advertising vendor. Litwin continues to claim, as he did before the NASD, both that LSI did not receive the bill until January 1995 -- several months after the services were rendered and one month after <(9)>(...continued) called for review by, the NASD Board of Governors, DBCC's decision constitutes final NASD disciplinary action). <(10)> In the November 1994 decision, these applicants were fined $1,000, jointly and severally, and were assessed costs of $670, for failing to book a $5,000 fine and $574.20 in costs assessed against applicants in February 1992. On issuance of the January 1992 decision, applicants entered into an agreement with the NASD to pay their fine and costs on a monthly installment basis until the liability was satisfied, but -- rather than accruing the entire liability in the month when the decision was rendered -- accrued the liability monthly as periodic payments were made. The NASD concluded in its November 1994 decision that, in accruing the liability monthly, applicants failed to maintain current and accurate books and records, overstated their net capital, and filed an incorrect 1992 annual audited financial report. <(11)> See, e.g., Wallace G. Conley, 51 S.E.C. 300, 302 (1993) (under generally accepted accounting principles, adverse judgment should be booked when judgment rendered, not when confirmed on appeal). <(12)> We need not agree with the NASD that Litwin's failure timely to book the liability "raises questions as to whether this violation was inadvertent" in order to sustain the NASD's finding of violation. ======END OF PAGE 5====== the December 6, 1994 date on the face of the vendor's bill -- and that the amount of the bill was in dispute at the time the Firm calculated its net capital for the month ended December 31, 1994. The NASD did not credit Litwin's claims, and we see no basis for disagreement with that assessment, particularly given the date of the bill, and the fact that, as the NASD noted, Litwin offered no evidence that the bill was in dispute other than his own testimony. <(13)> Litwin also focuses in this appeal on what he characterizes as "the DBCC's insinuation" that he "fabricated" the bill dispute. The NASD did not charge applicants with "fabrication," and we make no finding in this regard. 3. Applicants do not dispute that LSI, through Litwin, overstated the Firm's commissions receivable by $1,386 as of December 31, 1994. <(14)> This overstatement occurred when Litwin erroneously estimated LSI's commissions receivable for November 1994 from LSI's clearing firm and then failed to reconcile his estimate with the actual commissions received and confirmed from the clearing firm in December 1994. This failure to reconcile is particularly troubling because, prior to this overstatement, applicants had been warned that the Firm's practice of estimating commissions receivable had resulted in overstatements in prior months and had been directed to reconcile, on a monthly basis, LSI's commissions with confirmation statements received from LSI's clearing firm. <(15)> Applicants label the $1,386 overstatement a "minimal discrepancy" attributable to a change in the Firm's internal accounting systems and state that an overstatement of this nature cannot and will not happen again. We do not consider the laxity exhibited in this matter to be in any way excusable, or the violations established "minimal" or "technical" in <(13)> The credibility determinations of an initial fact- finder are entitled to considerable weight and deference, since they are based on hearing the witnesses' testimony and observing their demeanor. See, e.g., Jonathan Garrett Ornstein, 51 S.E.C. 135, 137 (1992) (citing Universal Camera Corp. v. NLRB, 340 U.S. 474 (1951)). Only where the record contains "substantial evidence" to the contrary will we reject such determinations. See Helene R. Schwartz, 51 S.E.C. 1207, 1208 n.5 (1994). <(14)> Commission receivables may be included in net capital, provided that they are not outstanding longer than thirty days. See Exchange Act Rule 15c3- 1(c)(2)(iv)(C). <(15)> In a Letter of Caution to Litwin and LSI, dated November 14, 1994, the NASD found that "the firm failed to . . . reconcile its commissions receivable account with its clearing firm's statements during the months of June and July 1994." ======END OF PAGE 6====== nature. <(16)> We accordingly sustain the NASD's finding that applicants failed to maintain current and accurate books and records in connection with the overstatement in violation of Article III, Sections 1 and 21 of the NASD Rules. 4. We now turn to the NASD's finding that applicants overstated net capital for December 31, 1994, by a total of $6,037 in violation of Article III, Sections 1 and 2 of the NASD Rules. Among other items related to the overstatement, <(17)> the NASD concluded that Litwin, acting for LSI, misclassified as allowable assets for net capital purposes, $2,610 in unsecured order flow receivables, i.e., fees due from LSI's clearing firm to LSI in return for the routing of customer orders to the clearing firm. <(18)> We agree with the NASD that these receivables are properly classified as non-allowable assets under our net capital rule. "Net capital" is defined as the net worth of a broker-dealer adjusted by, among other things, "[d]educting fixed assets and assets which cannot be readily converted into cash." <(19)> Assets that cannot be readily converted into cash, and thus may not be booked as allowable assets under Exchange Act Rule 15c3-1(c)(2)(iv), include "[a]ll . . . unsecured receivables" <(20)> unless otherwise specifically included under the rule. Acknowledging that their classification of the unsecured order flow receivables as allowable assets was in error, applicants claim that the NASD had not "informed" Litwin previously that order flow receivables were to be treated as unsecured receivables. This does not afford applicants any defense. NASD member firms and their FINOPs are charged with knowing the applicable regulations, including rules governing the computation of <(16)> See, e.g., Wallace G. Conley, 51 S.E.C. at 303 (net capital violations are serious offenses). <(17)> In deriving a total overstatement of $6,037, the NASD considered the $1,670 disciplinary fine and $470 vendor's liability discussed supra in Section II.B.1 and II.B.2, respectively, the $1,386 commissions receivable overstatement discussed in Section II.B.3, supra, and also made the following additional adjustments, which applicants have not disputed: (a) the trading account balance, which applicants incorrectly had recorded, was increased by $201; and (b) the error account position, which applicants had not reflected on the firm's books, was increased by $50 to reflect an options position in the account, and then decreased by $90 to reflect a debit balance in the account. <(18)> See Exchange Act Rule 10b-10(d)(9). <(19)> Exchange Act Rule 15c3-1(c)(2)(iv). See generally, Fundclear, Inc., 51 S.E.C. at 1319. <(20)> Exchange Act Rule 15c3-1(c)(2)(iv). ======END OF PAGE 7====== net capital, <(21)> and cannot shift their responsibility for compliance to the NASD. <(22)> We sustain the NASD's finding that, by overstating LSI's net capital by some $6,000, applicants failed to maintain current and accurate books and records in violation of Article III, Sections 1 and 21 of the NASD Rules. 5. Because LSI's FOCUS Report for the month ended December 31, 1994 included the $6,037 net capital overstatement, we sustain the NASD's finding that applicants filed an inaccurate FOCUS Report, Parts I and IIA for the period at issue, in violation of Article III, Section 1 of the NASD Rules. C. Lastly, the NASD found that an NASD regional examiner noticed, in reviewing LSI's financial records during an examination, that Litwin had deposited $15,000 of personal funds into LSI's bank account on December 30, 1994. This deposit caused the examiner to question whether LSI had been under capital immediately prior to the deposit. After backing out the $15,000 deposit and adding back checks written and bank charges the Firm incurred on December 30 and 31, 1994, the examiner determined that LSI had net capital of $46,300 as of December 29, 1994. Applicants did not notify this Commission or the NASD of this $3,700 net capital deficiency until February 1995, when directed to do so by NASD staff. Applicants do not dispute that, on December 29, 1994, LSI conducted a securities business with less than the required net capital and failed to provide the requisite notice of this deficiency. They focus instead on their lack of intent to violate the applicable law. Because intent is not relevant here, <(23)> we sustain the NASD's findings that applicants violated Article III, Section 1 of the NASD Rules when (a) on December 29, 1994, LSI, acting through Litwin, conducted a securities business while failing to maintain the minimum capital required by Exchange Act Rule 15c3-1, and (b) failed to give notice of the capital deficiency within twenty-four hours to the NASD and this Commission, as required by Exchange Act Rule 17a-11. III. <(21)> See Wallace G. Conley, 51 S.E.C. at 303 (a FINOP may not abdicate his responsibilities for assuring compliance with net capital rules). <(22)> See Thomas C. Kocherhans, Exchange Act Rel. No. 36556 (December 6, 1995), 60 SEC Docket 2589, 2593 n.14 (member firm cannot shift to NASD responsibility for compliance); G.K. Scott & Co., Inc., 51 S.E.C. 961, 966 n.21 (1994) (same). <(23)> Cf. Charters & Co., of Miami, 43 S.E.C. 175, 177 (1966) (inadvertent net capital violations are not excused). ======END OF PAGE 8====== LSI and Litwin contest the sanctions imposed. <(24)> Applicants claim that the NASD erred in suggesting that certain of Litwin's conduct here may have been deliberate rather than the result of inadvertence, and seek a remand to the NASD so that the sanctions may be reconsidered. We do not find that the sanctions imposed are either excessive or oppressive, given the breadth of violations established and applicants' long history of disciplinary violations. <(25)> The $25,000 joint and several fine imposed against applicants is a measured sanction for the violations found, and is within the fine range set forth in the NASD's guidelines. <(26)> Further, Litwin has proven himself incapable of managing the finances and operations of a broker-dealer. Litwin's consistent response to discipline, before both the NASD and this Commission, has been that, while he has no formal financial or accounting training, he has learned from the violations found and discipline imposed and therefore will not commit similar violations in the future. We cannot countenance FINOP training through discipline. We conclude, as did the NASD, that Litwin is not fit to serve as a financial and operations <(24)> Applicants have filed a motion to adduce additional evidence pursuant to Rule 452 of our Rules of Practice in order to substantiate their contentions that their violations "were not committed intentionally." We deny the motion. The issue of applicants' intent is irrelevant here. Nor have they shown good cause why such documents were not introduced before the NASD. <(25)> Since registering with this Commission and the NASD in 1982, LSI and Litwin have been the subject of at least six disciplinary proceedings, most of which involved financial or operational misconduct, including failures to keep accurate books and records, filing late or inaccurate FOCUS Reports, and failing to comply with net capital requirements. In November 1995 we reviewed one of these matters, and sustained the finding that applicants had violated LSI's restrictive agreement with the NASD. Litwin Securities, Inc. and Harold A. Litwin, Exchange Act Rel. No. 36500 (November 21, 1995), 60 SEC Docket 2173, 2177. In that case, as here, Litwin and LSI argued that the violations were inadvertent and "merely technical" in nature. <(26)> The NASD Sanction Guidelines ("Guidelines") suggest that the maximum fine for filing inaccurate FOCUS reports, for recordkeeping violations, or for net capital violations is $20,000 per violation. See NASD Sanction Guidelines (1993 & 1996 editions) at 23, 35, and 40. The Guidelines state that a FINOP bar also may be appropriate for egregious violations. Id. For repeated net capital violations the Guidelines provide that the fine may be imposed individually upon both the firm and the persons responsible for the violation. Id. at 35. ======END OF PAGE 9====== principal of a member firm. An appropriate order will issue. <(27)> By the Commission (Chairman LEVITT and Commissioners WALLMAN, JOHNSON, and HUNT). Jonathan G. Katz Secretary <(27)> All of the arguments advanced have been considered. They are rejected or sustained to the extent that they are inconsistent or in accord with the views expressed in this opinion. ======END OF PAGE 10====== UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. Admin. Proc. File No. 3-8991 : In the Matter of the Application of : : LITWIN SECURITIES, INC. : 329 Arthur Godfrey Road : Miami Beach, Florida 33140 : : and : : HAROLD A. LITWIN : 2815 Prairie Avenue : Miami Beach, Florida 33140 : : 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 Litwin Securities, Inc. and Harold A. Litwin, and the Association's assessment of costs, be, and they hereby are, sustained. By the Commission. Jonathan G. Katz Secretary