UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
Securities Exchange Act of 1934
Release No. 42079 / November 1, 1999
Accounting and Auditing Enforcement
Release No. 1198 / November 1, 1999
File No. 3-9846
In the Matter of :
: ORDER MAKING
JEFFREY L. HARFST, WILLIAM R. : FINDINGS, IMPOSING
HEBEL and JOSEPH E. MUEHL, : REMEDIAL SANCTIONS
: AND CEASE-AND-DESIST
: ORDER AS TO JOSEPH E.
Respondents. : MUEHL
Joseph E. Muehl has submitted an Offer of Settlement ("Offer") for the purpose of disposing of the issues raised by this proceeding. Solely for the purposes of these proceedings and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, and prior to hearing and without admitting or denying the findings set forth herein, Muehl consents to the entry of this Order Making Findings, Imposing Remedial Sanctions and Cease-and-Desist Order as to Joseph E. Muehl ("Order"). The Commission has determined that it is appropriate and in the public interest to accept the Offer of Settlement from Muehl, and accordingly is issuing this Order.1
Based on the foregoing, the Commission finds that:2
Joseph E. Muehl, age 37, was a First Vice President at The Nikko Securities Co. International, Inc. ("Nikko"). Nikko is a broker-dealer registered with the Commission pursuant to Section 15 of the Securities Exchange Act of 1934 ("Exchange Act") and is a wholly-owned subsidiary of The Nikko Securities Co. Ltd. Muehl, during the relevant time, traded derivative and pass-through mortgage-backed securities.
B. The Swap Transactions
In January 1995 Nikko's London-based affiliate, Nikko Europe Plc ("Nikko Europe") placed an order with Nikko to sell on an agency basis a block of its mortgage-backed securities ("MBS") at Nikko Europe's break-even price "or higher."
Muehl and his supervisor devised a plan to generate profits for Nikko and for the Fixed Income trading operation, and to hide the profits from the firm's customer, Nikko Europe. Muehl sold the securities well below the market price to an unaffiliated broker (the "Unaffiliated Broker"). The Unaffiliated Broker simultaneously sold to Nikko's proprietary account certain pass-through securities at prices that had been adjusted down to correspond to the profits hidden by Muehl from the customer, Nikko Europe. Muehl then immediately sold the MBS pass-through securities to the market and generated substantial profits without the knowledge or consent of Nikko Europe. The profits reflected favorably on Muehl's performance and on the profitability of the Fixed Income trading department.
Muehl engaged in four swap transactions with the Unaffiliated Broker pursuant to the plan: three in February 1995 and one in April 1995. In each transaction, the Unaffiliated Broker purchased Nikko Europe's MBS securities (principal-only strips), and at the same time sold Nikko pass-through securities. Muehl immediately sold the pass-through securities that Nikko received from the Unaffiliated Broker in the four swaps, generating profits for Nikko of $267,188, $369,297, $109,257, and $97,109, respectively. In these four transactions, Muehl, along with his supervisor, misappropriated a total of $842,851 from the client, Nikko Europe, without the client's knowledge or consent.
Nikko provided trade confirmations and account statements to Nikko Europe in which it represented that the trades were agency trades, and reported trade prices that omitted the misappropriated profits that were, in substance, part of the sale prices. In addition, the linkage of the sale of the principal-only strips from the MBS portfolio and the purchase of the pass-through securities was never recorded as terms and conditions of the transactions as it should have been in Nikko's books and records.
C. Muehl Conceals Profits by Mismarking GNMA Positions
in Nikko's Proprietary Accounts
To hide the large daily profits made on the swap transactions on his daily profit and loss, Muehl mismarked the prices on certain GNMA securities owned by Nikko and recognized the profits over the course of several weeks. Between February 22 and February 24, 1995, Muehl artificially marked down certain GNMA securities to offset the profits on the swap transactions. As a result of these actions, Nikko's February 1995 FOCUS report included the incorrect valuations and understated the firm's profits for that month by approximately $264,000. Net income reported for February 1995 was $645,169. Thus, the incorrect valuations of the GNMA positions caused Nikko's February net income to be understated by approximately 41%.
A. Antifraud Violations Section 10(b) of the Exchange Act and Rule 10b-5
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder make it unlawful to employ any device, scheme or artifice to defraud in connection with the purchase or sale of securities. As discussed above, Muehl misappropriated $842,851 from Nikko Europe through the swap transactions and, accordingly, willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
B. Broker-Dealer Books and Records Violations
Section 17(a) of the Exchange Act and Rule 17a-3 Thereunder
Section 17(a) of the Exchange Act requires brokerage firms to create and maintain books and records. Rule 17a-3 requires broker-dealers to maintain the following records: (1) ledgers or other internal records "reflecting all assets and liabilities, income and expense and capital accounts" (Rule 17a-3(a)(2)); (2) memoranda of brokerage orders, and of any other instructions, for the purchase or sale of securities showing the terms and conditions of the order or instructions and of any modification or cancellation thereof (Rule 17a-3(a)(6)); and (3) memoranda of purchases and sales for the firm's account reflecting terms and conditions of the transactions (Rule 17a-3(a)(7)). Information contained in a required record must be accurate. See Report Pursuant to Section 21(a) of the Securities Exchange Act of 1934 Regarding the Distribution of Certain Debt Securities Issued by Government Sponsored Enterprises, Exchange Act Rel. No. 30255 (Jan. 16, 1992). See also Sinclair v. SEC, 444 F.2d 399, 401 (2d Cir. 1971); In the Matter of James F. Novak, Exchange Act Rel. No. 19660, 47 SEC 892 (1983).
Nikko willfully violated Section 17(a) and Rule 17a-3 by maintaining inaccurate books and records by failing to reflect that (i) the linkage of Nikko Europe's MBS sales to the Unaffiliated Broker-Dealer, and Nikko's simultaneous purchases of pass-through securities from the Unaffiliated Broker-Dealer, were terms and conditions of the sales and purchases, which were required to be, but were not, reflected in the memoranda of the orders and (ii) the alteration in the valuation of the GNMA securities and the "bleeding" in of the profits from the swaps resulted in inaccurate accounting ledgers and profit and loss statements for February and March 1995.
Muehl inaccurately recorded the swap transactions and mismarked his GNMA position and thus willfully aided and abetted and caused Nikko's books and records violations with respect to the MBS portfolio.
C. False FOCUS Reports Sections 17(a) and 17(e) of the Exchange Act
and Rule 17a-5
Sections 17(a) and 17(e) of the Exchange Act require broker-dealers to file certain financial reports. Section 17(e) and Rule 17a-5 require broker-dealers to file annual reports with the Commission, containing, among other things, a statement of financial condition, a statement of income, and a statement of changes in financial position. Rule 17a-5(a) thereunder requires brokers and dealers to file monthly and quarterly unaudited financial reports, known as FOCUS reports, with the Commission or an SRO. Information contained in those reports must be accurate. See In the Matter of D.S. Meyers & Co., Exchange Act Rel. No. 22417, 1985 SEC LEXIS (Sept. 17, 1985) (filing of inaccurate FOCUS reports constitutes a willful violation of Rule 17a-5); see also In the Matter of Anthony Stoisich, Anthony DeStefano, Exchange Act Rel. No. 27626, 1990 SEC LEXIS 142 (Jan. 16, 1990) (filing false FOCUS reports with the NASD violates Section 17(a) of the Exchange Act and Rule 17a-5). The FOCUS report "constitutes the basic financial and operational report required of those brokers or dealers subject to any minimum net capital requirement . . . ." Form X-17A-5, Part II (General Instructions).
Nikko willfully violated Sections 17(a) and 17(e) of the Exchange Act and Rule 17a-5 thereunder by filing FOCUS reports that misstated the nature of the proceeds from the swap transactions from February 1995 forward and had an incorrect income statement reflecting the alterations by Muehl to disguise the profits taken on the sale of pass-through securities for February and March 1995. The misstatements made in Nikko's FOCUS reports caused Nikko's retained earnings and additional paid-in capital to be misstated, and caused Nikko's February 1995 net income to be understated by approximately $264,000 (41%) and its March 1995 net loss to be overstated by $264,000 (71%).
As discussed above, Muehl willfully aided and abetted and caused Nikko's violations of Sections 17(a) and 17(e) of the Exchange Act and Rule 17a-5 thereunder.
Based on the above, the Commission finds that Muehl willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and willfully aided, abetted and caused Nikko's violations of Sections 17(a) and 17(e) of the Exchange Act and Rules 17a-3 and 17a-5 thereunder.
Accordingly, it is hereby ordered that Muehl,
1. cease and desist from committing or causing any violations of, and committing or causing any future violations of, Sections 10(b), 17(a) and 17(e) of the Exchange Act and Rules 10b-5, 17a-3 and 17a-5 thereunder;
2. be, and hereby is, barred from association with any broker or dealer with the right to reapply for association after twenty-one (21) months to the appropriate self-regulatory organization, or if there is none, to the Commission; and
3. pay a civil money penalty of $50,000, as follows: $25,000 within ten (10) days of the entry of the Order; $12,500 plus post-judgment interest 100 days after the entry of the Order; and $12,500 plus post-judgment interest 190 days after the entry of the Order. Post-judgment interest shall accrue at the rate set forth in 28 U.S.C. Section 1961. Payment is to be made by U.S. Postal money order, certified check, bank cashier's check, or bank money order, made payable to the Securities and Exchange Commission and shall be hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312, under cover of a letter that identifies the respondent and the name and file number of this proceeding. A copy of the cover letter and of the form of payment shall be simultaneously transmitted to Laura B. Josephs, Esq., Securities and Exchange Commission, Division of Enforcement, 450 Fifth Street, N.W., Washington, D.C. 20549-0703.
By the Commission.
Jonathan G. Katz
1 This matter was instituted as to Mr. Muehl pursuant to Sections 15(b)(6) and 21C of the Securities Exchange Act of 1934 on March 8, 1999. In a related administrative proceeding, instituted August 27, 1998 (Release No. 34-40375), Nikko consented to the entry of a cease-and-desist order and three Nikko officers each consented to the entry of a cease-and-desist order, six month suspension from association with a broker-dealer and a $50,000 civil penalty. In a related civil action, also filed August 28, 1998 (Lit. Rel. No. 15861), Nikko consented to the entry of an order by the court pursuant to Section 21(e) of the Exchange Act ordering Nikko to comply with the Commission's prior cease-and-desist order and ordering the firm to pay a $2.5 million civil penalty. SEC v. The Nikko Securities Co. International Inc., 98 Civ.2058 (D.D.C. 1998).
2 The findings herein are made pursuant to Muehl's Offer of Settlement and are not binding on any other person or entity in this or any other proceeding.