INVESTMENT ADVISERS ACT OF 1940
Release No. 1833 / September 27, 1999
INVESTMENT COMPANY ACT OF 1940
Release No. 24053 / September 27, 1999
File No. 3-10029
In the Matter of
HARRY MICHAEL SCHWARTZ,
|ORDER INSTITUTING PUBLIC ADMINISTRATIVE AND
CEASE-AND-DESIST PROCEEDING PURSUANT TO SECTIONS 203(f) AND (k) OF THE INVESTMENT ADVISERS ACT OF 1940 AND SECTIONS 9(b) AND (f) OF THE INVESTMENT COMPANY ACT OF 1940, MAKING FINDINGS AND IMPOSING SANCTIONS AND CEASE-AND-DESIST ORDER
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that a public administrative and cease-and-desist proceeding be instituted pursuant to Sections 203(f) and (k) of the Investment Advisers Act of 1940 ("Advisers Act"), and Sections 9(b) and (f) of the Investment Company Act of 1940 ("Investment Company Act") against Harry Michael Schwartz ("Schwartz").
In anticipation of the institution of this proceeding, Schwartz has submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission, or in which the Commission is a party, and without admitting or denying any findings contained herein, except that Schwartz admits to the jurisdiction of the Commission over him and over the subject matter of this proceeding, Schwartz consents to the issuance of this Order Instituting Public Administrative and Cease-and-Desist Proceeding Pursuant to Sections 203(f) and (k) of the Investment Advisers Act of 1940 and Sections 9(b) and (f) of the Investment Company Act of 1940, Making Findings and Imposing Sanctions and Cease-and-Desist Order ("Order").
Accordingly, IT IS ORDERED that a proceeding pursuant to Sections 203(f) and (k) of the Advisers Act and Sections 9(b) and (f) of the Investment Company Act be, and hereby is, instituted.
On the basis of this Order and Schwartz's Offer, the Commission finds that:
A. Schwartz, age 31, has been associated with the following Commission-registered entities: from approximately December 1992 through February 1998, he was president and chief financial officer of a registered investment adviser (the "Adviser"); from approximately January 1994 through February 1998, he was president, a director, secretary, and treasurer of a registered investment company (the "Investment Company"); and from approximately March 1994 to the present, he has been president and sole owner of a registered broker-dealer (the "Broker-Dealer").
B. From approximately May 1990 through December 1997, Schwartz was employed and supervised primarily by one individual ("Schwartz's employer"). In July 1992, Schwartz's employer consented to a Commission administrative order (the "1992 Bar Order") which, among other things, barred him from associating with any investment adviser or investment company, with a right to reapply to become so associated after one year. Schwartz's employer never reapplied for the right to be associated with an investment adviser or investment company. The 1992 Bar Order was based on, among other things, findings that Schwartz's employer caused an investment adviser he controlled to default on an expense reimbursement payment of over $500,000, which it owed to an investment company he controlled.
C. Prior to the 1992 Bar Order, Schwartz's employer was president of an investment company which provided investment options for variable annuity contracts, and president of an investment adviser whose only client was the investment company. After the 1992 Bar Order, Schwartz became president of the Investment Company and the Adviser. These entities were nearly identical in structure and business purpose to the investment company and investment adviser which Schwartz's employer controlled prior to the 1992 Bar Order.
SCHWARTZ'S EMPLOYER ASSOCIATES WITH
THE ADVISER AND INVESTMENT COMPANY
D. From December 1992 through December 1997, Schwartz's employer, despite being subject to the 1992 Bar Order, associated with the Adviser and Investment Company (the "entities"). As evidence of such association, Schwartz's employer financed the formation and operation of the entities, assisted in the selection of portfolio managers for the Investment Company, and held himself out to third parties as a representative of the entities. In addition, Schwartz's employer used others financially dependent on him, such as his brother and Schwartz, to conceal his association with, and control of, the entities, shared office space with the entities, and actively participated in Investment Company board meetings.
THE ADVISER AGREES TO REIMBURSE THE INVESTMENT COMPANY
BUT DELAYS AND DEFAULTS IN MAKING THE PAYMENTS
E. In August 1996, Schwartz recommended to trustees of the Investment Company an expense reimbursement agreement which provided that the Adviser would reimburse the Investment Company for certain expenses which exceeded a specified limitation. The trustees approved this expense reimbursement agreement at an August 1996 trustees meeting. Shortly after the trustees meeting, Schwartz modified the agreement to provide for: (1) a one-time "capital contribution" in the amount of $228,000 by the Adviser to the Investment Company to reimburse the Investment Company for past expenses which exceeded a specified limitation; and (2) a limitation on future Investment Company expenses, beginning September 11, 1996, whereby the Adviser would reimburse the Investment Company for amounts exceeding the limitation. The Investment Company trustees ratified this modification of the expense reimbursement agreement at a November 1996 meeting. Schwartz recommended the original and modified expense reimbursement agreements at times when he knew or was reckless in not knowing that the Adviser was in a poor financial condition and had no ability to make a capital contribution or to reimburse the Investment Company in future periods.
F. The Adviser agreed to make the one-time "capital contribution" in late August 1996, but delayed making the actual payment until January 30, 1997. The payment was made only after a third party loaned money to the Adviser for the payment.
G. The Adviser agreed to reimburse the Investment Company by December 31, 1997, for all amounts paid by the Investment Company which exceeded the specified expense limitations. However, the Adviser defaulted on this payment for nearly six weeks. The payment, for $525,000, was made to the Investment Company in mid-February 1998, only after Schwartz and third parties raised the money for the payment.
VIOLATIONS OF THE 1992 BAR ORDER
H. From approximately December 1992 to December 1997, Schwartz's employer associated with the Adviser and Investment Company in violation of the 1992 Bar Order. During this period, Schwartz held positions of fiduciary responsibility with the Adviser and Investment Company, yet failed to prevent his employer's wrongful association with these entities. During this period, Schwartz either knew, or was reckless in not knowing, that his employer was barred from associating with any investment adviser or investment company. Accordingly, from approximately December 1992 through December 1997, Schwartz willfully aided and abetted his employer's and the Adviser's violations of Section 203(f) of the Advisers Act.
I. On September 3, 1996, the Investment Company filed a semi-annual report for the period from its inception to June 30, 1996. The report disclosed, among other things, that the Adviser had agreed to limit the Investment Company's future operating expenses and make a capital contribution to cover past expenses, but omitted to disclose that: (1) the Adviser was not obligated to actually reimburse the Investment Company until 12 months after the obligation arose; (2) the capital contribution had not been made; and (3) the Adviser had no present ability or committed source to make the capital contribution. In fact, the report affirmatively misstated that the capital contribution amounts "were contributed," when, in fact, such payment was not made until January 30, 1997. The omissions and misstatement were material because reasonable investors likely would have wanted to know the true timing of the Adviser's obligations and the ability of the Adviser to meet its obligations to the Investment Company. Schwartz was president of the Investment Company and the Adviser when the report was filed and participated in drafting and filing the misleading report. Schwartz thus willfully violated Section 34(b) of the Investment Company Act, and willfully aided and abetted and caused the Adviser's violation of Sections 206(1) and (2) of the Advisers Act.
J. At two Investment Company board meetings in 1996, at which trustees approved the expense limitation agreement and capital contribution, the Adviser failed to disclose its poor financial condition or the fact that it had no available funds or commitments to meet its financial obligations to the Investment Company. The Adviser's poor financial condition was reasonably likely to impair its ability to meet its substantial financial obligations to the Investment Company, i.e., to pay the capital contribution and reimburse future expenses in excess of the specified limitation. As a result of the Adviser's failure to disclose its poor financial condition, the Adviser violated Section 206(4) of the Advisers Act and Rule 206(4)-4 (a) (1) thereunder. Schwartz was the Adviser's president and an Investment Company trustee, led Investment Company trustee meetings, and prepared materials for the trustees to review prior to the meetings. He knew that the Adviser was in poor financial condition but failed to disclose this information to trustees in connection with their vote to approve or ratify the expense reimbursement agreements. Schwartz thus willfully aided and abetted and caused the Adviser's violation of Section 206(4) of the Advisers Act and Rule 206(4)-4(a)(1) thereunder.
K. The Adviser filed its initial Form ADV on May 21, 1993, and filed seven subsequent amended Forms ADV from August 1993 to June 1997. Schwartz filed and signed each Form ADV. Each filing failed to disclose: (1) Schwartz's employer's role in the formation and operation of the Investment Company and Adviser and his disciplinary history; and (2) Schwartz's prior and on-going employment with entities controlled by his employer. These omitted facts were material. Schwartz thus willfully violated Section 207 of the Advisers Act.
UNLAWFUL BORROWING VIOLATIONS
L. Sections 206(1) and 206(2) of the Advisers Act prohibit fraudulent actions by an adviser in its dealings with a client. When an adviser fails to make timely expense reimbursement payments it owes to a client, a "borrowing" by the adviser is deemed to have occurred.
M. The Adviser engaged in unlawful borrowing by its nearly six-week default in paying the $525,000 expense reimbursement it owed to the Investment Company. Schwartz was the Adviser's president and chief financial officer and was involved in executing this unlawful borrowing transaction. Schwartz thus willfully aided and abetted and caused the Adviser's violation of Sections 206(l) and 206(2) of the Advisers Act.
In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer submitted by Schwartz and impose the sanctions and cease-and-desist order specified therein.
Accordingly, IT IS ORDERED that:
(1) Schwartz shall be suspended from associating with any investment adviser or investment company for a period of 12 months, provided that, upon completion of the suspension, he provides the Pacific Regional Office with an affidavit that he has complied with the terms of the suspension;
(2) Schwartz shall cease and desist from committing or causing any violation and any future violation of Sections 203(f), 206 (1), (2), and (4), and 207 of the Advisers Act and Rule 206(4)-4(a)(1) thereunder, and Section 34(b) of the Investment Company Act; and
(3) Schwartz shall pay, within 30 days of the entry of this Order, a civil money penalty in the amount of $10,000 to the United States Treasury. Such payment shall be: (A) made by United States postal money order, certified check, bank cashier's check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, Virginia 22312; and (D) submitted under a cover letter that identifies Schwartz as a Respondent in these proceedings, and the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Sandra J. Harris, Associate Regional Director, Pacific Regional Office, Securities and Exchange Commission, 5670 Wilshire Boulevard, 11th Floor, Los Angeles, California 90036.By the Commission.
Jonathan G. Katz