==========================================START OF PAGE 1====== SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 38487 / April 8, 1997 Admin. Proc. File No. 3-8820 : In the Matter of the Application of : : PRIME INVESTORS, INC. : 10999 Metcalf, Suite 200 : Overland, Kansas 66210 : : and : : KENNETH JAMES WRIGHT : 16119 W. 143rd Terrace : Olathe, Kansas 66063 : : and : : MICHAEL LYN JOHNSON : 1007 E. 5th Street : Lee's Summit, Missouri 64063 : : 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 Violation of Regulation T Free Riding Violation of Margin Requirements Sale of Unregistered Securities Misuse of Customer Funds Member firm of registered securities association and its general securities principal engaged in trading that violated prompt payment and margin requirements. Principal and ==========================================START OF PAGE 2====== representative sold unregistered securities through member firm without exemption from the securities registration requirements, made materially misleading statements in connection with these sales, and misused customer funds. Held, association's findings of violations affirmed and the sanctions it imposed sustained. APPEARANCES: Kathy A. Elsmore, for Prime Investors, Inc. Kenneth James Wright, pro se. Michael Lyn Johnson, pro se. T. Grant Callery and Shirley H. Weiss, for the National Association of Securities Dealers, Inc. Appeal filed: September 21, 1995 Briefing completed: February 13, 1996 I. Prime Investors, Inc. ("Prime"), formerly a member of the National Association of Securities Dealers, Inc. ("NASD"); Kenneth James Wright, a registered general securities principal, registered financial and operations principal ("FINOP"), registered municipal securities principal, registered options principal, and Prime's president and majority shareholder; and Michael Lyn Johnson, a registered general securities representative, appeal from NASD disciplinary action. During the period at issue, Prime conducted a general securities business on a fully-disclosed basis through its clearing firm, Southwest Securities, Inc. ("Southwest") and had two full-time employees, Wright and Johnson. Wright, as Prime's general securities principal, supervised two part-time representatives, Kenneth Brent Gwinn and Earl Lawrence Smith. The NASD found that Prime, acting through Wright, violated Article III, Section 1 of the NASD's Rules of Fair Practice ("NASD Rules") by violating the prompt payment and margin requirements of Regulation T, promulgated by the Board of Governors of the Federal Reserve System pursuant to Section 7 of the Securities Exchange Act of 1934 ("Exchange Act"), and Article III, Section 30, Appendix A ("Section 30") of the NASD Rules. - [1]- ---------FOOTNOTES---------- -[1]- The NASD recently revised and renumbered its Rules of Fair Practice; no substantive changes were made to the particular rules at issue here. Article III, Section 1 of the NASD Rules [new Rule 2110] requires the observance of high standards of (continued...) ==========================================START OF PAGE 3====== The NASD also found that Prime, acting through Wright and Johnson, offered and sold securities in violation of the registration requirements of the Securities Act of 1933 (the "Securities Act"), made misleading statements in connection with the offer and sale of these unregistered securities, and misused investor funds. The NASD concluded that this varied misconduct violated Article III, Sections 1, 18, and 19 of the NASD Rules. -[2]- The NASD censured each applicant, expelled Prime from membership in the NASD, barred Wright from associating with any NASD member firm, barred Johnson from associating with any NASD member firm with a right to reapply after two years, fined Prime and Wright jointly and severally $150,000, and fined Johnson $50,000. -[3]- Our findings are based on an independent review of the record. II. Both Regulation T and Section 30 of the NASD Rules prohibit "free riding" in cash and margin accounts. -[4]- The "free ---------FOOTNOTES---------- -[1]-(...continued) commercial honor and just and equitable principles of trade. Section 30 of the NASD Rules [new Rule 2520] sets forth the requirements for transactions in margin accounts and prohibits free riding in cash accounts. Federal Reserve System Regulation T regulates extensions of credit by and to brokers and dealers and imposes initial margin requirements and payment rules with respect to securities transactions. Both Regulation T and Section 30 were revised since the events at issue here. In each case no relevant change was made. -[2]- Article III, Section 18 of the NASD Rules [new Rule 2120] prohibits the offer or sale of any security by means of any manipulative, deceptive, or fraudulent device. Section 19 [new Rule 2330] prohibits the misuse of customer funds. -[3]- The NASD also assessed costs. On September 28, 1995, we denied a motion by Prime and Wright requesting that we stay the expulsion and bar pending our resolution of this appeal. -[4]- With respect to cash accounts, Section 220.8(a) of Regulation T provides that a customer may purchase a security if there are sufficient funds in the cash account or if the customer agrees to make (continued...) ==========================================START OF PAGE 4====== riding" purchaser buys a security, expecting to pay for it through the sale of the security before payment is due. -[5]- The "free rider" profits, with little or no risk of his or her own capital, from any increase in the price of the security during the period he or she owns it. Except under narrowly-prescribed circumstances not present here, -[6]- if a cash account lacks sufficient funds to pay for a purchase of securities, Regulation T requires that full payment must be made within seven business days. Moreover, both Regulation T and Section 30 provide that the margin required for purchasing a security in a margin account must be obtained promptly. The record reflects, and Prime and Wright do not dispute, that between December 1991 and April 1993 Prime, through Wright, engaged in twenty-four instances of free riding involving both ---------FOOTNOTES---------- -[4]-(...continued) full and prompt cash payment for the security before selling it, and does not contemplate selling it prior to making such payment. Section 30 of the NASD Rules precludes an NASD member firm from permitting a customer to make a practice of effecting transactions in a cash account where the cost of securities purchased is met by the sale of the same securities. With respect to margin accounts, Section 220.4(c)(3) of Regulation T provides that the margin owed in connection with the purchase of a security must be provided within seven business days from the date of the trade. Section 30 of the NASD Rules precludes an NASD member firm from permitting a customer, faced with a margin call, to make a practice of either deferring the deposit of cash or securities beyond the ordinary settlement or clearance date, or meeting the required margin by the liquidation of instruments in the account. -[5]- See, e.g., John F. Lebens, Securities Exchange Act Release No. 36691 (January 5, 1996), 61 SEC Docket 57, 62-63 ("free riding" involves the purchase of securities with insufficient funds and the failure to pay for those securities on the settlement date); John T. Gabriel, 51 S.E.C. 1285, 1288 (1994), aff'd, No. 94-4208 (2d Cir. 1995) (unpublished opinion) (the "free riding" customer, in effect, borrows the funds to purchase securities in violation of Regulation T). -[6]- See Memorandum of the NASD Board of Governors relating to Regulation T, NASD Manual (CCH) 4018 (1992). ==========================================START OF PAGE 5====== individual and "group" trades -[7]- in a total of eight cash accounts. In each of the twenty-four trades at issue, the cash account had insufficient funds to pay for the security, funds were not deposited into the account to cover the purchase price and, as of the time the security was sold, no payment for the security had been received by Prime's clearing firm. Free riding also occurred in Prime margin accounts controlled by Wright. Prime and Wright do not dispute that, during 1993, Wright made a total of five trades in one customer margin account and in Prime's firm margin account, for which Wright acted as the registered representative. -[8]- In ---------FOOTNOTES---------- -[7]- Wright initiated the "group" trades by selecting an investment in a security and, on an informal basis, arranging for Prime representatives to join the trade. Wright expected each of Prime's registered representatives to participate in group trades and to make some of the group trades in their own accounts. Proceeds from a successive sale of the security then were used to cover that security's purchase price, and Wright distributed the profits (or apportioned the losses) among the group members according to the percentage of their participation in the trade. -[8]- The NASD's complaint originally charged that twelve trades made between July 1992 and July 1993 violated either Section 3(f)(10) of Section 30 (if executed before April 19, 1993) or Section 3(f)(7) of Section 30 (if executed after that date). The District Business Conduct Committee ("DBCC") subsequently dismissed the charges with respect to three of these twelve trades, specifying that these three trades were executed before April 19, 1993. The DBCC also specifically "dismiss[ed] any references to Section 3(f)(10) . . . in the Complaint," and further noted that "the reference in the Complaint to . . . Section 3(f)(7) . . . for those transactions occurring after April 19, 1993, is appropriate." It appears from the foregoing that the DBCC, although intending to dismiss Section 30 charges with respect to all pre-April 1993 trades, overlooked that four additional trades (two purchases of 3,000 shares each of Microsoft on July 6 and 14, 1992, and two purchases of 3,000 and 4,000 shares of U.S. Surgical on August 12, 1992), also were executed before April 19, 1993. We accordingly have determined to dismiss the NASD's findings of (continued...) ==========================================START OF PAGE 6====== each instance, the account had insufficient margin to cover the purchase of the securities, -[9]- no attempt was made to meet the margin requirement, and the margin call was met by liquidation of the same securities. -[10]- Prime and Wright acknowledge that the free riding and departures from margin requirements occurred. Nonetheless, they contend that they were "not aware that selling a security prior to its [sic] payment was wrong" and that, in any event, the trades at issue were a small portion of the many trades Prime executed during this period. -[11]- Prime and Wright also claim, variously, that brokerage firms commonly allow the practices on which we focus here, that it is commonly believed that free riding is not illegal as long as losses resulting from day trades are covered, that they believed the term "free riding" related only to initial public offerings, and that Prime's clearing firm, Southwest, "allowed [them] to do the trades." Prime, for its part, argues that it is a separate legal entity from Wright and as such, cannot be held liable for Wright's and other Prime representatives' alleged misconduct. We sustain the NASD's findings of violation against both Prime and Wright. Claimed ignorance of the regulations at issue ---------FOOTNOTES---------- -[8]-(...continued) violation of Section 30 with respect to these four trades. -[9]- Wright told the account holder of one of the margin accounts that she would have to meet the margin requirements only if the stock decreased in value, and then she would be responsible only for paying any losses. -[10]- In one instance, the securities purchased on margin were sold by Southwest in a "Regulation T sellout." A Regulation T sellout occurs when a clearing broker, in order to minimize its exposure from an unsecured debit, liquidates a margin position after a margin call has failed to produce additional equity to bring the margin to the required level. See Section 220.4(d) of Regulation T. -[11]- Because Wright benefitted from and orchestrated the group trades in accounts controlled by other Prime representatives, and made those trades that occurred in Prime's firm margin account, we reject Wright's claim that he can be held responsible for only one trade in the margin account of one of his customers. ==========================================START OF PAGE 7====== affords no excuse. An NASD member and its president, general securities principal, and FINOP are obligated to be familiar with and to comply with these essential rules. -[12]- Wright had an essential role in the free riding scheme. Prime, in turn, cannot avoid its own duties under the applicable regulations by attempting to shift blame to Wright, its principal and majority shareholder. Nor may Prime and Wright avoid responsibility by attempting to shift blame to Prime's clearing firm, Southwest. -[13]- III. Regulation T provides that, if a customer cannot make full cash payment within seven days of a securities purchase, the customer may request from the NASD an extension of time for payment. -[14]- The request must be made in good faith and the extension may be granted only if it is warranted by exceptional circumstances. If full cash payment is not obtained within the required time period, or if an extension is not granted, Regulation T requires that the executing broker cancel or otherwise liquidate the transaction. It is undisputed that, on nine occasions between April 1992 and May 1993, Prime, acting through Wright, requested through Southwest extensions of time, ostensibly to settle purchases in four cash and margin accounts. In these nine instances, Prime requested extensions on the grounds that (1) Prime representatives "could not contact the customer" for trades made in the representatives' personal accounts or accounts of their family members, or (2) payment was "in the mail," although payment ultimately was not tendered. Prime's extension requests directly facilitated the free riding scheme in which Prime and Wright engaged and, accordingly, were made neither in good faith ---------FOOTNOTES---------- -[12]- See, e.g., Gilbert M. Hair, 51 S.E.C. 374, 378 n.12 (1993) (an associated person has a duty to be aware of and comply with applicable agency rules and regulations). -[13]- See, e.g., Thomas G. Kocherhans, Securities Exchange Act Release No. 36556 (December 6, 1995), 60 SEC Docket 2589, 2593 n.14 (NASD member firm cannot shift to others responsibility for compliance); 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) (same). -[14]- See Section 220.8(d) of Regulation T. Because Prime operated on a fully-disclosed basis, Prime processed extension requests through Southwest. ==========================================START OF PAGE 8====== nor on the basis of exceptional circumstances. -[15]- Prime and Wright claim that Southwest supplied the stated reasons for the extension requests at issue. Wright testified before the NASD that Southwest's cashiers would grant Regulation T extension requests without requiring reasons from Prime or would themselves suggest the reasons. Two Southwest cashiers testified that it was not Southwest's policy to suggest the reasons for extension requests or to process extension requests without first obtaining reasons, and thus concluded that each of the reasons for Prime's extension requests must have come from Prime. -[16]- The NASD credited the testimony of the Southwest cashiers and did not credit the testimony of Wright, concluding that Prime and Wright did not act in good faith in making the nine extension requests. We find no reason to question the NASD's assessment of these witnesses' credibility. -[17]- Prime also argues that, if the extensions were illegal, Southwest and the individual Prime representatives should be held liable because Prime was not aware that the extension requests violated Regulation T. Prime was obligated to comply with the law and cannot shift blame to Prime's registered representatives or to Southwest. We sustain the NASD's findings of violation. -[18]- ---------FOOTNOTES---------- -[15]- Six of these nine extension requests were made for trades with respect to which, as we have found supra, Prime, through Wright, engaged in free riding in violation of Regulation T and Section 30 of the NASD Rules. -[16]- Neither Wright nor the Southwest cashiers could recall the specific extension requests at issue here. -[17]- 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, e.g., Charles E. French, Securities Exchange Act Release No. 37409 (July 8, 1996), 62 SEC Docket 828, 833-34. -[18]- Prime and Wright have moved to adduce the following additional evidence assertedly related to the issue of Prime's relationship with Southwest: a transcript of a tape-recorded conversation between another member firm and a Southwest cashier; a videotape of a news program (continued...) ==========================================START OF PAGE 9====== IV. The NASD also found that Prime, Wright, and Johnson sold unregistered securities, made false statements in connection with the sales, and misappropriated investor funds, in violation of Sections 1, 18, and 19 of the NASD Rules. A. On August 5, 1992, in one of the instances of free riding discussed above, a group comprised of Wright, Johnson, and Gwinn purchased 7,000 shares of U.S. Surgical ("USS") stock for approximately $600,000 in a margin account in the name of Gwinn's father. This account had a net zero balance at the time of the trade. The testimony of Wright and Gwinn establishes that the representatives did not intend to pay for the stock and, indeed, none had sufficient personal funds to cover the purchase. In the days immediately following, the price of the stock dropped significantly and with it the value of the group's investment. As of August 20, 1992, the Wright group had not paid for the USS trade. That day, Southwest required Wright to deposit $50,000 with Southwest to cover, in part, the more than $600,000 unsecured debit in the margin account. Wright borrowed the funds from his brother. The next day Southwest sold the stock for $528,379 and applied Wright's $50,000 to offset a portion of the unsecured debit in the margin account. Within days of the forced sale of the USS stock, Wright and Johnson began promoting a guaranteed investment program (the "investment program") to raise funds to cover their USS losses. Beginning in early September 1992, Johnson placed in a local newspaper three successive weekly advertisements promoting the investment program. The first advertisement specified a 12% "Tax Free Guaranteed Return of principle [sic] and interest" on a "Guaranteed Return on Investment Contract" with up to a one and one-half year commitment, and included the number for a telephone located at Prime's offices. -[19]- Successive ---------FOOTNOTES---------- -[18]-(...continued) on the brokerage industry; and the clearing agreement between Prime and Southwest. Prime and Wright also seek to subpoena the Southwest cashiers and others and confront them with this additional evidence. Prime and Wright have not demonstrated the materiality of the transcript and videotape. Nor have they demonstrated reasonable grounds for failing previously to adduce the clearing agreement. We therefore deny the motions. -[19]- Wright paid for the advertisements and debited Johnson's commissions for their cost. ==========================================START OF PAGE 10====== advertisements each specified a lower rate of return in order to, in Johnson's words, "instill urgency" in the minds of prospective investors. Copies of literature describing the investment program were placed with other investment information Prime made available to its walk-in customers. This literature promised a "yield [of] 12% a year on an investment with absolutely no risk of principle [sic] in this volatile market," and advised that this return would be achieved by pooling investors' money under Wright's name and investing through Wright in an account at Prime. The literature further specified that, because the "investing will be done in Ken Wright's name" (rather than Prime's), the NASD would not "govern" the activity; that the investors' funds would be "collateralized by the investments . . . purchase[d] plus an additional 40,000 shares of Ken [Wright]'s PRIME stock (worth about $70,000)"; and that the program was modelled on a Merrill Lynch investment. -[20]- The program literature also stated that "[t]iming is critical" because the promoters believed that "now is an opportune time to take advantage of some disparities in the market places." Wright encouraged Johnson, Gwinn, and Smith to promote the investment program and instructed them to direct prospective investors to him. Johnson was the initial contact for ten, Wright for two, and Smith for one of the thirteen investors. Wright had personal contact, either by telephone or in person at Prime's offices, with each of the thirteen individuals who invested in the program. Over a four-month period, these thirteen persons invested $254,352.40 in the investment program. Each investor executed a "Guaranteed Return On Investment Contract" that provided that, "[f]or the purpose of maximizing our return, we are forming an investment group under Kenneth Wright's name." The document was styled as a "contract/loan agreement" in which funds were to be lent to Wright personally, with "no ties" to Prime. In December 1992, an NASD regional examiner contacted Wright about the investment program. This examiner raised concerns about whether Wright was selling securities and suggested that Wright obtain investors' signatures on additional documentation designed to characterize the investment program as soliciting personal loans to Wright. Twelve of the thirteen investors ---------FOOTNOTES---------- -[20]- Investors were told that the "basic differences" between the offered program and the Merrill Lynch program were that Merrill Lynch guaranteed "only the capital, not the capital plus the 12% return" and that the Merrill Lynch program required a minimum investment of $100,000 and a commitment longer than the one-and-one-half years commitment that the Wright/Johnson program required. ==========================================START OF PAGE 11====== subsequently executed a revised "loan agreement" that characterized the prior investment as a "personal loan" to Wright, and stated that the loan was without recourse to Prime, that Wright had total control over the funds, and that the funds "will not be earmarked/intended for investment purposes." -[21]- The document also specified that it "supersede[d] any other note or documentation concerning [the investor's] loan to Wright." On January 1, 1993, the Missouri Secretary of State initiated an investigation into whether Prime, through Wright, had unlawfully borrowed customer funds, in violation of Missouri law. Prime and Wright settled the matter by agreeing to rescind the twelve investors' loan agreements, to pay a $250 fine, and to cease and desist from accepting loans from Prime's customers. By the Spring of 1994, Prime had refunded the entire $254,352 to the investors. B. Applicants argue that the instruments at issue were not securities. Under the Reves v. Ernst & Young, 494 U.S. 56 (1990), test for determining whether a note is a "security" under Section 3(a)(10) of the Exchange Act, a note is presumed to be a security unless (1) it bears a strong resemblance to certain notes recognized as being outside the investment market regulated under the securities laws, -[22]- or (2) based on certain factors described by the Court in Reves, it should be added to that list. -[23]- ---------FOOTNOTES---------- -[21]- One investor requested that his funds be returned and did not execute the revised loan agreement. Wright returned $10,000 to this investor on December 11, 1992, the same week that most of the other investors executed the revised loan agreements. -[22]- Among the types of notes intended to be excluded from the definition of a security are those notes that are issued in a purely commercial or consumer context, such as notes secured by a mortgage on a home or short-term notes secured by assignment of accounts receivable. Reves, supra, 494 U.S. at 65-66. -[23]- Those factors are: (1) the borrower's and lender's purposes; (2) the plan of distributing the notes; (3) the expectations of the investing public regarding whether the instruments were securities; and (4) the presence of any alternative scheme of regulation or other factor (continued...) ==========================================START OF PAGE 12====== The notes Wright and Johnson sold through Prime do not resemble the instruments recognized as not constituting securities. Nor should they be added to Reves' list of excluded "notes." Prime, through Wright and Johnson, issued the notes for the purpose of raising money. Investors parted with their funds in order to earn an investment return on them. The plan of distribution here was broad and generalized, as evidenced by the three successive newspaper advertisements and the ready availability to Prime's walk-in customers of literature on the program. Investors anticipated that Wright would purchase investments with their money, taking advantage of "disparities in the marketplace," in order to gain a guaranteed return of 12%. No alternate scheme or other factor reduced the risk of the instrument such that securities regulation is unnecessary. -[24]- We conclude, based on Reves, that the instruments here are securities. -[25]- We cannot agree that applicants' denomination of the notes -- some months after their issuance -- as "personal loans" somehow insulated the notes from the coverage of the securities laws. -[26]- ---------FOOTNOTES---------- -[23]-(...continued) that significantly reduces the risk of the instrument so as to make securities regulation unnecessary. Id. at 66-67. -[24]- See Reves, supra, 494 U.S. at 69 (because notes were uncollateralized and uninsured, they would escape federal regulation entirely if the securities laws were held not to apply). We note that these instruments also are analyzable as securities in the form of "investment contracts," as they represented an investment in a common venture with a reasonable expectation of profits to be derived from the entrepreneurial efforts of others. See United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 852 (1975); SEC v. W.J. Howey, 328 U.S. 293, 298-99 (1946). -[25]- This case is similar to William Louis Morgan, 51 S.E.C. 622, 626-27 (1993), in which a branch office manager, in order to cover personal litigation expenses, issued promissory notes to his firm's customers and to outside persons. In that matter we concluded that the promissory notes were securities. -[26]- Compare Darrell Jay Williams, 50 S.E.C. 1070, 1071-72 (1992) (loan denominated as "payment guarantee" was a security) and Gilbert M. Hair, (continued...) ==========================================START OF PAGE 13====== We also reject Prime's claim that it had no involvement with the investment program. This assertion is belied by the record, which establishes Prime's central role (through its offices and personnel) in promoting the program. Indeed, Wright funded Prime's business expenses and met payments in the accounts of Prime customers with a portion of the investors' funds. Applicants do not contest that these securities were not registered with the Commission pursuant to the Securities Act, -[27]- nor have they met their burden of demonstrating that the securities were exempt from registration. -[28]- We therefore sustain the NASD's finding that applicants sold unregistered securities in violation of Article III, Section 1 of the NASD Rules. C. Virtually all of the claims made in connection with applicants' promotion of the investment program were false or unsubstantiated. For example, Wright did not invest the $254,352 collected from investors, as promised, and did not have sufficient personal assets to guarantee even the investors' principal of $254,352. Investor funds were not collateralized, as had been represented, and applicants had no basis for their valuation of Wright's Prime stock at $70,000, for asserting that the proposed investment was "tax free" and "similar" to a Merrill Lynch product, -[29]- or for claiming that the notes would not be "governed" by the NASD. We accordingly sustain the NASD's finding that applicants made material misstatements of fact in connection with their sale of the investment program, in violation of Article III, Sections 1 and 18 of the NASD Rules. ---------FOOTNOTES---------- -[26]-(...continued) supra, 51 S.E.C. at 377 (borrower's subjective belief that note was not a security insufficient to take note outside of NASD jurisdiction). -[27]- See Section 5 of the Securities Act, 15 U.S.C.  77e. -[28]- See, e.g., SEC v. Ralston-Purina Co., 346 U.S. 119, 126 (1953); V.F. Minton Securities, Inc., 51 S.E.C. 346, 352 (1993), aff'd, 18 F.3d 937 (5th Cir. 1994) (table). -[29]- Wright created the investment program after Gwinn showed him an article from Business Week describing a Merrill Lynch market-linked CD. Wright read the Business Week article and, based solely on the news article, drafted a business plan promoting the investment program. ==========================================START OF PAGE 14====== D. There is no dispute that Wright applied approximately $158,840 out of the $254,352 invested in the investment program for personal uses or for Prime's expenses. Beginning in September 1992, Wright, through the use of a bank account and a Southwest brokerage account in his name, used approximately $9,500 of the investors' funds to pay Prime's business expenses, Wright's personal expenses, and to make loans to Wright's friends. Wright then transferred $25,090 of the investors' funds to Southwest to cover the remaining balance from the USS trade loss, loaned a total of $37,250 to Johnson, -[30]- used $52,000 to repay his brother's loan made after Southwest's demand for covering funds, used another $18,000 for personal expenses, and transferred $17,000 of the investors' funds to various Prime customers. Prime and Wright contend that investors knowingly entrusted their funds to Wright for use as he saw fit and, from this faulty premise, conclude that the use of investors' funds here was proper. No reasonable investor could have concluded, based on applicants' marketing of the program, that his or her funds would be used to fund Wright's personal expenses or bankroll Wright's friends. The investors' subsequent execution of revised "loan agreements" did not retroactively "cure" this violation. We accordingly find that Prime and Wright made improper use of customer funds, in violation of Article III, Section 19(a) of the NASD Rules. V. Applicants each contest the NASD's sanctions. We do not find that the sanctions imposed by the NASD are excessive or oppressive for the serious and wide-ranging misconduct found here. -[31]- While investor funds ultimately were returned as a result of Prime's and Wright's settlement with state regulators, these funds were placed at substantial risk through the conduct of each applicant. Prime contends that its actions do not warrant expulsion from the NASD. We disagree. Over an extended period, and for ---------FOOTNOTES---------- -[30]- Johnson later repaid these funds to Wright. -[31]- See NASD Sanction Guidelines (1993) at 11, 29, and 47, and NASD Sanction Guidelines (1996) at 13, 34, and 57 (bar is appropriate remedy for individuals in egregious cases of conversion of customer funds, misrepresentation, and sale of unregistered securities, and expulsion is appropriate remedy for firm in egregious cases of misrepresentation). ==========================================START OF PAGE 15====== its own benefit, Prime, acting through Wright, circumvented prompt payment and margin requirements that apply to all broker- dealers. Prime, along with Wright and Johnson, conducted a fraudulent scheme to sell unregistered securities to the general public and benefitted from that scheme when investor funds were used to fund its business expenses. Such flagrant disregard for the federal securities laws and NASD Rules warrants the sanctions imposed. Wright also argues that his conduct does not merit the bar imposed by the NASD. Wright obtained investor funds through deception and material misstatements and used those funds to pay off personal debts and make loans to friends. Wright's admitted lack of knowledge of very basic trading requirements and demonstrated willingness to misuse customer funds confirm he is not fit to continue in the securities business. We are not persuaded otherwise by Wright's claim that his sanction should be mitigated because of his assertedly clean disciplinary record -[32]- and his promises that he will never again engage in violative conduct. We do not believe that Johnson's conduct merits a lesser sanction than the bar with a right to reapply after two years that was imposed here. While this apparently is Johnson's first disciplinary offense, in this matter Johnson took an active role in selling unregistered securities by placing misleading advertisements and attracting ten of thirteen investors to the investment program. Johnson's claimed ignorance of the law with respect to whether the notes were securities does not mitigate his serious violations. Prime, Wright, and Johnson already have obtained from the NASD's National Business Conduct Committee ("NBCC") some reduction in the fines imposed; -[33]- we see no reason further to modify the fines. -[34]- ---------FOOTNOTES---------- -[32]- This claim is belied by Wright's settlement with Missouri securities regulators. -[33]- The NBCC, on review of fines imposed by the DBCC, reduced fines of $250,000 each imposed on Prime and Wright to a joint and several fine of $150,000 and reduced a $130,000 fine imposed on Johnson to $50,000. -[34]- Nor does our determination to set aside findings of violation with respect to four margin trades (see n. 8, supra) cause us to conclude that any reduction in the NASD's sanctions as to Prime and Wright is warranted. ==========================================START OF PAGE 16====== An appropriate order will issue. -[35]- By the Commission (Chairman LEVITT and Commissioners WALLMAN, JOHNSON, and HUNT). Jonathan G. Katz Secretary ---------FOOTNOTES---------- -[35]- 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 in this opinion. UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. Admin. Proc. File No. 3-8820 : In the Matter of the Application of : : PRIME INVESTORS, INC. : 10999 Metcalf, Suite 200 : Overland, Kansas 66210 : : and : : KENNETH JAMES WRIGHT : 16119 W. 143rd Terrace : Olathe, Kansas 66063 : : and : : MICHAEL LYN JOHNSON : 1007 E. 5th Street : Lee's Summit, Missouri 64063 : : 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 Prime Investors, Inc., Kenneth James Wright, and Michael Lyn Johnson, and its assessment of costs, be and they hereby are, sustained. By the Commission. Jonathan G. Katz Secretary