SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40719 / November 30, 1998 Admin. Proc. File No. 3-8508 : In the Matter of : : RICHARD D. CHEMA : 7302 Pilothouse Road : Burke, Virginia : : OPINION OF THE COMMISSION BROKER-DEALER PROCEEDINGS Grounds for Remedial Action Aiding, Abetting, and Causing Fraudulent and Manipulative Conduct Salesman for registered broker-dealer aided, abetted, and caused customer's fraudulent and manipulative conduct. Held, it is in the public interest to suspend salesman from association with any broker or dealer for one year and to order him to cease and desist from committing or causing further violations. APPEARANCES: Richard D. Chema, pro se. David S. Horowitz and Merri Jo Gillette, for the Division of Enforcement. Appeal filed: September 14, 1995 Briefing completed: December 6, 1995 I. Richard D. Chema, a registered representative who during the relevant period was employed by H. Beck, Inc., a registered broker-dealer, appeals from the decision of an administrative law judge. The law judge found that Chema aided, abetted, and caused violations of anti-manipulative and antifraud provisions of the Securities Exchange Act of 1934 committed by John G. Broumas, one of Chema's customers. The law judge concluded that Chema should be suspended from association with any broker or dealer for a period of eight months, and ordered to cease and desist from committing or causing any further violations of the provisions he was found to have violated. Our Division of Enforcement appeals both with respect to the length of Chema's exclusion from the brokerage business, and with respect to the law judge's failure to impose a collateral bar excluding Chema from other aspects of the securities industry. Our findings are based on an independent review of the record except for findings that are not challenged on appeal. II. A. During most of the period from January 1, 1989 through June 30, 1990, Broumas was chairman of the board of Madison National Bank of Virginia ("MNBV") and a director of James Madison, Limited ("JML"), the holding company for the Madison group of banks. [1] At that time, Broumas was experiencing severe financial difficulties. He was personally liable on more than $2,000,000 worth of notes owed to banks, had mortgage debt totaling more than $900,000, and was having serious problems meeting his current obligations. [2] As a result of these liabilities and others he could not repay, Broumas ultimately filed for bankruptcy protection in February 1991. Before doing so, however, during the period at issue he engaged in the fraudulent scheme outlined below in a desperate effort to raise money. Broumas owned about 190,000 shares of JML Class A common stock ("JML stock") which was listed on the American Stock Exchange ("AMEX"). His stock was held in about 25 margin accounts (including the accounts of several nominees) that Broumas controlled at 14 different broker-dealers. In a scheme similar to check-kiting, Broumas arranged over-the-counter "wash trades" of JML stock between these various accounts. [3] He instructed registered representatives at the firms on each side of the trades to contact each other and buy or sell specific amounts of his stock at a specified price. These transactions between his accounts produced needed cash for Broumas. Since the stock was held in margin accounts, he could obtain the proceeds from his sales one day after the transactions were completed, but could delay a week (until the settlement date) in paying for the corresponding purchases. Broumas claimed that he effected wash trades rather than outright sales of JML because he wanted to retain his JML stock holdings to maintain his position as chairman at the bank. During the relevant period, he effected 203 sets of wash trades involving 420 transactions. Although Schedule G to the By-Laws of the National Association of Securities Dealers, Inc. ("NASD"), which was in effect at the time of the events at issue, required that over-the-counter sales transactions in exchange-listed securities be reported, most of Broumas' wash trades were not reported. Nevertheless, the JML trades that were reported to the AMEX constituted 36.6% of the total reported market volume for the period January 1, 1989 through June 30, 1990, and, from July 1, 1989 through June 30, 1990, 44% of the reported volume. In addition to his wash trades, Broumas engaged in the practice of "marking the close" by purchasing small amounts of JML on the AMEX and the Midwest Stock Exchange at or near the close of trading. [4] Between January 18, 1989 and June 25, 1990, he made 69 purchases of JML during the final 10 minutes of the trading day. Of those purchases, 54 were the last trade of the day and 47 were executed on an uptick. [5] On several occasions, Broumas' trades raised the closing price of JML stock by 1/8. Broumas' purchases at the close of trading were beneficial to him in more than one respect. Brokerage firms use the closing price of a security in determining whether they will extend margin on the security, whether a customer's account meets margin requirements, and the customer's equity in his margin account. Moreover, the closing price of a security is quoted in the following day's newspapers. Broumas admitted to one of his registered representatives that he was trying to create interest in JML, observing that "if nobody [bought] it on a certain day, it [wouldn't] show up in the [newspaper] listing." [6] B. Chema handled seven separate accounts for Broumas at Beck, four of which were opened by Broumas' nominees. [7] Chema believed that the nominees opened their accounts to provide Broumas with additional credit to assist him in his effort to maintain his stock ownership in JML. Broumas called in all of the orders for six of the accounts, and most of the orders for the seventh. All of the transactions in two of the accounts and most of the transactions in the others were in JML stock. Chema maintained "posting sheets" for each account that reflected all of that account's trading. During the period October 2, 1989 through June 21, 1990, Chema effected 73 wash trades for Broumas covering 608,575 shares of JML stock. [8] Typically, Broumas would call Chema and tell him that he wanted to buy or sell a certain quantity of JML stock in a particular account. After Chema checked the bid and ask prices on a terminal that reported AMEX prices, Broumas would set a price and tell Chema that he would try to find a seller or buyer. Broumas would then call back and direct Chema to buy or sell a specific number of shares at a stated price from or to another broker-dealer. Sometimes, Broumas would provide Chema with all the necessary information in a single telephone call. On seven occasions, Chema executed trades between two of Broumas' accounts at Beck ("cross-trades"). These trades were either between two of the nominee accounts or between a nominee and one of Broumas' other accounts. According to Chema, Broumas would tell him that one of the nominees needed money and had to sell JML stock, and that Broumas would try to find a buyer. Later, Broumas would call back and say that he could not find a buyer but had persuaded another nominee to take the shares or was buying them himself. As noted above, Broumas' sales of JML had to be reported. Chema had been informed of the reporting requirement by another broker in September 1989. At that time, he contacted the NASD and was instructed on how to report such trades. However, Chema reported only 14 of the sales he effected for Broumas during the relevant period, and none of the cross-trades. Of the 73 Broumas wash trades that Chema effected during the period, a total of 34 (covering 303,050 shares of JML) were reported, 14 by Chema and the remainder by contra-brokers. During the five-month period November 27, 1989 through April 30, 1990, Chema executed 15 Broumas JML purchase orders on the AMEX during the last seven minutes of the trading day. The transactions all involved the purchase of 500 or fewer shares. Of the 15 trades, 13 were the last trade of the day, 10 were executed on an uptick, and 5 on a zero plus tick. [9] The trades were all called in by Broumas shortly before they were executed, and all of them were market orders. As Chema conceded, market orders are generally executed at the current offering price, which is often an uptick from the previous transaction price. III. Chema argues that the law judge erred in concluding that Broumas violated the antifraud provisions of Section 10(b) of the Exchange Act and Rule 10b-5 in connection with his wash trades. [10] He asserts that, in order to find such a violation, it must be shown that the respondent intended his trades to mislead investors by creating the false appearance of market activity. Chema states that there is no proof that Broumas had any such intent. It is not necessary to find that Broumas acted with manipulative intent in order to conclude that his wash sales defrauded investors. It is sufficient if Broumas engaged in a course of conduct that operated as a fraud or deceit as to the nature of the market for JML. [11] Here the reported JML wash trades substantially distorted investors' perception of the market, creating a false appearance of enhanced activity. Broumas was either aware of or recklessly indifferent to this natural consequence of his actions. Broumas, moreover, deliberately defrauded the firms that paid him for sales when in fact the ownership of the securities never changed. Indeed, the whole purpose of Broumas' scheme was to obtain infusions of cash by misleading the payors into believing that he was making legitimate sales of stock. In the case of Broumas' sales through Chema, Broumas defrauded Bear, Stearns & Co., Inc., Beck's clearing firm, into advancing him substantial sums of money. Chema further contends that, in order to find that investors were defrauded, it must be shown that they suffered harm, a result assertedly not in evidence here since Broumas' trades did not noticeably affect JML's market price. This contention is without merit. This proceeding is not a private action for damages but an action brought to redress the public interest. Thus, no proof of loss by investors is required. As we have stated in a similar context, "when investors and prospective investors see activity, they are entitled to assume that it is real activity." Even if no investor is injured, "[t]he vice is that the market has been distorted and made into a `stage-managed performance.'" [12] Broumas also violated the above antifraud provisions in connection with his "marking-the-close" transactions. We think it clear that his objectives in making those purchases included increasing the equity in his margin accounts and preserving the marginability of JML stock by raising the stock's price. Such a course of conduct is patently manipulative. By artificially influencing JML's price level at the end of the day, Broumas intentionally distorted the stock's market price, conveying false information to investors and the market, including brokers that used the closing price to assess margin. [13] We conclude that, in the foregoing respects, Broumas will- fully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. We also find that Broumas willfully violated Section 9(a)(2) of the Exchange Act which makes it unlawful to effect transactions in an exchange-listed security that raise the price of that security for the purpose of inducing others to purchase it. Broumas' "marking-the-close" purchases, which raised or supported the price of JML, were also designed to induce purchases by others. As noted above, Broumas admitted having that objective to one of the salesmen who serviced his accounts. IV. The three elements necessary to find aiding and abetting are: (1) securities law violations by another party; (2) substantial assistance by the aider and abettor in the conduct constituting those violations; and (3) general awareness or knowledge by the aider and abettor that his actions are part of an overall course of conduct that is illegal or improper. [14] Broumas' violations are clear, as is the fact that Chema lent them substantial assistance. Chema argues, however, that he was not an aider and abettor because he lacked the requisite knowledge of Broumas' misconduct. [15] We disagree. Chema admitted that, at the time he was executing over-the- counter trades for Broumas in 1989 and 1990, he considered Broumas' trading "most bizarre." Indeed, Chema was concerned that Broumas might be manipulating JML stock. He was aware that Broumas owned a large quantity of the stock, and was told by Broumas that he had various brokerage accounts "around town" and "wanted to keep his ownership in (JML) stock spread between various firms" in order to protect himself "if some firm went out of business or if the shares got tied [up]." With that knowledge, Chema admittedly considered the possibility that Broumas might be engaging in wash trades. According to Chema, he dismissed that possibility because "[n]o one knew that the trades were going on." However, as set forth below, Chema knew that some of Broumas' trades were being reported. As noted above, Chema was aware of the reporting requirement with respect to Broumas' sales. Indeed, Chema himself reported 14 of those transactions. He was also aware that brokers on the other side of Broumas' purchases at Beck were required to report the corresponding sales. In fact, twenty such sales were reported. Moreover, it must have occurred to Chema that Broumas could be engaging in wash trades between his brokerage accounts at other firms, engendering further reported volume. Thus, even though he chose not to report all of Broumas' trades, Chema could hardly dismiss the possibility that Broumas was engaging in manipulative activity that would deceive investors in the marketplace. [16] Chema was also aware of circumstances that put him on notice that Broumas might be defrauding Bear, Stearns and other firms of the funds they advanced on his purported sales. Chema knew that Broumas was having financial problems. When Chema opened accounts for Broumas' nominees, he understood that Broumas "needed their money, their credit, [and] their ability to buy shares because of his . . . financial situation." Chema also knew that, when Broumas sold stock, he often asked for immediate payment because he needed the cash. In March 1990, Carole Haynes, a broker who had been handling Broumas' accounts at another firm, discussed with Chema Broumas' practice of asking for his money immediately whenever he sold stock but waiting until the last possible minute to pay for any purchase. Haynes told Chema that she had closed Broumas' accounts because she was worried about his financial condition, and warned Chema to be careful. But Chema, despite his suspicions that Broumas might be engaging in wash trades, took no action, and continued to execute Broumas' orders. There are additional circumstances that suggest that Chema was aware that Broumas' over-the-counter JML trading was improper. Chema claimed that he did not know how to report Broumas' cross-trades, but admitted that he made no effort to find out, either from the NASD or anyone else. He further stated that these trades "could have been problematic" but that he kept them from becoming so by reporting the trades to Bear, Stearns only after the markets had closed. Thus, in Chema's view, the trades simply became "bookkeeping [entries]" at Bear, Stearns, and not a cause for concern since "no one else knew that the trades [had] occurred." Chema, moreover, did not explain why he failed to report 17 JML sales by Broumas and his nominees that were not part of the cross-trades. In addition, although Broumas told Chema that his chief reason for trading JML was to acquire large amounts of the stock in order to avoid being "driven out" of his position at the bank "in favor of younger people," Chema acknowledged that, "on occasion," Broumas sold out all of his JML stock in a particular account. [17] Chema also ignored facts suggesting that Broumas was improperly influencing JML's closing price. He knew that Broumas was using all the equity he possessed in his margin accounts and that it was important to Broumas to preserve the marginability of JML stock. It was Broumas' understanding that JML had to be worth at least $5 per share to be marginable. From mid-February 1990 through the beginning of May, the closing price of the stock hovered between 5 and 5«. On May 10, the price sank permanently below the $5 level, and, by the end of June, had dropped to 4. In their March 1990 conversation, Haynes and Chema discussed the financial straits Broumas would be in if the price of JML dropped below $5 or $4, and JML ceased to be marginable. Although other firms had different requirements, Haynes' clearing firm required a price of 5 1/8 per share for a stock to be marginable. Despite his discussion with Haynes and the falling price of JML, Chema, in April 1990, executed four JML purchases for Broumas on the AMEX in the last three minutes of the trading day, all of which served to bolster JML's price. Two purchases were executed on an uptick, and two at a zero plus tick. Chema admits that he could not "fathom" Broumas' "bizarre" trading. Yet, although he suspected that Broumas was engaging in manipulative activity, he made no effort to determine whether or not his suspicions were justified. Instead, he simply continued to execute all of Broumas' orders, including those on the AMEX at the end of the day. We conclude that, under the circumstances, Chema recklessly abdicated his responsibility to investigate Broumas' trading. As we stated more than twenty years ago: "The importance of a broker-dealer's responsibility to use diligence where there are any unusual factors is highlighted by the fact that violations of the antifraud and other provisions of the securities laws frequently depend for their consummation ... on the activities of broker-dealers who fail to make diligent inquiry to obtain sufficient information to justify their activity in [a] security." [18] We accordingly conclude that Chema willfully aided and abetted Broumas' violations of Sections 9(a)(2) and 10(b) of the Exchange Act and Rule 10b-5 thereunder. [19] We further conclude, pursuant to Section 21C of the Act, that Chema was a cause of those violations. [20] V. The record does not show that Chema knowingly lent himself to Broumas' schemes. Nevertheless, he ignored clear warning signals and recklessly failed to fulfill his investigatory obligations. We consider that a one-year suspension from association with any broker or dealer, coupled with a cease and desist order, will serve to awaken Chema to his responsibilities as a securities salesman, and deter any recurrence of the misconduct shown by this record. An appropriate order will issue. [21] By the Commission (Chairman LEVITT and Commissioners JOHNSON and HUNT); Commissioners CAREY and UNGER not participating. Jonathan G. Katz Secretary **FOOTNOTES** [1]: Broumas held these positions until May 24, 1990. [2]:Broumas was unable to borrow more money from the JML banks because he had reached his credit limit. [3]:We have defined "wash trades" as securities transactions that involve no change in the securities' beneficial ownership. See, e.g., Swartwood, Hesse, Inc., 50 S.E.C. 1301, 1306 n.12 (1992). [4]:"`Marking the close' is the practice of attempting to influence the closing price of a stock by executing purchase or sale orders at or near the close of the market." Thomas C. Kocherhans, Securities Exchange Act Rel. No. 36556 (December 6, 1995), 60 SEC Docket 2589, 2592. While Broumas' wash trades typically involved the purchase and sale of between 3,000 and 12,000 shares of JML, his "marking-the-close" purchases usually involved only 100-200 shares. [5]:An uptick occurs when a securities transaction is executed at a price higher than the previous transaction in the same security. [6]:On September 27, 1991, we brought an injunctive action against Broumas charging that he violated federal securities laws by executing wash trades in JML stock and marking the close. Without admitting or denying the allegations, Broumas consented to the entry of a permanent injunction. SEC v. John G. Broumas, Civil Action No. 91-2449 (D.D.C.). In November 1994, Broumas pled guilty to a criminal information charging him with misapplication of bank funds. The information alleged that, from April through June 1990, Broumas engaged in a check-kiting scheme, writing checks against insufficient funds in order to meet margin calls. It also charged that Broumas improperly used his position as board chairman of MNBV to exchange personal checks drawn on falsely inflated balances for cashier's checks in order to meet margin calls and pay other expenses. U.S. v. Broumas, Crim. No. 94-442 (D.D.C. Nov. 23, 1994). [7]:The three accounts opened by Broumas were (1) a joint account with his wife, (2) the "Les Girls" account, ostensibly belonging to Broumas' wife and daughter, and (3) the "BC Theaters" account, which Broumas, as a partner, opened on behalf of a partnership that ran movie theaters. Three of the nominees, Michael J. Connolly, Kevin K. Lemmon, and Matthew R. Johnson (Broumas' grandson), were MNBV employees. The fourth nominee, L. Lawton Rogers, was a Broumas business associate and attorney. [8]:These proceedings were instituted on September 30, 1994. In light of the Court's decision in Johnson v. SEC, 87 F.3d 484 (D.C. Cir. 1996), holding that the five-year statute of limitations contained in 28 U.S.C. Section 2462 applies to certain of our proceedings, we shall consider only those transactions effected by Chema that occurred within five years of the institution of proceedings in determining whether he committed violations. We note, however, that, even assuming that the prior conduct is time-barred, it may be considered as evidence of motive, intent, or knowledge. See, e.g., Fed. R. Evid. 404(b). [9]:A zero plus tick occurs when a securities transaction is executed at the same price as the previously executed trade in that security when that trade was executed at a price higher than the immediately preceding trade in the security. [10]:Chema also objects to the law judge's conclusion that Broumas violated Section 9(a)(1) of the Exchange Act in connection with those trades. On the basis of the evidence adduced before us, we sustain that objection. Section 9(a)(1) makes it unlawful for any person to engage in wash trades if they are effected for the specific purpose of creating a false or misleading appearance of active trading in a security registered on a national securities exchange, or a false or misleading appearance with respect to the market for such a security. We have held that the indicated intent must be specifically shown to establish a violation of Section 9(a)(1). Michael Batterman, 46 S.E.C. 304, 305 (1976); Harold T. White and Francis M. Weld, 3 S.E.C. 466, 510 (1938). No such intent was shown here. The evidence adduced by the Division shows only that Broumas arranged wash trades to take advantage of the float created by the transactions in the margin accounts that he controlled. [11]:See United States v. Charnay, 537 F.2d 341, 350-351 (9th Cir.), cert. denied, 429 U.S. 1000 (1976). [12]:Edward J. Mawod & Co., 46 S.E.C. 865, 871-872 (1977), aff'd, 591 F.2d 588 (10th Cir. 1979). [13]:See Thomas C. Kocherhans, 60 SEC Docket 2592. [14]:See Donald T. Sheldon, 51 S.E.C. 59, 66 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995), and the authorities therein cited. [15]:Chema further contends that he was disadvantaged in these proceedings because of the law judge's refusal to grant his motion seeking a definition of the term "wash sale." This claim is without merit. We defined that term forty years ago. See J.A. Latimer & Co., Inc., 38 S.E.C 790, 792 (1958), cited in Ernst & Ernst v. Hochfelder, 425 U.S. 185, 205 n.25 (1975). [16]:The 34 reported Broumas wash trades at Beck accounted for 33% to 100% of the reported JML volume on the days the trades were effected. [17]:Chema's explanation that Broumas' ownership of JML shares varied in accordance with "internal bank policies" and Broumas' need "to show shares at meetings" does not adequately explain why Broumas would divest an account of all its JML shares. [18]:Alessandrini & Co., Inc., 45 S.E.C. 399, 406 (1973). [19]:It has been held that clear proof of intent to violate the law may be necessary to find a respondent liable for aiding and abetting in a case where "the alleged aider and abettor conducts what appears to be a transaction in the ordinary course of his business" or "the evidence shows no more than transactions constituting the daily grist of the mill." Woodward v. Metro Bank of Dallas, 522 F.2d 84, 95, 97 (5th Cir. 1975). That is not the case here where, as Chema admits, Broumas' transactions were "bizarre." [20]:Our finding that Chema willfully aided and abetted Broumas' violations necessarily makes him a "cause" of those violations. See Dominick & Dominick, Incorporated, 50 S.E.C. 571, 578 n.11 (1991). As noted above, to conclude that a respondent aided and abetted another's violation, it must be found that the respondent acted with scienter. A respondent is a "cause" of another's violation if the respondent "knew or should have known" that his act or omission would contribute to such violation. Exchange Act Section 21C(a). [21]:All of the contentions 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. UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40719 / November 30, 1998 Admin. Proc. File No. 3-8508 : In the Matter of : : RICHARD D. CHEMA : 7302 Pilothouse Road : Burke, Virginia : : ORDER IMPOSING REMEDIAL SANCTIONS On the basis of the Commission's opinion issued this day, it is ORDERED that Richard D. Chema be, and he hereby is, suspended from association with any broker or dealer for a period of one year; and it is further ORDERED that Chema cease and desist from committing or causing any violation and committing or causing any future violation of Sections 9(a)(2) and 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder; and it is further ORDERED that Chema's suspension shall be effective at the opening of business on December 14, 1998. By the Commission. Jonathan G. Katz Secretary