INITIAL DECISION RELEASE NO. 136 ADMINISTRATIVE PROCEEDING FILE NO. 3-9484 UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 _________________________ In the Matter of : : INITIAL DECISION RUSSO SECURITIES, INC., : March 2, 1999 PATRICK RUSSO, and : KIMBERLY KENT : _________________________ APPEARANCES: Anthony Ragozino, Esq. and Lisa Rosenthal, Esq. for the Division of Enforcement, Securities and Exchange Commission Charles B. Manual, Esq. and James C. Jones, Esq. for the Respondents BEFORE: G. Marvin Bober, Administrative Law Judge I. Introduction On November 7, 1996, the Securities and Exchange Commission ("Commission") issued an order instituting public administrative and cease and desist proceedings ("OIP") pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Sections 15(b), 19(h), and 21C of the Securities Exchange Act of 1934 ("Exchange Act"). As more fully set forth in the OIP, the Division of Enforcement ("Division") alleges that: (1) Russo Securities, Inc. ("RSI") willfully violated Section 15(c)(3) of the Exchange Act and Rule 15c3-1 thereunder, the Commission's net capital rule, in that it executed customer transactions on December 29, 1995, and January 31, February 29, and March 22, 1996, while it did not have a minimum of $100,000 of net capital; (2) RSI violated Section 17(a)(1) of the Exchange Act and Rules 17a-3, 17a-5, and 17a-11 thereunder, in that its books and records, including its Financial and Operational Combined Uniform Single ("FOCUS") reports, reflecting its net capital computations on the above dates were inaccurate, and that it failed to notify the Commission of its net capital and books and records deficiencies; and (3) Patrick Russo ("Russo") and Kimberly Kent ("Kent") willfully aided and abetted, and were causes of RSI's violations. As directed by the Commission in the OIP, I held an administrative trial from April 27 to 30, 1998, in New York, New York to determine whether the allegations contained in the OIP are true and, if so, whether sanctions against Respondents are appropriate and in the public interest, whether a cease and desist order should issue against Respondents, and whether Respondents should be ordered to pay civil penalties. At the trial, the Division called two witnesses and introduced fifty-two exhibits. Respondents introduced seventeen exhibits and called six witnesses, including one expert witness. Thirteen Administrative Law Judge exhibits were also introduced.[1] Both parties filed post-hearing pleadings. II. Findings Of Fact My findings and conclusions are based upon the record and upon 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). A. Respondents 1. RSI RSI, a New York corporation with offices located in Staten Island, New York, is a broker-dealer registered with the Commission, and a member of the New York Stock Exchange, Inc. ("NYSE") and the National Association of Securities Dealers, Inc. ("NASD"). (Tr. 46.) RSI is owned by Russo and his brothers, Richard Russo and Ferdinand Russo ("F. Russo"). (Tr. 385.) RSI operates as an introducing broker and clears customer accounts on a fully disclosed basis through another NYSE member firm. (Tr. 349-50.) RSI has run afoul of securities regulators several times in recent years. In December 1993, the NYSE censured and fined RSI after concluding that, among other things, RSI failed to maintain adequate net capital and filed inaccurate reports, including FOCUS reports. (Div. Ex. 53.) On September 12, 1994, the Office of the Secretary of State Securities Division for the State of Massachusetts sanctioned RSI for filing false or misleading documents in connection with its application for registration in Massachusetts. (ALJ Ex. 7.) On April 28, 1998, the second day of the administrative trial, the NYSE notified RSI that it did not have sufficient net capital. (ALJ Ex. 7.) On August 4, 1998, the NYSE again informed RSI that it did not have adequate net capital. The NYSE further instructed RSI to stop doing business until it resolved its net capital deficiency and requested that RSI seek Commission approval to liquidate its firm positions. (ALJ Ex. 11.) 2. Russo Russo, age fifty-five, has served as RSI's president and chief executive officer since the firm's inception in 1979. (Tr. 383-84.) In 1994, the Office of the Secretary of State Securities Division for the State of Massachusetts sanctioned Russo individually for his role in connection with RSI's filing false or misleading documents relating to its application for registration in Massachusetts. (ALJ Ex. 7.) From at least December 1, 1995 through March 1996 (the "relevant period"), Russo supervised RSI's net capital computations, was ultimately responsible for the net capital computations prepared by Kent, and signed the FOCUS reports filed during the relevant period. (Tr. 386; Div. Exs. 1, 10, 19.) Russo signed investment banking agreements with BestSellers Group, Inc. ("BestSellers"), American Diversified Group, Inc. ("ADGI"), and Semicon Tools, Inc. ("Semicon") during the relevant period. (Div. Exs. 17, 18, 9, 27; Tr. 403, 406.) 3. Kent Kent has been employed by RSI since 1982. (Tr. 293.) Since 1993, she has served as RSI's chief financial officer and registered financial and operations principal ("FINOP"). (Tr. 293.) During the relevant period, Kent supervised the preparation of RSI's net capital computations and underlying financial documents and materials. (Tr. 293.) B. Background The allegations in the instant proceeding originate with RSI's decision to report stocks due the firm pursuant to investment banking agreements with BestSellers, ADGI, and Semicon as "allowable assets" or "good capital" under the net capital provisions of the federal securities laws. 1. Russo Included Unauthorized, Unregistered ADGI Stock in its Net Capital Computations for December 29, 1995 On October 27, 1995, RSI entered into an investment banking agreement with BestSellers ("BestSellers Agreement I"). In return for providing investment banking services to BestSellers, RSI was entitled to receive, upon execution of the agreement, 800,000 shares of BestSellers common stock. (Resp. Ex. B.) On December 14, 1995, RSI entered into a investment banking agreement with ADGI. (Div. Ex. 17.) In return for providing investment banking services to ADGI, RSI was entitled to receive, upon execution of the agreement, 1 million shares of ADGI common stock. (Div. Ex. 17.) In late December 1995, RSI learned that ADGI planned to acquire 100% of BestSellers in a friendly merger. (Tr. 311-12, 391-93.) On December 28, 1995, in anticipation of the merger, RSI negotiated an amendment to the December 14 agreement, whereby ADGI assumed BestSellers' commitment to RSI. (Div. Ex. 18.) In return for investment banking services provided by RSI, ADGI agreed to convey to RSI, upon execution of the amended agreement, 3 million shares of ADGI common stock. (Div. Ex. 18.) RSI's FOCUS report for the month ended December 31, 1995, reported that it had net capital of $302,857 on that date.[2] (Div. Ex. 10.) On that date, RSI included as an allowable asset on its books and records the value of 2 million shares of ADGI common stock. (Tr. 55-60, 294; Div. Exs. 10-14.) The stock was valued at $460,000, or forty-five percent of RSI's total reported allowable assets. (Div. Ex. 10; Tr. 401.) RSI included the ADGI stock as an allowable asset in December of 1995 on the basis of the December 14, and December 28, 1995 ADGI agreements. (Tr. 308.) However, as of December 29, 1995, when RSI included the ADGI stock in its net capital computations, the shares had not been authorized by ADGI's board of directors for issuance to RSI. The president of ADGI during the relevant period, Jerrold Hinton ("Hinton"), stated that "[ADGI] never issued a resolution of its Board of Directors authorizing the issuance of any stock to [RSI]." (ALJ Ex. 5 (emphasis in original).) Respondents contend that ADGI, in fact, authorized the issuance of stock to RSI. Russo, however, could not point to any part of the ADGI agreements or any other documentary evidence that demonstrated his claim that ADGI authorized the issuance of stock to RSI. (Tr. 388-89, 402.) Karlton Zamost ("Zamost"), a RSI consultant who has known the Russo brothers for approximately twenty years, testified he attended a meeting prior to the December 14 ADGI agreement and saw a board resolution authorizing the issuance of the disputed ADGI stock. (Tr. 487-90.) Respondents, however, produced no such resolution[3] and Zamost's testimony is directly contradicted by Hinton's declaration. The disputed ADGI shares, in addition to not being authorized for issuance by the board of directors, were not registered with the Commission and were never received by RSI. (ALJ Ex. 1; Tr. 404.) If the value of the ADGI stock is deducted from RSI's reported net capital for December 31, 1995, RSI had a negative net capital balance of $39,621, or $139,621 below what it should have been on that date. (Tr. 79-82; Div. Ex. 35.) There were no other events on December 31, 1995 that would have brought RSI above its minimum net capital requirement. (Tr. 78-79.) RSI executed customer transactions in securities on December 29, 1995. (Div. Exs. 44-45.) RSI, Russo, and Kent failed to notify the Commission, by telephone or otherwise, that it had less than $100,000 in net capital on or around December 29, 1995, or that its books and records were inaccurate. (Tr. 71.) 2. Russo Included Unauthorized BestSellers Stock in its Net Capital Computations for January 31, and February 29, 1996 The proposed BestSellers/ADGI merger fell through in January 1996. (Tr. 311-12, 391-93.) In response, RSI updated BestSellers Agreement I whereby BestSellers reassumed its commitment to provide RSI with BestSellers stock as compensation for its services. (Div. Ex. 9.) The amended BestSellers agreement ("BestSellers Agreement II"), dated January 17, 1996, entitled RSI to receive, upon execution of the agreement, 2 million shares of BestSellers common stock. (Div. Ex. 9.) RSI's FOCUS report for the month ended January 31, 1996, reported that it had net capital of $279,338 on that date. (Div. Ex. 19.) The FOCUS report for the month ended February 29, 1996, reported that RSI had net capital of $275,766 on that date. (Div. Ex. 1.) On both dates, RSI included as an allowable asset on its books and records the value of 2 million shares of BestSellers common stock. The stock was valued at $400,000 on January 31, and at $380,000 on February 29, 1996. (Tr. 55-56; Div. Exs. 1-5, 19-24.) The value of the BestSellers stock represented forty-two percent of RSI's total reported allowable assets on January 31, and thirty-eight percent on February 29, 1996. (Tr. 405.) RSI included the BestSellers stock as an allowable asset on the strength of BestSellers Agreement II. (Tr. 299-300, 341-42, 355, 387-93.) However, as of January 31, and February 29, 1996, when RSI included the BestSellers stock in its net capital computations, the shares had not been authorized by the BestSellers' board of directors for issuance to RSI. (ALJ Ex. 4; Div. Ex. 28.) The board of directors did not approve BestSellers Agreement II or authorize the issuance of stock to RSI until March 25, 1996. (ALJ Ex. 4; Div. Ex. 28.) BestSellers did not ultimately issue the shares to RSI until April 2, 1996. (Tr. 73; Div. Ex. 29.) Zamost testified that he attended a meeting in 1995 in Coral Gables, Florida, in which BestSellers Agreement I, dated October 27, 1995, was approved. (Tr. 426-28, 435-37.) Respondents, however, produced no corroborating evidence of such a meeting and, more importantly, no resolution or other documentary evidence authorizing the issuance of the disputed BestSellers shares. Moreover, the net capital computations at issue in this proceeding involve amended BestSellers Agreement II, dated January 17, 1996, not the October 1995 agreement. Zamost offered no testimony regarding any approval of amended BestSellers Agreement II. If the value of the BestSellers stock is deducted from RSI's reported net capital for January 31 and February 29, 1996, RSI had a net capital balance of negative $23,651 and positive $21,818, respectively. Thus, without the BestSellers stock RSI's net capital balance was $123,651 and $78,182 below what it should have been on those dates.[4] (Div. Exs. 36-37.) There were no other events on January 31, or February 29, 1996 that would have brought RSI above its minimum net capital requirement. (Tr. 78- 79.) RSI executed customer transactions in securities on January 31 and February 29, 1996. (Div. Exs. 44-45.) RSI, Russo, and Kent failed to notify the Commission, by telephone or otherwise, that it had less than $100,000 in net capital during either January or February 1996, or that its books and records were inaccurate. (Tr. 71.) 3. Russo Included Unauthorized BestSellers and Unauthorized and Unregistered Semicon Stock in its Net Capital Computations for March 22, 1996 On March 6, 1996, RSI entered into an investment banking agreement with Semicon ("Semicon Agreement"). In return for providing investment banking services to Semicon, RSI was entitled to receive, upon execution of the Semicon Agreement, options, exercisable until September 30, 1996, to purchase 6 million shares of Semicon stock.[5] (Div. Ex. 9.) RSI's FOCUS report for the month ended March 22, 1996, reported that it had net capital of $308,000 on that date.[6] (Div. Ex. 26.) RSI included as an allowable asset on its books and records 671,000 shares of BestSellers common stock valued at $120,798 and 525,000 shares of Semicon common stock valued at $357,000. (Div. Ex. 26.) RSI included the BestSellers and Semicon stock as an allowable asset on the basis of BestSellers Agreement II and the Semicon Agreement. (Tr. 299-300, 341-42, 355, 387-93; Div. Ex. 9.) When RSI included the BestSellers stock in its net capital computations, however, the shares had not been authorized by the BestSellers' board of directors for issuance to RSI. (ALJ Ex. 4; Div. Ex. 28.) The shares were not authorized for issuance to RSI until March 25, 1996.[7] (ALJ Ex. 4; Div. Ex. 28.) Similarly, Semicon's board of directors did not authorize for issuance to Russo either the options to purchase shares of Semicon or the stock itself until March 29, 1996.[8] (Div. Ex. 56.) RSI, in turn, did not exercise the Semicon options until April 3, 1996, nearly two weeks after it counted the stock as an allowable asset in its net capital computations.[9] (Tr. 287; Div. Ex. 30.) Zamost testified that he saw corporate minutes authorizing the Semicon Agreement prior to March 22, 1996. (Tr. 511.) However, the existence of the Semicon board of directors resolutions, dated March 29, conflicts with and undermines Zamost's testimony. Moreover, Respondents failed to provide any corroboration, documentary or otherwise, for Zamost's contentions. As of March 22, 1996, the disputed Semicon shares, in addition to not being authorized for issuance by the board of directors, were not registered with the Commission. (Div. Ex. 56.) Semicon's board of directors did not authorize the company's officers to register the options and stock until March 29, 1996, and Semicon did not file its Form S-8 registration statement with the Commission until April 3, 1996. (Div. Exs. 42, 56.) If the value of the BestSellers and Semicon stock is deducted from RSI's reported net capital for March 22, 1996, RSI had a negative net capital balance of $19,333, or $119,333 less than the $100,000 minimum net capital required for RSI. (Tr. 86- 90; Div. Ex. 38.) There were no other events on March 22, 1996 that would have brought RSI above its minimum net capital requirement. (Tr. 79.) RSI executed customer transactions in securities on March 22, 1996. (Div. Exs. 46.) RSI, Russo, and Kent failed to notify the Commission, by telephone or otherwise, that it had less than $100,000 in net capital on or around March 22, 1996, or that its books and records were inaccurate. (Tr. 71.) 4. Russo and Kent's Roles in RSI's Net Capital Computations a. Russo Russo was aware that on the dates at issue the ADGI, BestSellers, and Semicon stock represented a significant percentage -- approximately forty percent -- of RSI's reported allowable assets. (Tr. 388, 399, 405, 407.) He was also aware of and/or recklessly disregarded the fact that if RSI was unable to include assets of that size in its net capital, it would fall below minimum net capital requirements. (Tr. 400-01.) Nevertheless, Russo did not investigate the status of the disputed stock purportedly owned by RSI or the propriety of including the stock as an allowable asset in net capital. For example, Russo admits that as of the dates RSI counted the stock as an allowable asset, he made no efforts to determine whether the ADGI or Semicon stock had been registered with the Commission or issued to RSI. (Tr. 403-04, 407.) Russo was further aware that as of the dates RSI counted BestSellers as an allowable asset, the stock had not yet been issued to RSI. (Tr. 405-06.) Regarding board authorization of the ADGI stock, Russo could only point to the December 14 and December 28, 1995 ADGI agreements, which he admitted made no mention of authorization. (Tr. 402- 04.) Russo also admitted that during the relevant period, he made no efforts to determine whether BestSeller's board of directors had authorized issuing BestSeller's stock to RSI. (Tr. 405.) Finally, Russo pled ignorance when asked whether he had confirmed the authorization or lack thereof of Semicon stock, stating "I don't know." (Tr. 407-08.) b. Kent Kent, like Russo, knew that on the dates in question the ADGI and BestSellers stock represented a large percentage -- approximately forty to forty-five percent -- of RSI's reported allowable assets. (Tr. 307-08, 312.) She was also aware of and/or recklessly disregarded the fact that if RSI was unable to include these assets in its net capital, it would fall below minimum net capital requirements. (Tr. 307, 312-13.) Kent considered the stock in question to be "readily convertible into cash," and counted it as a long position in RSI's inventory.[10] (Tr. 299, 317-18.) Yet, Kent, like Russo, did not investigate the status of the stock purportedly owned by RSI or the propriety of including such stocks as allowable assets in net capital. Specifically, Kent did not determine whether any of the three stocks had been issued, registered, or authorized to RSI by the issuers' boards of directors. (Tr. 309, 313, 315.) Kent argued that although RSI was not in possession of the disputed stock, it was "in transit" and readily accessible. (Tr. 317-18.) In December 1995 and January 1996, in reports filed with the NYSE RSI represented that it was to receive the ADGI and BestSellers stock within thirty days. (Tr. 297-98; Resp. Ex. A.) Kent admitted, however, that RSI did not receive the stock within thirty days from the dates of the reports to the NYSE. (Tr. 310- 11.) Despite this fact, Kent and RSI continued to include the stock as an allowable asset. Kent and RSI made no attempt to determine the propriety of continuing to count the stock as an allowable asset. (Tr. 318-20.) Also, at no point from December 1995 until March 22, 1996, did Kent or RSI ask ADGI or BestSellers to issue the stock that was supposedly "in transit" and available on demand. III. Conclusions of Law A. Net Capital Violations A broker-dealer violates Section 15(c)(3) of the Exchange Act and Rule 15c3-1 (the "Net Capital Rule") thereunder when it uses the mails, or any means or instrumentality of interstate commerce, to effect any transaction in, or to induce or attempt to induce the purchase or sale of, any security (other than exempt securities) while not maintaining minimum net capital. Pursuant to Rule 15c3-1(a)(iii)(B), from December 1, 1995 through March 22, 1996, RSI's minimum net capital requirement was $100,000. The basic concept of the Net Capital Rule is liquidity.[11] Exchange Act Rule 15c3-1(c)(2)(iv) provides that assets which cannot be readily converted into cash, including unsecured receivables, must be deducted from total capital to compute net capital. Exchange Act Rule 15c3-1(c)(2)(vii) separately provides that securities for which there is no ready market, as defined in subparagraph (c)(11) of the Net Capital Rule, must be deducted from total capital to compute net capital. 1. Unauthorized Stock is Not Readily Convertible into Cash As noted above, Rule 15c3-1(c)(2)(iv) instructs that broker- dealers must deduct from net capital all assets, including certain unsecured and partly secured receivables, that cannot be readily turned into cash at the time of the net capital computation. Generally, securities inventories held by a broker- dealer are regarded as allowable assets. Lowell H. Listrom, 50 S.E.C. at 886. Nonetheless, "where a [broker-dealer] claims that an asset is convertible into cash, it bears the burden of establishing the claim." Dillon Securities, Inc., 51 S.E.C. 142, 144 (1992). Respondents argue that RSI was entitled to include the disputed stock due it under its investment banking agreements because the stock was properly authorized prior to or contemporaneously with the execution of the respective investment banking agreements. Zamost testified on direct examination that he attended meetings with representatives of ADGI, BestSellers, and Semicon, at which the investment banking agreements with RSI were approved prior to or contemporaneously with their signing. Critical portions of Zamost's testimony, however, are contradicted by sworn testimonials or documentary evidence from the very sources one would expect to corroborate or support Zamost's version of events, if they were credible. For example, Hinton's express rebuke of Zamost's contention that the ADGI stock was properly authorized prior to or contemporaneously with the execution of the ADGI Agreement is especially powerful.[12] Additionally, William T. Hart ("Hart"), an attorney acting on behalf of BestSellers, drafted the board of directors resolution in which BestSellers authorized the issuance of shares to RSI on March 25, 1996. (See ALJ 4.) Hart, who worked for BestSellers throughout the relevant period, made no mention of any prior board authorization. Finally, Zamost's testimony regarding prior authorization of the Semicon shares is flatly contradicted by the Semicon board of directors resolutions, dated March 29, 1996. (See Div. Ex. 56.) In light of Zamost's long-time relationship with Respondents, the dearth of evidence corroborating his testimony, and persuasive evidence that questions or contradicts his contentions, I find Zamost's testimony on the subject of stock authorization not credible. I conclude that the stock RSI counted as an allowable asset for net capital purposes was, in fact, not properly authorized by the issuers' boards of directors.[13] Rather, until it had been authorized by the issuers' board of directors, the stock due RSI represented unsecured receivables, i.e., mere contractual agreements by each of the issuers to deliver stock. I conclude that RSI's contractual rights to receive stock were not readily convertible into cash and thus did not possess the necessary liquidity to justify inclusion as an allowable asset for net capital purposes.[14] 2. The Disputed Stock Was Not "When Issued" Stock "When issued" stock, according to the NYSE Glossary, represents "[a] short form of `when, as and if issued.'" (Div. Ex. 58.) The term indicates "a conditional transaction in a security authorized for issuance but not as yet actually issued." (Div. Ex. 58 (emphasis added).) "When issued" stock that has a well-established market, in the absence of any restrictions on resales, is considered readily convertible into cash. (ALJ Ex. 2.) The stock counted by RSI as an allowable asset was not, however, "when issued" stock. It has already been established that the boards of directors of ADGI, BestSellers, and Semicon did not properly authorize the disputed stock to RSI on the dates in question. Thus, the stock was not "when issued" stock, as defined by the NYSE Glossary. Consequently, Respondents are unable to claim that because it was "when issued" stock, the disputed stock was readily convertible into cash. 3. The Disputed Shares Were "Non-marketable Securities" Within the Meaning of Rule 15c3-1(c)(2)(vii) The disputed shares of ADGI, BestSellers, and Semicon, in addition to being not readily convertible into cash, were "non- marketable securities" and should have been deducted in full from RSI's net capital computations. Securities for which there is no ready market and securities that cannot be publicly offered or sold because of statutory, regulatory or contractual arrangements or other restrictions, are to be fully deducted when computing net capital. Exchange Act Rule 15c3-1(c)(2)(vii). The definition of "ready market" includes: a recognized established securities market in which there exists independent bona fide offers to buy and sell so that a price reasonably related to the last sales price or current bona fide competitive bid and offer quotations can be determined for a particular security almost instantaneously and where payment will be received in settlement of a sale at such a price within a relatively short time conforming to trade custom. A "ready market" shall also be deemed to exist where securities have been accepted as collateral for a loan by a bank as defined in Section 3(a)(6) of the Securities Exchange Act of 1934 and where the broker or dealer demonstrates to its Examining Authority [i.e., the NYSE] that such securities adequately secure such loans as that term is defined in paragraph (c)(5) of this Rule. Exchange Act Rule 15c3-1(c)(11)(i)-(ii). Respondents claim there was a ready market for the ADGI, BestSellers, and Semicon stock. Respondents, however, are mistaken in believing that because a public market existed for outstanding shares of the above issuers, there was necessarily a ready market for the shares at issue in this proceeding. As noted above, on the dates that RSI counted the ADGI, BestSellers, and Semicon stock as allowable assets those stocks were neither authorized nor issued. I conclude that at least until the disputed shares were authorized and issued there could be no ready market. Therefore, because there was no ready market for the ADGI, BestSellers, and Semicon shares on the dates in question, the stock was non-marketable within the meaning of the net capital rule. Exchange Act Rule 15c3-1(c)(2)(vii). The disputed shares of ADGI and Semicon, in addition to having no ready market, were not registered. Both the December 14 and December 28, 1995 ADGI agreements and the Semicon Agreement provided that in order to be freely tradable the stock to be issued to RSI was required to be registered pursuant to Form S-8. As noted above, Rule 15c3-1(c)(2)(vii) contemplates that securities that cannot be sold without registration are not given value in computing net capital. Therefore, because it was not registered on the dates in question, the ADGI and Semicon stock was non-marketable within the meaning of the net capital rule. I conclude that the disputed shares of ADGI, BestSellers, and Semicon were "non-marketable securities" and should have been deducted in full from RSI's net capital computations. 4. Unauthorized, Unissued Stock is Not Sufficiently Analogous to Margin Stock Raymond Holland ("Holland"), Respondents' expert witness, testified that he believed RSI's decision to treat the disputed shares as good capital was proper. (See ALJ Ex. 3.) According to Holland, while he was a Managing Director at A.G. Becker & Co., Inc. ("Becker"), a NYSE member firm, he was involved in an "analogous" situation. (ALJ Ex. 3 at  6.) Holland testified that Furman Selz, L.L.C. ("Furman"), a NYSE member firm and introducing broker, cleared its transactions through Becker. During the course of its investment banking activities, Furman, like RSI, was on certain occasions paid with stock issued by corporate clients. Furman inquired whether Becker would extend margin credit in such situations. (ALJ Ex. 3, at  7.) According to Holland, he contacted the NYSE and received an oral determination that it was proper for a clearing firm to extend margin to an introducing firm solely on the basis of an investment banking agreement for yet to be issued stock. (ALJ Ex. 3, at  8.) Respondents, however, failed to produce any corroborating evidence of this or similar determinations by the NYSE, despite opportunities to do so at trial and during the extensive period following the trial when the record was held open. More importantly, Respondents offered, and I found, no legal authority which supports Holland's contention that because an unauthorized, unissued security may serve as collateral for margin purposes, it necessarily follows that it may also be counted as an allowable asset for net capital purposes. In short, I am unconvinced that the scenario testified to by Holland is sufficiently analogous to the instant situation so as to be relevant or instructive to this proceeding. B. Books and Records Violations Section 17(a)(1) of the Exchange Act and Rules 17a-3 and 17a-5 thereunder, require registered broker-dealers to make and keep current certain specified books and records relating to their business, and to make certain filings with the Commission. Implicit in these provisions is the requirement that information contained in a required book or record be accurate. See, e.g., James F. Novak, 47 S.E.C. 892, 897 (1983).[15] Exchange Act Rule 17a-3(a)(2) requires that every registered broker-dealer make and keep current records reflecting all assets and liabilities, income and expenses, and capital accounts. Exchange Act Rule 17a-3(a)(11) requires that every registered broker-dealer make and keep a current trial balance reflecting the money balances of all ledger accounts and a record of its net capital computations. Exchange Act Rule 17a-5(a) requires that certain registered broker-dealers, including RSI, file monthly FOCUS reports containing a net capital computation. RSI's balance sheets and general ledgers for December 1995, and January and February 1996 inaccurately characterized as long positions in inventory the value of the ADGI and BestSellers stock, in violation of Rule 17a-3(a)(2). RSI's trial balances for the same periods inaccurately included the value of this stock as long positions in inventory, in violation of Rule 17a- 3(a)(11). RSI also created and filed inaccurate FOCUS reports for these periods in violation of Rule 17a-5(a). Finally, RSI created an inaccurate record of its net capital computation for March 22, 1996, in violation of Rule 17a-3(a)(11). I conclude that RSI violated Section 17(a)(1) of the Exchange Act and Rules 17a-3 and 17a-5 thereunder in that RSI failed to make and keep current properly executed records. C. Violation of Notice Provisions Section 17(a) of the Exchange Act and Rule 17a-11(b) thereunder require every registered broker-dealer whose net capital declines below the minimum amount required pursuant to Rule 15c3-1[16] to give notice of such deficiency that same day to the Commission. Rule 17a-11(d) requires that every broker- dealer who fails to make or keep current books and records required by Rule 17a-3 give notice to the Commission of this fact that same day, specifying the books and records which have not been made or which are not current. The broker-dealer is also required to transmit a report to the Commission within forty- eight hours of the notice stating what it has done or is doing to correct the situation. RSI failed to provide any notice, telegraphic or otherwise, or report to the Commission that it was out of net capital compliance on December 29, 1995, and January 31, February 29, and March 22, 1996. Therefore, I conclude that RSI violated Exchange Act Section 17(a) and Rule 17a-11 thereunder. D. Aiding and Abetting; Cause Violations For aiding and abetting violations of the federal securities laws, three elements must be present: (i) a primary or independent securities law violation that has been committed by some other party; (ii) awareness or knowledge by the aider and abettor that his or her role was part of an overall activity that was improper; and (iii) that the aider and abettor knowingly and substantially assisted the conduct that constitutes the violation. 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.), cert. denied, 449 U.S. 919 (1980); ITT v. Cornfield, 619 F.2d 909, 922 (2d Cir. 1980); Woodward v. Metro Bank of Dallas, 522 F.2d 84, 94-97 (5th Cir. 1975); SEC v. Coffey, 493 F.2d 1304, 1316 (6th Cir. 1974), cert. denied, 420 U.S. 908 (1975); William R. Carter, 47 S.E.C. 471, 502-03 (1981). The knowledge or awareness requirement can be satisfied by recklessness when the alleged aider and abettor is a fiduciary or active participant. See Ross v. Bolton, 904 F.2d 819, 824 (2d Cir. 1990); Cornfield, 619 F.2d at 923, 925; Rolf, 570 F.2d at 45-48; Woodward, 522 F.2d at 97. The first and third elements, that a primary violation was committed by RSI and that Russo and Kent knowingly and substantially assisted the conduct that constitutes the violation, are clearly present. The second element, awareness or knowledge that his or her role was part of an overall activity that was improper, is also present for both Russo and Kent. Russo and Kent were aware of and/or recklessly disregarded the fact that unless they counted the disputed stock as an allowable asset, RSI would be out of net capital compliance. Russo and Kent's actions created the false impression that RSI was in compliance with net capital rules. Based on the same reasoning, the acts and omissions of Russo and Kent were also a "cause," within the meaning of Exchange Act 21C, of RSI's violation of Sections 15(c)(3) and 17(a)(1) of the Exchange Act, and Rules 15c3-1, 17a-3, 17a-5, and 17a-11 thereunder. IV. Sanctions A. Cease and Desist Order Section 21C(a) provides, in pertinent part, that: [i]f the Commission finds, after notice and opportunity for a hearing, that any person is violating, has violated, or is about to violate any provision of this title, or any rule or regulation thereunder, the Commission may . . . enter an order requiring such person, and any other person that is, was, or would be a cause of the violation, due to an act or omission the person knew or should have known would contribute to such violation, to cease and desist from committing or causing such violation and any future violation of the same provision rule, or regulation. The evidence establishes that RSI violated Sections 15(c)(3) and 17(a)(1) of the Exchange Act, and Rules 15c3-1, 17a-3, 17a-5, and 17a-11 thereunder, and that Russo and Kent knew or should have known that their acts would contribute to RSI's violations. RSI has violated net capital provisions in the past. (Div. Ex. 53.) Moreover, RSI is still active in the securities industry with Russo and Kent continuing to serve as president and FINOP, respectively. Lastly, subsequent to trial, RSI has continued to violate net capital provisions. (Div. Exs. 8, 11.) Therefore, I find it especially necessary that Respondents be ordered to cease and desist from engaging in this conduct. B. Censure, Suspension, and Bar The Division seeks to censure each Respondent, impose a bar against Russo (with a right to reapply after two years), and suspend Kent for one year. Sections 15(b) and 19(h) of the Exchange Act authorize the Commission to censure, place limitations on the activities or functions of such person, or suspend for a period not exceeding twelve months, or bar such person from being associated with a broker-dealer, or a member of a national securities exchange or registered securities association if the Commission finds that, on the record after notice and opportunity for hearing, that such censure, placing of limitations, suspension, or bar is in the public interest. The starting point for assessing what sanction is appropriate in the public interest requires consideration of many factors, including deterrence and: [t]he 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 his occupation will present opportunities for future violations. Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979) (quoting SEC v. Blatt, 583 F.2d 1325, 1334 n.29 (5th Cir. 1978)), aff'd on other grounds, 450 U.S. 91 (1981). The Court of Appeals for the District of Columbia explained that "[t]he `public interest' standard is obviously very broad, requiring that the Commission consider a full range of factors bearing on the judgment about sanctions that the expert agency ultimately must render." Blinder, Robinson & Co. v. SEC, 837 F.2d 1099, 1110 (D.C. Cir. 1988). The severity of sanctions depends on the facts of each case and the value of the sanction in preventing a recurrence of the violative conduct. Berko v. SEC, 316 F.2d 137, 141 (2d Cir. 1963); Leo Glassman, 46 S.E.C. 209, 211 (1975); Richard C. Spangler, Inc., 46 S.E.C. 238, 254 n.67 (1976). Sanctions should demonstrate to the particular respondent, the industry, and the public generally that egregious conduct will merit a harsh response. Arthur Lipper Corp. v. SEC, 547 F.2d 171, 184 (2d Cir. 1976). As demonstrated above, Respondents' violations were egregious. Respondents had been previously sanctioned for violating net capital and books and records requirements. Russo and Kent, thus, should have given special attention to maintaining proper and accurate net capital. Russo and Kent, nevertheless, determined to include unauthorized, unissued, and in the case of ADGI and Semicon, unregistered stock in its calculation of RSI's net capital. Russo and Kent made no attempt to determine the propriety of their actions despite the fact that the disputed stock represented approximately forty to forty-five percent of RSI's reported allowable assets. Respondents' actions not only caused RSI to fail to meet its minimum $100,000 net capital requirement, but on three separate occasions also allowed RSI to operate with negative net capital. Respondents' violations were recurrent in nature and committed willfully. On four separate occasions Respondents caused and aided and abetted RSI's violations of the net capital, books and records, and notice provisions. Moreover, as documented in the Findings of Fact, on two occasions since the trial RSI has failed to maintain sufficient net capital. Respondents' actions were intentional. Russo and Kent were aware of and/or recklessly disregarded the fact that unless they counted the disputed stock as an allowable asset RSI would be out of net capital compliance. Russo and Kent's actions created the false impression that RSI was in compliance with net capital rules. RSI's violations of the net capital provisions subsequent to the trial demonstrate that Russo and Kent have failed to recognize the wrongful nature of their actions. Moreover, Russo and Kent have given no assurances against future violations, and, because of their positions at RSI, remain in a situation that presents opportunities for future violations. I conclude that it is in the public interest to impose administrative sanctions against Respondents. Specifically, I find that it is in the public interest to bar Respondent Russo from being associated with any broker-dealer, and from being associated with a member of a national securities exchange or registered securities association, with the right to reapply after two years. Further, I find that it is in the public interest to suspend Respondent Kent from being associated with any broker-dealer, and from being associated with a member of a national securities exchange or registered securities association for one year after the date of this decision. C. Civil Money Penalty Section 21B(a) of the Exchange Act authorizes the Commission to assess civil money penalties in any proceeding instituted pursuant to Sections 15(b) against any person, after notice and an opportunity for an administrative trial, if it finds that such person has willfully aided, abetted, counseled, commanded, induced, or procured a violation of any provision of the Securities Act or the Exchange Act. Section 21B(b) of the Exchange Act specifies a three-tier system for assessing the maximum amount of a penalty. In the first tier, the maximum penalty for each act or omission is $5,000 for a natural person or $50,000 for any other person. In the second tier, the maximum amount is $50,000 for a natural person or $250,000 for any other person if the act or omission involved fraud, deceit, manipulation or deliberate or reckless disregard of a regulatory requirement. In the third tier, the maximum amount is $100,000 for a natural person or $500,000 for any other person if the act or omission (1) involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement, and (2) directly or indirectly resulted in substantial losses 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 Division urges this court to impose third tier penalties on RSI of $500,000, and $100,000 each on Russo and Kent. The assessment of a penalty pursuant to Section 21B of the Exchange Act depends on a finding that such an assessment is in the public interest. The factors that may be considered in determining the penalty amount are specified in Section 21B(c) of the Exchange Act. They are: (1) whether the act or omission for which the penalty is assessed involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement; (2) the harm to other person(s) resulting either directly or indirectly from such act or omission; (3) the extent to which any person was unjustly enriched, taking into account any restitution made to persons injured by such behavior; (4) whether the respondent previously has been found by the Commission, another regulatory agency or a self-regulatory organization to have violated federal or state securities laws or the rules of a self-regulatory organization or has been enjoined or convicted by a court of competent jurisdiction of violations of such laws or rules; (5) the need to deter respondent and others from committing such acts or omissions; and (6) such other matters as justice may require. See New Allied Development Corp., 63 SEC Docket 807, 821 n.33 (Nov. 26, 1996); First Securities Transfer System, Inc., 60 SEC Docket 441, 446 (Sept. 1, 1995). Section 21B(a) of the Exchange Act requires that the public interest finding support the amount of a particular assessment, not merely the overall decision to assess a penalty. See First Securities Transfer Systems, Inc., 60 SEC Docket at 447 n.15. A penalty is appropriate in the public interest in this case. Respondents' actions on four separate occasions caused or aided and abetted RSI's violations of net capital, books and records, and notice provisions. I find such actions involved a deliberate or reckless disregard of regulatory requirements. Such actions also created a significant risk of substantial losses to investors and others in the brokerage community who deal with RSI. RSI and Russo's prior violations of the securities laws, in particular the failure in 1993 to maintain sufficient net capital, indicates that despite adverse regulatory decisions RSI, Russo, and to a lesser extent Kent have been unwilling or unable to conform their behavior to the requirements of the securities laws. Net capital violations are serious and cannot be ignored.[17] Absent sufficient deterrence, Respondents likely will continue their actions thereby continuing to put the public at risk. Therefore, I order that RSI pay a penalty of $100,000. I further order that Russo and Kent each pay a penalty of $25,000. V. Record Certification 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 revised record index issued by the Secretary of the Commission on February 19, 1999. VI. Order Based on the findings and the conclusions set forth above, pursuant to Sections 15(b), 19(h), 21B, and 21C of the Exchange Act, I ORDER that: (1) Respondent Patrick Russo is barred from being associated with any broker-dealer, and from being associated with a member of a national securities exchange or registered securities association, with a right to reapply after two years. (2) Respondent Kimberly Kent is suspended from being associated with any broker-dealer, and from being associated with a member of a national securities exchange or registered securities association for one year after the date of this decision; (3) Respondents Russo Securities, Inc., Patrick Russo, and Kimberly Kent shall cease and desist from committing or causing any violations or future violations Sections 15(c)(3) and 17(a)(1) of the Exchange Act, and Rules 15c3-1, 17a-3, 17a-5, and 17a-11 thereunder; (4) Respondent Russo Securities, Inc. shall pay a civil penalty of $100,000. Respondent Patrick Russo shall pay a civil penalty of $25,000. Respondent Kimberly Kent shall pay a civil penalty of $25,000. Payment of penalty shall be made on the first day following the day this initial decision becomes final by certified check, U.S. Postal money order, bank cashier's check or bank money order payable to the Securities and Exchange Commission. The check and a cover letter identifying the Respondents, Russo Securities, Inc., Patrick Russo, and Kimberly Kent, and the proceeding designation, Administrative Proceeding No. 3-9484, should be delivered by hand or courier to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, Virginia 22312. A copy of the cover letter should be sent to the Commission's Division of Enforcement at the above address. This order shall become effective in accordance with and subject to the provisions of Rule 360 of the Commission's Rules of Practice, 17 C.F.R.  201.360. Pursuant to that rule, a petition for review of this initial decision may be filed within twenty-one 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 days after service of the initial decision upon him, 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 timely files a petition for review, or the Commission acts to review as to a party, the initial decision shall not become final as to that party. ____________________________ G. Marvin Bober Administrative Law Judge **FOOTNOTES** [1]: I will refer to Division exhibits as "(Div. Ex. __)," Respondent exhibits as "(Resp. Ex. __)," and to Administrative Law Judge exhibits as "(ALJ Ex.__)." I will refer to the transcript as "(Tr. __)." [2]: December 31, 1995 was a Sunday. Thus, RSI's FOCUS report for the period ended December 31, 1995 reflects its position as of the close of business on Friday, December 29, 1995. [3]: Shortly after the conclusion of the trial, Respondents produced a purported ADGI Board of Directors resolution dated December 27, 1993. The document, however, predates the ADGI agreements by two years and concerns 1.2 million shares of stock to be allocated between RSI and another firm, Equity First Capital Corporation, not 2 million shares for RSI to keep for itself. Moreover, the document relates to an entity named American Diversified Medical Corporation, not American Diversified Group, Inc. Respondents failed to make a credible or convincing argument regarding the authenticity, relevance, and even origination of the document. Therefore, I decline to include it as part of the evidentiary record. [4]: Maria Reichert, a compliance examiner for the Commission who took part in an examination of RSI during portions of March and April 1996, testified that RSI failed to calculate accurate blockage and haircut charges for its January 31, 1996 net capital balance. (Tr. 82-84.) Adjusting the net capital balance for the necessary corrections, according to the Division and Ms. Reichert, further reduces the balance to negative $64,897, or $164,897 less than what it should have been on that date. (Div. Exs. 36-37; see also ALJ Ex. 2 at 10.) However, even without the adjustments to the January balance, RSI had insufficient net capital on January 31. [5]: The price of the stock underlying the options ranged from $0.10 per share for the first 1 million shares to $1.75 per share for the last 1 million shares. (Div. Ex. 9.) [6]: Because the RSI's broker-dealer examination was initiated before the firm's FOCUS Report for the period ending March 31, 1996 came due, the Commission's examination staff asked Russo and Kent to calculate RSI's net capital as of March 22. (Tr. 66.) [7]: As noted earlier, BestSellers did not ultimately issue the shares to RSI until April 2, 1996. (Tr. 73; Div. Ex. 29.) [8]: On March 29, 1996, the Semicon board of directors specifically approved three items: (1) the board "approved and adopted [the Semicon Agreement]" and "authorized and directed [Semicon's officers] to enter into the [Semicon Agreement];" (2) the board authorized the "officers of the Company . . . to grant the . . . options to [RSI];" and (3) the board authorized the "officers of the Company . . . to issue the Company's Common Stock [to RSI] upon the exercise of the options described . . . ." (Div. Ex. 56.) [9]: F. Russo testified that on March 20, 1996, RSI exercised its options to purchase the 525,000 shares of Semicon. (Tr. 344-45.) According to F. Russo, he drafted an options exercise form (see Resp. Ex. T at 1-2) on March 20 and that same day had Kent fax the request to RSI's clearing firm Murphey, Marseilles, Smith & Nammack ("MMSN"). (Tr. 344-45.) The purported options exercise form submitted by Respondents (Resp. Ex. T at 1), unlike other faxes originating from RSI (see Div. Ex. 30), contains no date, time, or other transmittal information. The purported fax transmission verification report (Resp. Ex. T at 2) contains a date and time, but no characteristics which can definitively link it to the alleged transaction. From the evidence adduced at trial, it is unclear when or if MMSN received the purported original request. John Derrico, president of MMSN and currently a consultant to RSI, testified that the original fax was, in fact, received, but that his office "apparently misplaced [it]." (Tr. 271.) Derrico admitted that no action was taken on the purported original request. (Tr. 271.) Before MMSN exercised an options request, it required a copy of the relevant investment baking agreement and an opinion of counsel letter from the issuer's counsel. (Tr. 287-88.) MMSN received Semicon's opinion of counsel letter, dated March 29, 1996, on April 3, 1996. (Tr. 284; Resp. Ex. L.) On April 3, 1996, MMSN advanced the funds to purchase the 525,000 shares to Semicon on RSI's behalf. (ALJ Ex. 6.) Thus, despite the uncertainty in the record, it is clear that RSI did not successfully exercise the Semicon options until April 3, 1996. (See Div. Ex. 30, dated April 3, 1996, "[RSI] hereby elect[s] to exercise our said Option and hereby purchase FIVE HUNDRED TWENTY- FIVE THOUSAND (525,000) Shares of Semicon Tools, Inc. ("STI") common stock;" see also Tr. 287, Derrico's testimony, "the actual option was exercised on April.") [10]: According to Kent, because RSI was contractually entitled to receive stock under the three investment banking agreements, it was permissible to include as of the date of the agreements the stock due RSI as an allowable asset for net capital purposes. (Tr. 332.) [11]: The rule is designed to ensure that broker-dealers have sufficient liquid capital to protect the assets of customers and to meet their obligations to creditors. Lowell H. Listrom, 50 S.E.C. 883, 886 (1992). [12]: Hinton's affidavit states, "Mr. Zamost's claim is untrue. In fact, [ADGI] never issued a resolution of its Board of Directors authorizing the issuance of any stock to [RSI]." (ALJ Ex. 5 (emphasis in original).) [13]: Respondents alternately contend that the issuance of the disputed shares was properly authorized when the presidents of ADGI, BestSellers, and Semicon executed the respective investment banking agreements with RSI. Respondents are incorrect. Under Delaware law, where BestSellers is incorporated (Div. Ex. 54; Resp. Ex. B), and Nevada law, where ADGI and Semicon are incorporated (Div. Exs. 17, 27), any issuance of stock by a corporation must be duly authorized by its board of directors, not its corporate president. Del. Code Ann. tit. 8,  141, 152, 153 (1998); Nev. Rev. Stat.  78.120, 78.200, 78.215 (1997). [14]: On the dates in question, because the disputed stock had not been authorized, there was no asset which RSI could liquidate. [15]: The reporting and recordkeeping provisions of the securities laws are "important both to monitor the financial status of broker-dealers and [to protect] public investors." Palm State Equities, Inc., 59 SEC Docket 1812, 1819 (June 20, 1995). Violations of these provisions are serious, and adversely impact the monitoring function exercised by regulatory authorities. This, in turn, interferes with the goal of protecting public investors. See, e.g., Fundclear, Inc., 51 S.E.C. 1316, 1318 & n.7 (1994). [16]: As noted earlier, pursuant to Rule 15c3-1, RSI was required to maintain at least $100,000 in net capital. [17]: Net capital violations "strike at one of the central tenets of the regulatory scheme intended to protect customers of securities firms." Fundclear, 51 S.E.C. at 1322. 1