SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40474 / September 24, 1998 Admin. Proc. File No. 3-9428 : In the Matter of the Application of : : JOHN M. W. CRUTE : P. O. Box 1198 : Fort Stockton, TX 79735 : : For Review of Disciplinary Action Taken by the : : NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.: : OPINION OF THE COMMISSION REGISTERED SECURITIES ASSOCIATION -- REVIEW OF DISCIPLINARY PROCEEDINGS Violations of Rules of Fair Practice Failure to Comply with Free-Riding and Withholding Interpretation Failure to Give Notice of Association with Member Failure to Inform Member of Personal Securities Account Registered general securities representative associated with member firm traded in "hot issues" and failed to inform member firm that he maintained trading account at second firm, and second firm that he was associated with a member firm. Held, the NASD's findings of violation and sanctions imposed are sustained. APPEARANCES: John M. W. Crute, pro se. Alden S. Adkins and Norman Sue, Jr., for NASD Regulation, Inc. Appeal filed: September 23, 1997 Last brief received: January 6, 1998 I. John M. W. Crute, a registered general securities representative with Capital Investment Group, Inc. ("Capital") at the time of the events at issue in this proceeding, appeals from disciplinary action taken by the National Association of Securities Dealers, Inc. ("NASD" or "Association"). The NASD found that Crute purchased securities in a number of initial public offerings that rose to an immediate premium at the opening of secondary trading ("hot issues"), failed to notify Capital in writing that he maintained a securities account at his former employer, J.C. Bradford & Co. ("Bradford"), and failed to notify Bradford in writing that he had become associated with Capital. The NASD concluded that Crute's purchases violated the Board of Governor's "Free-Riding and Withholding" Interpretation ("Free- Riding Interpretation") [1]/, promulgated under former Article III, Section 1 of the NASD's Rules of Fair Practice ("NASD Rules"), /[2]/ and that Crute's notification failures violated former Article III, Sections 1 and 28 /[3]/ of the NASD Rules. The NASD censured Crute, fined him $3,544.27, and assessed costs of $541.50. We base our findings on an independent review of the record. /[4]/ **FOOTNOTES** [1]:// This rule now is recodified as Conduct Rule IM-2110-1, and prohibits, among other things, sales of stock of hot issues to all persons associated with members and their immediate families. [2]:// This rule, now recodified as Conduct Rule 2110, requires that members observe high standards of commercial honor and just and equitable principles of trade. [3]:// This rule, now recodified as Conduct Rule 3050, requires, among other things, that a person associated with a member notify in writing both the employing member of a personal account with another member and the member where the account is maintained of the fact of association with the employing member. [4]:// The NASD incorrectly asserts that the review standard here is whether its findings of violation are supported by substantial record evidence. To the contrary, we are required under Section 19 of the Securities Exchange Act of 1934 to "make our own findings as to the conduct of applicants seeking review of NASD action, [and to] determine whether such conduct violated the NASD's rules." Sumner B. Cotzin, 45 S.E.C. 575, 580 (1974) (emphasis in original). II. Crute began his career in the securities business in 1964 and was registered as a general securities representative at various firms until 1995. Between May 1991 and March 30, 1992, Crute was employed by Bradford. At the time Crute left Bradford, he negotiated an affiliation with Capital, another NASD member. Crute had inherited some money which, according to Crute, permitted him to end "a direct personality clash" with his supervisor at Bradford by resigning and going into semi- retirement. Crute, on the advice of friends in the brokerage business, approached Capital hoping to manage some accounts at that firm and to "place his license with Capital in order to prevent its expiration." /[5]/ The record reflects that Crute became a registered general securities representative of Capital on March 26, 1992 and remained registered with this firm until July 5, 1995 -- after the NASD filed its complaint in this matter. Crute is not currently registered with a member firm. During a routine 1994 examination of Bradford's underwriting activities, the NASD checked the names of purchasers of a hot issue, including Crute's, against its Central Registration Depository ("CRD"). CRD records reflected that Crute was registered with Capital at the time he purchased the shares. NASD investigators pursued the matter further and discovered that, between February and June 1993, Crute purchased stock in a number of initial public offerings that were hot issues through a personal securities account that he continued to maintain with Bradford after his registration with Capital. In the course of its investigation, NASD staff questioned employees at both Bradford and Capital to determine whether Crute notified each firm in writing of his connection with the other firm. According to statements provided by persons at Bradford, Crute left that firm on the understanding that he was retiring from the securities business and would be pursuing other interests. According to Bradford's general counsel, Crute, who remained subject to a non-compete agreement contained in his employment contract with Bradford, agreed to retire and leave both his customer accounts and his personal investment account at Bradford. In return, Bradford agreed not to require Crute to repay immediately principal and interest on an outstanding $20,000 loan the firm had made to Crute. Neither Bradford's general counsel nor the Bradford broker handling Crute's personal account evidenced knowledge that Crute intended to associate or register as a representative with Capital. Similarly, the president of Capital stated in a letter to the NASD that he did not know that Crute maintained a personal securities account at Bradford. On June 8, 1995, the NASD filed its complaint against Crute. Subsequently, after a hearing and decision by the District Business Conduct Committee ("District Committee"), the National Business Conduct Committee ("National Committee"), on its own motion, remanded this matter in February 1996 to the District Committee to supplement the record with evidence that the stocks at issue traded at an immediate aftermarket premium. /[6]/ After remand, the National Committee found that Crute violated the Free-Riding Interpretation with respect to five of six stock purchases charged in the complaint. The National Committee dismissed charges related to the sixth stock after concluding that the record contained insufficient evidence that this stock was a hot issue. In addition, the National Committee found that Crute violated former Article III, Sections 1 and 28 of the NASD Rules by failing to notify Bradford in writing of his association with Capital, and by failing to notify Capital in writing that he maintained a personal securities account at Bradford. This appeal followed. III. The predicate for the violations charged is Crute's status as an "associated person of a member" during the period at issue. Crute contends that he was never "associated" with Capital as that term is defined in Article I of the NASD By-Laws, and, as a result, asserts that he did not commit these violations. Crute acknowledges that he was registered with Capital during the relevant period but urges us to disregard this fact, as his continued registration with Capital during the relevant period was, he asserts, inadvertent. Crute claims that his hope of working for Capital ended when Bradford discovered his intention to move to Capital and threatened to sue him for breach of his non-compete agreement with Bradford. Crute further claims that, in response to this threat, he informed Capital orally that he would not be able to join the firm and assumed that Capital filed documents with the NASD necessary to terminate his status as a general securities representative. According to Crute, Capital's failure to terminate his registration resulted from the inexperience of Capital's compliance officers. Crute also defends against liability here by asserting that his purchases of the hot issues occurred during a nine-month period he spent touring the United States, allegedly out of contact with Capital. Former Article I(m) of the NASD By-Laws -- the provision in effect during the applicable period /[7]/ -- defines "associated person of a member" as: every sole proprietor, partner, officer, director, or branch manager of any member, or any natural person occupying a similar status or performing similar functions, or any natural person engaged in the investment banking or securities business who is directly or indirectly controlling or controlled by such member, whether or not any such person is registered or exempt from registration with the Corporation pursuant to these By-Laws. In contrast to Crute's position that, in determining his status, we should disregard the fact of his registration with Capital, the NASD urges us to consider any individual's registration with the NASD as fully equivalent to "associated person" status for purposes of the NASD Rules. It is unnecessary for us to do so in this case. While the fact that Crute was registered with Capital when he purchased the hot issues is important to our determination of Crute's status during that period, the record as a whole reflects that during the relevant period Crute was an "associated person" of Capital. Given Crute's registration with Capital, Crute was subject to the control of that firm while "engaged in the investment banking or securities business" of the firm. At the time Crute executed the "Uniform Application for Securities Industry Registration or Transfer" on Form U-4 seeking registration with Capital, Crute's admitted purpose was to associate with Capital and to handle some securities accounts at the firm. Subsequently, although Crute limited his activities for Capital because of his agreement not to compete with Bradford and Bradford's threats of suit, Crute engaged in Capital's securities business, and, thus, was an "associated person" of Capital. Specifically, Crute, before he traded in the hot issues, recommended that certain Bradford customers transfer their account to Capital. These customers followed Crute's recommendation and Crute consequently received compensation from Capital for transactions in that account. While the record is not entirely clear on the matter, we infer that that compensation was paid for account activity that occurred both before and during the period Crute was trading the hot issues. /[8]/ Crute's involvement with Capital increased as his non- compete agreement with Bradford neared its expiration. The broker handling Crute's account at Bradford stated in a letter to the NASD that Crute moved his personal account from Bradford to Capital in September 1993 because Capital had agreed to pay Crute commissions for trades in this account. Crute acknowledges that he considered himself "associated" with Capital as of September 1993. Another record document -- a letter dated June 28, 1994 from the president of Capital to the NASD -- provides further evidence that Crute was associated with Capital, although his activities were limited. In that letter, Capital's president states that while Crute's securities activities were limited during the "waiting period" imposed by the non-compete agreement, Crute "has informed me that his non-compete moratorium was over this spring, [and] he is making the decision to become more involved in the brokerage business or get out all together." /[9]/ Crute's status as an "associated person" is not dependent on whether he was an "employee" of Capital. Thus, Crute's reliance on the facts that, during the period at issue, he did not receive a salary from, and was not in day-to-day communication with, Capital, is misplaced. Crute conducted such securities-related activities as he believed were consistent with the non-compete agreement and with a break from day-to-day employment. In sum, Crute's securities-related activities while under the control of Capital made him an associated person of that firm. /[10]/ We do not accept Crute's claim that he had no reason to believe he was associated with Capital. In support of his claim, Crute contends that he was justified in assuming that Capital terminated his registration after he told Capital of Bradford's threat to sue him. Crute, however, acknowledges that he never received a copy of a "Uniform Termination Notice for Securities Industry Registration" on Form U-5 that Capital would have had to file with the NASD to terminate Crute's registration. Pursuant to former Article IV, Section 3 of the NASD By-Laws, /[11]/ Crute should have received a copy of the Form U-5 from Capital. Failure to receive the Form U-5 should have caused Crute to investigate further the status of his registration. Similarly, Crute has not explained how, if he presumed his registration with Capital terminated in 1992, he reasonably considered himself associated with Capital as of September 1993 -- just a few months after the trades at issue -- when he had not filed another Form U-4 with the NASD. **FOOTNOTES** [5]:// Pursuant to former Schedule C, Part III (1)(c) of the NASD By-Laws (now Membership and Registration Rule 1031(c)), representatives must retake the qualification examination if their most recent registration as a representative has been terminated for two or more years. [6]:// See Charles Martin Powell, 51 S.E.C. 601, 603 (1993) (record must show that securities traded at an immediate aftermarket premium to establish violation of NASD's free-riding and withholding interpretation relating to "hot issues"). [7]:// The cited provision has been amended and renumbered as Article I(ee) of the NASD By-Laws. The amendment codifies what the NASD characterizes in its brief to us as the Association's "long-standing interpretation" that any natural person registered with the NASD is a "person associated with a member," without regard to that person's employment responsibilities. See File No. SR-NASD-97-71, Securities Exchange Act of 1934 Rel. No. 39326 (November 14, 1997), 65 SEC Docket 2678, 2681-82 (order approving proposed rule change). As our order approving the amendment relates, its impetus was the NASD's determination to "counter[] the suggestion in certain case law [i.e., Slade v. Metropolitan Life Insurance Co., et al., Index No. 117688/94, Decision and Order of April 9, 1996 (Sup.Ct.N.Y.Co.), aff'd, 231 A.D.2d 467 (N.Y. 1996), appeal denied, 676 N.E. 2d 500 (N.Y. 1996) (table)] that any person whose job title or position is not specifically identified in the Association's definition of "associated person" (regardless of whether the individual is registered under an NASD member firm) may not be considered an associated person if he or she is not directly 'engaged' in the securities business." 65 SEC Docket at 2681-82. [8]:// Crute testified that he received a check from Capital that totalled "a couple of thousand dollars," and represented commissions that had accumulated in these customers' accounts "over a year or so." Before the District Committee Crute indicated he received this check in 1994; before the National Committee Crute indicated that it in fact was sent to him "a year and a half" after Bradford threatened suit in April 1992. Reconciling this testimony, we infer that Crute received the check in late 1993 or early 1994. [9]:// We also note that the NASD did not charge Capital with violating former By-Laws Schedule C Part III (1)(a) -- now recodified as Membership and Registration Rule 1031(a) -- which prohibits, among other things, a member from making an application for a representative's registration or maintaining such registration where (1) the representative is not active in the member's securities business, (2) the sole purpose is to avoid the examination requirement, or (3) the member does not intend to employ the representative in its securities business. [10]:// Compare Dale M. Russell, 51 S.E.C. 561, 563-64 (1993) (registered representative cannot avoid obligations as associated person by attempting to delay employment with member firm while engaging in other activities evidencing his association with firm); Meritquest Group, Inc., 51 S.E.C. 223, 225 (1992) ("independent contractor" label did not preclude individual engaging in securities business from being considered associated person and employee where member firm had control over individual). [11]:// This provision has been renumbered as Article V, Section 3 of the NASD By-laws. IV. A. The NASD found that Crute engaged in free-riding by purchasing at the initial offering price stock in five companies -- Rocky Shoes at $10 per share, Harry's Farmer's Market at $17 per share, Regional Acceptance at $10 per share, Sodak Gaming at $16 per share, and Brock Candy at $14 per share. According to records submitted to the District Committee on remand, the initial aftermarket trades in each stock were effected at a premium over the offering price -- Rocky Shoes at $12.25, Harry's Farmer's Market at $19.25, Regional Acceptance at $11, Sodak Gaming at $22, and Brock Candy at $15.50. Thus, each of the offerings was a hot issue. The NASD's Free-Riding Interpretation ensures that NASD members and their associated persons make bona-fide distributions to the public of securities that are part of a public offer- ing. /[12]/ The interpretation is designed to prevent restrictions on the supply of offerings that trade at an immediate aftermarket premium. /[13]/ It is a "prophylactic" rule "and does not require scienter to support a finding of violation." /[14]/ Crute, given his association with Capital at the time of the stock transactions at issue, acted in contravention of the Free-Riding Interpretation and thus violated former Article III, Section 1 when he purchased the five hot issues, even if, as he claims, he did not believe he was subject to the prohibition on hot issue purchases. B. The NASD also found that Crute violated former Article III, Sections 1 and 28(c) because Crute failed both to notify Capital in writing of his personal securities account at Bradford, and to notify Bradford in writing of his association with Capital. Crute acknowledges that he never informed either firm in writing of his connection to the other firm, but claims that each firm had constructive knowledge of such connection. Crute claims that Bradford became aware of his overtures to Capital and threatened to sue him for breach of the non-compete agreement. Crute also claims that he orally informed his superiors at Capital that he maintained an account at Bradford. Constructive awareness and verbal notification, however, are insufficient under the terms of former Section 28(c), which requires notification "in writing." /[15]/ Crute also cannot escape liability by arguing that he did not knowingly violate former Section 28(c). "Section 28(c), by its terms, has no knowledge component." /[16]/ We sustain the NASD's findings of violation. V. In considering what sanction was in the public interest, the NASD recognized several mitigating factors. The minimal profit Crute received from the hot issue purchases suggested to the NASD that Crute did not deliberately attempt to circumvent the NASD Rules. Rather, the NASD concluded that his violations were primarily the result of ignorance and inattention. In addition, the NASD specified that Crute has not been the subject of any previous disciplinary actions during his 29 years as a registered representative. Given these considerations, the NASD departed from the Sanction Guideline for free-riding violations. The NASD imposed a base fine of $2,500 (the minimum amount specified in the Guideline), and based the remainder of the fine on Crute's actual profit of $1,425 on these stocks, rather than on a larger amount equalling what the Guideline refers to as "transaction profit" -- that is the greater of the immediate aftermarket unrealized profit (the price determined to be the immediate aftermarket price times the number of shares minus the public offering price) or the actual profit. /[17]/ The NASD also chose not to impose any additional sanction for Crute's notification failures. We do not consider these sanctions -- a total monetary sanction of $3,544.27 and a censure -- to be excessive or oppressive for the conduct established on this record. Further, while Crute claims that it was "a violation of [his] individual rights to be charged $541.50 for thirty minutes hearing cost after the cost and time of flying to New Orleans to inform NASDR [he] had done nothing wrong," we see no basis for concluding that the hearing cost assessment was anything other than fair and appropriate under the circumstances, as provided by former Article IV, Section 2 of the NASD Code of Procedure. /[18]/ In sustaining these sanctions, we reject Crute's claim that they are inappropriate and reveal him to be a "scapegoat" because the broker who handled Crute's account at Bradford allegedly received only a censure, and no individuals at Capital were disciplined by the NASD. We have held that the question of whether disciplinary action is excessive depends on the particular facts and circumstances of the case and cannot be determined by comparison with the action taken in other cases. /[19]/ An appropriate order will issue. /[20]/ By the Commission (Chairman LEVITT and Commissioners JOHNSON and HUNT); Commissioners CAREY and UNGER not participating. Jonathan G. Katz Secretary **FOOTNOTES** [12]:// See Sherman, Fitzpatrick & Co. Inc., 51 S.E.C. 1048, 1054 (1994). [13]:// See First Philadelphia Corp., 50 S.E.C. 360, 361 (1990). [14]:// Id.; see also Rothschild Securities Corp., 45 S.E.C. 444, 446 (1974) (In a disciplinary proceeding that charges free- riding, it is "immaterial, except in connection with fixing the nature of the sanctions to be imposed in the public interest, whether [the respondent] was aware [that he] was violating the NASD rule."). [15]:// Compare Russell, 51 S.E.C. at 563 n.9 (verbal notification of private securities transaction was insufficient: "[a]s we have previously made clear, `furnishing notice in writing is necessary for compliance with the rule'") (quoting Dale Dwight Schwartzenhauer, 50 S.E.C. 1155, 1162 (1992) (emphasis in original)); accord Paulson Investment Company, Inc., 47 S.E.C. 886, 889 (1983). [16]:// Jay Michael Fertman, 51 S.E.C. 943, 951 n.34 (1994) (noting distinction between Section 28(c) and Section 28(a), which, unlike Section 28(c), requires knowledge on the part of the violator). See also Philip S. Sirianni, 47 S.E.C. 355, 359 (1980) (registered representative's ignorance of his obligation to report private securities transactions to member firm did not excuse the representative from this obligation). [17]:// See NASD Sanction Guidelines (1993 ed.) at 24. [18]:// This provision has been renumbered as Complaints, Investigations and Sanctions Rule 8330. [19]:// David A. Gingras, 50 S.E.C. 1286, 1293-94 (1992), and the cases there cited. See also Markowski v. SEC, 34 F.3d 99, 105 (2d Cir. 1994) (claim by broker that he was victim of selective prosecution -- because other employees of same firm were not charged -- was meritless). [20]:// We have considered all of the parties' contentions. We have rejected or sustained them 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. 40474 / September 24, 1998 Admin. Proc. File No. 3-9428 : In the Matter of the Application of : : JOHN M. W. CRUTE : P. O. Box 1198 : Fort Stockton, TX 79735 : : 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. ("NASD") against John M. W. Crute, and the NASD's assessment of costs be, and they hereby are, sustained. By the Commission. Jonathan G. Katz Secretary