UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION INVESTMENT ADVISERS ACT OF 1940 Release No. 1622 / March 18, 1997 ADMINISTRATIVE PROCEEDING File No. 3- 9275 ----------------------------- : ORDER INSTITUTING PUBLIC In the Matter of : ADMINISTRATIVE AND : CEASE-AND-DESIST PROCEEDING, : MAKING FINDINGS AND : IMPOSING REMEDIAL SANCTIONS H.P. HAMBRICK CO., INC. : : and HENRY P. HAMBRICK, : : : : Respondents. : : _____________________________: I. The Securities and Exchange Commission (the "Commission") deems it appropriate and in the public interest that a public administrative and cease-and-desist proceeding be instituted pursuant to Sections 203(e), 203(f) and 203(k) of the Investment Advisers Act of 1940 ("Advisers Act") against H.P. Hambrick Co., Inc. ("HPH") and Henry P. Hambrick ("Hambrick"). Accordingly, IT IS HEREBY ORDERED that an administrative and cease-and-desist proceeding against HPH and Hambrick be, and hereby is, instituted. II. ==========================================START OF PAGE 2====== In anticipation of the institution of this proceeding, HPH and Hambrick have submitted an offer of settlement ("Offer"), which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the Commission's findings contained herein except that HPH and Hambrick admit the jurisdiction of the Commission over them and over the subject matter of this proceeding, HPH and Hambrick consent to the issuance of this Order Instituting Public Administrative and Cease-and-Desist Proceeding, Making Findings and Imposing Remedial Sanctions ("Order"). ==========================================START OF PAGE 3====== III. On the basis of this Order and the Offer, the Commission makes the following findings: A. HPH is a California corporation that has been registered with the Commission as an investment adviser since June 11, 1976 (File No. 801-11653). During the relevant period, HPH had custody and discretionary trading authority over the assets of 47 advisory clients, including 28 clients whose assets HPH s Swiss affiliate, Pajolo AG ( Pajolo ), held in its own name at several Swiss banks. HPH ceased operations in October 1993 after Pajolo filed for bankruptcy in Switzerland. B. Hambrick, age 73, resides in Pismo Beach, California, and was the President and sole shareholder (with his wife) of HPH and Pajolo. During the relevant period, Hambrick controlled the operations of HPH and Pajolo. In October 1993, after Pajolo filed for bankruptcy, Hambrick retired and closed down HPH. C. Pajolo was a Swiss corporation located in Zug, Switzerland that was HPH's unregistered affiliate from its inception in 1976 until late 1993. During the relevant period, Pajolo maintained custody of funds and investments belonging to 28 HPH advisory clients. It filed for bankruptcy in Switzerland in late September 1993, and has been liquidated. None of HPH's clients received any funds from the bankruptcy estate. The CD Investment Program D. From at least 1992 through September 1993, HPH and Hambrick, through Pajolo, offered and sold at least $3.5 million of short-term foreign certificate of deposit investments ("CD Investments" or "CDs") to HPH's unsophisticated (and in many cases, elderly) advisory clients.-[1]- The CD Investments were denominated in European currencies, had typical maturities of between 30 and 90 days and, in many cases, carried interest rates slightly higher than those available on domestic CDs. Hambrick emphasized the safety of the CD Investments by stating to the clients that reputable European banks would issue all of the investments. He further stated that clients could profit from these investments if currency exchange rates changed favorably. E. HPH and Hambrick pooled the funds and investments of 28 advisory clients in Pajolo's accounts at several large Swiss banks. The banks acted as Pajolo's securities brokers. HPH and ---------FOOTNOTES---------- -[1]- In prior years, the clients had purchased approximately $1.9 million of foreign stocks and bonds through Pajolo. ==========================================START OF PAGE 4====== Hambrick represented to the clients that their funds and securities would be held in separate accounts at the Swiss banks, and did not disclose this pooling arrangement to the clients. ==========================================START OF PAGE 5====== F. HPH and Hambrick purchased many CD Investments for clients with margin credit provided to Pajolo by the Swiss banks. The banks secured Pajolo's margin loans with all of Pajolo's assets, including funds and investments belonging to clients who did not use margin credit. The banks also required Pajolo to maintain 20% equity in its bank accounts to avoid margin calls. HPH and Hambrick did not disclose Pajolo's margin arrangement with the banks to the clients. G. HPH and Hambrick also provided other valuable services to the advisory clients. Among other things, they managed Pajolo's operations and maintained its business relationship with the Swiss banks so that clients could purchase CD Investments. Moreover, HPH and Hambrick reinvested the proceeds from maturing CD Investments into new investments and made payments of principal and interest to clients when necessary. Finally, they maintained HPH's and Pajolo's books and records and provided quarterly account statements to the clients listing the clients' purported individual investments. In exchange for providing these services, HPH charged the clients an advisory fee consisting of one percent of the clients' total assets under management. HPH's and Hambrick's Fraudulent Misuse of the Advisory Clients' Assets H. Even though Hambrick told the advisory clients that their CD Investments were safe and profitable at Pajolo, the exact opposite was true. During 1992 through late 1993, many clients suffered losses on their CD Investments due to adverse currency exchange rate changes. The losses decreased Pajolo's total equity at the Swiss banks, triggered margin calls, caused the banks to confiscate a substantial portion of the clients' assets and left Pajolo in extremely poor financial condition. As a result, HPH and Hambrick began misappropriating certain advisory clients' assets to pay periodic withdrawals of principal and interest to other clients. By September 1993, they had misappropriated $5,447,958 which led to more margin calls and Pajolo's ultimate collapse and bankruptcy. I. One way that HPH and Hambrick misappropriated assets from clients was to secretly roll over the clients' fractionalized interests in large Portuguese escudo CD Investments ("Jumbo CD Investments" or "Jumbo CDs") into increasingly smaller Jumbo CDs at maturity. HPH and Hambrick purchased the smaller Portuguese escudo investments for HPH's clients up to the time of Pajolo's bankruptcy. HPH and Hambrick used the misappropriated portions of the Jumbo CDs to cover Pajolo's margin calls at the Swiss banks and pay withdrawals of principal and interest to various clients. ==========================================START OF PAGE 6====== J. During 1992 and 1993, while engaging in the fraudulent activities described in paragraphs III(H) and (I) above, HPH and Hambrick misrepresented to the advisory clients that: 1. CDs and Jumbo CDs purchased by Pajolo were safe investments even though clients for years had unknowingly suffered losses on those investments; 2. all of the clients' investments existed and that Pajolo held them on deposit at Swiss banks; and 3. certain clients owned individual CD investments (rather than interests in Jumbo CD Investments). K. During 1992 and 1993, while engaging in the fraudulent activities described in paragraphs III(H) and (I) above, HPH and Hambrick omitted to state to the advisory clients that: 1. Pajolo was in extremely poor financial condition; 2. HPH and Hambrick had used a large portion of the clients' assets to supplement Pajolo's failing cash flow; 3. all of the clients' assets were commingled in Pajolo's Swiss bank accounts; 4. all of the clients' assets secured Pajolo's margin loans from the Swiss banks, including the assets of clients who did not use the banks' margin credit; 5. the Swiss banks confiscated clients' assets when making margin calls on Pajolo, including assets of clients who did not use the banks' margin credit; and 6. certain clients who owned Jumbo CDs were rolled over into smaller Jumbo CDs so that Pajolo could use some clients' funds to supplement its failing cash flow. L. During 1992 and 1993, HPH, while acting in bad faith and in breach of its fiduciary duty to the clients, willfully violated Sections 206(1) and 206(2) of the Advisers Act by: (1) misrepresenting and omitting to state the material facts described in paragraphs III(J) and (K) above to the clients; and (2) misusing the clients' assets as described in paragraphs III(H) and (I) above. M. During 1992 and 1993, Hambrick caused and willfully aided and abetted HPH's violations of Sections 206(1) and 206(2) ==========================================START OF PAGE 7====== of the Advisers Act by: (1) misrepresenting and omitting to state the material facts described in paragraphs III(J) and (K) above to the advisory clients; and (2) directing HPH, an entity under his control, to misuse the clients' assets as described in paragraphs III(H) and (I) above. HPH's and Hambrick's Failure to Disclose HPH's Poor Financial Condition N. Section 206(4) of the Advisers Act makes it unlawful for an investment adviser to engage in any act, practice or course of business which is fraudulent, deceptive or manipulative and authorizes the Commission to adopt rules defining fraudulent, deceptive or manipulative conduct within the meaning of this section. Rule 206(4)-4(a)(1) provides that it shall constitute a fraudulent, deceptive or manipulative act, practice or course of business within the meaning of Section 206(4) for an adviser to fail to disclose to any client or prospective client all material facts concerning a financial condition of the adviser that is reasonably likely to impair that adviser's ability to meet its contractual commitments to clients. Disclosure under this rule is required when, as relevant here, an adviser has discretionary authority and custody over clients' funds and securities. O. In fact, advisers have a fiduciary duty to disclose their insolvent or precarious financial condition along with the possibility that they may be unable to meet their obligations to clients, as these are material facts. In the Matter of Intersearch Technology, Inc., [1974-1975 Transfer Binder] Fed. Sec. L. Rep. (CCH) 80,139 at 85,189 (February 28, 1975). See also, In the Matter of the Dynamics Letter, [1961-1964 Transfer Binder] Fed. Sec. L. Rep. (CCH) 76,936 (September 4, 1963); Financial and Disciplinary Information That Investment Advisers Must Disclose to Clients, [1987 Transfer Binder] Fed. Sec. L. Rep. (CCH) 84,158, Advisers Act Rel. No. 1083 (October 2, 1987). P. In this case, during 1992 through late 1993, HPH and Hambrick falsified HPH's balance sheets in order to conceal HPH's ever-deteriorating financial condition from the Commission and the advisory clients. In fact, HPH, at Hambrick's direction, improperly recorded large amounts of uncollectible advisory fees as revenue and as an account receivable on HPH's books. By improperly recording these transactions, HPH and Hambrick were able to grossly inflate HPH's assets and equity, as discussed in paragraphs III(Q) through (S) below. Q. For the calendar year ended December 31, 1991, HPH and Hambrick filed a balance sheet for HPH with the Commission on April 6, 1992, that grossly overstated HPH's assets and equity, and thereby concealed its poor financial condition. They stated on this balance sheet that HPH had total assets of $538,158, ==========================================START OF PAGE 8====== including $228,091 of advisory fees receivable from clients. These advisory fees were uncollectible because, due to HPH's and Hambrick's misappropriations of the assets of the advisory clients, the clients lacked funds at Pajolo to pay the fees. If Hambrick had directed HPH to write off this large receivable, -[2]- its major asset, HPH would have suffered a reduction in assets and an operating loss large enough to eliminate its $120,749 of balance sheet equity. The writeoff also would have exposed HPH's poor financial condition and its likely inability to continue to meet its contractual obligations to its advisory clients. HPH did not provide this balance sheet to its clients. R. For the calendar year ended December 31, 1992, HPH and Hambrick continued to overstate HPH's assets and equity. They created a balance sheet for HPH showing that it had total assets of $553,043, including $232,393 of advisory fees receivable. These advisory fees, most of which had been carried over from the prior year, were uncollectible. Nevertheless, Hambrick did not direct HPH to write them off as a loss on HPH's books. If HPH had recognized this loss, its $138,336 of balance sheet equity again would have been totally depleted thereby exposing its likely inability to continue to meet its contractual obligations to its advisory clients. HPH did not provide this balance sheet to its clients. S. During 1993, HPH remained in poor financial condition. At September 30, 1993, the date of Pajolo's bankruptcy, HPH and Hambrick prepared an interim balance sheet for HPH showing that HPH still had a large advisory fees receivable on its books that, if written off, would have totally wiped out HPH's $178,557 of balance sheet equity and again exposed its likely inability to continue to meet its contractual obligations to its advisory clients. HPH did not provide this balance sheet to its clients. T. By not disclosing its continuing poor financial condition to its advisory clients during 1992 and 1993, as described in paragraphs III(Q) through (S) above, HPH -----FOOTNOTES-------- -[2]-Paragraphs 8, 22 and 23 of the FASB Statement of Financial Accounting Standards No. 5, "Accounting For Contingencies," provide that a company shall write off an account receivable when: (1) it is probable that the receivable is uncollectible; and (2) the uncollectible amount can be reasonably estimated. In this case, it was very probable that HPH's advisory fees were uncollectible because HPH's clients lacked assets at Pajolo to pay their advisory fees. Moreover, most of the clients had invested their entire life savings with HPH and Hambrick and did not have any other assets on deposit elsewhere with which to pay the advisory fees. Therefore, HPH should have written off its advisory fees receivable in 1991. ==========================================START OF PAGE 9====== willfully violated Sections 206(1), 206(2) and 206(4) of the Advisers Act and Rule 206(4)-4(a)(1) thereunder. U. Hambrick caused and willfully aided and abetted HPH's violations of Sections 206(1), 206(2) and 206(4) of the Advisers Act and Rule 206(4)-4(a)(1) thereunder, as described in paragraphs III(P) through (T) above, by directing HPH to conceal its continuing poor financial condition from the clients during 1992 and 1993. ==========================================START OF PAGE 10====== Hambrick Caused HPH to File a False 1991 Balance Sheet With the Commission V. Rule 204-1(b)(2) under the Advisers Act requires a registered investment adviser with custody of its clients' assets to file its annual balance sheet with the Commission. Under Rule 204-1(d), this balance sheet constitutes a "report" for purposes of Section 207 of the Advisers Act. W. Section 207 of the Advisers Act provides, among other things, that it shall be unlawful for any person willfully to make any untrue statement of material fact in any report filed with the Commission under Section 204 of the Advisers Act, or willfully to omit to state in any such report any material fact required to be stated therein. X. In this case, HPH and Hambrick both willfully violated Section 207 of the Advisers Act when they prepared and filed HPH's materially false and misleading calendar year 1991 balance sheet with the Commission as described in paragraph III(Q) above. HPH Failed to Refrain From Taking Action With Respect to Advisory Clients' Funds and Securities Without Notifying Clients of Changes in the Location of These Assets Y. Under Rule 206(4)-2(a)(3) under the Advisers Act, an investment adviser with possession or custody of client funds or securities engages in fraudulent acts, practices or courses of business within the meaning of Section 206(4) of the Advisers Act by taking any action with respect to the funds and securities without, among other things, notifying clients in writing when the adviser has changed the location where it maintains custody of those funds and securities. Z. In this case, HPH willfully violated, and Hambrick caused and willfully aided and abetted HPH's violations of, Section 206(4) of the Advisers Act and Rule 206(4)-2 thereunder during 1992 through late 1993. HPH violated these provisions when it conducted its advisory business (i.e., took action with respect to the clients' funds and securities) without notifying the clients that it had changed the place in which their funds and securities were maintained (i.e., due to its misappropriations of some of the clients' assets from certain Pajolo bank accounts) as described in paragraphs III(H) and (I) above. Hambrick caused and willfully aided and abetted HPH's violations by failing to have HPH refrain from conducting its advisory business under these circumstances. Failure to Refrain From Taking Action With Respect to Advisory Clients' Funds ==========================================START OF PAGE 11====== and Securities Without Having an Independent Accountant Conduct Annual Surprise Counts of Those Funds and Securities AA. Under Rule 206(4)-2(a)(5) under the Advisers Act, an investment adviser with possession or custody of client funds or securities also engages in fraudulent acts, practices or courses of business within the meaning of Section 206(4) of the Advisers Act by taking any action with respect to client funds and securities without having an independent accountant: (1) conduct a surprise count and verification of those funds and securities during each calendar year; and (2) promptly thereafter file a verification certificate with the Commission setting forth the accountant's findings in the surprise count. AB. In this case, HPH willfully violated, and Hambrick caused and willfully aided and abetted HPH's violations of, Section 206(4) of the Advisers Act and Rule 206(4)-2 thereunder during 1992 through late 1993. HPH violated these provisions when, while maintaining custody of the clients' funds and securities at Pajolo, it conducted its advisory business without having an independent accountant conduct surprise counts of the clients' funds and securities at Pajolo and thereafter file certificates with the Commission. Hambrick caused and willfully aided and abetted HPH's violations by failing to have HPH refrain from conducting its advisory business under these circumstances. IV. Based on the foregoing, the Commission finds that: A. HPH willfully violated Sections 206(1), 206(2), 206(4) and 207 of the Advisers Act and Rules 206(4)-2 and 206(4)-4(a)(1) thereunder; B. Hambrick willfully violated Section 207 of the Advisers Act and caused and willfully aided and abetted HPH's violations of Sections 206(1), 206(2) and 206(4) of the Advisers Act and Rules 206(4)-2 and 206(4)-4(a)(1) thereunder; and C. HPH and Hambrick have submitted sworn financial statements and other evidence and have asserted their financial inability to pay disgorgement, plus prejudgment interest, or a substantial civil money penalty. The Commission has reviewed the sworn financial statements and other evidence provided by HPH and Hambrick and has determined that they do not have the financial ability to pay disgorgement of $5,447,958, plus prejudgment interest, or a civil money penalty larger than $8,000. ==========================================START OF PAGE 12====== Accordingly, the Commission deems it appropriate and in the public interest to impose the remedial sanctions specified in HPH's and Hambrick's Offer. Therefore, effective immediately, IT IS HEREBY ORDERED that: A. HPH and Hambrick cease and desist from committing or causing violations and any future violation of Sections 206(1), 206(2), 206(4) and 207 of the Advisers Act and Rules 206(4)-2 and 206(4)-4(a)(1) thereunder; B. HPH's registration as an investment adviser is revoked; C. Hambrick is barred from association with any broker, dealer, municipal securities dealer, investment adviser or investment company; ==========================================START OF PAGE 13====== D. HPH and Hambrick pay disgorgement of $5,447,958, plus prejudgment interest, pursuant to Sections 203(j) and 203(k)(5) of the Advisers Act, but that payment of such amount be waived based upon their demonstrated inability to pay disgorgement; E. Hambrick, within 30 days from the date of entry of this Order, pay a civil money penalty in the amount of $8,000 to the United States Treasury pursuant to Section 203(i)(2)(C) of the Advisers Act. Such payment shall be: (1) made by United States postal money order, certified check, bank cashier's check or bank money order; (2) made payable to the Securities and Exchange Commission; (3) hand-delivered to the Office of the Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop 6-9, Washington, D.C. 20549; and (4) submitted under cover letter that identifies Hambrick as a respondent in this proceeding. A copy of the cover letter and money order or check shall be sent to Ronald E. Wood, Assistant Regional Director, in the Commission's Pacific Regional Office; and F. The Division of Enforcement may, at any time, petition the Commission to: (1) reopen this matter to consider whether HPH and Hambrick provided inaccurate and incomplete financial information at the time such representations were made; (2) determine the amount of disgorgement, prejudgment interest and additional civil penalties to order; and (3) seek any additional remedies that the Commission would be authorized to impose in this proceeding if HPH's and Hambrick's Offer had not been accepted. No other issues shall be considered in connection with this petition other than: whether the financial information provided by HPH and Hambrick was fraudulent, misleading, inaccurate or incomplete in any material respect; the amount of disgorgement, prejudgment interest and additional civil penalties to order; and whether any additional remedies should be imposed. HPH and Hambrick may not, by way of defense to any such petition, contest the findings in this Order or the Commission's authority to impose any additional remedies that were available in the original proceeding. By the Commission. Jonathan G. Katz Secretary