==========================================START OF PAGE====== SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 38486 / April 8, 1997 Admin. Proc. File No. 3-8994 __________________________________________________ : In the Matter of the Application of : : STEPHEN THORLIEF RANGEN : 2544 Angelo Drive : Los Angeles, California 90077 : : For Review of Disciplinary Action Taken by the : : NEW YORK STOCK EXCHANGE, INC. : : __________________________________________________: OPINION OF THE COMMISSION NATIONAL SECURITIES EXCHANGE -- REVIEW OF DISCIPLINARY PROCEEDINGS Violations of Exchange Rules Conduct Inconsistent with Just and Equitable Principles of Trade Unsuitable Recommendations Excessive Trading Where registered representative of member firm of national securities exchange made unsuitable recommendations to customers and engaged in excessive trading in customers' accounts, held, exchange's findings of violation and the sanctions it imposed sustained. APPEARANCES: Stephen Thorlief Rangen, pro se. Arthur S. Okun, Steven F. Korostoff, James A. Nofi, and Marc D. Fink, for the New York Stock Exchange, Inc. Appeal filed: April 29, 1996 Last brief received: August 23, 1996 ==========================================START OF PAGE====== I. Stephen Thorlief Rangen, who during the relevant time period was a registered representative with Shearson Lehman Brothers, Inc. ("Shearson" or the "Firm"), a member firm of the New York Stock Exchange, Inc. ("NYSE" or the "Exchange"), appeals from disciplinary action. The NYSE found that Rangen made unsuitable recommendations and excessively traded in three custo- mer accounts. The Exchange determined that Rangen's conduct was inconsistent with just and equitable principles of trade. -[1]- Rangen was censured and suspended from membership, allied membership, approved person status, and employment or association in any capacity with any NYSE member or member organization for a period of four years. Our findings are based on an independent review of the record. II. The recommendations and trading at issue occurred from March 1991 through March 1992. During that time, Rangen was the registered representative for the accounts of Peter Rejlek, Edith and Erwin Stapes, and Floyd Stapes. The background of the accounts and Rangen's handling of them are as follows. A. In March 1991, Peter Rejlek opened an account with Rangen at Shearson. Rejlek was 29 years old, single, and working as a real estate appraiser for Great Western Bank. He had an annual income of approximately $35,000 and a net worth of about $80,000. Rejlek's stated investment objective was income with safety. He was interested in simple investments, such as certificates of deposit and mutual funds. Rejlek initially invested $79,000 in Blackstone Income Trust, Inc. ("Blackstone"). -[2]- However, three weeks later, Rangen contacted Rejlek to suggest that Rejlek purchase zero-coupon U.S. Treasury STRIP securities ("STRIPS") on margin. Rangen told Rejlek that there was minimal risk and that he would sell his position in the STRIPS by June 1991. Rangen further convinced Rejlek to change the listed investment objective on his new account form to speculation. Rangen assured Rejlek that changing Rejlek's listed investment objective was just a formality. ---------FOOTNOTES---------- -[1]- NYSE Rule 476(a) provides that members and their employees can be disciplined by the NYSE for violating any rule of the Exchange or for conduct that is "inconsistent with just and equitable principles of trade." -[2]- The parties agree that Blackstone was a safe, income-producing investment. ==========================================START OF PAGE====== On March 27 and March 28, 1991, on Rangen's advice, Rejlek purchased on margin STRIPS with a face value of $1,000,000 and $200,000, respectively. By the end of March, Rejlek's account had a $343,000 debit balance as a result of STRIPS being purchased on margin. By June, Rejlek became so distraught by the amount of money he was losing each month that he had Rangen sell all the STRIPS in his account. His loss on those transactions was $40,000. Based on Rangen's advice, Rejlek then invested all of his capital in the stock of Aura Systems, Inc. ("Aura Systems"). It appears that all the purchases of Aura Systems were made on margin. During the nine months from March 1991 through November 1991, 36 transactions in the total amount of $1,889,332.94 were effected for Rejlek's account on the basis of Rangen's recommendations. Those transactions generated $43,273.19 in commissions. Rejlek also paid $10,039.81 in margin interest. By the end of the review period, Rejlek's account had a net loss of $58,461.86 and a debit balance of $66,088.82. Rangen's trading in Rejlek's account produced an annualized turnover rate of 42.9 between March and November 1991. -[3]- The annualized "cost/equity maintenance factor" for this account for ---------FOOTNOTES---------- -[3]- "The turnover rate is a ratio computed by dividing the aggregate amount of purchases in an account by the average monthly investment. The average monthly investment is the cummulative total of the net investment in the account at the end of each month, exclusive of loans, divided by the number of months under consideration". See Shearson Lehman Hutton Inc., 49 S.E.C. 1119, 1122 n. 10 (1989). See also Frederick C. Heller, 51 S.E.C. 275, 279 (1993); Reynolds & Co., 39 S.E.C. 902, 906 n. 10 (1960). Rangen argues that the turnover ratio formula is not appropriate for measuring activity in a margin account. We disagree. Turnover ratio is an established method for measuring the level of trading in an account. See Looper & Co., 38 S.E.C. 294 (1958). The fact that the securities were bought on margin does not affect the validity of the methodology used in this case. But see Eugene J. Erdos, 47 S.E.C. 985, 989 n. 14 (1983), aff'd, 742 F.2d 507 (9th Cir. 1984)(Commission found that the turnover ratio formula was not appropriate for measuring activity in an account trading options). ==========================================START OF PAGE====== the period at issue was 236, meaning that the account had to increase in value on an annualized basis by 236% to break even. -[4]- B. In May 1991, Edith and Erwin Stapes opened an account with Rangen at Shearson ("the Stapes account"). Mr. Stapes, 70 years old, was a retired auto mechanic and Mrs. Stapes, 70 years old, was not employed outside the home. They had a modest annual income of approximately $20,000 and a net worth of $300,000. Mr. and Mrs. Stapes wanted an investment that was safe and would provide them with a steady income. Mr. Stapes' education ended after the eighth grade, and he had minimal prior experience in the stock market. Mr. and Mrs. Stapes initially invested $84,979.35 with Rangen at Shearson. Approximately a month after the account was opened, Rangen convinced them to change their listed investment objective to speculation, although Mr. Stapes testified that he really was not interested in speculating. From June 1991 through March 1992, Rangen effected 55 transactions for the Stapes account in the total amount of $1,530,344.23. The majority of these securities were purchased on margin. -[5]- As a result, the Stapes paid $4,200 in margin interest over a ten-month period. Furthermore, these purchases and sales generated $45,468.49 in commissions. At the end of the relevant period, the Stapes account had a net loss of $21,746.48 and a debit balance of $218,291.19. -[6]- Rangen's trading in the Stapes account produced an annualized turnover rate of 9.2 between June 1991 and March 1992. The annualized cost/equity maintenance factor for this account for the period at issue was 48. ---------FOOTNOTES---------- -[4]- The "cost/equity maintenance factor" determines what the rate of return would have to be in an account to overcome the cost of maintaining that account. See Frederick C. Heller, 51 S.E.C. at 276. -[5]- Rangen purchased and sold 46,000 shares of Aura Systems within a five-month period in the Stapes account. This resulted in 80% of Mr. and Mrs. Stapes' equity being concentrated in one stock. -[6]- The Stapes account held 54% of the purchases for less than 60 days. ==========================================START OF PAGE====== C. Based on a referral from his brother, Erwin Stapes, Floyd Stapes opened an account with Rangen at Shearson (the "F. Stapes account"). F. Stapes was 75 years old, a widower, and retired. He and his brother had owned a service station and garage for 24 years. Like his brother, F. Stapes left school after the eighth grade. He had no pension, but did receive a monthly Social Security check. In addition, F. Stapes received approximately $800 income per month from some church bonds and a couple of mutual funds that he owned. His net worth was approximately $300,000. F. Stapes explained to Rangen that he needed additional income from his investments to cover his expenses. F. Stapes opened his account with Rangen by investing approximately $100,000 in Blackstone and New America High Income Fund. -[7]- The following month, on Rangen's advice, F. Stapes began purchasing over-the-counter stocks on margin. From November 1991 through March 1992, Rangen effected 31 transactions for the account in the total amount of $1,001,378.21. The transactions generated $33,583.46 in commissions for Rangen, as well as $1,923 in margin interest. By the end of the relevant time period, the debit balance in F. Stapes' account was $129,000. -[8]- Rangen's trading in F. Stapes' account produced an annualized turnover rate of 14 between November 1991 and March 1992. The annualized cost/equity maintenance factor was 80. III. We find that Rangen's recommendations to these customers were unsuitable and, therefore, inconsistent with just and equitable principles of trade. Rejlek, Mr. and Mrs. Stapes, and F. Stapes were all seeking safe, income-producing investments, and did not wish to speculate. Rejlek was an unsophisticated investor who had no desire to risk his principal. Mr. and Mrs. Stapes and F. Stapes were also inexperienced as investors, elderly and retired, with limited means, who were seeking to generate additional income through their investments. Rangen's ---------FOOTNOTES---------- -[7]- The Exchange characterized the New America High Income Fund as a junk bond fund. -[8]- F. Stapes' investments were highly concentrated. For the period December 23, 1991 through January 29, 1992, a majority of the equity in F. Stapes' account was invested in one stock, Hycor Biomedical, Inc. ("Hycor Biomedical"). By March 5, 1992, the majority of F. Stapes' equity was invested in Micropolis Corp. ==========================================START OF PAGE====== method of trading in these accounts was contrary to their goals in several ways. Neither the STRIPS nor the over-the-counter stocks produced income. -[9]- Furthermore, Rangen's use of margin in these accounts was inappropriate. Trading on margin increases the risk of loss to a customer for two reasons. First, the customer is at risk to lose more than the amount invested if the value of the security depreciates sufficiently, giving rise to a margin call in the account. Second, the client is required to pay interest on the margin loan, adding to the investor's cost of maintaining the account and increasing the amount by which his investment must appreciate before the customer realizes a net gain. At the same time, using margin permitted the customers to purchase greater amounts of securities, thereby generating increased commissions for Rangen. -[10]- We consider, under the circumstances, that the extent to which Rangen used margin to effect transactions in the accounts was unsuitably risky for customers with the level of experience and the stated investment objectives of these customers. Finally, by concentrating so much of their equity in particular securities, Rangen increased the risk of loss for these individuals beyond what is consistent with the objective of safe, non-speculative investing. This is particularly true because of Rangen's strategy for trading the accounts. Rejlek's entire net worth was invested in either STRIPS or a single over- the-counter stock. The Stapes and F. Stapes accounts lacked sufficient diversity as well. During a five-month period, 80% of the equity in the Stapes account was concentrated in one stock, Aura Systems. As previously noted, F. Stapes' investments were also highly concentrated. From December 1991 through January 1992, F. Stapes, per Rangen's advice, invested $132,000 in Hycor Biomedical. After selling Hycor Biomedical, Rangen concentrated a large portion of F. Stapes' equity in Micropolis Corp. The investment strategy pursued by Rangen was unsuitable for Rejlek, Mr. and Mrs. Stapes, and F. Stapes. Rangen admits that Mr. and Mrs. Stapes and F. Stapes were investing in a manner that was not suitable for them; however, he contends that they were aware of the risks and it would have been wrong for him to refuse their orders merely because he felt that ---------FOOTNOTES---------- -[9]- The record does not include evidence of the characteristics of the individual stocks traded in the accounts, other than that they did not pay a dividend. Therefore, we are unable to address their alleged speculative nature. -[10]- Rangen deliberately misled Rejlek by telling him to ignore the margin calls he was receiving. ==========================================START OF PAGE====== the investments were not suitable. Even if we were to accept Rangen's view that these clients wanted to speculate and were aware of the risks -- a conclusion not supported on this record -- the Commission has held on many occasions that the test is not whether Mr. and Mrs. Stapes and F. Stapes considered the transactions in their account suitable, but whether Rangen "'fulfilled the obligation he assumed when he undertook to counsel [them], of making only such recommendations as would be consistent with [their] financial situation and needs.'" -[11]- Rangen attempts to shift the blame to his employer, Shearson, for his recommendations to his clients. First, he contends that it was Shearson's research department that recommended the purchase of STRIPS because interest rates were expected to fall and the value of the STRIPS would increase. He further contends that the stocks recommended to Mr. and Mrs. Stapes and F. Stapes were all in the "top rated categories of the Lehman Research Division." However, Rangen cannot shift his responsibility as an investment counselor to his employer. It was Rangen's duty to make only such recommendations as were in the best interests of his clients. Rangen was obligated not only to consider Shearson's recommendations, but his clients' investment objectives and financial situations, which he failed to do. -[12]- Contrary to Rangen's assertions, the record reflects that Rangen did not fulfill his obligation as a registered representative. ---------FOOTNOTES---------- -[11]- Cf. Eugene J. Erdos, 47 S.E.C. at 989, citing Phillips & Company, 37 S.E.C. 66, 70 (1956)(applying the NASD's suitability rule). See also Clinton Hughs Holland, Jr. Securities Exchange Act Rel. No. 36621 (December 21, 1995), 60 SEC Docket 2935, 2941, aff'd, No. 96-70084 (9th Cir. 1997)(unpublished opinion)(finding violation of NASD suitability rule even though the client understood the risks because salesperson failed to make reasonable recommendations); Paul F. Wickswat, 50 S.E.C. 785, 786-87 (1991). -[12]- See Clyde J. Bruff, 50 S.E.C. 1266, 1269 (1992). See also Larry Ira Klein, Securities Exchange Act Rel. No. 37835 (October 17, 1996), 63 SEC Docket 70, 81 n. 30 (salesman cannot use an employer's general approval as a substitute for an individual determination that a security was suitable for his clients). Cf. David Joseph Dambro, 51 S.E.C. 513, 516 (1993)(salesman not entitled to rely solely on an employer's glowing but unsubstantiated recommendation). ==========================================START OF PAGE====== IV. Excessive trading occurs when a broker has control over trading in an account and the level of activity in that account is inconsistent with the customer's objectives and financial situation. -[13]- Rangen claims that he did not have control over the accounts. The evidence proves otherwise. Control may be established when a customer relies upon the broker to such an extent that the broker is in a position to control the volume and frequency of the transactions in the account. -[14]- Rangen used his influence over his customers' accounts to pursue an aggressive, short-term trading strategy that was inconsistent with his customers' investment objectives. All the customers involved here were relatively unsophisticated, conservative investors, who relied on Rangen for the investment decisions in their respective accounts. For example, initially Rejlek's investment objective was income with safety. However, Rangen convinced Rejlek to change the indication on the account form to speculation, telling Rejlek that this was "just a formality." This change, however, facilitated Rangen trading STRIPS in Rejlek's account without arousing supervisory attention. Rejlek testified that he knew nothing about the bond market and felt he was in "way over his head." Nonetheless, Rejlek followed Rangen's advice. Even after having lost $40,000 in the bond market, Rangen recommended that Rejlek purchase Aura Systems and Rejlek agreed. As was the case with Rejlek, all the investment decisions made by Mr. and Mrs. Stapes and by F. Stapes were based on Rangen's recommendations. Neither Rejlek, Mr. and Mrs. Stapes nor F. Stapes initiated any transactions in their respective accounts. They relied heavily on and followed Rangen's advice in overseeing their accounts. The transactions occurred simply on the basis of Rangen's recommendation. All three accounts experienced extremely high turnover rates. -[15]- As discussed earlier, the evidence shows that ---------FOOTNOTES---------- -[13]- John M. Reynolds, 50 S.E.C. 805, 806 (1992). -[14]- Id. at 807. -[15]- Rangen argues that the high turnover rate in Rejlek's account was due to margin calls, which necessitated the sale of securities. To regain his original position, Rejlek would then repurchase securities. Nevertheless, Rangen's trading of the account exclusively in one security on margin created a situation that unnecessarily (continued...) ==========================================START OF PAGE====== the annualized turnover rates for Rejlek's account, the Stapes account, and the F. Stapes account were 42.9, 9.2, and 14, respectively. The Commission has previously found rates below these levels to be excessive. -[16]- Furthermore, as a result of Rangen's trading in the accounts, the account values would have had to increase by 236%, 48%, and 80%, respectively, just to break even. Accordingly, we find that Rangen placed his own interests above those of his customers by excessively trading in the accounts and that this conduct is inconsistent with just and equitable principles of trade. V. Rangen makes various claims of unfairness arising from the NYSE Hearing Panel's ("Hearing Panel") conduct. -[17]- ---------FOOTNOTES---------- -[15]-(...continued) increased the risk of a margin call in the event of a decline in value of the security. -[16]- See Shearson Lehman Hutton Inc. 49 S.E.C. 1119, 1122 (1989)(turnover rate of 7.4 excessive); Samuel B. Franklin & Company, 42 S.E.C. 325, 327 (1964)(turnover rates of 3.5 and 4.4 are excessive). See also David A. Gingras, 50 S.E.C. 1286, 1289 (1992)(turnover rates of 19.4 and 42.7 found to be "wildly excessive"). -[17]- Rangen claims that his civil rights were violated because the Exchange notified Gilford Securities ("Gilford"), his present employer, of the charges filed against him before he was notified of such action by letter the following week. According to Rangen, this was done in order to apply pressure on Gilford to remove him from its employ. We find no impropriety in the Exchange notifying Gilford of the pending complaint. The Exchange is entitled to keep a member firm fully apprised of developments in a disciplinary action affecting one of the firm's employees. See Frank DeRose, 51 S.E.C. 652, 660 (1993). Rangen also charges the Exchange with "selective enforcement" because the accounts had previously been audited by the management at Shearson and the NYSE without Rangen ever being told that there was a problem or a violation at issue. There is no evidence in the record of prior audits, exams, or reviews conducted by either Shearson or the NYSE. In any event, we have previously held that a regulatory authority's failure to take early action neither (continued...) ==========================================START OF PAGE====== Rangen complains that the Hearing Panel misstated and mischaracterized most, if not all, of the testimony presented at the hearing. We disagree. Our independent review of the record provides no basis for disagreement with the Hearing Panel's determinations. -[18]- Rangen also contends that the Hearing Panel failed to question him with respect to the individual trades that occurred in the accounts, thereby demonstrating "an apparent lack of desire on the part of the Hearing Panel to hear pertinent and material evidence to the controversy." Thus, he was not given "the opportunity to justify the trading in each account." It was Rangen's responsibility to marshall the evidence in his defense before the NYSE. -[19]- Moreover, the Hearing Panel allowed Rangen a great deal of latitude at the hearing, even permitting him to testify as his own expert witness. Rangen could have offered evidence regarding the individual trades in each account. Finally, we find no merit to Rangen's argument that one member of the Hearing Panel was biased against Rangen because the member accused Rangen of "character assassination" of the Exchange's expert witness. While questioning this expert witness, Rangen made several accusations challenging the expert ---------FOOTNOTES---------- -[17]-(...continued) operates as an estoppel against later action nor cures a pending violation. Cf. G.K. Scott & Co., Inc., 51 S.E.C. 961, 966 n. 21 (1994), aff'd, No. 94-1161 (D.C. Cir. 1995) (unpublished opinion)(Applicants unable to shift responsibility for compliance with NASD markup policy to the NASD or to the Commission, even though they claimed firm routinely passed numerous markup exam reviews and was never questioned about the firm's method of determining the prevailing market price). -[18]- The credibility determination of the initial decision maker is entitled to considerable weight and deference, since it is based on hearing the witnesses' testimony and observing their demeanor. See Universal Camera Corp. v. NLRB, 340 U.S. 474 (1951). See also Robert E. Gibbs, 51 S.E.C. 482, 483 (1993), aff'd, 25 F.3d 1056 (10th Cir. 1994); Anthony Tricarico, 51 S.E.C. 457, 460 (1993); Jonathan Garrett Ornstein, 51 S.E.C. 135, 137 (1992). -[19]- See, e.g., Thomas E. Warren III, 51 S.E.C. 1015, 1020 (1994), aff'd without opinion, 69 F.3d 549 (10th Cir. 1995) (table); John M. Reynolds, 50 S.E.C. at 810. ==========================================START OF PAGE====== witness' credentials. These accusations proved to be baseless. One of the Hearing Panel's members stated on the record that he found Rangen's unsubstantiated accusations "offensive" and to be "character assassination." The member reminded Rangen that he should be sure of his facts before speaking out. We see no prejudice to Rangen resulting from the member's participation in the Hearing Panel. Our review of the record indicates that the members of the Hearing Panel acted fairly and objectively in their conduct of the hearing. VI. Rangen engaged in serious misconduct. By handling the accounts in an unsuitable manner and excessively trading the accounts, he placed his own interests above those of his customers. Moreover, Rangen has exhibited a disturbing lack of understanding of a registered representative's duty to his customers. Thus, based on the foregoing we cannot find that the sanctions assessed by the Exchange are excessive or oppressive. An appropriate order will issue. -[20]- By the Commission (Chairman LEVITT and Commissioners WALLMAN, JOHNSON, and HUNT). Jonathan G. Katz Secretary ---------FOOTNOTES---------- -[20]- All of the arguments 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. ==========================================START OF PAGE====== UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. Admin. Proc. File No. 3-8994 __________________________________________________ : In the Matter of the Application of : : STEPHEN THORLIEF RANGEN : 2544 Angelo Drive : Los Angeles, California 90077 : : For Review of Disciplinary Action Taken by the : : NEW YORK STOCK EXCHANGE, INC. : : __________________________________________________: ORDER SUSTAINING DISCIPLINARY ACTION TAKEN BY NATIONAL SECURITIES EXCHANGE On the basis of the Commission's opinion issued this day, it is ORDERED that the disciplinary action taken by the New York Stock Exchange, Inc. against Stephen Thorleif Rangen be, and it hereby is, sustained. By the Commission. Jonathan G. Katz Secretary