SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 37865 / October 25, 1996 Admin. Proc. File No. 3-8870 __________________________________________________ : In the Matter of the Application of : : MICAH C. DOUGLAS : 2415 Brookdale Drive : Kingwood, Texas 77339 : : 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 Violation of Rules of Fair Practice Fraud in the Sale of Securities Violation of Just and Equitable Principles of Trade Where former registered representative of member firms of registered securities association made a fraudulent misrepresentation to a customer in the sale of securities, misrepresented his business activities to a potential customer, and failed to provide a member with notice of his outside business activities, held, association's findings of violation and the sanctions it imposed sustained. APPEARANCES: Micah C. Douglas, pro se. Alden S. Adkins and Anne H. Wright, for the National Association of Securities Dealers, Inc. and the National Association of Securities Dealers Regulation, Inc. Appeal filed: October 24, 1995 Briefing completed: May 13, 1996 ==========================================START OF PAGE 2====== I. Micah C. Douglas, who formerly was a registered representative of member firms of the National Association of Securities Dealers, Inc. ("NASD"), appeals from NASD disciplinary action. The NASD found that Douglas made a fraudulent misrepresentation to a customer in the sale of a security, -[1]- made misrepresentations about his business activities to a potential customer, and failed to provide his member firm with notice of his outside business activities. -[2]- The NASD censured Douglas, fined him $7,500, and suspended him from association with any member for 45 days. -[3]- Our findings are based on an independent review of the record. II. A. In March 1992, Douglas, who had been a securities salesman since 1977, was employed as an institutional salesman by M.G.S.I. Securities, Inc. ("M.G.S.I."). In this role, Douglas contacted William Rahmig of PVG Asset Management, which served as investment adviser for Jarvis Christian College ("Jarvis"). -[4]- Subsequently, in several conversations, Douglas offered to Rahmig various investments for Jarvis. In Rahmig's words, he told Douglas "very clearly" that he was interested only in "straight bonds, nothing fancy." On March 19, 1992, Douglas offered for sale to Rahmig a note issued by the Federal National Mortgage Association ("FNMA" or "Fannie Mae"). Rahmig felt that the yield sounded attractive for "a high quality bond" and decided to make a purchase of $700,000 from Douglas and M.G.S.I. ---------FOOTNOTES---------- -[1]- The NASD found that this violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. -[2]- The NASD found that Douglas thereby violated Article III, Section 1 of the NASD's Rules of Fair Practice, which requires compliance with high standards of commercial honor and just and equitable principles of trade. The NASD has recently renumbered the NASD Manual. This provision is now Rule 2110. -[3]- The NASD also assessed costs. -[4]- Douglas stated to Rahmig that Douglas knew a board member of Jarvis and would like to do business with PVG. ==========================================START OF PAGE 3====== A transcript of the conversation between Douglas and Rahmig -[5]- indicates that Douglas told Rahmig that M.G.S.I. had for sale a five-year AAA rated Fannie Mae security with "an extremely attractive yield" of 8.7125%. Rahmig expressed interest and stated to Douglas "now, this is a Fannie Mae straight?" -[6]- Douglas replied, "8.7125," and confirmed that the security was rated AAA and matured in five years (on February 12, 1997). Rahmig told Douglas that he would call back with an answer. In a follow-up call, Douglas advised Rahmig that Douglas could "get the order in right now and buy them at par for a yield of 8.7125 percent, AAA rated." Rahmig agreed to a purchase of $700,000. Douglas was credited a $19,687.50 commission on the sale. Rahmig in fact had purchased a FNMA Yield Curve Adjustable Note ("Y-CAN"). This FNMA note had an adjustable rate coupon that was reset semiannually. The coupon rate was determined by subtracting from 12.9% the six-month London Interbank Offering Rate (LIBOR). Thus, the coupon rate floated inversely to the LIBOR benchmark. -[7]- Between the trade and settlement dates, Rahmig "got rather chilled" when he realized that the security was not what he thought he was purchasing. He attempted to speak to Douglas, who was on vacation. Rahmig spoke instead with an M.G.S.I. trader and explained that the Y-CAN was not what he thought he was buying. The trader explained to Rahmig the security's variable interest rate features. While speaking to Rahmig, the trader formed the impression that Rahmig previously had not received an accurate description of the security. The trade had not yet ---------FOOTNOTES---------- -[5]- The compliance officer at M.G.S.I. explained to the District Business Conduct Committee that the firm's standard practice was to tape all telephone calls. Employees were aware that their conversations with clients were taped. -[6]- At the hearing, Rahmig stated that he understood "straight" to mean "it just yielded the same yield straight to maturity, and . . . it was not tied to anything." M.G.S.I. personnel testified that they understood that the term "straight" referred to a security with a fixed coupon and fixed maturity. -[7]- Notes of this type are generically referred to as "inverse floaters." At the time of the hearing, the note in question was yielding 7.5875%. ==========================================START OF PAGE 4====== settled and the trader, who had authority to cancel a transaction, decided to reverse the trade. -[8]- Information concerning the Y-CAN was readily available to Douglas. M.G.S.I. had been selling the security in question for over one month prior to the reversed sale to Rahmig. As a matter of firm practice, inventory positions, as well as messages from the traders to the sales force, were posted on a board in the open trading area. Although the trader did not have a specific recollection regarding the security at issue here, the practice of the traders was to list on the board essential aspects of the investments offered for sale, such as the LIBOR calculation here. Traders also "educate[d]" the sales force about specific investments when the firm first took an inventory position in the particular security. Additionally, the traders spoke weekly to the entire sales force about the securities in the firm's inventory, explaining various characteristics of those securities. Douglas serviced four or five customer accounts and did not generate a large number of transactions per month. On several occasions prior to the sale to Rahmig, Douglas had dealt with securities with floating interest rates similar to the security at issue here. M.G.S.I.'s standard procedure was that, when a salesman had an order, the salesman would speak with the trader, who would then write the order ticket. Consistent with standard firm procedure, the salesmen then would be handed back immediately a copy of the trade ticket written by the trader. Douglas denied receiving a copy of the ticket, which clearly identified the security that Douglas had sold Rahmig. Upon Douglas' return from vacation, M.G.S.I.'s compliance officer and a principal of the firm spoke to Douglas about the cancellation. Douglas explained to these M.G.S.I. officials only that he had "accentuated the positive" to the customer. -[9]- B. We find that Douglas misrepresented to Rahmig the interest rate features of the FNMA note. Douglas also omitted to disclose material facts about the security. The transcript of Douglas' conversations with Rahmig indicates that Douglas deliberately gave Rahmig the impression that the security had a fixed interest rate. Douglas at no time provided Rahmig with the essential facts about the variable nature of the security's ---------FOOTNOTES---------- -[8]- The trader explained at the hearing that cancellations were very rare. -[9]- M.G.S.I.'s compliance officer also reviewed the tape of Douglas and Rahmig's conversations. The firm dismissed Douglas over the incident. ==========================================START OF PAGE 5====== coupon. The aftermath of Douglas' misrepresentations and omissions demonstrates their significance: as soon as Rahmig realized that Douglas had sold him something other than what Douglas had represented, Rahmig called M.G.S.I. and the firm reversed the trade. Douglas claimed before the NASD that he believed that the note paid straight interest and mistakenly presented it to Rahmig as such. The District Business Conduct Committee, which observed the witnesses' demeanor, found Douglas' explanations "unpersuasive." In this regard, we note that Douglas previously had dealt with similar securities with floating interest rates and the firm's traders made it a practice to discuss with the sales force salient aspects of securities in inventory. Moreover, the features of securities were described on the inventory board and Douglas, who did not make frequent transactions, expected to earn a substantial commission on the sale. We therefore find that Douglas violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. III. From January 1, 1993 through August 31, 1993, Douglas was associated as a registered representative with First Affiliated Securities, Inc. ("FAS"), an NASD member firm. When Douglas became affiliated with FAS in late 1992 he filled out a questionnaire regarding outside business activities conducted "under any name other than FAS or any of its entities." The form stated the importance of notifying the firm of outside activities and was to be updated when any changes occurred. Additionally, FAS' procedures manual stated that no salesman could perform services or solicit customers "outside the auspices" of FAS. Nevertheless, on May 18, 1993, in an attempt to form a business relationship with the State of Texas, Douglas submitted by fax a completed "Broker/Dealer Questionnaire" -- a standard form used by the state -- to an official of the Texas State Treasury. Among other things, Douglas represented in that questionnaire that Micah C. Douglas & Co. ("MCD") was a broker- dealer offering institutional brokerage services. He further stated that MCD "ha[s] formed a joint venture with Bear Stearns" and that MCD cleared through "Bear Stearns." Douglas also answered "yes" to the question on the form asking whether the firm "had full SIPC insurance coverage." On the facsimile cover sheet transmitted with the questionnaire, Douglas wrote that "all our trades are guaranteed by Bear Stearns." Douglas did not disclose to the Texas State Treasury that he was registered to conduct business only as a representative of FAS. Moreover, MCD was not a registered broker-dealer and had no ==========================================START OF PAGE 6====== relationship with Bear, Stearns & Co., Inc. -[10]- MCD also did not have Securities Investor Protection Corporation, or SIPC, coverage. Nor did Douglas notify the FAS principal who supervised Douglas, or other FAS personnel, that Douglas, through MCD, was soliciting the State of Texas as a customer. The questionnaire that Douglas submitted to the Texas State Treasurer contained serious misrepresentations. By submitting the completed form, Douglas solicited business through MCD without disclosing to FAS this outside business activity, in violation of FAS policy. By this conduct, we find that Douglas violated just and equitable principles of trade. IV. A. Douglas argues that the proceeding should be "dismissed" based on what he claims is a conflict of interest on the part of William Felder, a member of the District Business Conduct Committee hearing panel, because of his asserted connection with a witness appearing before the panel. -[11]- We have considered Douglas' claim regarding Felder, but see no unfairness in his participation on the hearing panel. Linda Patterson, who testified before the hearing panel, was Assistant Deputy State Treasurer and Director of Investments at the Texas State Treasury. On June 2, 1993, she wrote a letter to the NASD complaining about Douglas' submission to her office of the completed broker-dealer questionnaire discussed in detail in Section III of this opinion. By the hearing date, August 25, 1995, Patterson had left her position with the state and served as president of Patterson & Associates, an investment adviser. Felder, the hearing panelist of whom Douglas complains, is a principal of Southwest Securities, Inc., a broker-dealer. The parent corporation of Southwest Securities, Inc. also owns an investment adviser. Four months before the hearing, a Texas state investment pool contracted with Southwest Securities' corporate parent to function as the pool's General Manager. The parent corporation, as General Manager, in turn contracted with its investment adviser subsidiary to act as investment adviser to the pool. The subsidiary contracted with Patterson & Associates, witness Patterson's firm, to act as a sub-adviser to the pool. Southwest Securities' parent and its affiliates do not have any ---------FOOTNOTES---------- -[10]- Bear, Stearns & Co., Inc. was, however, the clearing firm for FAS. -[11]- Douglas has advanced this argument in the form of a "Motion to Dismiss." We have treated this motion as Douglas's brief on appeal. ==========================================START OF PAGE 7====== ownership interest in Patterson & Associates. Nothing in the record indicates that Patterson and Felder were acquainted previously. B. Douglas claims, based on these facts, that Felder had an undisclosed business relationship with Patterson that amounts to a disqualifying conflict. Douglas first made this claim to the NASD's National Business Conduct Committee ("NBCC"). The NASD staff responded with "controverting affidavits," including that of Felder, who stated that he does not know Patterson and that he first became aware that Patterson was a registered investment adviser "whose activities might be described as those of a vendor of services to one of Southwest's subsidiaries," when Douglas raised the claim that a conflict existed. -[12]- NASD Rules prevent any member of a hearing panel from adjudicating a proceeding "substantially affecting his interest or the interests of any person in whom he is directly or indirectly interested." -[13]- Felder had no personal financial interest, substantial or otherwise, in the matters tried at the hearing. Likewise, it is difficult to see how his firm's interests could be affected, even tangentially, by the outcome of the proceeding. Additionally, Patterson herself did not have a stake in the NASD's action against Douglas. Douglas' assertion that the "ruling against Douglas would and did create a potential business bonanza" for Patterson is without any documentary or testimonial support. Patterson was not an employee of Southwest Securities. She merely had an arm's length contract with another subsidiary of Southwest Securities' parent. ---------FOOTNOTES---------- -[12]- Douglas argues to us that these affidavits should not be considered because they were filed before the NASD several days late. Douglas, who at the time was represented by counsel, failed to object to the affidavits on timeliness grounds. In any event, we see no reason not to consider the affidavits. Douglas has made a serious charge of impropriety, to which the NASD has responded. We would be remiss not to consider the NASD's rebuttal of Douglas's allegation. We also note that the NBCC may direct supplementation of the record on appeal pursuant to its own motion. NASD Code of Procedure, Article III, Section 3(a) (now renumbered as Rule 9312(a)). -[13]- Article XVI, Section 4 of the NASD's By-Laws and Article X, Section 1 of the NASD Code of Procedure (now renumbered as Rule 9131). ==========================================START OF PAGE 8====== Moreover, Patterson and Felder had no personal relationship. Douglas has offered no substantiation for his claim -- raised for the first time to us -- that Felder "was the contact person at [Felder's firm] for all questions concerning" Patterson's firm. Felder, in contrast, specified in his affidavit that he does not know Patterson. -[14]- V. Douglas committed serious violations. He was an experienced salesman, yet used fraudulent means to sell a security to a customer. Douglas also failed to inform his employer firm, as he was obligated to do, of his outside business activities. This failure deprived potential customers of the oversight and supervision provided by Douglas' employer firm. Further, he then solicited business using false and misleading information. Under these circumstances, we cannot find that the relatively modest sanctions imposed on Douglas are excessive or oppressive. An appropriate order will issue. -[15]- By the Commission (Chairman LEVITT and Commissioners WALLMAN, JOHNSON, and HUNT). Jonathan G. Katz Secretary ---------FOOTNOTES---------- -[14]- Cf. Datek Securities Corp., 51 S.E.C. 542, 544-45 (1993) (disqualification required when hearing panel members were associated with firms directly involved with transactions at issue in the proceeding). -[15]- All of the contentions advanced by the parties have been considered. The contentions 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. 37865 / October 25, 1996 Admin. Proc. File No. 3-8870 __________________________________________________ : In the Matter of the Application of : : MICAH C. DOUGLAS : 2415 Brookdale Drive : Kingwood, Texas 77339 : : 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 Micah C. Douglas, and its assessment of costs against him, be, and they hereby are, sustained. By the Commission. Jonathan G. Katz Secretary