INITIAL DECISION RELEASE NO. 135 ADMINISTRATIVE PROCEEDING FILE NO. 3-9448 UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ____________________________________ : In the Matter of : : INITIAL DECISION ABRAHAM AND SONS CAPITAL, INC. : January 28, 1999 and BRETT G. BRUBAKER : ____________________________________ APPEARANCES: Jane E. Jarcho, Elizabeth A. Evans, and Richard E. Weber for the Division of Enforcement, Securities and Exchange Commission Arne R. Rode for Respondents BEFORE: Robert G. Mahony, Administrative Law Judge I. INTRODUCTION The Securities and Exchange Commission (Commission) instituted this proceeding on September 29, 1997. The Order Instituting Public Administrative and Cease-and-Desist Proceedings (Order) is brought pursuant to Sections 203(e), (f), and (k) of the Investment Advisers Act of 1940 (the Advisers Act), Section 8A of the Securities Act of 1933 (the Securities Act), and Sections 15(b)(6), 19(h) and 21C of the Securities Exchange Act of 1934 (the Exchange Act). A hearing was held in Chicago, Illinois, on January 6-8, 1998, during which the Division of Enforcement (Division) and Respondents introduced documentary and testimonial evidence. The parties submitted post-hearing briefs and the Division submitted a reply brief.[1] The remedies sought are: (i) a cease and desist order against both Respondents; (ii) revocation of the registration of the corporate Respondent; (iii) a collateral bar for the individual Respondent; (iv) disgorgement of administrative fees plus prejudgment interest; and (v) third tier civil penalties. (DB., p. 31-38.) The parties have stipulated to certain facts, which are incorporated by reference herein. (see JX. 1.) My findings and conclusions are based upon the record and my observation of the various witnesses that testified at the hearing, as well as the arguments and proposals of fact and law of the parties, and the relevant statutes and regulations. I applied preponderance of the evidence as the applicable standard of proof. See Steadman v. SEC, 450 U.S. 91 (1981). 1. Allegations The Order states that Respondent Abraham and Sons Capital, Inc. (ASCI), is an investment adviser that has been registered with the Commission since September 1, 1992. Respondent Brett G. Brubaker (Brubaker) is ASCI’s president and has been its sole officer since at least December 1993. He has been a registered representative since April 1980. Since at least November 1985, Brubaker has been president of Abraham and Sons, Inc. (the Broker-Dealer), a broker-dealer registered with the Commission. The Order alleges that Abraham and Sons Limited Partnership (the Fund) is a private, pooled hedge fund that was formed in April 1991. Since at least September 1992, ASCI and Brubaker have been co-managing general partners of the Fund. Beginning in June 1995, the Fund had a net asset value (NAV) of approximately $12.8 million and approximately 50 limited partners. During the period June through December 1995, the value of the Fund dropped approximately 50%. The Order further alleges that during the period July 1995 through December 1995 Respondents defrauded the Fund and its investors by materially misrepresenting the Fund’s performance and fraudulently engaging in the offer and sale of the Fund’s securities in violation of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. It further alleges that Respondents violated Sections 206(1) and 206(2) thereunder by defrauding the Fund and the limited partners. In addition, it is alleged that the Respondents violated Section 204 of the Advisers Act and Rule 204-2(a)(2) thereunder by failing to keep true and accurate ledgers or other records that accurately reflected ASCI’s income during the second half of 1995. Finally, the Respondents are charged with violating Section 206(4) of the Advisers Act and Rule 206(4)-2 thereunder by failing to have an independent public accountant verify, by actual examination without notice to ASCI, the funds and securities in accounts that ASCI maintained for the Fund. Respondents filed a Joint Answer on October 22, 1997. They admit that they have been co-managing general partners of the Fund since at least September 1992. They further admit that the Fund’s performance was overstated during the latter half of 1995 in interim reports to limited partners, but assert that because the limited partners were permitted to redeem as of January 31, 1996, they did not suffer any loss from overstatement of the Fund’s value during this period. Respondents admit that during 1995, Brubaker made all investment decisions for the Fund and kept the Fund’s records and reports. Additionally, they admit that they were entitled to a 2% quarterly administrative fee based upon the Fund’s value. The Joint Answer states that for 1995, the value of the Fund had to be adjusted downward. This adjustment caused a reduction in accrued administrative fees in the amount of $19,777, which amount has been repaid to the Fund. Respondents admit that during 1995, ASCI did not have an independent public accountant verify, by actual examination without notice to ASCI, the funds and securities in accounts ASCI maintained for the Fund. Respondents deny generally the allegations that they defrauded the Fund and its investors. II. SUMMARY OF THE TESTIMONY 1. The Division’s Case-In-Chief a. Brett G. Brubaker Respondent Brubaker was called by the Division as an adverse witness, and testified pursuant to subpoena. (TR. 28.) He established the Broker-Dealer in 1986. (TR. 29.) In 1991 he established the Fund and became a general partner to it. The only other general partner was ASCI, an investment adviser he established and controlled. Brubaker made all investment decisions for the Fund and, along with ASCI, kept the Fund’s records. In 1995 the Fund was ASCI’s only client, and during 1995 the Fund’s stock trades were executed through the Broker- Dealer. (TR. 30.) Between June and December 1995 Brubaker prepared and sent monthly letters to the Fund’s investors. Additional letters, along with charts reflecting the individual investor’s interest in the Fund, were prepared by Brubaker and sent out near the end of November. (TR. 30-31.) Brubaker testified that he believed the figures he communicated to investors were accurate when they were sent out, but a "reconstruction" of the Fund’s records in early 1996 revealed that the figures were inaccurate. (TR. 33.) Brubaker stated that because he believed the stock market was overvalued during the second half of 1995, he invested some of the Fund’s assets in approximately 25 short stock positions during that period. In order to make a profit from a short sale, the price of the stock must decrease; if the price rises, a loss is incurred. (TR. 36.) Because he made the investment decisions, Brubaker kept track of the stock market. He knew when stock splits occurred, the factor of each split, and the readjusted prices of the various stocks. He also knew the Fund’s approximate cash position. (TR. 39.) Brubaker testified that Spear, Leeds and Kellogg (SLK) was the clearing broker for the Fund’s transactions in late 1995. He received three reports each day by fax from SLK: a "short" report dealing with broker accounts, a "clearance activity report" reflecting the previous day’s trading activity, and a "P & L" report on the Broker-Dealer account. (TR. 43-44, 46.) He further testified that, in the latter half of 1995, he did not receive, on a daily basis, the information listed under the "activity," "positions," and "balances" categories contained in the "exception status reports" generated by SLK. (see DX. 29.) However, the daily clearance activity reports would have shown the information listed in the "summary" section of the exception status reports to the extent that it was a recap of the prior day’s trading. (TR. 48-53.) He testified that he did receive the activity, position, and balance information when the Fund’s trading account was first set up in the latter part of 1994, but stopped receiving that information at the end of 1994. He did not receive it at all in 1995, but began receiving it again on January 11, 1996. Brubaker further testified that he did not receive a margin call from SLK for the Fund’s trading account during the second half of 1995, and he never wired money to the SLK account in July, August, or November 1995 to satisfy a margin call. However, an investor did make a capital contribution of $1 million on November 29, 1995, and those funds were wired into the SLK account the following day. (TR. 56-57.) He testified that a "large" but not "substantial" percentage of the overvaluation in the Fund’s trading account that he reported during the second half of 1995 was caused by a computer software program known as Advent. The program was supposed to calculate, among other things, gains in stock positions that the Fund sold short. (DX. 17; TR. 58-61.) Brubaker was responsible for entering the stock split information into the Advent system. He agreed that the Advent system correctly calculated the gains based upon the information he put into it, and acknowledged that any overstatement of realized gains resulted from his failure to enter accurate information into the program. (TR. 61-64.) Yet he insisted that discrepancies between the SLK statements and his records concerning approximately ten stock positions were caused by defects in the Advent system. (TR. 61, 63-64.) Brubaker claimed that during 1995 he methodically monitored the Fund’s investments. He used a trade blotter to review the Fund’s trades each day, and then compared his own records to the clearance activity report he received from SLK each following day. Through May 1995, he reconciled his records every month with the SLK monthly brokerage statements. (TR. 64-65.) Although he had discovered errors while reconciling the two sets of records, he came to regard the month-end reconciliations as repetitious, and he stopped doing them after May 1995. He did not review monthly statements covering the last half of 1995 again until late December 1995 or early January 1996. (TR. 65.) In order to determine the monthly performance for an investor’s account, Brubaker started with the ending value from the previous month, and then performed certain calculations involving realized and unrealized gains and losses; other income, such as dividends; and expenses. For the period June through December 1995, he had records supporting the performance and valuation figures he reported to the limited partners, but he subsequently destroyed all of those records. (TR. 65-66.) At the time he destroyed the records, he knew the Fund was scheduled to be audited for the first time in the near future. On January 9, 1996, he sent a letter to the Fund’s investors in which he told them that the information he had given them for the previous six months was wrong. Between January 11 and February 15, investors who held about 85% of the Fund’s value as of December 31, 1995 requested that their investments be redeemed. (TR. 67- 68.) Brubaker testified that the Fund’s Limited Partnership Agreement (the Agreement) entitled him to an administrative fee at the end of each quarter. In addition to the fee he took for the fourth quarter of 1995, he also took a fee for the month of January 1996 from the investors who had recently requested redemption. (TR. 69.) He stated that his fee accrual records were based upon an inflated value of the Fund. (TR. 78.) When the Fund’s NAV[2] was adjusted downward, Brubaker created a fee accrual record using the lower NAV. (TR. 76; DX. 18.) He further testified that under the Agreement, he was supposed to base the value of the Fund’s stock portfolio based upon the last sale price of each stock, but during 1995 he priced the Fund’s securities on the mean between the closing bid and asked prices on the last trading day of the month. He went through the same process each time he priced the Fund’s stock positions. (TR. 71-74.) b. Chris Flynn The Division called Chris Flynn (Flynn), an employee of Advent Software Inc. (Advent) since July 1993, and qualified him an expert witness in the use and capabilities of the Advent software system. Flynn is a sales consultant for Advent, and his duties include identifying client needs and making presentations to clients. He previously worked as a portfolio manager with Chase Manhattan Bank. He earned a BA in History from Cornell University. He testified that Advent produces computer systems, trading systems, and portfolio accounting systems for money management firms. The systems handle the record-keeping, reporting, and performance measurement of portfolios. (TR. 84- 86.) Flynn testified that Respondents purchased an Advent system called Professional Portfolio in 1987. The accounting system tracks the positions in a portfolio including all "raw" transactions. It will do all the reporting and record-keeping for a firm, as well as the performance measurement. He has worked extensively with this particular software program, and is familiar with its accounting, record-keeping, and reporting capabilities. Advent no longer sells the Professional Portfolio system, but it has clients that still use it. (TR. 87-88.) Flynn reviewed a letter Brubaker sent to the Fund’s investors dated June 13, 1996. (DX. 17.) In the letter, Brubaker attributed substantially all of the overvaluation of the Fund to the way the Advent system calculated realized and unrealized gains caused by stock splits. Flynn, however, opined that the system was not to blame. Rather, inflated gain figures were the result of the user entering incorrect information into the system, or failing to run portfolio reports after the correct information was entered. (DX. 17; TR. 89-94, 106.) Flynn stated that Advent does not allow the user to cover short positions enlarged by stock splits unless the system has been told that the positions exist. (TR. 98, 106-07.) Nor does the system automatically carry forward unrealized gains and losses with each successive report. If the user wants to determine realized or unrealized gains or stock holdings as of a certain date, they must run a report covering all transactions for the designated time period. (TR. 98-99.) On cross-examination, Flynn testified that the software had been updated after Respondents purchased it, but the updates could not affect how the program functioned. As long as the data was entered correctly, the correct result would be obtained. When the user ran a position report, the program would go back to the beginning of the file and "roll through" all the transactions to calculate up to the date being used to run the report. (TR. 110-12.) For example, it would read through all the transactions to determine the holdings as of a certain date, and then calculate the effects of the split on the position as of that date. (TR. 114.) If, however, the user entered incorrect "ex dates" [3] for the splits, the system could report inflated gains. (TR. 119-21.) c. Timothy Christiansen Timothy Christiansen (Christiansen) has been an investment analyst for the city of Gainesville, Florida since October 1997. Christiansen earned a BS in Chemistry and an MBA from Duke University. He worked for the Broker-Dealer and the Fund from late January or early February 1995 until early February 1996. He then went to work as a stock trader in Chicago, where he remained until he took his present position. During his tenure with Brubaker, he and Brubaker were the only people in the office, though Brubaker’s wife, Chris, was also on the payroll. Brubaker determined Christiansen’s job duties. (TR. 126-31.) Christiansen’s duties with respect to the Broker-Dealer and the Fund included: soliciting new business; executing trade orders; monitoring securities prices; reviewing accounts; and sending a blotter detailing the trading activities of both the Broker- Dealer and the Fund to the clearing broker, SLK, each day. (TR. 132-34.) He testified that Brubaker kept the daily records that came in from SLK. If faxes came in from SLK while Brubaker was not in the office, he would put them on Brubaker’s desk. (TR. 135-36.) He would also download information concerning stocks that met the criteria Brubaker had established for assessing undervalued or overvalued securities. Brubaker made all investment decisions for the Fund, but he did provide Christiansen with information regarding the positions in the Fund. (TR. 136-37.) In the spring of 1995, Christiansen noticed errors in reports generated by the Advent system. The reports showed incorrect share quantities. He pointed this out to Brubaker and the errors were corrected "right away." (TR. 140-41.) Christiansen estimated that he saw errors about six times during the year that he worked with Brubaker. The last time was in early December 1995. He has particular recall of this incident because Brubaker commented that the Fund was up about 8% for November. Christiansen remarked to Brubaker that the share quantities in two or three stocks were not correct because of stock splits. In response, Brubaker reworked his calculations and then told Christiansen the Fund was up only 6% for November. (TR. 141-42.) Christiansen recalled receiving several margin calls from SLK regarding the Fund. The first was in May or June and the last in August of 1995. He did not recall the name of the person to whom he spoke, but he informed Brubaker about the calls. When he told Brubaker about a margin call in August, Brubaker replied that he would satisfy the margin call by cutting back on some of the Fund’s positions. They proceeded to execute trades to achieve the necessary cutbacks. (TR. 143-45.) In early January 1996, Christiansen learned that the Fund’s reported performance for 1995 was incorrect. Brubaker showed him a letter he planned to send to investors in which Brubaker announced that the Fund’s performance was down 50% for the year. (TR. 145-47; DX. 15.) Christiansen was very upset and asked Brubaker how the errors had occurred. Brubaker responded that he "lost track of things." Christiansen worked about two or three more weeks for Brubaker, but Brubaker was never in the office during that time. (TR. 148-50.) On cross-examination, Christiansen testified that he did make some recommendations to Brubaker regarding investments for the Fund. For the most part his recommendations were followed, including those with respect to futures trades. (TR. 153.) There were some margin calls in the futures accounts, but they did not cause him to be concerned about the Fund’s performance because he thought Brubaker was monitoring the Fund, and Brubaker did not seem troubled by the margin calls. (TR. 153-54.) d. Louis Gracia Louis Gracia (Gracia), is a certified public accountant (CPA), who has been a staff accountant with the Commission since 1994. Gracia conducts routine examinations of the books and records of registered investment advisers. He conducted an examination of ASCI on or about February 8, 1996. The examination was prompted by an article in the Wall Street Journal the previous day that referenced the letter from Brubaker informing his investors of the Fund’s poor performance in 1995. The examination was conducted at Brubaker’s home, which was listed as his current business address. The examination focused on the financial statements and records of ASCI and those of the Fund. Records relating to the Fund’s performance calculations were not available. Brubaker advised the examiners that the records had been overwritten in the computer system. (TR. 177- 79.) Gracia stated that the quarterly administrative fee that Brubaker took for the quarter ending December 31, 1995 was $33,800. He further stated that approximately 85% of the Fund’s investors sought redemption of their interests after learning of the Fund’s drop in value. If the Fund’s NAV had been reduced by 85% when Brubaker took his administrative fee on December 31, the fee would have been diminished by about $28,700. (TR. 181-83; DX. 22.) He further stated that Brubaker took an administrative fee for the month of January 1996, which was contrary to the terms of the Agreement. (TR. 183.) Using the figures the parties stipulated to, Gracia determined that Brubaker reported to the limited partners that the Fund’s cumulative performance for the period May through December 1995 resulted in a gain of 5.1% in the Fund’s NAV. (TR. 186-87; DX. 20-21; JT. EX. 1.) In fact, the Fund’s NAV decreased by 59.7% during that period. (TR. 187; DX. 20-21.) e. Theodore Caldwell Theodore Caldwell (Caldwell) is president of Lookout Mountain Capital, Inc. (LMC). LMC operates several funds-of- funds and does consulting in the hedge fund area. Caldwell defined a fund-of-funds as an investment pool that distributes investors’ assets among different partnerships. In the hedge fund industry, funds-of-funds invest in private partnerships. LMC has about $23 million in assets under management. (TR. 216- 17.) Through LMC, he invested $140,000 in the Fund in January 1995. He received information from Brubaker through monthly letters and also visited with him at least twice a month by telephone. (TR. 220.) His understanding was that his investment earned a slight profit in 1995. None of the information he received during 1995 led him to believe that the Fund’s performance was being inaccurately reported. In October 1995, LMC advised Brubaker that it would withdraw its investment as of December 31. (TR. 221.) Caldwell could not say specifically why he decided to withdraw from the Fund. In general, he was "uncomfortable" with Brubaker’s investment approach. Brubaker was adamant in his belief that the market was overvalued and that a decline was imminent. (TR. 221-22.) Caldwell feared LMC’s investment was exposed because Brubaker refused to assume any defensive posture. Brubaker thought he was "smarter than the market" and this attitude did not agree with Caldwell’s investment strategy. (TR. 222-23.) In early January 1996 Caldwell learned that the previous communications he had received from Brubaker contained inaccurate information. He then asked Brubaker to get copies of the monthly statements for the whole year from the prime broker. After reviewing these documents and talking with Brubaker, Caldwell realized that the monthly statements from the broker clearly indicated a problem and did not correspond with what Brubaker had reported to the limited partners. When Caldwell demanded an explanation, Brubaker told him he had failed to notify the investors of the problems because he was "too busy" and he had not opened the monthly statements from the prime broker. (TR. 223-25.) Caldwell testified that had he known that the accounts were not being reconciled, he would have immediately liquidated his investment. (TR. 226.) In Caldwell’s view, an investment manager’s failure to reconcile account data amounts to a complete breach of his duties. He further testified that it was unacceptable for Brubaker to take an administrative fee for the month of January. Doing so violated industry practice as well as the Fund’s Agreement. (TR. 227.) On cross-examination Caldwell clarified why reconciliation is fundamental to efficient fund management. While the portfolio manager and the prime broker may occasionally disagree as to the exact makeup of the portfolio, daily and monthly reconciliations serve to resolve discrepancies as they arise. In addition to bringing the manager and the broker into agreement regarding the portfolio, reconciliation also serves to detect quickly human errors that are bound to occur. (TR. 235.) f. James Bisenius James Bisenius (Bisenius) graduated from Oregon State University where he majored in Communications. He is currently employed by Weedon & Company and is a general partner of Common Sense Partners, LP (CSP) and Common Sense Investment Management. He has been in the investment business as a broker since 1978. (TR. 247-48.) CSP is a fund-of-funds with a value of about $200 million. Bisenius is a general partner with CSP and he makes the investment decisions for the partnership. (TR. 248.) CSP invested about $5 million in the Fund prior to receiving information in January 1996 that the Fund was overvalued. CSP held the largest interest in the Fund. (TR. 249.) Bisenius received monthly letters and quarterly reports from Brubaker in addition to having telephone conversations and a couple of meetings with Brubaker during the year. He had no reason to doubt that the information he received from the Respondents accurately reflected the performance of the Fund. However, upon learning that the value of the Fund dropped over 50% during the second half of 1995, Bisenius withdrew CSP’s investment. (TR. 250-52; DX. 8-15.) After having numerous discussions with Brubaker as to how the decline could have occurred, Brubaker explained that he had experienced accounting problems and problems with the Advent system. (TR. 253.) Bisenius testified that if he had received accurate information about the Fund’s performance, or if he had known that Brubaker was not reconciling the monthly account statements, he most likely would have liquidated his investment in June 1995 rather than waiting until January 1996. (TR. 254.) g. Angelo Gonzalez Angelo Gonzalez (Gonzalez), an employee of SLK since 1986, described SLK as a specialist firm that sets markets for various securities and clears trades for broker-dealers, investment advisers, and "regular" customers. He has been in SLK’s retail margin department since 1989, and is now the manager of the department. (TR. 266-69.) The margin department monitors customer activity to ensure that the customers are in compliance with the applicable regulations. Both the Broker-Dealer and the Fund were SLK clients in 1995. (TR. 270-71.) When Brubaker made trades as a broker- dealer, he would tell SLK how to allocate the trades among his clients and the SLK margin department would follow his instructions. As a broker-dealer, Brubaker was provided a clearance activity report, a marked-to-market P & L equity report, and a customer trade list. For the Fund, Brubaker requested that SLK fax him an exception status report each day. SLK’s practice is to send these reports to their hedge fund and broker-dealer clients. These transmissions were separate from the daily reports sent to the Broker-Dealer. The exception status report generated by SLK is divided into four units displaying: (i) the customer’s trading activity; (ii) adjustments to the customer’s special miscellaneous account; (iii) a summary of the customer’s positions; and (iv) a trial balance showing cash available, total equity, and whether there was a margin call that day. The presence of a house margin call is also noted on the upper left corner of the first page of the report. Gonzalez believed the exception status reports were sent to Brubaker and ASCI daily from 1994 through 1996 because he spoke with Brubaker frequently during that period, and Brubaker was conversant with developments in the Fund’s accounts. (TR. 273-76, 287-88, 308, 328-29; DX. 38.) He was also of the opinion that SLK’s computer records show the reports were sent to Brubaker. (TR. 308-10; DX. 38.) Gonzalez stated that stock splits were reflected in the reports. (TR. 288.) The exception status reports Brubaker allegedly received also show that SLK frequently demanded additional collateral from the Fund during the second half of 1995. The daily reports constitute technical notification of the margin calls; in addition, as a matter of course, SLK would have contacted Brubaker by phone to discuss any margin call. (TR. 275-76; DX. 30.) Gonzalez and members of his staff had numerous telephone conversations with Brubaker concerning margin calls. (TR. 277, 286.) SLK customers receive a house margin call when the equity- to-value ratio of an account falls below 40%. (TR. 297-99.) A margin call can be satisfied by depositing additional funds or securities into the account, or trading out of the account. (TR. 276-77.) Brubaker had a history of covering or partially covering the Fund’s margin requirements by depositing funds into the account: in July 1995 he deposited $340,000 in partial satisfaction of a $509,277 call; in August he made a similar "good faith" deposit of $250,000 to cover part of a $568,485 deficiency. (TR. 277-78; DX. 29, 30.) There came a time in late November 1995, though, when the Fund received a "huge" margin call for $866,000. (TR. 277-78; DX. 30, 31.) SLK saw that Brubaker was systematically, repeatedly trading in and out of the account in an apparent effort to avoid having to deposit more funds into the account. SLK demanded some showing from Brubaker that he would cover the margin call. Brubaker satisfied the call by wiring $1 million into the Fund’s account. (TR. 277-78; DX. 31.) On cross-examination, Gonzalez stated that SLK had called for additional margin for the Fund account on July 13, August 14, and November 29, 1995. The calls were indicated on exception status reports covering those three days, and the SLK All Transactions History for the Fund reflected transfers from the Fund’s bank account to the Fund’s equity account on July 14, August 15, and November 30, 1995. (TR. 292-96; DX. 29-31; 33, p. 8.) The exception status reports covering each trading day in August and November 1995 reveal that the Fund had a house margin call almost every day. SLK would have regarded deposits received from Brubaker during that month as having been made in satisfaction of margin calls provided that a house call was indicated on a concurrent exception status report. (TR. 301-02; DX. 35, 36.) With regard to a series of margin calls in November that he did not personally handle, Gonzalez could only speculate that other company officials gave Brubaker time to trade out of the account. (TR. 300-01; DX. 36.) Gonzalez stated that he could be sure it was not just a coincidence that Brubaker transferred $1 million to SLK the day after the November 29 margin call because Gonzalez had personally contacted Brubaker to demand additional collateral. (TR. 305.) h. Robert Connor Robert Connor (Connor) testified as an expert witness for the Division concerning the securities industry and investment advising. Connor has a BA in History and Political Science from the University of California at Santa Barbara. He earned both an MBA and an MPA from Harvard University and has pursued Ph.D. studies there in Economics, Government, and Statistics. (TR. 342-43; DX. 40, p. 25.) Connor testified that he is employed by three firms, two of which are investment related: Thornapple Associates, an expert witness and litigation support services firm; and Connor Capital Corporation, an investment advisory firm. He has previously testified in administrative proceedings as an expert. He provided a written report in this proceeding that was admitted in evidence. (DX. 40; TR. 344-47.) Connor described a hedge fund as a private pool of money drawn from multiple investors. These funds typically take both long and short positions in the market. He viewed the Fund as relatively small based upon the number of stock positions it held. In his opinion, one person should have been able to manage the Fund. (TR. 348.) After describing a short sale[4] and a stock split,[5] he stated that a stock split affects a short sale in two ways. First, the price per share is adjusted downward in proportion to the increase in the number of shares. For instance, if a stock splits two-for-one, the number of shares outstanding doubles but the price per share is cut in half. The investor who takes a short position prior to the split will be short by twice as many shares on the effective date due to the split, but the market value of the position will not change. Second, the lower price per share may stimulate greater demand for the stock. This, in turn, may cause a slight price increase. (TR. 350-51.) Connor testified that, after reviewing material concerning the Respondents, he was of the opinion that Brubaker intentionally overstated the value of the Fund during the second half of 1995, and did so "in a fashion that provided . . . plausible deniability as to his intent to deceive in the event that the ruse was discovered." He further testified that the record-keeping practices employed by Brubaker and ASCI failed to meet industry standards governing, inter alia, fiduciary responsibility and the exercise of due diligence. (TR. 352; DX. 40, pp. 5, 15.) According to Connor, Brubaker was aware at all times of the composition and value of the securities in the Fund portfolio. (TR. 352, 369.) Brubaker had total, "soup to nuts" involvement in the Fund. He selected which stocks to invest in and determined the size of the Fund’s position in each stock. He administered the Fund, kept its records, and updated the Fund’s information base to reflect the impact of its market transactions. In his view, Brubaker was very familiar with the strategy behind short sales and effects of stock splits on short positions. (TR. 353-54.) He must, therefore, have been aware of gains and losses resulting from the closure of particular short positions even before he entered the stock split information. As an example, Connor points out that on September 22 Brubaker closed out half of the Fund’s short position in U.S. Robotics for a $20 per share loss. Although he must have been "acutely aware" of this loss, Brubaker reported to his partners a gain of $49 per share, a swing of $69. Brubaker thus transformed a known losing position to one showing an inexplicable profit. (DX. 17, pp. E, I; 40, p.8.) Connor was also of the opinion that the Advent system played no part in misreporting the valuation of the Fund. If stock split information is accurately entered into Advent, the reports of realized and unrealized gains will be correct. In Connor’s opinion, the system properly processed incorrect information provided by Brubaker. (TR. 355-56.) For example, Connor stated in his report that because Brubaker admittedly was aware of the particular splits affecting the portfolio, he must have also been aware that an open short position in the Advent system, not yet adjusted for a stock split, would necessarily understate the number of post-split shares held by the Fund. Consequently, Brubaker must have known that use of the lower post-split prices in valuing an unadjusted short position would result in overstatement of unrealized profits. (DX. 40, p. 10.) Brubaker’s handling of a short sale of Micron Technology stock illustrates why he must have known he was misrepresenting the Fund’s value and performance to the limited partners. The Fund accumulated a 10,000-share short position in Micron Technology from late April through early May 1995. As a result of a two- for-one stock split on May 23, the Fund held a 20,000-share short position through the end of the month. Brubaker has admitted that he had not yet entered the May 23 stock split information into the Advent system as of month’s end; thus, he must have known that the unrealized profit in Micron reflected on a month- end report would be overstated. Furthermore, when Brubaker closed out his entire 20,000-share short position in June, he was required to -- and did in fact -- enter closing purchases of 20,000 shares into the Advent system. Advent would not have allowed him to close a 20,000-share position with only 10,000 shares. (DX. 40, pp. 10-11.) Connor concluded that Brubaker’s explanation was part of a "fanciful" attempt to blame the computer software for his own misconduct. (TR. 357.) Connor examined the spread sheet Brubaker sent to investors in June 1996 showing the "differences between reported valuation and accountant’s results," and found that Brubaker intentionally misled his investors as to the valuation of the Fund. (TR. 357- 58; DX. 17, p. G; 40, pp. 15-18.) In the letter, Brubaker attributed the mispricing of the portfolio to two distinct types of error: one relating to stock splits and defects in the Advent system (stock split errors), and another caused by pricing the Fund’s securities using the mean between the bid and ask as opposed to the last sale price (pricing differences). Connor agreed with Brubaker’s conclusion that these two factors combined to create the overvaluation of the portfolio. (TR. 358-59). Yet Connor maintained that Brubaker’s inconsistent treatment of the two types of errors provides the clearest indication of his intent to deceive the limited partners. Connor believed the so- called "stock split errors" were not errors but, rather, intentional misrepresentations designed to disguise the Fund’s lackluster performance. Conversely, the pricing differences were the result of inadvertent oversights. Connor reasoned that if both errors were caused by honest mistake, both would have been "either cumulative or non-cumulative in their effect" upon unrealized gains and losses. (DX. 40, pp. 15-18.) Connor stated: There is only one possible explanation for the inconsistency in Brubaker’s treatment of "pricing differences" as non-cumulative while simultaneously causing "stock split" errors to be cumulative: Brubaker must have been aware of the "stock split" error at the time he intentionally chose to preserve the associated overstatements of unrealized gains and losses apart from the Advent computer system. In contrast, Brubaker was genuinely unaware at the time of the "pricing differences" error, and its effect was therefore not consciously accumulated by him at the time. Instead, the "pricing differences" error appeared monthly, but was isolated in its impact on unrealized gains and losses from one month to the next and, therefore, was non-cumulative in its effect. (DX. 40, p. 17.) Connor also analyzed Brubaker’s pricing methods. During May 1995, the Fund portfolio contained approximately 22 over-the- counter (OTC) stocks and 23 exchange-listed stocks. Connor’s analysis focused on the OTC stocks because they have larger spreads between the bid and ask prices. He obtained from the National Association of Securities Dealers (NASD) the closing bid-ask quotations and last trade prices of the OTC stocks in the Fund portfolio as of May 31, 1995. (TR. 359-61; DX. 28.) He compared the NASD prices to those listed on a May 31, 1995 "unrealized gains and losses" report generated by Brubaker. (TR. 361; DX. 28a.) Connor found that Brubaker’s numbers did not consistently conform to either the mean bid-ask or to the last sale. Rather, the prices varied significantly in an "unrandom" pattern so that the valuation of each position was in Brubaker’s favor. If the Fund had a long position, the higher price was used; if the position was short, the lower figure prevailed. Connor concluded that "Brubaker intentionally overvalued his month-end portfolio positions in reporting his performance to clients." (TR. 361-62; DX. 40, p. 19.) Connor proceeded to emphasize the misleading effects of Brubaker’s pricing methods. The average spread between Brubaker’s prices and the NASD prices was $2 per share. Connor divided the amount of the overstatement by the number of shares in the portfolio and determined that the pricing method had an impact of $2.08 per share. This is extraordinary because markets do not create that kind of spread, nor do they "cooperate so conveniently as to drive the short position prices lower and the long position prices higher." (TR. 362-63; DX. 40, p. 19.) The actual average difference between the bid-ask average and last sale for the OTC stocks in May was only $0.17. For the exchange- listed securities, the difference was about $0.12. In sum, "[t]he magnitude of [Brubaker’s] ‘pricing differences’ widely exceeds the actual variance that would attend the use of mean between bid and ask versus last sale as a basis of pricing the securities positions . . . both for N.A.S.D. over-the-counter stocks [and] exchange-listed stocks." Using the accurate price figures, Connor determined that the portfolio would have been overvalued by approximately $125,000 in May if Brubaker had properly and uniformly applied the "mean" method. By selectively using either the mean or last sale method, Brubaker was able to inflate the Fund’s value by $747,718. (DX. 17, p. G; 40, pp. 19- 20.) In some instances, Brubaker’s price figures for May 1995 were "pure fiction." The closing bid-ask average for Alliance Semi-Conductor, a stock in which the Fund held a short position, was $49.125; Brubaker calculated the mean at $39.375. Connor opined that Brubaker invented the lower figure out of a desire to make the investment appear more profitable. With respect to another stock, Coherent Technology, Brubaker calculated the price at $22.25. Coherent did not trade for less than $23.375 at any time during the month of May. The lower figure for Coherent alone skewed the Fund’s value upward by approximately $50,000 for that month. (TR. 364-65; DX. 28, 28a.) Connor also testified that Brubaker’s unsound record-keeping made it impossible to reconstruct an "audit trail" because each time he revised or updated the Fund’s records, he used existing records. "The creation of the [new] document[s] obliterated the" underlying documents. (TR. 366.) Furthermore, Connor found that Brubaker failed to conform to industry standards for investment advisers by leaving monthly account statements unopened and by failing to reconcile the Fund’s accounts each month, especially when he knew that approximately two dozen stock splits had occurred over the course of the year. Those splits would significantly influence the Fund’s holdings and value. As the sole manager of an investment adviser, Brubaker was responsible for the adviser’s record- keeping and accounting. If he was overwhelmed by increased activity in the portfolio, he should have hired an accountant or bookkeeper to help him. In the alternative, he should have told the Fund’s investors so that they could have taken steps to protect their interests. (TR. 367-68.) 2. The Respondents’ Case-In-Chief a. Byron Van Dyke Byron Van Dyke (Van Dyke), CPA, testified on behalf of Respondents. Van Dyke has audited and prepared tax returns for the Broker-Dealer, the Fund, and ASCI. In January 1996, he attended a meeting at the offices of Ernst & Young concerning the Fund. Also in attendance were Brubaker, Bisenius, and an Ernst & Young partner, Benji Wolken (Wolken). Wolken gave Van Dyke a list of instructions, and all attendees agreed that Van Dyke would follow those instructions in performing a review of the Fund’s 1995 accounting records. (RX. 16.) The group discussed recalculating the net worth of the Fund, and determining the true value of each individual partner’s investment. (TR. 408-10.) At the time of the meeting, Brubaker had already recalculated the value of the Fund. During the meeting, the parties resolved that Brubaker would reconstruct the Fund’s records for 1995, and that Van Dyke would assess the partnership interests based on that reconstruction. The group did not discuss maintaining an audit trail that would reflect how Brubaker had accomplished the reconstruction. (TR. 411.) **FOOTNOTES** [1]: I will cite the hearing transcript as (TR. __ ) and the exhibits admitted into evidence at the hearing by the Division of Enforcement (Division), the Respondents, and all parties as (DX. __ ), (RX. __ ), and (JX. __ ) respectively. I will cite the Division’s proposed findings of fact as (DF. __ ), and the Respondents’ proposed findings of fact as (RF. __ ). I will cite the Division’s post-hearing brief as (DB. __ ), the Respondents’ post-hearing brief as (RB. __ ), and the Division’s reply brief as (Reply __ ). [2]: The Agreement defined "Net Asset Value" as "the Value of Securities of the [Fund] less all net liabilities of the [Fund], determined in accordance with generally accepted accounting principles consistently applied." (DX. 6, ¶ 1.18.) [3]: Flynn defined "ex date" as: "the day after shareholders are eligible to obtain the stock split." (DX. 39, p. 3.) [4]: In his report, Connor defined a short sale as one in which shares of stock are "borrowed from your broker [and] sold with the expectation that the stock will drop in price and you will then buy the stock at a lower price, and replace the stock you borrowed. Buying the stock back is called covering the short position." (DX. 40, p. 23.) [5]: According to Connor: "In a stock split, a company increases the number of shares outstanding based on a selected ratio, causing existing shareholders to own more shares. Since the market capitalization of the company is not affected, the effect in the market place is to reduce the price of each share in reverse proportion to the ratio of the stock split." (DX. 40, p. 23.) 1 b. Brett G. Brubaker Brubaker testified that he is 47 years old. He earned a BA from the University of Miami and an MBA in Finance from the University of Akron. After graduation in 1974, he worked at various jobs in banking, securities, and asset management. He opened the Broker-Dealer in 1985 and received NASD approval in early 1986. (TR. 464-66.) Prior to opening the Broker-Dealer, he had never been responsible for record-keeping or bookkeeping. He initially operated the Broker-Dealer from his house in New York, and later moved to Chicago. The business base of the Broker-Dealer was, and continues to be, institutional accounts such as mutual funds. He also produces an investment strategy letter and researches individual companies. (TR. 466-67.) The Fund was created in 1991, and ASCI was created in connection with the Fund. (TR. 467.) In 1995, the Broker-Dealer earned between $250,000 and $270,000, of which approximately $50,000 was derived from trading for the Fund. The current Broker-Dealer staff consists of Brubaker and his wife, who keeps the books. (TR. 468-69.) After he hired Christiansen, the amount of paperwork Brubaker had to handle increased significantly because Christiansen traded more aggressively than Brubaker. Brubaker was responsible for processing the high volume of trade tickets generated by Christiansen’s activities. (TR. 469, RX. 15.) The "dramatic increase" in his administrative burdens caused him to give up virtually all recreational activities. (TR. 476.) In retrospect, he admitted he should have hired additional office help or obtained the services of outside help such as an accounting firm. He testified that, at the time, it did not "cross his mind" to take such corrective measures. (TR. 477.) Brubaker testified that he wrote the January 1996 letter (DX. 15) after spending the last part of December and the first week of January reviewing the account statements for each month of 1995. In this process he realized that there was a problem with the calculations for the last half of the year. After discussing the matter with his wife, he wrote the letter advising the limited partners that the Fund had suffered a decline of 50% for the year. (TR. 419.) The letter precipitated a negative article in the Wall Street Journal. In response to the letter and the article, many limited partners elected to redeem their investments. (TR. 423-24.) The day after he sent the letter he called the limited partners, including Bisenius, and ultimately the Ernst & Young meeting was arranged. (TR. 419-20.) Following the meeting he continued to review the account statements, but he had a "very difficult problem in reconciling the books." He testified that the system still showed inaccurate stock positions, and the balances "were all messed up." (TR. 421.) In the end, he determined that his balances varied from the SLK balances by $300,000 to $400,000. (TR. 422.) In a subsequent meeting with Ernst & Young, he learned that the Agreement required him to value the portfolio using the last sale and not the mean between the closing bid and ask prices. He had been using the latter method since the beginning of the partnership. He recalculated both the Fund’s value and the investment adviser fees to reflect the diminished performance figures. (TR. 423.) Brubaker testified that once Van Dyke commenced his analysis, Brubaker continued to try to determine where and why the pricing variances occurred. He noticed problems with a group of stocks having similar characteristics. Each of the stocks had split while the Fund held them in short positions, and the Fund had traded the stocks on or about their split dates. Additionally, Brubaker had year-end positions he could not get to balance. (TR. 426.) He eventually determined that the year-end imbalances were caused by his entering incorrect ex dates for the stock splits into the Advent system. (TR. 429.) When he prepared the "analysis of differences between reported valuation and accountant’s results" for the investors, he treated both realized and unrealized gains as accumulated at end of the year. Brubaker thought that this would "show things appropriately." (TR. 430-32; DX. 17, p. G.) Brubaker explained how he created the Fund’s "unrealized gains and losses" report for May 1995. (DX. 28a.) He attempted to distinguish the figures Connor used in analyzing the pricing differences from those he used in arriving at the mean closing bid-ask price. He explained that he took his prices from a quote system that was intended to be used by those who trade with large institutional investors. The quotes in such systems are "based upon size bid, size offer" applicable to trades involving 50,000 or 100,000 shares. By contrast, Connor based his calculations on "tight market" quotes that would apply to much smaller trades of, say, 100 shares. Brubaker maintained that his quotes were "real," whereas Connor’s quotes were "fantasy." (TR. 433). He explained that he did not look at the SLK monthly statements from about July through November 1995 because he had just returned from a trip and he had to catch up on increased trading activity. He entered the trades and if the confirmation he received the next day matched his entry, he believed the information he was putting into the computer was correct. (TR. 434.) He was "never uncomfortable" with the fact that he was not comparing the reports generated by Advent with the monthly statements from SLK. Although he had detected errors in prior SLK monthly statements, the errors were not replicated in the Advent system, so he did not regard comparison as critical. (TR. 435-36.) Brubaker testified that he got one fax each day from SLK, and the exception status report was not included in the fax. (TR. 452-53.) He introduced in evidence three exhibits in an effort to rebut Gonzalez’ testimony regarding communications with SLK, particularly margin calls. (TR. 439-40; RX. 19, 22, 23.) The exhibits detail the Fund’s trading activity on July 13, August 14, and November 29, 1995. They are comprised of trade blotters Brubaker prepared and sent to SLK on these three days, and the corresponding transmissions Brubaker received from SLK on July 14, August 15, and November 30, 1995. The SLK transmissions attached to the blotters are incomplete. In each instance, several pages from the original transmission are missing from the exhibit. According to Brubaker, the missing pages did not contain exception status reports. (TR. 440-44; RX. 19, 22, 23.) He maintained that he did not receive any such reports during 1995. (TR. 444-45.) Brubaker attempted to rebut the Division’s allegation that a July 14, 1995 wire transfer from the Fund’s account at Lakeside Bank to the Fund’s SLK trading account in the amount of $250,000 was intended to satisfy partially a July 13, 1995 margin call. According to Brubaker, SLK’s exception status report for July 13, which showed a margin deficiency in the amount of $509,277, "could not have been" part of the fax he received on July 14. (TR. 452-53; DX. 29; RX. 19.) Furthermore, the trade blotter for July 13 shows that the Fund increased its positions on that day. (TR. 453-55; DX. 19.) By Gonzalez’ own reckoning, this activity would be inconsistent with an attempt to meet a margin call. (TR. 455.) Finally, the funds in question came from two partners. (TR. 456.) ASCI received the money from one partner near the end of June; it received the other partner’s funds on July 3. Brubaker claimed he was on vacation from the time the money was deposited in the Fund’s bank account until July 13. It was his return to work, not a margin call, that caused him to wire the funds to SLK on July 14. (TR. 456-57.) While he acknowledged that he deposited $250,000 into the Fund’s SLK account on August 15, he denied that the deposit was made in response to a margin call. First, Brubaker stated that he "could not have" received the August 15 exception status report reflecting a $568,485 margin call from SLK. He reached this conclusion by comparing the exception status report for August 14, to the fax he received from SLK on August 15. (Compare DX. 30 with RX. 22.) Brubaker asserted that the exception status report was longer than the number of pages missing from the fax transmission. Second, like the trading on July 13, the Fund did not liquidate any positions on August 14. Third, the Fund received the $250,000 check on August 10. (TR. 457-58; RX. 22; DX. 30.) Brubaker did not transfer the funds into the SLK account until the August 15 "because the size [of the contribution] wasn’t that significant." (TR. 460.) He testified that, as with the two previous margin calls, he did not receive the November 30 exception status report notifying him of the $866,683 deficiency in the Fund’s account. (TR. 461- 62; DX. 31; RX. 23.) Once more he asserted that the exception status report was longer than the number of pages missing from his exhibit. (Compare DX. 31 with RX. 23.) He denied having a telephone conversation with Gonzalez concerning the margin call. (TR. 462-63.) The trading activity on November 29 was "not really noteworthy one way or another." (TR. 462.) The $1 million that went into the SLK account at that time came from an existing partner. Brubaker stated that he did not ask the partner for the money and he did not know it was coming. (TR. 463-64.) Brubaker tried to explain why pricing variances for OTC stocks were always favorable to him. During the summer of 1995, the stocks in which the Fund held short positions were near their 52-week highs, and the stocks in which the Fund was long were near their 52-week lows. At the same time, there were "problems" in the OTC market caused by the use of market-on-close orders at the end of the month. (TR. 489-90.) He states that there was unusual month-end buying activity for stocks at their 52-week highs: the stocks were "bid up" by market makers on the last sale to a price above the "real market" price. The stocks that were at their 52-week lows were likewise being "pressed down" below their real market price. (TR. 490-91.) Brubaker claimed his "systems" were designed to show the real market price. (TR. 491.) Brubaker testified that according to the Agreement, a limited partner could redeem all of his units in the Fund at the end of the calendar quarter upon thirty days written notice. The units so redeemed would be valued at the NAV per unit as of the end of the last business day of the calendar quarter in which the redemption notice was received. (TR. 497; DX. 6, § 13.01.) Brubaker claimed he disregarded the technical requirements of the agreement in order to accord greater benefit to those partners who redeemed their investments in late 1995 and early 1996. He cited the case of limited partner Caldwell, who filed his redemption notice in October 1995. By the terms of the agreement, Caldwell should have been paid based on the Fund’s NAV as of December 31, 1995, the last day of the fourth quarter. Instead, Brubaker based Caldwell’s unit value on the Fund’s NAV as of January 31, 1996. According to Brubaker the delay worked to Caldwell’s advantage because the share value was 15% to 20% higher at the end of January. (TR. 498.) Although he was not obligated to do so, Brubaker gave all investors who redeemed in December and January the value of their investments as of January 31. (TR. 498-500, 503-04.) Brubaker stated that he kept track of the cash component of the Fund’s value through the Advent system. He did not need to consult the monthly statements from SLK. (TR. 505.) He never believed that he had an obligation to have an independent accountant verify the sums contained in the Fund because his role was limited to "investment oversight" and he was not a "custodian" for the accounts in question. (TR. 506.) He is no longer doing administrative work, and he has made arrangements with Van Dyke to have the Fund’s accounts reconciled with the SLK bank information. (TR. 507-08.) On cross-examination, Brubaker acknowledged that his fourth quarter fee would have been based upon a much smaller pool of money if investors had withdrawn their capital contributions during the third quarter. (TR. 509-10.) c. James L. Kubik James L. Kubik (Kubik), a principal in an investment firm and an investor in the Fund, testified as a character witness for Brubaker. He has known Brubaker for twelve to fourteen years and testified that he has an impeccable reputation. "[H]e’s a very high quality person. Absolutely not an ethical question." (TR. 518-19.) d. Mary Bender Mary Bender, the Chief Regulatory Officer of the Chicago Board Options Exchange, also testified as a character witness. She has known Brubaker for about ten years and was also one of his investors. She testified that he is very thoughtful person who faces difficult issues with extreme honesty. Her opinion was based upon their friendship, not upon her experience as a regulator. (TR. 521-24.) III. FINDINGS OF FACT 1. The Fund ASCI is an investment adviser that has been registered with the Commission since September 1, 1992. Brubaker has been ASCI’s president since its inception and has been ASCI’s sole officer since at least December 1993. Brubaker has been a registered representative since April 1980. Since at least November 1985, Brubaker has been president of the Broker-Dealer. The Broker- Dealer is registered with the Commission. (JT. EX. 1, ¶¶ 1-4.) Brubaker established the Fund in April 1991. Since at least September 1992, ASCI and Brubaker have been co-managing general partners of the Fund. (JT. EX. 1, ¶ 5.) During 1995, Brubaker had one full-time employee, Christiansen, who conducted research for both ASCI and the Broker-Dealer and serviced many of the brokerage accounts. (TR. 127, 131-33.) Christiansen did not have authority to make trading decisions for the Fund and, in fact, did not make any. He did not create any records for ASCI’s clients. (TR. 30, 137.) During 1994 and early 1995, the size of the Fund grew from 15 partners and $2 million in assets to 47 partners and $12 million in assets. (TR. 434.) As of June 30, 1995, the Fund had about 50 limited partners. (JT. EX. 1, ¶ 6.) On or about November 29, 1995, a limited partner purchased $1 million of additional interests in the Fund. (JT. EX. 1, ¶ 29.) As of December 31, 1995, the Fund had 15 remaining investors, and the aggregate value of their investments was approximately $1 million. (JT. EX. 1, ¶ 39.) During 1995, the complexity of accounting for the Fund’s positions increased markedly. (TR. 367, 476.) This was due to an increase in the portfolio’s size, and a corresponding rise in the number of transactions for the portfolio. The monthly stock turnover rate for 1995 was more than triple that of 1994, with a commensurate increase in the number of trade tickets generated. Futures contract turnover grew by a factor of six. Also during 1995, approximately twenty-five of the Fund’s short stock positions were subject to splits, and the Fund traded in many of the short positions both before and after the splits. (TR. 367, 469-75; DX. 34; RX. 15.) The Agreement outlined ASCI’s and Brubaker’s responsibilities as general partners. (DX. 6; TR. 79.) Section 3.02 of the Agreement authorized ASCI and Brubaker to make all investment decisions for the Fund. Under this provision, Respondents had sole discretion and power to perform, among other things, the following acts: (i) purchase, hold, sell, exchange, receive and otherwise acquire and dispose of securities and commodity interests; (ii) sell securities and commodity interests short and cover such sales; (iii) open, maintain and close accounts; (iv) open, maintain and close bank accounts and draw checks or other orders for the payment of moneys; (v) borrow money, on a secured or unsecured basis, from banks, brokers or any of the partners and secure the payment of any obligations of the partnership by hypothecation or pledge of all or part of the assets of the partnership; (vi) act for and on behalf of the partnership in all administrative matters; and (vii) exercise all rights, powers, privileges and other incidents of ownership or possession with respect to the assets of the partnership. (JT. EX. 1, ¶¶ 30-31; DX 6, § 3.02.) Pursuant to Section 3.03 of the Agreement, ASCI and Brubaker were obligated to and did maintain complete books of accounts regarding the Fund’s operations. They were also obligated to and did provide the limited partners with quarterly reports of the Fund’s performance. (JT. EX. 1, ¶¶ 32-33; DX. 6, § 3.03.) Throughout the life of the Fund, Brubaker generated the Fund’s records and reports, as well as the letters sent by ASCI to the Fund’s limited partners. (JT. EX. 1, ¶ 34.) 2. Misrepresentations Concerning the Fund’s Value and Performance ASCI and Brubaker reported to each of the limited partners, by letter dated June 23, 1995, that the value of the Fund had gained .74% for the month ending May 31, 1995. In fact, for the month ending May 31, 1995 the Fund experienced a loss of nearly 8.4%. (JT. EX. 1, ¶¶ 9-10.) During the period July through December 1995, ASCI and Brubaker reported the monthly performance of the Fund to each of the limited partners by letters dated July 14, August 24, September 6, October 4, November 1, and December 4. (DX. 8-12, 14; TR. 30-31.) In addition, ASCI and Brubaker sent the limited partners reports for the quarters ending June 30 and September 30, 1995 that summarized the dollar value of each investor’s interest in the Fund. These quarterly reports were contained in letters dated July 14 and November 22, 1995. (DX. 8, 13; TR. 32- 33). In the July 14 letter, Respondents stated the Fund’s NAV, as of June 30, to be $12.3 million. Respondents then calculated the value of each investor’s interest in the Fund using the $12.3 million figure. (JT. EX. 1, ¶¶ 12-13.) Yet, the Fund’s NAV as of June 30 was approximately $8.7 million. (JT. EX. 1, ¶ 11.) The July letter also reported that the Fund had lost 11.2% of its value for the month ending June 30, 1995. In fact, it had an actual loss of nearly 27%. (JT. EX. 1, ¶¶ 14-15; DX. 20.) The letter overstated the value of the Fund by 58.5%. (DF. 20.) For the month ending July 31, 1995, the Fund had an actual loss of nearly 26.9%, but ASCI and Brubaker reported to each of the limited partners, by letter dated August 24, 1995, that the Fund had a loss of only 2.7% as of July 31. (JT. EX.1, ¶¶ 16-17; DX. 20). The reported figure overstated the Fund’s value by 89.9%. (DF. 22.) By letter dated September 6, 1995, ASCI and Brubaker reported to each limited partner that the Fund had gained 9.2% in value as of August 31, 1995. In fact, it had gained only 3.2%. (JT. EX. 1, ¶¶ 18-19; DX. 20). Thus, Respondents overstated the Fund’s value by 187.5% for this period. (DF. 24.) For the month ending September 30, 1995, the Fund had an actual loss of approximately 10.3%. However, ASCI and Brubaker reported to each of the limited partners, by letter dated October 4, 1995, that the Fund had gained approximately 0.4% in value as of September 30, 1995. (JT. EX. 1, ¶¶ 23-24; TR. 207; DX. 20.) This represented an overstatement of value of 103.8%. (DF. 29.) ASCI and Brubaker reported to each of the limited partners, by letter dated November 1, 1995, that the Fund’s value had gained approximately 2.5% for the month ending October 31, 1995. For this period, however, the Fund had an actual loss of approximately 5.4%. (JT. EX. 1, ¶¶ 25-26; DX. 20.) This represented an overstatement of value of 146.2%. (DF. 31.) Respondents recalculated the NAV of the Fund for the third quarter of 1995 in order to update the investors as to the value of their respective interests. They arrived at a figure of $12.5 million. By letter dated November 22, 1995, ASCI and Brubaker sent each investor a summary of changes in their investments during the third quarter. Respondents valued the individual interests using the $12.5 million figure. As of September 30, 1995, the Fund had an actual NAV of approximately $5.9 million. (JT. EX. 1, ¶¶ 20-22.) For the month ending November 30, 1995, the Fund had an actual loss of approximately 5.9%, but ASCI and Brubaker reported to each of the limited partners, by letter dated December 4, 1995, that the value of the Fund had gained approximately 7.5% as of November 30. (JT. EX. 1, ¶¶ 27-28; DX. 20.) This represented an overstatement of value of 227.1%. (DF. 33.) 3. Brubaker’s Knowledge of the Fund’s Value and Performance Based upon Brubaker’s testimony that he controlled all aspects of the Fund’s investment decisions and record keeping, as corroborated by the Joint Stipulation of Facts, I make the following additional Findings of Fact: at all times during the second half of 1995 Brubaker (i) set the investment strategy of the Fund based upon his belief that the stock market was overvalued. (TR. 30, 36-39, 223, 353, 355, 371-75; DX. 8-11, 13- 14, 16); (ii) knew or was reckless in not knowing the Fund’s stock positions and the amount of cash in the Fund (TR. 38-39); (iii) knew or was reckless in not knowing the number of shares of each stock that the Fund held (TR. 38); (iv) knew or was reckless in not knowing whether a particular position had been invested long or short (TR. 38); (v) knew or was reckless in not knowing when stock splits occurred in the Fund’s positions, including the date, factor, and readjusted price of the stock after the split (TR. 39); (vi) had access to all of the Fund’s documentation regarding trading, and therefore knew or was reckless in not knowing the Fund’s true approximate net value and that it was losing money (TR. 352-55). I also make the Findings of Fact set out below with regard to particular issues in dispute; namely, (i) whether Respondents received calls for additional margin from the Fund’s clearing broker; (ii) whether the computer system Respondents used to keep the Fund’s records and measure its performance caused the Respondents to communicate misleading statements to the limited partners; (iii) whether Respondents neglected their duty to the Fund’s limited partners by failing to reconcile the Fund’s accounts with outside account statements; (iv) whether Respondents destroyed relevant records containing valuation and performance calculations in order to cover-up evidence of wrongdoing; and (v) whether Respondents’ attempt to explain the misstatements to the limited partners reveals an intent to deceive the limited partners as to the true cause of the misstatements. a. Margin Calls The evidence is in conflict as to whether and when the Respondents received margin calls from the clearing broker alerting them to the fact that the Fund was losing money. For the reasons set out below, I find that SLK made several margin calls, and Brubaker knew of them when they were made. Although SLK margin logs that would establish if and when margin calls occurred were not introduced in evidence, the exception status reports reflect that margin calls were made. (DX. 29, 30, 31.) Further, Gonzalez testified that SLK sent Brubaker exception status reports indicating margin deficiencies. There is, however, ambiguity surrounding the reasons Brubaker transferred funds to SLK on July 14, August 15, and November 30, 1995. The Division contends that these sums were transferred in response to SLK’s margin calls. However, Brubaker denies that he received margin calls from SLK. He testified that he did not receive exception status reports each day that would have indicated when margin calls were being made. Brubaker contends that the sums transferred on days following the alleged margin calls were, in fact, recently received investor contributions. For example, a $1 million contribution was made on November 29, and Brubaker deposited the $1 million along with additional monies in the Fund’s SLK equity account on November 30. The $1 million was, according to Brubaker, an unanticipated contribution resulting from a limited partner’s previously scheduled retirement plan payout. Furthermore, because the exception status report for November 29 would not have been faxed to him until November 30, he contends that the money could not have been solicited in response to a November 29 margin call. This, according to Brubaker, is additional evidence that Gonzalez did not speak to him about a margin call on November 29. Brubaker further contends that because the amount actually transferred to SLK on November 30 -- $1.26 million -- was well in excess of the amount required to cure the $866,683 margin deficiency, the deposit was not made in response to a margin call. Brubaker also points out that the daily exception reports for August and November show margin deficiencies almost every day. Therefore, by Gonzalez’ logic, SLK would have considered any deposit of funds into the equity account during those months as a response to a margin call. Brubaker’s interpretation is consistent with the substance of Gonzalez’ testimony that at the end of November 1995: [T]here was a stretch of time that he had pretty huge calls throughout the month. And there was this one time where he had a call -- at that time, we saw him trading in and out, in and out and it was just being too consistent. So my manager at the time had asked me to call him and just to state that we couldn’t let him trade out of it, we wanted to see some collateral, we wanted him to wire in some money to show good faith in meeting the call. . . . [Brubaker] wired a million dollars into the account. (TR. 277-78.) I do not credit Brubaker’s testimony that he did not receive calls for additional margin from SLK. Rather, I credit the testimony of Gonzalez and Christiansen to support my finding that, during the second half of 1995, SLK made margin calls with respect to the Fund and Brubaker knew such calls were made. Christiansen testified that he took several telephone calls during the second half of 1995 from SLK indicating that the Fund needed to satisfy margin calls. On at least one occasion, he and Brubaker discussed ways in which ASCI would satisfy a margin call, and then proceeded to execute trades to reduce the Fund’s positions. (TR. 144-45.) In addition to his testimony that he and his staff informed Brubaker about margin calls, Gonzalez testified at length about the usual business practices of SLK with respect to maintaining margin requirements. These practices included sending SLK customers reports notifying them of the status of their margin, and requesting additional collateral from customers whose equity- to-value ratio fell below a specific level. There is no evidence to rebut Gonzalez’ contention that SLK followed its normal business practices in dealing with the Respondents, and I find that it did. Gonzalez also testified that the exception status reports were faxed to Brubaker daily pursuant to Brubaker’s specific request. I am not persuaded by Brubaker’s testimony that the exception status reports "could not have been" part of the faxes he received from SLK on July 14, August 15, and November 30, 1995. Nor am I persuaded that the SLK-generated reports included in those fax transmission were the only items SLK sent the Respondents on the days in question. (see RX. 19, 22, 23.) I find it much more likely that the Respondents did receive the exception status reports notifying them of margin calls. (TR. 273-74.) Gonzalez also testified that Brubaker consistently traded out of his positions in an effort to satisfy margin requirements. I credit this testimony as additional evidence of Brubaker’s awareness of margin deficiencies in the Fund’s portfolio during the latter half of 1995. (TR. 277.) I further find that funds transferred from the Fund to SLK on July 14, August 15, and November 30, 1995 were, at least in part, intended to satisfy margin calls. b. The "Advent" Record-Keeping Program At all relevant times during 1995, ASCI and Brubaker used Advent to assist in portfolio management and record-keeping. This system tracks portfolio positions, calculates performance and performs various record-keeping functions. (JT. EX. 1, ¶ 36; TR. 87.) Brubaker was responsible for entering stock split information into the Advent system. (TR. 62.) He communicated to investors that "substantially all overvaluation errors" resulted from stock split information being entered into the Advent system "several days after the split[s] on an ‘as of’ basis." According to Brubaker, the combination of delay and failure to enter a proper "ex date" caused Advent to improperly calculate gains. (TR. 429-30; DX. 17, p. A.) Any readjustment in the price and the number of shares could only occur when Brubaker entered the information into the system. Short positions affected by a stock split could only be fully covered when Brubaker put the correct information into the system; Advent will not let the user cover short positions unknown to the system. The date the split information is entered is not relevant to any calculation the system makes as long as the performance report is run after the correct information is entered. (TR. 63, 98, 106-07, 111-14, 122-23, 376-79; DX. 39, 40.) Brubaker was aware of the splits and the impact they necessarily had on the Fund’s short positions. Because the system calculated gains based upon information Brubaker entered into the system, he knew or was reckless in not knowing of any overstatement of gains before he ran the reports. I credit the expert opinions of Flynn and Connor, as set out above, to support my finding that any errors concerning short or long positions contained in reports generated by the Advent system, or other record-keeping errors affecting the Fund’s accounts, were due to Brubaker’s misuse or nonuse of the system and not the system itself. Therefore, I find that Brubaker, not the Advent system, was responsible for the overstated value of the Fund during the last half of 1995. (TR. 59-64, 66, 81-82, 90-93.) c. Failure to Conduct Account Reconciliations Prior to June 1995, Brubaker performed a monthly reconciliation of the Fund’s accounts, which included verifying his internal records using monthly account statements from the Fund’s equity, options, bank, and money market accounts. The statements documented the closing monthly balances in the respective accounts. Also, prior to June 1995, Brubaker became aware of discrepancies between his monthly records and the independent monthly account statements while performing the monthly reconciliations. (TR. 64-66.) Although he continued to receive monthly account statements after May 1995, Brubaker stopped performing monthly reconciliation of his account records with the outside account statements. He stopped because he decided that the process was redundant and he was too busy to perform the task. He testified that he did not open the mail containing the account statements beginning in June 1995. (TR. 65, 435.) In early January 1996, after reviewing the valuation figures in the outside account statements for June and July 1995, he detected a dramatic difference between his internal records and the outside account statements. (TR. 418-19.) I credit the expert opinion of Connor and find that a reconciliation of internal records with outside independent monthly statements is a basic responsibility of a fund manager. (TR. 366-67.) Reconciliation is the only way managers can verify their own records and accurately calculate the NAV of the fund. (TR. 225-26, 254-55, 366-67.) I further find, based on Connor’s testimony, that by failing to keep accurate and complete records, Brubaker and ASCI breached the customary standards of fiduciary responsibility they owed to the Fund and its investors. (DX. 40, p. 5.) d. Destruction of Records Brubaker testified that when Respondents sent out performance letters with Fund valuation and performance information to investors, he had records that supported the reported figures. However, in January 1996, after learning that the figures he reported were overvalued, he deleted the stock split information and trading records for the months of June through December. This information would have disclosed how the overvaluation came about. He did not keep a copy of the deleted records, and there are no records supporting the valuations and performance figures he reported to investors. Any supportive records were destroyed at a time when Brubaker knew that the Fund was scheduled to be audited in the near future. (TR. 66-67, 421- 22, 488, 492.) The Division contends that the destruction of the trading records was part of Brubaker’s scheme to cover up information that would show he knew the Fund was losing money. Brubaker agrees that in hindsight it would have been better to keep a copy of what he entered to compute the NAV and track the Fund’s performance. However, he contends that he was acting on the advice of accounting professionals who instructed him to reconcile the figures he reported with the actual performance by deleting old data from the system and then entering data from the SLK monthly statements. (RF. 85-91.) I do not credit Brubaker’s testimony on this issue. Brubaker had extensive experience in the securities industry and as a money manager. Notwithstanding any instructions given to him by Ernst & Young regarding the need to reconcile the accounts from the beginning of the year, there is no evidence that any accountant told him to destroy all the records of his initial calculations. Moreover, even if he had been so instructed, the destruction of those records contravened the express terms of the Agreement, which required that complete books and records be maintained. (DX. 6, ¶ 3.03.) Based on Connor’s testimony, and considering Brubaker’s experience in the securities industry, I find that Brubaker’s destruction of the computer documents prevented the recovery of damaging information that would have been inconsistent with his defense. I further find that the information contained in the documents would be persuasive evidence that Brubaker and ASCI intentionally misrepresented the NAV and performance figures for the Fund during the second half of 1995. e. The Respondents’ Misleading Explanation In his June 13, 1996 letter to investors, Brubaker prepared a spread sheet which purported to explain the cause of the valuation and performance misstatements. He attributed most of the misstatements to using the wrong pricing methodology and errors associated with stock splits. He stated that he was unaware of these mistakes when he priced the portfolio during 1995. (DX. 17.) The Division’s expert, Connor, whose opinion I credit, testified that the overvaluation attributed to pricing differences is not cumulative while the overvaluation attributed to the stock split errors is cumulative. According to Connor, the two errors are interrelated and should be treated similarly. They could be treated differently only if Brubaker was aware of one of them when he valued the portfolio. In Connor’s opinion, the spreadsheet Brubaker created to explain the Fund’s losses is clear evidence that he was aware of the errors in his portfolio valuations at the time he reported the figures to the limited partners. (TR. 59, 358, 396-401; DX. 17, p. G; 40, p. 17-18.) Respondents were unable to explain this inconsistency, or otherwise dispute Connor’s conclusion. I am persuaded that the different treatment of the two types of errors reveals Brubaker’s intent to mislead the limited partners as to the true cause of the overvaluations. 4. Books and Records I find that throughout the life of the Fund, ASCI did not have an independent public accountant verify, by actual examination without notice to ASCI, the funds and securities in accounts that ASCI maintained for the Fund. I further find that ASCI and Brubaker failed to calculate, record, and report accurately the value of the Fund for 1995. (TR. 35, 58-59, 63- 64, 418-19; JT. EX. 1, ¶ 35). 5. Administrative Fees The Agreement provided that limited partners could withdraw their investment only at the end of the calendar quarter after giving written notice to the general partner thirty days before the end of the quarter. (DX. 6, § 2). The earliest date that a limited partner could have withdrawn based on a correct report of performance for the period ending June 30, 1995 was September 30, 1995. Investors who exited the Fund after September 30, 1995 were permitted to withdraw as of January 31, 1996. (TR. 496- 500). The Agreement permitted ASCI and Brubaker to receive an administrative fee of "50 basis points (1/2%) of the [NAV] of the partnership as of the end of each calendar quarter." (DX. 6, § 5.02.) The fee for the quarter ending December 31, 1995 was $33,800 based upon a NAV of $6.7 million. In January 1996, the Fund received requests from limited partners who represented approximately 84.8% of the Fund’s NAV as of December 31, 1995 to liquidate their holdings in the Fund. Absent the holdings of the redeeming investors, the fee for the quarter ending December 31, 1995 would have been $5,100. The Division contends that by basing the fee on the holdings of all of the limited partners, including those who announced their intention to redeem, Brubaker was unjustly enriched. Respondents, in their Answer, state that in 1996, the value of the Fund and the administrative fee was recomputed as of the end of 1995, and $19,777 in excess fees were repaid to the Fund. Brubaker also testified that a repayment was made and that testimony is unrebutted. Respondents’ assert that "the number of investors who would have withdrawn at the end of the third quarter" after learning of a poor second quarter and month of July is "entirely speculative." (RF. 99.) They further assert that they are entitled to the fees because they performed valuable services from October 1995 through January 1996 such that the Fund increased in value by 20%, which resulted in a substantial benefit to investors who remained in the Fund during those four months. (RF. 100.) I find that the number of investors that might have withdrawn at the end of the third quarter cannot be reasonably ascertained. Because of this uncertainty, I conclude that there is no reasonable way to determine an amount that constitutes unjust enrichment for the fourth quarter, particularly in light of the Respondents’ repayment of $19,777. Further, I find that Respondents were entitled to some fee for this period. I will not, therefore, order disgorgement of any part of the fourth quarter fees. In addition to the fourth quarter fee, ASCI and Brubaker took an administrative fee for the month of January 1996 based upon the Fund’s NAV before that figure was deflated by the withdrawal of nearly 85% of the Fund’s assets. (TR. 69, 184; Answer ¶ II.F.) The Division contends that this fee violated the terms of the Agreement which states that the fee shall be based on the NAV at the end of the calendar quarter, and that the fee is payable only at the end of the each calendar quarter. (DF. 96-97.) The Division urges disgorgement of 84.8% of the $13,700 fee Respondents charged the limited partners for the month of January. (DB., p. 21 & n.2.) Respondents’ position is that this fee does not violate the Agreement because, pursuant to Section 13.01, they exercised their discretion as general partners to move the redemption date forward to January 31. (DX. 6; § 13.01; Answer ¶ II.F; RB., p. 28-29.) However, there is no language in Section 13.01 that gives the general partner the discretion to move up the redemption date. (DX. 6, § 13.01.) Therefore, I find that the additional fee taken for January was taken without the permission of the investors and contrary to the terms of the Agreement. I conclude that the portion of the fee ASCI and Brubaker charged the limited partners who liquidated their holdings in the Fund constituted unjust enrichment, and an order shall issue directing Respondents to disgorge $11,600. IV. CONCLUSIONS OF LAW Respondent ASCI has admitted that its conduct violated Sections 17(a)(2) and 17(a)(3) of the Securities Act; and Sections 204, 206(2), and 206(4) of the Advisers Act as well as Rules 204-2(a)(2) and 206(4)-2 thereunder. Respondent Brubaker has admitted that he violated Sections 17(a)(2) and 17(a)(3) of the Securities Act; and Section 206(2) of the Advisers Act. Brubaker has also admitted that he caused and aided and abetted ASCI’s violations of Sections 204 and 206(4) of the Advisers Act, and Rules 204-2(a)(2) and 206(4)-2 thereunder. (RB., pp. 2, 31, 36-37.) The evidence of their conduct adduced at the hearing, as credited above in the Findings of Fact, supports their admissions. I conclude that Respondents willfully[6] violated the Sections and Rules they have admitted violating. I further conclude, based upon the same admissions and evidentiary matter, that Brubaker caused and willfully aided and abetted ASCI’s violations of Sections 204 and 206(4) of the Advisers Act and Rules 204-2(a)(2) and 206(4)-2 thereunder. The outstanding issues are whether Respondents willfully violated Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10(b)-5 thereunder, and Section 206(1) of the Advisers Act. It must also be determined whether Brubaker caused and willfully aided and abetted ASCI’s alleged violation of Section 206(1). Section 17(a)(1) of the Securities Act makes it unlawful "in the offer or sale" of securities, by jurisdictional means, to employ any device, scheme, or artifice to defraud. Section 10(b) of the Exchange Act and Rule 10b-5 thereunder proscribe similar practices "in connection with" the purchase or sale of securities. Section 206(1) of the Advisers Act makes it unlawful for any investment adviser, by jurisdictional means, to employ any device, scheme, or artifice to defraud any client or prospective client. Scienter, which must be proven to establish a violation of the above provisions, is a "mental state embracing intent to deceive, manipulate, or defraud." Aaron v. SEC, 446 U.S. 680, 686 n.5 (1980); see also Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 n.12 (1976). Reckless conduct can satisfy the scienter requirement under Section 17(a)(1) and Section 10(b) and Rule 10b-5 thereunder as well as Section 206(1). SEC v. Steadman, 967 F.2d 636, 641-42 (D.C. Cir. 1992); Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990); David Disner, 63 SEC Docket 2246, 2254 & n.20 (Feb. 4, 1997). Reckless conduct is conduct which is "‘highly unreasonable’ and which represents ‘an extreme departure from the standards of ordinary care . . . to the extent that the danger was either known to the [respondent] or so obvious that the [respondent] must have been aware of it.’" Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 47 (2d Cir. 1978) (quoting Sanders v. John Nuveen & Co., 554 F.2d 790, 793 (7th Cir. 1977)). a. Violations of the Securities Act and the Exchange Act In order to establish a violation of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, the Division must prove that these Respondents: (1) made a material misrepresentation, omitted to state a material fact, or otherwise engaged in a scheme and artifice to defraud; (2) acted with the requisite scienter; (3) committed the fraudulent acts in connection with the offer, purchase or sale of a security; and (4) employed the jurisdictional means. A misrepresentation or omission is material if a reasonable investor would consider the fact important in making an investment decision or, when viewed by a reasonable investor, it significantly alters the "total mix" of information available. Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). The evidence establishes, and the Respondents concede, that during the period June through December 1995, these Respondents made material misstatements and omissions to investors by mailing monthly letters that did not accurately report the true value of the limited partnership interests. These misstatements were material because they overstated the performance of the Fund by at least 58% and as much as 227% and, in quarterly letters, overstated the Fund’s NAV by at least 41% and as much as 112%. A reasonable investor would have attached great significance to these discrepancies in making their investment decision. During that same period, Respondents were obtaining additional capital contributions from the limited partners. A limited partnership interest is a security under the federal securities law, and additional capital contributions to a limited partnership constitute separate purchases and sales of securities. See Goodman v. Epstein, 582 F.2d 388, 413-14 (7th Cir. 1978). One example of such purchase and sale was the additional $1 million dollar capital contribution made by a limited partner at the end of November 1995. Thus, ASCI and Brubaker’s misstatements and omissions were made "in connection with" the purchase and sale of a security. ASCI and Brubaker acted with an intent to deceive, manipulate, or defraud when they misrepresented the value and performance of the Fund to the limited partners. Several facts prove that the Respondents knew the Fund was losing value during the latter half of 1995. Among other indications of their awareness set out above in the Findings of Fact, Respondents received calls for additional margin on several occasions, and knew that specific stock positions had to be readjusted to account for the effects of splits. They received daily and monthly account statements alerting them to the Fund’s steady decline. They knew the Fund’s cash and stock positions. Moreover, Respondents attempted to disguise both the losses and their own failure to disclose the losses. They destroyed relevant records containing valuation and performance calculations as the Fund’s first scheduled audit approached. When they offered the limited partners a detailed written explanation of how the decline had gone undetected, they manipulated both the figures and the attendant footnotes to make the misstatements appear accidental. Finally, the scheme to defraud was perpetrated through the use of the mails and other means of transportation and communication in interstate commerce, and thus the jurisdictional element is satisfied. I therefore conclude that Respondents ASCI and Brubaker willfully violated Section 17(a)(1) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. b. Violations of the Advisers Act Respondents were investment advisers who engaged in fraudulent activities and breached their fiduciary duty by making false and misleading statements and omissions of material fact. As general partners to the Fund, Respondents were investment advisers under the statutory definition of the term contained in Section 202(a)(11) of the Advisers Act. Abrahamson v. Fleschner, 568 F.2d 862, 869-70 (2d Cir. 1977). As was established above, the Respondents acted with the requisite mental state. See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 193-95 (1963); Steadman v. SEC, 603 F.2d 1126, 1134 (5th Cir. 1979), aff’d, 450 U.S. 91, (1981). I therefore conclude that for the period June through December 1995, Brubaker and ASCI, by the use of the mails and means and instrumentalities of interstate commerce, directly and indirectly employed a device, scheme and artifice to defraud their investors by concealing, among other things, the true NAV and performance of the Fund. This scheme and artifice to defraud was perpetrated by Brubaker and ASCI, and constituted a willful violation of Section 206(1) of the Advisers Act. Three elements must be present to establish an aiding and abetting charge: (1) a primary violation committed by a third party; (2) awareness or knowledge on the part of the aider and abettor that his or her role was part of an illegal activity; and (3) the aider and abettor’s knowing and substantial assistance in the violative activity. Woods v. Barnett Bank of Fort Lauderdale, 765 F.2d 1004, 1009 (11th Cir. 1985); Investors Research Corp. v. SEC, 628 F.2d 168, 178 (D.C. Cir. 1980); IIT v. Cornfeld, 619 F.2d 909, 922 (2d Cir. 1980). The Division has proven ASCI’s primary violations. In addition, it has proven that Brubaker was aware of those violations, and that he provided substantial assistance to ASCI in committing the violations. He was ASCI’s sole officer, and an 85% owner of the firm. He prepared the records and reports that served as the basis for the performance misrepresentations sent to investors. He wrote and signed the letters containing the misrepresentations. I therefore further conclude that Brubaker caused and willfully aided and abetted ASCI’s violations. V. SANCTIONS The Division urges imposition of the following sanctions: (i) a cease and desist order against both Respondents; (ii) a collateral bar against Brubaker; (iii) the revocation of ASCI’s registration as an investment adviser; (iv) disgorgement from both Respondents of 84.8% of their fourth quarter advisory fee plus prejudgment interest, and; (v) third tier civil penalties. Respondents’ position is that a cease and desist order, along with the institution of appropriate administrative procedures to prevent future miscalculations, are the appropriate sanctions. Respondents represent that appropriate administrative procedures designed to prevent the recurrence of violations of the securities laws have already been instituted. They argue that all other sanctions sought by the Division are "clearly punitive" and unwarranted. (RB., pp. 37-42.) 1. Public Interest The imposition of administrative sanctions requires consideration of: the egregiousness of the defendant’s actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant’s assurances against future violations, the defendant’s recognition of the wrongful nature of his conduct, and the likelihood that the defendant’s occupation will present opportunities for future violations. Steadman, 603 F.2d at 1140 (quoting SEC v. Blatt, 583 F.2d 1325, 1334 n.29 (5th Cir. 1978)). The severity of a sanction depends on the facts of each case and the value of the sanction in preventing a recurrence. Berko v. SEC, 316 F.2d 137, 141 (2d Cir. 1963); Richard C. Spangler, Inc., 46 S.E.C. 238, 254 n. 67 (1976); Leo Glassman, 46 S.E.C. 209, 211-12 (1975). 2. Cease and Desist Section 8A of the Securities Act, Section 21C of the Exchange Act, and Section 203(k) of the Advisers Act, provide that the Commission, after notice and opportunity for a hearing, may enter an order requiring any person who "is violating, has violated, or is about to violate" or cause a violation of any of the above provisions to cease and desist from committing or causing such violation and any future violation of the same provision. These statutes, by their terms, permit the entry of a cease and desist order upon concluding that a violation of the securities law has occurred. In this proceeding, I have concluded that violations of the securities laws have been committed by Brubaker and ASCI. A cease and desist order shall issue. 3. Disgorgement Section 8A(e) of the Securities Act, Section 21C(e) of the Exchange Act, and Section 203 of the Advisers Act provide that in any cease and desist proceeding, the Commission may enter an order requiring disgorgement of profits and reasonable interest. Brubaker testified that after recomputing the portfolio value in 1996, adjustments were made in the fees and monies were repaid to the Fund. The Respondents’ Answer also states that $19,777 has been repaid to the Fund. I have concluded that it is not possible to determine an amount that constitutes unjust enrichment for the fourth quarter of 1995, and therefore I decline to order disgorgement of the Respondents’ fourth quarter fees. However, the January 1996 fee was taken in contravention of the Agreement. I will order 84.8% of the January 1996 fee to be disgorged with appropriate interest. 4. Civil Penalties Section 21B of the Exchange Act and Section 203(i) of the Advisers Act provide that in any proceeding instituted pursuant to Section 15(b) of the Exchange Act, the Commission may impose a civil penalty if it finds that the respondent has willfully violated the Securities Act, Exchange Act or the Advisers Act. Assessment of a penalty under this section is predicated on a finding that such penalty is in the public interest. Other factors that may be considered in arriving at the amount of penalty include: (i) whether the act or omission involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement; (ii) the harm to others resulting either directly or indirectly from such act or omission; (iii) the extent to which any person was unjustly enriched, taking into account any restitution made to persons injured by such behavior; (iv) whether the Commission or another regulatory body has found that the respondent violated the federal securities laws; (v) the need to deter the respondent and others from committing similar acts or omissions; and (vi) any other factors the interests of justice may require. The Division recommends that "third tier" penalties be imposed. (DB., p. 36.) Third tier penalties may be appropriate if the violation committed by the respondent involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement; and the act or omission directly or indirectly resulted in substantial losses to other persons, or created a significant risk of substantial losses to other persons, or resulted in substantial pecuniary gain to the person who committed the act or omission. The maximum amount of penalty for each such act or omission is $100,000 for a natural person or $500,000 for any other person. Respondents argue that any civil penalties imposed should not rise above the first tier, which carries a maximum penalty for each act or omission of $5,000 for natural persons or $50,000 for other persons. The Division argues that Respondents should be assessed third tier penalties because, among other things: the violations they committed involved fraud, deceit, manipulation, and deliberate disregard of a regulatory requirement; the investors suffered significant harm because they were induced into maintaining their investments in the Fund, and as a result incurred substantial losses; the Respondents destroyed records and otherwise attempted to conceal the true causes of the misleading statements they issued; and the Respondents’ actions resulted in substantial pecuniary gain to them in the form of unauthorized and unearned fees. (DB., pp. 36-38.) Respondents argue that the violations they committed did not involve fraud. They further contend that investors did not lose money by remaining in the Fund from October 1995 through January 1996, and that Brubaker was not unjustly enriched. They emphasize that they have no history of prior violations. (RB., pp. 41-42.) Brubaker has been in the securities business for about 20 years. Prior to this proceeding, Respondents had never been found to have violated the federal securities laws. In addition, the Respondents have taken some steps to return funds to those they deceived. However, after observing Brubaker at the hearing and listening to his explanations, I am not convinced that he understands the seriousness of these offenses. I did not detect any sense of remorse for the harm he caused to the Fund’s investors. Indeed, he went to great lengths to blame a computer program, and to deny that he intentionally overvalued the Fund. These efforts were not only futile, they were dishonest. I therefore question his assurances that he will not violate the securities laws in the future. I am persuaded by the Division’s recommendation that third tier penalties be imposed against Respondents. Respondents repeatedly deceived their clients. The harm caused by the deceptions is best indicated not by the amount of money these investors gained or lost by remaining limited partners when they might have withdrawn their investments at an earlier time, but by the fact that when they learned that the Respondents had abused their trust, nearly all of them withdrew their investments immediately. Furthermore, regardless of whether the investors gained or lost money, the Respondents’ fraudulent scheme created a significant risk of substantial losses. I am also persuaded by the Division’s argument that "Respondents’ motivation for perpetrating the fraudulent scheme was to conceal from investors that the Fund’s investment strategy . . . was failing. Brubaker . . . believed that the market would soon [decline] as he [had] predicted and the Fund would recoup its losses. . . . Under Respondents’ theory, as long as gains occurred in the future, their fraudulent conduct was justified . . . ." (Reply, p. 10.) This assessment echoes Caldwell’s criticism that Brubaker was "dangerous" because he thought he was "smarter than the market." (TR. 222.) Respondents and those who adopt similar attitudes must be deterred from engaging in the kind of conduct that gave rise to this proceeding. It is critical to the integrity of the securities industry that securities professionals face severe sanctions when they defraud investors. This case involved a fraudulent scheme that lasted for about six months and resulted in multiple violations of the federal securities laws. Brubaker has demonstrated that he is not only willing to perpetrate such a scheme, he is also sophisticated enough to disguise his wrongdoing. Third tier penalties are appropriate. Brubaker and ASCI shall each be ordered to pay a penalty of $50,000. 5. Bar and Suspension Sections 15(b) and 19(h) of the Exchange Act, and Section 203(f) of the Advisers Act, authorize the Commission to order a wide range of sanctions restricting the ability of securities professionals to serve in the securities industry if the Commission determines that person has committed certain wrongful acts. Such persons may be censured, suspended, barred from participation in the offering of a penny stock, barred from association with a broker or dealer, and have other limitations imposed upon them. In certain cases, the Commission has the authority to order an industry-wide, "collateral bar" preventing certain respondents from associating with any broker, dealer, municipal securities dealer, investment adviser, investment company, registered securities association, stock exchange, or municipal securities dealer. Meyer Blinder, 65 SEC Docket 1970, 1981 (Oct. 1, 1997). Collateral bars are appropriate in "in cases where it is contrary to the public interest to allow someone to serve in any capacity in the securities industry." Id. The most important factor to consider in deciding for or against such a sweeping prohibition is whether the respondent’s "misconduct is of the type that, by its nature, ‘flows across’ various securities professions and poses a risk of harm to the investing public in any such profession." Id. Also pertinent to the inquiry is "whether the egregiousness of the respondent’s misconduct demonstrates the need for a comprehensive response in order to protect the public." Id. The Commission also has the authority to suspend for a period not exceeding twelve months, or revoke the registration of an investment adviser pursuant to Section 203(e) of the Advisers Act. In light of the public interest factors cited above, I conclude that it is appropriate to suspend Brubaker from association with a broker, dealer, or investment adviser for six (6) months and to suspend the registration of ASCI as an investment adviser for six (6) months. Although Brubaker’s misconduct is the type that "flows across" the securities industry, and it is certainly reprehensible, it is not so egregious as to merit an industry-wide bar. See Alan E. Rosenthal, 67 SEC Docket 2694, 2698 (Sept. 1, 1998). I therefore conclude that a collateral bar as to Brubaker and the revocation of ASCI’s registration would be excessive and not in the public interest. CERTIFICATION OF RECORD Pursuant to Rule 351(b) of the Commission’s Rules of Practice, 17 C.F.R. § 201.351(b), I certify that the record includes the items set forth in the record index issued by the Commission’s Office of the Secretary on April 9, 1998. ORDER Based upon the Findings of Fact and Conclusions of Law as set out above: IT IS ORDERED, pursuant to Section 8A of the Securities Act, Section 21C of the Exchange Act and Section 203(k) of the Advisers Act, that Respondent Brett G. Brubaker and Respondent Abraham and Sons Capital, Inc. cease and desist from committing or causing any violations or future violations of Section 17(a) of the Securities Act; Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; Sections 204, 206(1), 206(2), and 206(4) of the Advisers Act and Rules 204-2(a)(2) and 206(4)-2 thereunder; IT IS FURTHER ORDERED, pursuant to Section 8A of the Securities Act, Section 21C of the Exchange Act, and Section 203 of the Advisers Act, that Respondent Brett G. Brubaker and Respondent Abraham and Sons Capital, Inc. disgorge $11,600 plus prejudgment interest at the rate established under Section 6621(a)(2) of the Internal Revenue Code, 26 U.S.C. § 6621(a)(2), compounded quarterly, pursuant to Rule 600 of the Commission’s Rules of Practice, 17 C.F.R. § 201.600, and computed from January 31, 1996 until the date on which the funds are paid; IT IS FURTHER ORDERED, pursuant to Section 203(f) of the Advisers Act and Sections 15(b)(6) and 19(h) of the Exchange Act, that Respondent Brett G. Brubaker be, and hereby is, suspended from being associated with any broker, dealer, or investment adviser for a period of six (6) months; IT IS FURTHER ORDERED, pursuant to Section 203(e) of the Advisers Act, that Respondent Abraham and Sons Capital, Inc. be, and hereby is, suspended from acting as an investment adviser for a period of six (6) months; IT IS FURTHER ORDERED, pursuant to Section 21B of the Exchange Act and Section 203(i) of the Advisers Act, that Respondent Brett G. Brubaker pay a civil penalty in the amount of fifty thousand dollars ($50,000.00); IT IS FURTHER ORDERED, pursuant to Section 21B of the Exchange Act and Section 203(i) of the Advisers Act, that Respondent Abraham and Sons Capital, Inc., pay a civil penalty in the amount of fifty thousand dollars ($50,000.00). Payment of penalty, disgorgement, and interest shall be made on the first day after this decision becomes final. Such payment shall be: (i) made by United States postal money order, certified check, bank cashier’s check or bank money order; (ii) made payable to the Securities and Exchange Commission; (iii) delivered by hand or courier to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop-0-3, Alexandria, Virginia 22312; and (iv) submitted under cover letter that identifies Brett G. Brubaker and Abraham and Sons Capital, Inc. as Respondents in this proceeding, and the file number of the proceeding. A copy of the cover letter also should be delivered to the Commission’s Division of Enforcement. This order shall become effective in accordance with and subject to the provisions of Rule 360, 17 C.F.R. § 201.360 of the Commission’s Rules of Practice. Pursuant to that rule, a petition for review of this initial decision may be filed within twenty-one (21) days after service of the decision. It shall become the final decision of the Commission as to each party who has not filed a petition for review pursuant to Rule 360(d)(1) within twenty-one (21) days after service of the initial decision upon the party, unless the Commission, pursuant to Rule 360(b)(1), determines on its own initiative to review this initial decision as to any party. If a party files a timely petition for review, or the Commission acts to review as to a party, the initial decision shall not become final as to that party. ___________________________ Robert G. Mahony Administrative Law Judge **FOOTNOTES** [6]: Under the federal securities laws, the willfulness standard is satisfied by proving intent to commit the act which constitutes the violation. An act may be willful even if the defendant did not intend to violate the law. Arthur Lipper Corp. v. SEC, 547 F.2d 171, 180 (2d Cir. 1976); Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965). 2