INITIAL DECISION RELEASE NO. 137
UNITED STATES OF AMERICA
_________________________________________________ In the Matter of : : SKY SCIENTIFIC, INC., W.A. DOROW, JR., : JERRY L. FOSTER, : GILBERT MARSHALL & CO., INC., : MICHAEL A. USHER : STRATEGIC RESOURCE MANAGEMENT, INC., : WILLIAM A. MOLER, DANIEL R. LEHL, :INITIAL DECISION THOMAS PATRICK MEEHAN, :March 5, 1999 DOUGLAS A. GLASER, : SMITH, BENTON & HUGHES, INC., : MICHAEL ZAMAN, GEORGE T. HELLEN, : ROBERT SCHLIEN, : AMERICAN CAPITAL NETWORK, INC., : PHILIP M. GEORGESON, : MELVIN L. LEVINE, and : WILLIAM DAVID JONES : _________________________________________________
APPEARANCES: Robert M. Fusfeld, Julie K. Lutz, and John Badger Smith for the Division of Enforcement, Securities and Exchange Commission
Howard A. Tescher for Respondents Robert Schlien, American Capital
John Henry Schlie for Respondents Gilbert Marshall & Co., Inc., and
Jeffrey J. Scott for Respondents Strategic Resource Management, Inc.,
Irving M. Einhorn, Douglas P. Vining, and Claudia J. Zaman for Respondents Smith, Benton & Hughes, Inc., and Michael Zaman
Peter W. Runkle for Respondent Jerry L. Foster
Respondents George T. Hellen, Philip M. Georgeson, and Daniel R. Lehl appeared pro se
BEFORE: Robert G. Mahony, Administrative Law Judge
The Securities and Exchange Commission (Commission) instituted public administrative and cease-and-desist proceedings 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) in this matter on December 16, 1996. The Order Instituting Public Administrative Proceedings (OIP) alleges that from about April 1993 through about June 1995 (the relevant period) 1 the above named Respondents 2 violated several federal securities laws.
All Respondents allegedly violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder (antifraud provisions). (OIP ¶¶ IV-VI.) All Respondents except Jerry L. Foster (Foster), Strategic Resource Management, Inc. (Strategic), and William A. Moler (Moler) are charged with distributing unregistered common stock of Sky Scientific, Inc. (Sky) to the public in violation of Sections 5(a) and 5(c) of the Securities Act (registration provisions). (OIP ¶ III.) It is further alleged that Respondents Robert Schlien (Schlien), Melvin L. Levine (Levine), American Capital Network, Inc. (ACN), and William David Jones (Jones) violated Section 17(b) of the Securities Act by circulating promotional brochures without disclosing the receipt of compensation from Sky for their efforts. (OIP ¶ IX.) In the alternative to the antifraud and registration allegations, Respondents Michael A. Usher (Usher) and Michael Zaman (Zaman) are charged with failure to supervise certain persons under their control with a view to preventing violations of the registration and antifraud provisions. (OIP ¶ X.) In addition to the antifraud charges, Foster also allegedly violated certain accounting records and filing requirements of the Exchange Act. (OIP ¶¶ VII, VIII.)
A hearing was held on August 25-27, September 8-10, October 14, and November 12, 1997 in Denver, Colorado; on November 13, 1997 in Los Angeles, California; on November 19, 1997 in Fort Lauderdale, Florida; and on January 20, 1998 in Richmond, Virginia. 3
Respondents Jones; ACN; Schlien; Levine; Foster; Strategic; Moler; Gilbert Marshall & Co., Inc. (Gilbert Marshall); Usher; Smith, Benton & Hughes, Inc. (Smith Benton); and Zaman filed post-hearing briefs. 4 Respondents Daniel R. Lehl (Lehl), George T. Hellen (Hellen), and Philip M. Georgeson (Georgeson) have not filed post-hearing briefs. The Division filed a post-hearing brief, a reply brief, and supplemental post-hearing briefs concerning Respondents Jones, Smith Benton, and Zaman. 5
I. PRELIMINARY MATTERS
A. Investigative Testimony
Respondents Foster, Schlien, Levine, Jones, Douglas A. Glaser (Glaser), and Lehl gave sworn testimony before the Commission during its investigation of Sky. (Div. Exs. 84-91, 96.) The Division represents that Glaser became a fugitive shortly after the default order was entered against him in the instant proceeding, and he was unavailable to testify at the hearing. (Division's Motion to Admit Prior Sworn Testimony of Respondent Glaser at 2.) The other Respondents who had testified during the investigation subsequently invoked the Fifth Amendment and refused to testify when called by the Division at the hearing. (Tr. 595-98, 741-42; Tr. 1/20/98 at 6-7.)
The transcripts of testimony given by Lehl, Glaser, Schlien, Jones, Levine, and Foster were admitted for use against the individual declarants, and ruling was reserved on the issue of whether the testimony is admissible against the other Respondents. (Tr. 650-51, 829-31, 1250; Order Granting Motion to Admit Testimony of Respondent Jerry L. Foster.) The Division has moved that the investigative testimony be admitted against all Respondents, save Strategic and Moler, for all purposes. (Division's Motion to Admit Prior Sworn Testimony of Respondent Glaser; Motion to Admit Testimony Transcript of Respondent Foster; Division Brief at 57.) In support of its motion, the Division argues that the testimony was given under oath, that the Respondents in their testimony admitted significant facts indicating wrongdoing by themselves and their co-schemers, and that other reliable evidence corroborates the statements in the transcripts. (Division Brief at 57.) None of the Respondents addressed this issue in their post-hearing briefs. 6
The Federal Rules of Evidence (FRE) may serve as a guide in determining the admissibility of evidence in administrative proceedings. Yanopoulos v. Department of Navy , 796 F.2d 468, 471 (Fed. Cir. 1986). Under FRE 801(d)(2)(A), a party's own statement is not considered hearsay if it is offered against that party. Each party's investigative testimony is, therefore, admissible insofar as it is offered against that party. Under FRE 801(d)(2)(E) statements by coconspirators of a party made during the course of and in furtherance of the conspiracy are not considered hearsay. Although the rule refers to a coconspirator, "the rule is meant to carry forward the universally accepted doctrine that a joint venturer is considered as a coconspirator for the purposes of this rule even though no conspiracy has been charged." Senate Comm. on Judiciary, Federal Rules of Evidence, S. Rep. No. 1277 at 26 (1974), reprinted in 1974 U.S.C.C.A.N. 7051, 7073 (citing United States v. Rinaldi , 393 F.2d 97, 99 (2d Cir. 1968)). The Respondents in this matter, with the exception of Strategic and Moler, are charged as co-schemers, and the investigative testimony is, therefore, admissible against those charged with participating in the alleged scheme.
I therefore grant the Division's motion and admit the transcripts of investigative testimony given by Foster, Schlien, Levine, Lehl, Glaser, and Jones into evidence as to all Respondents except Strategic and Moler. (Div. Exs. 84-91, 96; Tr. 650-51, 829-31, 1250.) The testimony will be evaluated in the context of the entire record to determine how much weight, if any, it ought to be given.
B. Adverse Inference
Respondents Schlien, Levine, Jones, Lehl, and Foster refused to answer questions when called by the Division to testify in this matter. (Tr. 595-98, 741-42; Foster Tr. 6-7.) The Administrative Law Judge may draw adverse inferences from a witness' refusal to testify or explain facts that may be particularly within the witness' knowledge. Baxter v. Palmagiano , 425 U.S. 308, 319 (1976); Pagel, Inc. v. SEC , 803 F.2d 942, 946-47 (8th Cir. 1986); Prudential-Bache Securities, Inc. , 48 S.E.C. 373, 389 n.19 (1986). Although silence alone is insufficient to support an adverse decision against one who invokes the protections of the Fifth Amendment, it may be considered along with other relevant facts in assessing the evidence against Respondents in the Commission's administrative proceedings. Pagel, Inc. , 803 F.2d at 947. Accordingly, where appropriate, I will draw adverse inferences from the witness' refusal to testify.
II. FINDINGS OF FACT: VIOLATIONS OF THE ANTIFRAUD PROVISIONS
My findings are based on the record and my observation of the witnesses' demeanor. I applied preponderance of the evidence as the applicable standard of proof. See Steadman v. SEC , 450 U.S. 91, 102 (1981). I have considered all proposed findings and conclusions, and I accept those that are set forth herein. 7
A. Introduction to Sky Scientific, Inc.
Respondents Foster and W.A. Dorow, Jr. (Dorow) 8 formed Sky as a privately held "mining and processing" company in 1991. (Div. Ex. 96 at 12-13.) Neither had been involved in mining prior to that time. (Div. Ex. 96 at 12, 17.) As a private company, Sky acquired the Berry Mine in Nevada and the Evergreen Mine in California in 1992. (Div. Ex. 2s at 38-39; 96 at 16, 102.) On March 29, 1993, Sky became a public company by merging with a "shell" corporation called Winners Circle. 9 (Div. Exs. 86 at 24; 96 at 30-33, 161; Tr. 1321-23.)
By mid-1994, Sky held approximately five mining properties in California and Nevada. (Div. Ex. 2s; Tr. 525-26, 529.) In addition to the Evergreen and Berry mines, it had also acquired the Tallulah, Danner, and Bowerman properties. (Div. Exs. 1e; 1hh; 1ii; 2s at 16, 25-26.) The company employed people who had significant experience in mining, including the following "key employees": Raymond J. Bowkus (Bowkus), Director of Mining Operations; Michael J. Skopos (Skopos), Chief Geologist; and Dennis Bal, a metallurgical engineer. (Div. Ex. 2s at 53; Tr. 252-54.) During the relevant period, the company repeatedly entered into and then backed out of agreements to acquire or lease mining properties. (Div. Exs. 1d; 1q; 1z; 2hh at 5, 7; 2s at 25-26; 2u at 17.)
Sky's total reported revenues from mining operations during 1993 and 1994 were $35,052. (Div. Exs. 2s at 33; 2hh at 22.) Despite its inability to establish its mining business, 10 the company had great success marketing its stock. Sky common stock began trading publicly upon completion of the merger with Winners Circle and continued throughout the relevant period. 11 At the time of the merger, the company had a market capitalization 12 of under $2 million, with 1.6 million shares of common stock outstanding. (Div. Exs. 2s at 32; 7a.) Daily trading volumes rarely exceeded 4000 shares, and high bid prices fluctuated between $.75 and $.82 per share. (Div. Ex. 7n.) All of that changed with the merger. In April 1993 Sky began issuing press releases containing highly optimistic projections. (Div. Ex. 1b-1d.) In response, the stock price increased to $4.50 per share and Sky's trading volume consistently exceeded 200,000 shares a day. (Div. Ex. 7n.) The company's market capitalization quintupled in just a few weeks. (Div. Ex. 7o.) Sky was able to keep the momentum going, issuing millions of shares of stock 13 while keeping the price level stable 14 through the remainder of 1993 and well into 1994. (Div. Exs. 7a; 7n.) Then, in the summer of 1994, the company mailed out approximately 350,000 glossy promotional brochures to prospective investors and broker-dealers. (Div. Exs. 9a; 50d; 50e; 51; 52; 86 at 56; Tr. 676.) This publicity campaign drove the company's market capitalization to an all-time high of $80 million. The prosperity was short-lived, however, and by the end of October Sky's market capitalization was less than one-third of what it had been in August. (Div. Ex. 7o.)
B. Elements of the Scheme to Market Sky Stock
All Respondents, except Strategic and Moler, are charged as co-schemers who made untrue statements of material facts and omitted to state material facts, using the jurisdictional means, to investors and prospective investors concerning, inter alia: (1) the existence and value of Sky's assets, liabilities, mining business, properties, precious metals reserves, environmental compliance, revenues, and mining technology; (2) the magnitude of Sky's income, expenses, net loss, sources and uses of capital, and financial ability to continue its activities without material interruption; (3) the value of preferred stock issued by Sky or its subsidiaries in connection with the acquisition of assets; (4) the value of financial instruments purportedly issued by a Russian bank and purportedly owned by a Sky subsidiary; and (5) the prospects and likelihood of success of Sky's business ventures and the risks of investing in Sky stock. (OIP ¶ IV.B.) The misstatements and omissions were allegedly included in Commission filings, company press releases, and promotional brochures, as well as in oral statements made to investors. (OIP ¶ IV.B.)
1. False Statements in Commission Filings, Press Releases, and Tout Sheets
During the relevant period, the company filed 25 current, 7 quarterly, and 2 annual reports in Forms 8-K, 10-Q, 10-K and 10-KSB. (Div. Exs. 2a-2hh.) It also issued at least 67 press releases, which were reported verbatim on the Dow Jones News Service. 15 (Div. Exs. 1a-1ppp; Tr. 76-79, 1147.) In addition, it publicly circulated "tout sheets" in June, August, and October 1993, and in the summer of 1994. (Div. Exs. 9a; 10a-10d.)
I find that in furtherance of the scheme Respondents specified below materially misrepresented Sky's financial condition in the current, quarterly, and annual reports Sky filed with the Commission and in company press releases. I further find that the tout sheets produced and disseminated by Respondents specified below were materially misleading. The following is an analysis of the misstatements and omissions related to Sky's mining business contained in these sources.
Sky claimed to have hundreds of millions of dollars worth of mineral reserves located on its Berry, Bowerman, Danner, Tallulah, and Evergreen properties. 16 (Div. Exs. 1b; 1ii; 1p; 1ww; 2s at 1, 8, 13, 20, 25; 9a; 10d.) The Division's expert geologist Geoffrey Snow (Snow) testified that "mineral reserve" is a term of art; he defined a reserve as an ore deposit that is both economically and legally extractable. (Tr. 193, 225.)
As to the economic element, Snow explained that Sky never compiled the kind of "three-dimensional" data required to justify its reserve claims. (Tr. 196-97, 207, 209-10, 214-15, 226, 249.) Without this preliminary data, the company could not take the next step along the path toward developing the properties, namely, the completion of costly and lengthy feasibility studies. (Div. Ex. 14f; Tr. 224, 229-31.) Even if the company had explored these properties adequately, it lacked the enormous amount of working capital necessary to begin development. (Div. Ex. 2s at 33; Tr. 136; 228-31, 237-38, 246.) Sky CFO Foster concedes there was a "[c]onstant money problem" at Sky. (Div. Ex. 96 at 39, 170.) The company lacked funds to pay its most basic operating expenses, including payroll and lease payments on several of its mining properties. 17 (Div. Ex. 30a; Tr. 342, 389.)
In addition to the economic barriers, Sky was prohibited by law from commencing mining activities on these properties. (Div. Exs. 2s at 25; Tr. 225-26, 317-18, 320-23, 328-37.) All of its properties were located on land regulated by the Bureau of Land Management (BLM) and the U.S. Forest Service (Forest Service). (Tr. 315, 330, 333-34, 337, 526.) Sky was required by law to get BLM and Forest Service permits in order to commence mining. (Tr. 226, 317-18, 320-23, 328-37.) The process of applying for and securing the necessary permits would have taken months, perhaps years to complete. (Div. Exs. 2s at 25; Tr. 320, 323, 336.) Sky never obtained the permits. (Tr. 226, 328-37.)
I credit Snow's opinion and find that, whatever deposits of ore these properties held, they did not qualify as reserves because they were neither economically nor legally extractable. (Tr. 196-97, 207-10, 214, 226, 249.)
Sky went well beyond merely declaring it had vast reserves of precious metals. It also claimed its mining operations were in production. (Div. Exs. 1a; 1b; 1k; 1p; 1hh; 1rr; 1v; 2s at 1, 2, 25, 26; 9a; 10d.) I find that these claims were false. (Div. Exs. 2hh at 2; 40a-zzz; Tr. 230, 284-85, 288-89, 296, 301, 307-09, 322; 369; 371-72, 531, 533, 535-38, 540, 560-61.)
Particularly illustrative is the case of the Tallulah Mine, a property Sky acquired in early February 1994. (Div. Ex. 1ii.) In a March 1994 press release, Sky predicted full-scale production would begin at Tallulah in four to six weeks. (Div. Ex. 1pp.) According to a press release issued the following month, Tallulah was in full time production, "ten hours per day, seven days per week," and workers were rapidly stockpiling ore for milling. (Div. Ex. 1rr.) In its 1994 Form 10-K, the company again stated that Tallulah was in full time production. (Div. Ex. 2s at 1, 2, 26.) With Wall Street Watch, Sky further exaggerated its claims regarding production at Tallulah. The brochure contained a photograph of miners at work inside a cavern clearly represented as the Tallulah Mine. (Div. Exs. 9a; 86 at 61-62.) It went on to emphasize how easy it had been for Sky to draw riches from the mine: "Getting the gold out,' an expert explains, is like pushing a cart down a supermarket aisle, picking food from the shelves and tossing it into the basket.'" (Div. Ex. 9a.) Levine, when asked, could not identify the expert. (Div. Ex. 86 at 63.)
Tallulah was never in production. (Tr. 296, 301, 307, 535-38.) Sky did make some efforts to construct a processing mill at the Tallulah site, though the result was nothing approaching an actual mining operation engaged in full-time production. (Tr. 284-96, 300-02, 307-10.) Rather, the purpose of these exertions was to dupe Sky's independent auditors when they inspected the site in late June or early July 1994. James C. Garst (Garst), a neighboring landowner who was present during the auditors' visit, recalled:
Carleen Achuff (Achuff) is a geologist who has been employed by the Commission for 13 years. (Tr. 524-25.) In July 1994 she visited and photographed the Danner, Evergreen, Tallulah, Bowerman, and Berry mining properties. (Tr. 525-26, 547; Div. Exs. 40a-40zz.) Public access to the properties is unrestricted. (Div. Ex. 2s at 6, 11, 16; Tr. 315, 330-34, 337, 526.) Achuff testified that when she visited the properties, no production or mining was in progress, and she found no evidence of recent mining or exploration activities at the sites. 18 (Tr. 560-61.) She further testified that her evaluation of the properties is consistent with the information she obtained through her investigative interviews with Skopos and Bowkus. (Tr. 545-61.) The photographs Achuff took of the sites, along with the testimony of those who visited the Evergreen, Berry, and Tallulah properties during the relevant period, 19 corroborate her testimony. I therefore credit her assessment of the California and Nevada properties, and find that virtually no production or processing occurred on them during the relevant period.
(c) Revenues and Earnings
Sky frequently stated that its properties were generating revenues. (Div. Exs. 1k; 2e, at 14; 2j at 16; 9a) Yet Sky derived almost no revenues from mining activities during the relevant period. (Div. Exs. 2d at 4; 2e at 4, 8; 2j at 4; 2s at 33; 2u at 4; 2y at 4; 2gg at 4; 2hh at 2, 22; Tr. 379-80.) As late as June 1995 the company admitted it had "conducted minimal revenue producing operations." (Div. Ex. 2hh at 2.)
Sky also disseminated many exorbitant earnings projections. (Div. Exs. 1h; 1v; 1pp; 1rr; 1ss; 2s at 8, 10, 15, 20-21, 26; 9a.) There is ample evidence in the record that these projections were baseless. For example, in July 1994, Wall Street Watch announced that Tallulah would "generate over $3,000,000 pre-tax profit" that year, and added that this "windfall initial projection [is] rapidly proving too conservative." (Div. Ex. 9a) As detailed above, Tallulah was incapable of yielding $3 million in mining revenues in 1994. (Div. Ex. 14f; Tr. 335-37, 535-38.) By October 1994, Sky had abandoned the site completely. (Tr. 290-93, 335-36.)
Also, in its 1994 Form 10-K, the company estimated net revenues from the Danner mine of over $31 million for the quarter ending November 30, 1995. (Div. Ex. 2s at 21.) At the time it made this projection, the Danner site was devoid of mining activity. (Tr. 538-39.) The company had learned only a few months prior to filing the 10-K that the Danner site required at least two years of evaluation and exploration to determine whether the property was worth mining at all. (Tr. 274.)
Finally, a couple of months after the merger, the company estimated earnings of nearly $4.5 million and revenues of over $11 million for its fiscal year ended February 28, 1994. (Div. Ex. 1h.) Sky had no revenues from mining operations whatsoever for that fiscal year. (Div. Ex. 2s at 33.)
(d) Accounting Practices
I find that Sky's quarterly and annual filings with the Commission contained overvaluations of virtually all of the company's assets, and failed to report all but a small fraction of the company's expenses and losses. (Div. Exs. 2d, 2e, 2j, 2s, 2u, 2y, 2ff, 2gg, 2hh, 7a, 7b; Tr. 119, 124-29, 135-38, 145-49, 157-58.) Leslie Patten (Patten), the Division's accounting expert, testified that it was a violation of generally accepted accounting principles (GAAP) 20 to value assets and report expenses in this fashion, and that the financial statements were materially false. (Tr. 124-29, 146.) I credit his testimony, which is unrebutted. 21
Sky acquired the bulk of its assets by paying for them with "Preferred Class A" Sky stock, 22 which it arbitrarily priced at $10 per share. The value of these assets was determined by multiplying the number of shares issued for each item by the $10 face value of the preferred shares. (Div. Exs. 2s at 38, 43; 2hh at 27, 31; Tr. 124-25, 410.) According to Patten, the preferred stock had no market value, and the lack of any other reliable indicia of value made it impossible to calculate the worth of the assets acquired with the stock. (Tr. 126-37.)
In its 1994 Form 10-K, the company reported total assets of over $69.7 million. Mining properties valued at approximately $29.5 million and certificates of deposit valued at $40 million comprised the majority of reported assets. (Div. Ex. 2s at 31; Tr. 127.) As to the mining properties, $27 million of the $29.5 million was arrived at using the valuation method just described. (Div. Ex. 2s at 31, 38-39, 43; Tr. 127.) If these assets had been valued according to prescribed accounting principles, they would have been recorded at a nominal value of, at most, a few hundred dollars. (Tr. 138.) The certificates of deposit merit special attention. On the last day of its 1994 fiscal year, Sky issued four million shares of preferred stock in exchange for restricted certificates of deposit issued by a Russian bank. (Div. Ex. 1mm; Tr. 139.) Both the stock and the certificates of deposit were recorded on Sky's balance sheet at a value of $40 million. (Div. Ex. 2s at 31-32, 38, 43; Tr. 139.) The certificates of deposit were totally worthless. 23 (Div. Exs. 2ii, 44; Tr. 143-45.) Thus, at least 95% of the assets reported on Sky's 1994 annual report were illusory.
Sky also failed in all of its filings to adequately report expenses and operating losses associated with the payment of common stock to its various consultants. (Tr. 145-49.) The consultants routinely received stock in exchange for their services. (Tr. 145-46.) Because the value of the stock greatly exceeded the value of the services, Sky was required to record the difference between the two figures as an expense on its financial statements. (Div. Exs. 7a, 7b; Tr. 146-49.) From May 31, 1993, through November 30, 1994, Sky reported net losses totaling approximately $5.2 million. (Div. Exs. 2s at 33; 2hh at 22; 7a at 1; 7b.) If it had properly recorded expenses connected with the issuance of stock over that same period, losses would have exceeded $35 million. (Div. Exs. 7a; 7b at 6.) I find that the company under-reported its losses by approximately 700% during this period.
Although Sky found two independent auditors who agreed with the company's methods of evaluation and reporting, and who, therefore, disagreed with Patten's estimation of those methods, I credit Patten's opinion and reject the opinions of Sky's auditors for the following reasons. (Div. Exs. 2s at 49-50; 2hh at 34-35; Tr. 176.)
Sky's management had great difficulty finding independent auditors who would do their bidding. (Tr. 158, 410-16.) During the relevant period, Sky employed six different independent auditors. (Div. Ex. 2hh at 34-35.) From the time of the merger until the filing of its 1994 Form 10-K, Sky "terminated" four separate auditors before finding the one that completed the audit, Scutillo & Blake (Scutillo). (Div. Ex. 2s at 49-50.) In Scutillo's opinion, the financial statements contained in the 1994 10-K conform to GAAP. (Div. Ex. 2s at first unnumbered page between pages 30 and 31, 47.) Scutillo's own report, however, proceeds to undermine the valuation method employed in the audit:
Furthermore, Sky personnel and management kept the truth about the company hidden from its auditors. The company failed to provide suitable records to Lipson's firm, Joel S. Baum, CPA (Baum), thereby frustrating the firm's efforts to conduct the fiscal year 1993 audit. (Tr. 408-10.) When Sky hired Scutillo to replace Baum, Sky staged a sham demonstration of the Tallulah processing mill designed to trick Scutillo into believing the mill was operating. (Div. Ex. 2hh at 35; see supra Section II.B.1(b).)
C. The Promoter Respondents
(a) Robert Schlien and American Capital Network
ACN is a Florida corporation owned and controlled by Schlien. 26 (Div. Ex. 84 at 42) Schlien is a "financial consultant" who helps his clients "grow their companies." (Div. Exs. 84 at 21; 96 at 22.) More specifically, Schlien promotes his clients' stock by inducing broker-dealers to sell it to their customers. (Div. Exs. 15a; 84 at 44; 87 at 19; Tr. 358-59, 666.) As compensation for his services he receives stock and stock options from his clients. He then sells the stock. (Div. Exs. 15b-15d; 84 at 64-65; 87 at 19.)
Schlien worked for Sky from October 1, 1992 through at least September 1994. (Div. Exs. 15a; 84 at 21.) Beginning in the spring of 1993, Schlien entered into a series of consulting agreements with Sky in which Schlien committed to provide marketing services that included: providing financial advice; preparing Sky "brochures, advertising materials and other literature"; and disseminating information about Sky to brokers and dealers. (Div. Exs. 15b-15d; 84 at 40.) In consideration of Schlien's consulting services, Schlien obtained Sky stock plus options to purchase Sky stock at prices set out in the consulting contracts. (Div. Exs. 15b-15d.) Schlien ultimately received $2.6 million in proceeds from the sale of Sky stock. (Div. Exs. 7c-7f.)
Schlien was Sky's chief fund-raiser, responsible for liquidating large blocks of Sky stock, and then routing the proceeds back to Sky, his associates, and himself. (Div. Exs. 7e, 7f, 7g; Tr. 358-59, 624-37, 665-66.) From the outset of his association with Sky he was intimately involved in the company's day-to-day operations. (Div. Exs. 15b; 84 at 73-74, 76, 102; 96 at 156-59.) He was instrumental in guiding Sky's management through the merger with Winners Circle. (Div. Ex. 84 at 26-27.) Thereafter, he advised Sky's management on matters ranging from acquisition of mining properties and other businesses, to dealings with the National Association of Securities Dealers (NASD) and the Commission. (Div. Exs. 84 at 46-51, 78, 91; 96 at 157-69.) He enlisted the services of Respondents Levine, Jones, and Georgeson to act as promoters and middle-men. (Div. Exs. 7f; 7g; 57a; 84 at 37, 138; 86 at 24; 89 at 76-77; Tr. 664.) He created the network of nominal consultants necessary to convert Sky stock to cash. (Div. Exs. 7c; 7f; 84 at 114-123; Tr. 359, 689-93.) He directed the highly successful mass mailing of tout sheets in the summer of 1994 that significantly increased both the trading volume and market price of Sky stock. (Div. Exs. 7f; 7g; 7n; 7o; 9a; 11a at 6-7; 56b; 84 at 138-44; 86 at 60; Tr. 671, 673.) He reviewed Sky press releases. (Div. Ex. 84 at 9, 159.) He flooded the market with Sky stock by overseeing the efforts of various broker-dealers who sold Sky to their customers. (Div. Exs. 15a; 84 at 114; Tr. 359, 662-66, 686-87.) To prevent rapid dilution of the stock's value from driving down its market price, Schlien executed a series of wash trades 27 and engaged in other manipulative practices to maintain the price. (Div. Exs. 7d; 84 at 126-32; Tr. 155, 683-88.)
(b) Melvin L. Levine
Schlien and Levine are "good friends" and business associates. (Div. Exs. 84 at 36-37; 86 at 28.) In 1993, Schlien asked Levine to work with him on the "Sky project." (Div. Exs. 84 at 36, 83-84; 86 at 24, 28.) Levine became a Sky consultant as early as the summer of 1993 and continued working for the company until at least the end of July 1994. (Div. Ex. 86 at 82-83; Tr. 430, 473-74.) Although Levine's arrangement with Sky 28 called for the company to pay Levine with S-8 29 stock, Schlien "took care of the stock" and then paid Levine in cash pursuant to an informal agreement between them. (Div. Exs. 84 at 123-24; 86 at 50-51, 99-101, 107-08.) Levine received at least $79,350 for his efforts. (Div. Exs. 7c-7f; Tr. 636.)
According to Schlien, Levine "knows people in every business." (Div. Ex. 84 at 38.) Levine was able to draw upon his extensive store of business contacts to recruit several so-called consultants, including Michael Todd (Todd), David Moon (Moon), Joseph Wythe (Wythe), and William Morris (Morris), whose names were used to liquidate Sky stock. (Div. Exs. 84 at 110-12; 86 at 33-40, 100; Tr. 359, 429, 452, 471-72, 494-95.) Schlien told Levine that Sky would pay the consultants with stock, but that Schlien had to have "power of attorney over the [consultants'] accounts to liquidate the shares . . . [o]therwise, they wouldn't be hired." (Div. Ex. 84 at 106.) Schlien did in fact secure powers of attorney allowing him to trade in the accounts of Todd, Moon, Wythe, and Morris. (Div. Exs. 20c; 21b; 22b; 23d.) The accounts were established at a Canadian brokerage firm called Canaccord. The Schlien-controlled Canaccord accounts will hereafter be referred to collectively as the "Canaccord accounts." 30
Levine also has extensive experience in graphic arts and printing. (Div. Ex. 86 at 10-11.) He has done a great deal of public relations work for various public and private companies. (Div. Ex. 86 at 9-10; Tr. 496.) His public relations work consists, in part, of gathering information from his corporate clients and using that information to assemble "promotional pieces" in the form of "a news release or brochure" called a "corporate profile." Once produced, these publications are distributed to broker-dealers in an effort to interest them in the company. (Div. Ex. 86 at 10-11, 13, 16, 84.) Prior to working for Sky he had apparently done some public relations work for mining companies. (Div. Ex. 84 at 37-38; 86 at 16-18.) Levine used his skills and experience to publish tout sheets for Sky and Schlien. ( See infra Section II.C.2.)
(c) William David Jones
After graduating from college in 1983, Jones worked as a securities broker for approximately nine years. (Div. Exs. 10f; 87 at 8.) He first became acquainted with Sky in mid-1993 toward the end of his career as a broker. (Div. Ex. 87 at 13-14, 18.) He gradually stopped selling securities and went into the business of selling leads, doing business as Best Brokerage Leads (BBL). (Div. Exs. 87 at 6-7; 88 at 188; Tr. 628.) Jones knew Schlien and Levine were promoting Sky. (Div. Ex. 87 at 18-19.) While he admits he sold leads to Schlien and ACN, and knew that these leads were in turn being passed on to brokers, he testified that his only connection to Sky was accidental and indirect, namely, that through "hanging around" with his friend Schlien he occasionally allowed Schlien to use his cellular telephone. (Div. Ex. 87 at 18-22, 61-76.) Jones and BBL received over $4.5 million from the sale of Sky stock out of the Canaccord accounts as well as directly from ACN. 31 (Div. Ex. 7f; Tr. 628-28, 635-36.)
(d) Philip M. Georgeson
Georgeson began working in the securities business in late 1982. (Tr. 653.) He worked for approximately eight different firms from the time he started in the industry in various positions, including retail broker and wholesale trader. (Tr. 653-57.)
Georgeson contacted Schlien in mid-1993. (Tr. 661-62.) At that time, Georgeson was a trader at a broker-dealer firm. (Tr. 660-61.) He wanted to move out of trading securities and into public relations. Schlien told him he was raising funds for Sky, and he wanted Georgeson to distribute leads to a "broker network." (Tr. 662-66.) Georgeson understood that, in addition to this "public relations" work, Schlien was also eager to exploit Georgeson's access to traders who might have valuable information about "who [was] offering particular stock for sale, where the stock might be coming from, that sort of thing." (Tr. 662-64.)
In December 1993, Georgeson 32 entered into a "Financial Advisory and Consulting Agreement" with ACN. (Div. Ex. 57a.) Although the express terms of the agreement are vague as to what services Georgeson was to provide and how his compensation was to be figured, Georgeson had a "general understanding" with Schlien that Georgeson would be compensated based on the amount of Sky stock Respondent Smith Benton sold. 33 (Tr. 686-87.) Georgeson spent a total of 1000 to 1500 hours promoting Sky over a thirteen month period. (Tr. 688.) He received approximately $273,572 for his efforts. (Div. Exs. 7f, 7g; Tr. 688.)
In December 1994, at Schlien's urging, Georgeson entered into a "Professional Consulting Agreement" with Sky. (Div. Ex. 57b; Tr. 689.) Pursuant to an understanding Georgeson reached with Schlien, Georgeson was to be paid with S-8 stock, but Georgeson was, in turn, required to convert that stock to cash "to finance the promotional campaign." (Tr. 690-91.) The cash would, in other words, be returned to Schlien. According to the plan, S-8 stock registered in Georgeson's name would go into Georgeson's brokerage account where it would be sold. The proceeds from the sale would then be wired into several bank accounts opened in Georgeson's name. Georgeson would proceed to make withdrawals from those bank accounts in increments of less than $10,000 in order to avoid cash reporting requirements. This arrangement made Georgeson uncomfortable, and caused him to end his relationship with Schlien and Sky. (Tr. 691-92.)
2. The Preparation and Distribution of Fraudulent Tout Sheets
The promoter Respondents, along with Sky management and personnel, produced 34 and disseminated tout sheets as part of a concerted effort to stimulate broker and investor interest in Sky stock. (Div. Exs. 7f; 7g; 9a-9c; 10a-10d; 56b; 84 at 138-40, 144; 85 at 203; 86 at 26, 49, 58-59, 64-65, 68, 91; 87 at 14; 88 at 189-90; 90 at 39; 91 at 183-86; Tr. 635-36, 670-71, 673-74, 678, 697-98, 1140.) Formatted as newsletters titled "Chicago Financial Services Inc.," and "Wall Street Watch," the publications were circulated from June 1993 through August 1994. (Div. Exs. 9a, 9b, 10a-10d.) The largest concentration of approximately 350,000 Wall Street Watch brochures was mailed during the summer of 1994. (Div. Exs. 9a; 9b; 10a-10d; 11a at 2; 48; 50d; 50e; 51; 52; 84 at 136; 86 at 60; 87 at 54; Tr. 671-73.)
Attached to each Wall Street Watch brochure was a business reply card addressed to a post office box in Fort Lauderdale, Florida. 35 Recipients indicated their interest in learning more about Sky by filling out the cards and mailing them to the Ft. Lauderdale address. Interested parties also had the option of calling a toll free telephone number to receive additional information. (Div. Ex. 9a, 9b; Tr. 671-72, 939-40, 1164, 1192-93.) Schlien, Jones, and Georgeson then gave these leads free of charge to brokers who had agreed to solicit investors for Sky. (Div. Exs. 66; 87 at 27, 29, 32, 54-57, 72-74; 88 at 186, 194; 90 at 35, 41; Tr. 672, 694, 906, 1363-65, 1419-21.) The brokers, including those employed by Respondents Gilbert Marshall and Smith Benton, followed up by calling those who had sent in the post cards or called the toll free number. (Div. Ex. 90 at 25; Tr. 901, 1164, 1211, 1192-93.) Sales agents were also provided copies of Wall Street Watch, which they sent to prospective investors. (Tr. 1137, 1210-11, 1363-65, 1423-24.) Investors and broker-dealers alike responded to the mass mailing, and caused Sky's market capitalization to reach more than $80 million. (Div. Exs. 7n, 7o; Tr. 1123, 1156, 1164, 1362.)
The promoter Respondents with the exception of Georgeson, attempt to distance themselves from the deceptive brochures. Schlien denies having any involvement with Wall Street Watch and the other newsletters beyond recommending Levine's services to Sky's management. (Div. Ex. 84 at 10, 138-39.) Although the consulting agreement between ACN and Sky calls for ACN to "prepare proofs of brochures" Schlien testified that he never did any work of that sort for Sky. (Div. Exs. 15b; 84 at 46, 139.) Levine concedes he published the newsletters, but contends he tried to make sure the information contained therein came from Sky rather than "from the moon." (Div. Exs. 84 at 17; 86 at 45-46; 87 at 14; 88 at 190; Tr. 362, 696) According to Levine, as he was gathering information for inclusion in the brochures, Sky personnel told him it was important to the company that all information contained in the tout sheets was truthful. (Div. Ex. 86 at 58-59.) Jones testified that he saw the brochures in Schlien's office and "glanced through" a copy. (Div. Ex. 87 at 52-54.) He was aware that Schlien and Levine were sending the mailer to investors in order to generate leads which would then be given to brokers, but he testified that he did not know the specific details of the mailing. (Div. Ex. 87 at 54-55.)
I am not persuaded by the assertions of the promoter Respondents. I find that, Schlien, ACN, and Levine together developed and executed "the plan" to generate leads by means of tout sheets and then give those leads to brokers who would sell the stock. (Div. Exs. 84 at 37; 86 at 24, 57, 114; 87 at 57.) They invented the title "Wall Street Watch" for the Sky promotional brochure. (Div. Ex. 86 at 42-43, 77.) They produced the tout sheets. (Div. Exs. 48; 84 at 17; 86 at 49, 64-65, 68; 87 at 14, 27, 54; 88 at 189-90; 91 at 183-85; Tr. 694-696, 904, 1140.) They arranged for the mailings. (Div. Exs. 9a; 11a at 6-7; 84 at 77, 137-38, 143-44; 87 at 55; 89 at 73-74; 91 at 183-85; Tr. 670-73, 677-78, 904, 1430.)
Jones paid over $40,000 in Wall Street Watch mailing expenses. (Div. Exs. 7f, 7g, 54; Tr. 614, 636.) He distributed copies of Wall Street Watch to Georgeson and others, introduced Georgeson to brokers who were involved in the leads program, and advised Georgeson when Schlien was not available to do so. (Div. Ex. 88 at 191, 194; Tr. 685-86, 694, 697-98.) He introduced Levine to Eric Weinstein (Weinstein), 36 who printed Wall Street Watch. (Div. Exs. 48; 88 at 195-96.) Jones faxed leads generated by Wall Street Watch to Smith Benton and other brokers, and he worked with Schlien on both the mailing of the brochures and the distribution of leads generated by the mailing. (Tr. 697-98.)
Georgeson testified concerning the activities of the other promoter Respondents and the scheme to condition the market for Sky stock. In the spring of 1994 Georgeson told Schlien that preliminary efforts to interest brokers in marketing Sky were proving unsuccessful. (Tr. 677-78.) Schlien assured him that a forthcoming direct mail campaign would turn things around. (Tr. 678.) Georgeson testified that Schlien, ACN, and others were responsible for producing the direct mail brochures subject to the approval of Sky's management. (Tr. 673-74.) He knew Jones and Levine were Schlien's partners. (Tr. 694.) Schlien was his source for leads generated by the mailer, and Schlien occasionally sent leads directly to brokers. (Div. Ex. 66; Tr. 674.) At one point, Georgeson ordered a box of brochures straight from the printer and gave them to Smith Benton brokers for distribution to potential investors. (Div. Ex. 56a; Tr. 675-76.)
3. Market Manipulation
Stimulating broker interest in and investor demand for Sky stock using the fraudulent newsletters was only one of several courses of conduct the promoter Respondents pursued in furtherance of the scheme. The promoter Respondents also prevented the steady stream of stock they were pouring into the market from eroding the stock's price. (Div. Ex. 84 at 105-12, 129-30.) Toward this end, they assembled and regulated the pipeline through which Sky stock was routed from the company, through the broker-dealers, and into the hands of investors.
Between April 1993 and December 1994, Sky issued approximately twenty million shares of S-8 stock to Schlien, Levine, ACN, and other Sky consultants including Moon, Todd, Wythe, and Morris. (Div. Exs. 6a-6ccccc, 7a, 7b.) These recipients of S-8 stock maintained brokerage accounts at Canaccord. (Div. Exs. 7d; 20c; 21b; 22b; 23d; 84 at 109-114, 119-21, 124; 86 at 40; Tr. 435, 484, 502-04.) Schlien controlled all of the accounts, and Levine and Jones each had power of attorney for the ACN account. (Div. Exs. 7b; 7d; 24a; 24b; 84 at 14-16, 69, 81, 83, 102-03, 106, 123; 86 at 40, 107-08.) Moon, Todd, Wythe, and Morris each testified that they performed little or no work for the company and, although millions of dollars moved through their accounts, they received only small amounts of cash from Schlien and Levine. (Div. Exs. 84 at 105-06, 112, 115, 119-21; Tr. 443-47, 456-57, 463-67, 472, 478-79, 486, 496-501.)
Of the 19 million shares sold by the Canaccord accounts, roughly half were purchased by Respondents Smith Benton, Gilbert Marshall, and Strategic. 37 (Div. Exs. 7d, 7h.) These firms, as well as several others, knew they could buy Sky stock at a discount from Schlien through Canaccord. (Div. Exs. 84 at 126-28, 130-32; Tr. 684-85.) Schlien testified that he used the bargain pricing to control the impact of the sales on the stock price. (Div. Ex. 84 at 129-30.) He also paid brokers at Gilbert Marshall and Smith Benton with cash and Sky stock. (Div. Exs. 7f; 59; 84 at 169-75; 89 at 44-47; Tr. 699, 705-08, 920-25, 935.) Schlien, Jones, or Georgeson contacted the Respondent broker-dealers prior to almost every purchase from the Canaccord accounts by the broker-dealers. (Div. Ex. 8; Tr. 701-03, 823-24, 870-73, 927-28, 967.)
With this infrastructure in place, the promoters were able to manipulate the price of Sky stock through wash trades and "cleaning the street." 38 (Tr. 681-84.) Wash trades occurred in the Canaccord accounts on 96 days between April 1993 and December 1994. Frequently, the shares were purchased at higher prices than they had been sold for earlier in the day. (Div. Ex. 7d.) I find that the wash trades created a deceptive and fraudulent appearance of market activity by interfering with the free forces of supply and demand. I further find that the practice of "taking out the low bid" or "cleaning the street" was likewise calculated to interfere with the natural operation of market forces by altering the price of the stock and manufacturing the appearance of legitimate trading activity.
Each promoter Respondent performed a function necessary to the success of the scheme. Georgeson's contacts in the industry enabled him to gather information concerning the low offer for Sky stock, information Schlien frequently used to buy up all of the lowest-priced shares of Sky and drive the price up. (Tr. 682-88.)
Jones acted as a link between Schlien, Canaccord, and the network of broker-dealers who sold the stock coming from the accounts. (Div. Exs. 7f; 7g; 8; 24a; 87 at 33-37; Tr. 635-46, 694, 697-98.) He placed several orders to sell Sky from Schlien's Canaccord accounts, and directed that Canaccord wire funds from Schlien's accounts. (Div. Ex. 87 at 33-37.) He took information from Georgeson concerning the market for Sky. (Tr. 686, 697.)
As explained above, Levine assisted Schlien in creating and maintaining the nominee accounts. Levine also allowed Schlien to use his Canaccord account move S-8 stock into the market. (Div. Exs. 84 at 102-06, 110-21; 86 at 40; Tr. 436, 438, 440, 457, 460-61, 474, 485-86, 496-99, 504, 510.)
Schlien supervised the manipulative operation. With the aid of the other promoters, he sold $19.7 million and purchased $7.1 million worth of Sky stock, continually trading through the Canaccord accounts to create the misleading appearance of market activity. (Div. Ex. 7c; Tr. 592.)
D. The Broker-Dealer Respondents
1. Smith Benton & Hughes, Michael Zaman, and George T. Hellen
Smith Benton is a broker-dealer registered with the Commission pursuant to Section 15(b) of the Exchange Act. It has been registered since 1987, and has its principal office in Los Angeles, California. (Smith Benton Answer ¶ 2.) During 1994 it was headquartered in Englewood, Colorado. (Smith Benton Answer ¶ 4; Tr. 678.) A search of the Commission's records confirms Smith Benton's assertion that it withdrew its broker-dealer registration in mid-1998. (Smith Benton Brief at 2.)
Zaman started working in the securities brokerage industry in 1987. (Tr. 879.) After working as a salesman at five brokerage firms over a four-year period, he joined Smith Benton as a registered representative in 1991. (Tr. 879-80.) In 1992, Zaman became owner, president, compliance officer, and head trader for Smith Benton. He ran the firm throughout 1994. (Tr. 881, 1582.) He was responsible for supervising the brokers, monitoring trading, and conducting due diligence inquiries. (Tr. 1582.) Zaman filed a Uniform Termination Notice for Securities Industry Registration Form U-5 with the Central Registration Depository in April 1998. ( See Smith Benton Brief at 2.)
Hellen began working in the securities brokerage industry in 1986. (Tr. 1403.) After working for approximately a dozen securities firms in less than eight years, Hellen took a position as a sales manager and registered representative with Smith Benton in June 1994. (Tr. 1403-05, 1409.) Hellen joined Smith Benton just before the firm began selling Sky to its retail customers. (Tr. 698, 884, 1202, 1204, 1409-10, 1583.) Shortly after he started working at Smith Benton, Hellen stopped coming to work regularly. On those occasions, Zaman was forced to supervise the retail brokers. (Tr. 894, 1204.) Hellen resigned from Smith Benton on October 14, 1994, having received $12,962 in payments from the firm. (Div. Exs. 7r, 63; Tr. 951, 1454-55.) At the hearing, Hellen represented that he has not been associated with a brokerage firm since 1996. (Tr. 1407.)
(b) Sales of Sky by Smith Benton
Zaman hired Hellen to be a sales manager who would recruit and supervise several retail sales representatives. (Tr. 884.) At the time he hired Hellen, Zaman knew that Hellen had been sanctioned by the NASD and that he had worked for several broker-dealers. Zaman testified that Hellen's employment history did not cause him concern; rather, it made him confident that Hellen possessed the knowledge necessary for the position. (Tr. 885.)
Under Hellen's direction and subject to Zaman's approval, Smith Benton hired five or six retail brokers in 1994. (Tr. 886, 1410.) The new brokers needed leads in order to build a customer base. Hellen looked for a source of leads for his sales force. (Tr. 1411-12.) He knew his friend Georgeson was doing promotional work for Sky. (Tr. 1412, 1414.) After consulting with Zaman, they agreed that Smith Benton would make a market in Sky. (Tr. 887, 1412-13.) Shortly thereafter, Georgeson started supplying Smith Benton with leads produced by the Wall Street Watch program. (Tr. 698.) Georgeson visited the Smith Benton office several times each week during Hellen's term of employment. (Tr. 678, 907-08.) He spoke to Hellen, Zaman, and the Smith Benton retail sales agents when he visited the office. (Tr. 914-17, 1423, 1586-87.) All of these people understood that Georgeson was promoting Sky and that Smith Benton was participating in a leads program. (Tr. 679, 1205, 1414, 1422.)
In addition to bringing leads to Smith Benton, Georgeson also delivered between 1000 and 1500 copies of Wall Street Watch to Smith Benton with the understanding that Smith Benton would mail the brochures to prospective customers. (Div. Ex. 56a; Tr. 676.) Smith Benton brokers did mail copies of Wall Street Watch to their customers. (Tr. 1210-11.) Zaman admits that he examined all of Smith Benton's outgoing mail, but testified that he did not know Wall Street Watch was being mailed out of Smith Benton. (Tr. 902.) Hellen admits that Georgeson delivered a stack of brochures to Smith Benton, but asserts they were "absolutely not" to be sent out to customers. He testified that he was merely "inquisitive" and wanted a sample brochure to see how the leads were being generated. (Tr. 1425-26.) I do not credit their testimony. On the basis of Georgeson's testimony, and that of Jeffrey Connell (Connell), a Smith Benton broker who personally mailed the brochure to customers, I find that copies of Wall Street Watch were mailed out of Smith Benton's office, and that Zaman and Hellen were not only aware of it, but encouraged it. (Tr. 676, 1210-11.)
Zaman, Hellen, and Georgeson pressured the Smith Benton sales force to recommend Sky to their customers. 39 (Tr. 701-02, 892-93, 1207-08, 1414.) The brokers had multiple incentives to sell as much Sky as they could. In addition to the commissions they received, the brokers were promised additional leads on Sky and other stocks if they were successful in selling Sky. (Tr. 1207-08.) Georgeson and Hellen motivated the brokers by telling them they were competing with Gilbert Marshall brokers to see which group could out-sell the other. The winner would get more leads. (Tr. 1211-12.)
From June 2, 1994 through October 5, 1994, Smith Benton sold its retail customers $536,921 of Sky stock. (Div. Exs. 7k, 7 l .) Sky sales accounted for approximately 60% of Smith Benton's retail sales. (Div. Exs. 7k, 7 l .) The firm acquired over 80% of the Sky stock it sold from the Canaccord accounts. (Div. Exs. 7d; 7h; 84 at 131; Tr. 701-703, 928, 1418.)
The testimony of Smith Benton customers reveals that the brokers misrepresented Sky's financial condition, predicted the stock's price would continue to rise, and engaged in other improper sales practices. (Tr. 1157-60, 1216-18.) After receiving Wall Street Watch and returning a lead card, William Kunow (Kunow) received several calls from a Smith Benton sales person. (Tr. 1154-58.) Kunow bought $1000 of Sky stock through Smith Benton. (Tr. 1158.) The sales person did not inform Kunow of the going concern qualification in the company's audited financial statement, and failed to inform Kunow that the company needed operating capital. (Tr. 1159.) Kunow mistakenly believed the company was engaged in mining operations at the time he bought the stock. (Tr. 1159.)
James Esposito (Esposito) invested in Sky after he received an unsolicited telephone call from a Smith Benton representative. (Tr. 1216-18.) The sales agent told Esposito nothing about the company's business, but he assured Esposito that the stock's price was "going to move." (Tr. 1216.) Esposito bought in at $1.50 per share. (Tr. 1217.) Initially, the agent's prediction proved accurate: Sky rose to $2 per share, and the agent convinced Esposito to increase the amount of his investment. (Tr. 1218.) The price then fell to approximately $0.10 per share. (Tr. 1218.) Esposito contacted Zaman repeatedly and directed him to sell his Sky stock. (Tr. 1219-21.) Each time, Zaman refused to sell the shares. (Tr. 1221.)
(c) Due Diligence at Smith Benton
Zaman claims he split the due diligence responsibilities at Smith Benton into "wholesale" and "retail" due diligence. (Tr. 888.) Zaman's recollection as to who performed the retail due diligence is inconsistent. At certain points in his testimony, Zaman states that he conducted the wholesale due diligence properly, and that he delegated all retail due diligence responsibilities concerning Sky to Hellen, believing he could rely upon Hellen's evaluation of the company. (Tr. 887-89, 941, 963-67, 1583.) At other points he says he did not rely on Hellen to do any of the due diligence, retail or wholesale, and contends he did it all himself. (Tr. 912-13, 969, 1582.) He also suggests a third possible arrangement whereby he and Hellen shared responsibility for the retail due diligence. (Tr. 969.)
Zaman's Due Diligence . Zaman's own review of Sky was cursory at best. He read the "package from NASDAQ" and some documents he received from Sky. 40 (Tr. 888, 962-63.) He concluded the stock was "approved by SEC and NASDAQ, it was trading on the computer freely. . . . It was a lovely situation." (Tr. 888.) Zaman reviewed the Commission filings and "probably" reviewed some of the Sky press releases. (Tr. 888-89.) Although he noted many inconsistencies between the filings and the press releases, they did not trouble him because he felt they were the mark of a typical start-up company trying to raise capital. (Tr. 936-41, 943-46.) He knew that Georgeson and Schlien were promoting Sky, and that Sky was sponsoring the "beautiful" Wall Street Watch mailing. (Tr. 898-99, 904-06, 914, 944.) Yet Zaman took no steps to verify the information he received by personally contacting the company, inquiring of appropriate governmental agencies, or visiting any of the purported mine sites. (Tr. 941, 944.)
As far as his delegation of due diligence duties to Hellen, I find Zaman never knew what, if anything, Hellen did to research the company. (Tr. 890-91, 965-67, 1591.) For instance, Zaman contends that he sent Hellen to Florida to investigate Sky. (Tr. 889-90, 1592-93.) Hellen did take a trip to Florida to meet with Schlien, but the trip occurred long after Smith Benton began making a market in Sky, and Hellen concedes the trip had nothing to do with Sky. (Tr. 1432-33, 1435, 1442-43.)
Hellen's Due Diligence . Hellen admittedly had "a lot of unanswered questions" about Sky. (Tr. 1445.) Hellen was introduced to Sky through its promoters, and he understood that promoters exist for the express purpose of driving up the price of the stock they market. (Tr. 1414-15.) He "tried to" conduct a due diligence investigation of Sky before he and the other Smith Benton retail brokers started recommending the stock to customers. (Tr. 1436.) His examination was limited to reviewing information he received from Sky and its promoters; like his supervisor, Zaman, Hellen admittedly made no effort to obtain information about Sky from sources not affiliated with the company. 41 (Tr. 1436-37, 1440, 1449.) He "probably looked at" Sky's financial statements and read at least some of its press releases. (Tr. 1437.) He does not recall how much time he spent reviewing the information he received or what he did to update the minimal amount of research he claims he performed. (Tr. 1440, 1442, 1449.)
I find that the failure to perform due diligence by Smith Benton, Zaman, and Hellen, was a material fact that was concealed from investors and furthered the fraudulent scheme in the offer, purchase, and sale of Sky stock.
2. Gilbert Marshall & Co., Michael A. Usher, and Daniel R. Lehl
In 1994 and 1995 Gilbert Marshall was a broker-dealer registered with the Commission with its corporate headquarters in Greeley, Colorado. (Gilbert Marshall Answer ¶ 2; Tr. 746.) In 1994 Gilbert Marshall had from 4 to 8 branch offices, including one in Englewood, Colorado, which was known as the "Denver office." (Tr. 746, 754-55.) Lehl's corporation, D&L Investments (D&L) owned the Denver office from March 1994 through approximately mid-September 1994, when he sold the branch to Glaser. 42 (Gilbert Marshall Answer ¶¶ 10, 12; Lehl Answer ¶ 10 .) Gilbert Marshall represents that it is no longer in business. (Gilbert Marshall Brief at 28.)
Usher has been a securities broker since 1981. (Tr. 743.) He has passed the Series 7, Series 24, and Series 63 examinations. (Tr. 743-45.) In 1984 he became president and chief executive officer of Gilbert Marshall. (Tr. 744-45.) Usher ran Gilbert Marshall throughout 1994. (Tr. 746.) During that year he spent about one third of his time fulfilling his duties as chief executive officer, and the rest of his time servicing his personal clients. (Tr. 747.) He approved all order tickets and reviewed the trade blotters daily. (Tr. 747-48.) He was responsible for determining which stocks Gilbert Marshall sold and setting the firm's markup policies. (Tr. 749, 765, 822, 875.) All outgoing correspondence from registered representatives to customers had to be reviewed by a branch manager or supervisor who reported directly to Usher. (Div. Ex. 75; Tr. 752.)
By 1994 Lehl had five to six years experience as a securities broker, and had obtained Series 7 and Series 63 licenses. (Div. Ex. 90 at 7, 11; Tr. 741-42.) Lehl owned and controlled D&L. (Div. Ex. 90 at 7.) From July 1993 until March 1994, D&L owned a branch office of Strategic. (Lehl Answer ¶ 10.) As noted above, from March 1994 until September 1994, D&L owned a branch office of Gilbert Marshall. (Lehl Answer ¶ 10; Gilbert Marshall Answer ¶¶ 10, 12.) After Lehl left Gilbert Marshall in September 1994, Schlien arranged for Lehl to become a promoter for Sky and Jockey Club, a company Sky merged with in 1995. (Div. Exs. 2hh at 3; 91 at 168, 184-86.) Lehl received a total of $269,759 for his participation in the scheme. (Div. Ex. 7r.)
(b) Sales of Sky by Gilbert Marshall
While Lehl was associated with Strategic, Schlien contacted him because Strategic was buying Schlien's Sky stock. (Div. Ex. 84 at 130.) Lehl introduced Schlien to Moler and Kathleen Parker (Parker), Strategic's Director of Corporate Finance, in February 1994. 43 (Tr. 1076, 1080.) Shortly thereafter, Moler ordered Strategic's sales people to stop selling Sky. Lehl and Moler had a falling out over this decision, and Lehl left Strategic for Gilbert Marshall, taking Thomas Meehan (Meehan) 44 and several other registered representatives with him. (Div. Ex. 90 at 50-52; Tr. 1092-93, 1311; Lehl Answer ¶ 10.)
Lehl and Meehan contacted Usher in late February or early March 1994. (Div. Ex. 90 at 65.) They wanted to open a franchise branch of Gilbert Marshall because they were very unhappy with Strategic. (Tr. 758-59.) They told Usher they wanted their office, with its sales staff of seven brokers, to focus primarily on selling Sky, just as they had done as a Strategic branch office. (Div. Ex. 90 at 65-66.) Usher interviewed them and checked their backgrounds, 45 but did not call Moler, Parker, or anyone else at Strategic to ascertain precisely why Lehl, Meehan, and the other sales agents had left Strategic. (Tr. 759-60, 764.) Usher ultimately approved the franchise arrangement without understanding who actually owned and managed the Denver branch. (Tr. 761.) He thought Lehl and Meehan were co-owners of the branch, and that Meehan was Lehl's supervisor. (Tr. 767-69.) In fact, Lehl was the sole owner and manager. 46 (Tr. 768-69, 1355.)
Gilbert Marshall's Denver office concentrated almost entirely on selling Sky stock. (Div. Ex. 7j; Tr. 770.) The Denver office sold $5,435,183 worth of Sky stock to customers from March 24, 1994 through November 4, 1994 in 862 transactions. (Div. Ex. 7i, 7j.) These sales represented 65% of the total dollar volume of sales at that office, and 78% of its total sales transactions. 47 (Div. Exs. 7i, 7j.) It acquired 97% of its inventory from the Canaccord accounts. (Div. Exs. 7h; 84 at 124-127, 129; 90 at 122.) Meehan routinely called Gary Boldt (Boldt), Gilbert Marshall's trader, to let him know that Canaccord would be calling to offer Gilbert Marshall a block of Sky stock. (Tr. 870-71.) A few minutes later, Canaccord would call Boldt to complete the transaction. (Tr. 871-72.) Usher knew about this pattern, regarded it as unusual, and claims someone at Gilbert Marshall called Canaccord to find out more about the source of the stock. (Tr. 824-25.) Usher testified that Canaccord refused to identify the sellers of the stock. That was the extent of Usher's investigation into the unusual arrangement between the Denver office and Canaccord. (Tr. 825.)
At Lehl's direction, brokers at the Denver office sent the tout sheets to customers, and used the press releases and a script as sales tools. (Div. Ex. 90 at 137; 92; Tr. 1137, 1141-43, 1359-61, 1364.) Lehl and Meehan gave the brokers leads generated by Wall Street Watch, which Schlien provided free of charge. (Div. Ex. 90 at 18, 25, 35, 41, 123, 135.) The brokers, including Lehl, employed high-pressure sales tactics to get customers to buy Sky stock. (Div. Ex. 89 at 68-69; Tr. 1116, 1124-25, 1127, 1145, 1274-77.) These tactics included calling certain customers several times every day, guaranteeing price increases, making false promises to buy the stock back if the price failed to meet expectations, assuring customers that Gilbert Marshall had inspected the mine sites, and representing Sky as a risk-free or "self-funding" investment. (Tr. 1116-17, 1124-25, 1181-82, 1184, 1194-95, 1226-28, 1231, 1269-70.) Meehan asked one investor, Brian Throneberry, to mortgage his home in order to buy 100,000 shares. (Tr. 1116.) When the Gilbert Marshall agents were no longer able to keep their customers from selling off Sky, they often convinced the customers to "roll over" into Tuscan Industries stock. (Tr. 1126-27, 1131, 1139, 1145-46, 1185-86, 1188, 1197-98, 1259, 1274-77.)
After reviewing the trade blotters every day for approximately two months, Usher became concerned about the Denver office's concentration in a single stock, 48 and he told Lehl and Meehan to diversify their customers' portfolios. (Tr. 771, 776.) In June 1994, the NASD directed Usher to inspect the Denver office. (Tr. 773.) On July 27, Usher conducted an announced inspection of the office over the course of a single afternoon. (Div. Ex. 68; Tr. 773-75, 1358, 1366.) During that visit, he did not listen to what the brokers were telling customers about Sky, nor did he have any conversation with Meehan, the putative office manager, about sales practices. 49 (Tr. 771-75, 812.) He saw at least one tout sheet in the office, and Meehan told him it was part of a mass mailing that would produce leads for the brokers. (Tr. 795-97.) Although he knew the office had been using leads to open new accounts, he did not attempt to learn the source of those leads or whether they were somehow linked to the tout sheets he had seen in the office and in the initial due diligence package. (Tr. 790.)
Following the inspection, Usher wrote to the NASD and reported that the Denver office had "made a commitment to diversify their clients' investments," and promised that Gilbert Marshall would "continue to monitor their activities closely." (Div. Ex. 68; Tr. 779.) In August 1994, approximately 200 customers were sold out of Sky and put into other stocks, even though Sky was moving up in price. (Tr. 788-89.) When Sky's price began falling in mid-August, many customers refused to pay for the stock they had ordered. 50 These sell-outs were costly because of the stock's steadily declining market price, so Usher placed restrictions on the Denver office's freedom to trade in Sky in September. (Tr. 785-86.) Lehl left Gilbert Marshall of his own accord around this time, and Glaser became the owner of the Denver office. (Div. Ex. 90 at 16.) In mid-October Usher fired Meehan due to the continuing problem of sell-outs and lack of diversification. (Tr. 853.) Despite the absence of Meehan and Lehl, the Denver office continued to sell Sky stock to its customers until the first week of November 1994. (Div. Ex. 7i, 7j.)
(c) Due Diligence at Gilbert Marshall
Usher claims he performed due diligence prior to authorizing sales of Sky, and continually updated his research for as long as the firm sold Sky. 51 (Tr. 762, 799, 843.) He reviewed some press releases and Commission filings, all of which were provided by the company. (Usher Ex. B; Tr. 815, 859.) According to Gilbert Marshall's compliance manual, the firm generally would not make a market in "[s]tocks with high capitalization values, and little or no revenues." (Div. Ex. 75 at 18; Tr. 806-07.) Though Sky showed no revenues from mining, Usher was encouraged by the fact that it was listed on NASDAQ, had several market makers, and was actively traded. (Tr. 808, 859.) The going concern qualification in the annual report did not trouble him because, in his experience, such qualifications are included in the reports for all speculative companies. (Tr. 809.) He saw that the company routinely failed to achieve projected goals; acquired most of its assets -- including the questionable Russian certificates -- with preferred stock; and increased the amount of its outstanding common stock by eight-fold in under a year. (Tr. 834-35, 838-39, 845-46, 853.) He felt these facts also were consistent with Sky's developmental status, and he was reassured by Dorow's public announcement that the company would soon turn a profit. (Tr. 808, 835-36, 838.) Contradictory statements regarding Tallulah, Evergreen, and mining operations in general evidently escaped Usher's attention altogether. (Tr. 813-14, 844-45.)
I find that Usher's and Gilbert Marshall's failure to adequately perform due diligence was a material fact that was concealed from investors, and furthered the fraudulent scheme in the offer, purchase, and sale of Sky stock.
E. Jerry L. Foster
Foster is a certified public accountant (CPA) and a licensed real estate broker. (Div. Ex. 2s at 52; 96 at 9-10.) He and Dorow started Sky in the fall of 1991. (Div. Ex. 96 at 13.) Foster was a director and chief financial officer for Sky from the time it began trading publicly on March 29, 1993 until at least June 13, 1995. (Div. Exs. 2s at 52; 2hh at 37) Before his involvement with Sky he had no experience with a company required to file reports with the Commission, and no experience with mining companies. (Div. Ex. 96 at 4, 9-12.) Foster spent 25%-100% of his time on Sky work, in addition to working for other accounting clients. (Div. Ex. 96 at 9-11.) When Sky's center of operations moved from Richmond, Virginia, to Boca Raton, Florida, some time in late 1992 or early 1993, Foster remained in Richmond but continued to work for Sky, earning a salary of $42,000 per year. (Div. Exs. 2hh at 38; 96 at 18-20, 160.)
2. Foster's Participation in the Scheme
Foster was Sky's principal financial and accounting officer. (Div. Exs. 2s at last page; 2hh at last page; 96 at 36-37.) He maintained the company's books and records, and worked closely with its independent auditors. (Div. Ex. 96 at 36-37, 150; Tr. 406-09.) He implemented the practice of valuing Sky's assets according to the arbitrarily calculated face value of preferred stock exchanged for the assets. (Div. Ex. 96 at 150.) Foster signed Sky's November 1993 Form 10-Q, 1994 Form 10-K, May 1994 Form 10-Q, August 1994 Form 10-Q, November 1994 Form 10-Q, and 1995 Form 10-KSB. (Div. Exs. 2j at 20; 2s at last page; 2u at 19; 2y at last page; 2gg at last page; 2hh at last page.) He worked extensively on the 1994 Form 10-K. (Div. Ex. 96 at 60, 114, 135-36.) In addition, he prepared the financials included in Sky's May 1993 and August 1993 Forms 10-Q. (Tr. 374-78.)
Foster was responsible for maintaining Sky's bank accounts, including those used as repositories for $4.5 million in proceeds from the unregistered distribution of S-8 stock. (Div. Exs. 7e; 7g; 96 at 44-45, 49-50, 173-74; see infra Section V.) He maintained Sky's general ledger. (Div. Ex. 96 at 50-52; Tr. 348.) As a director, he participated in board decisions to issue large blocks of stock to Schlien, ACN, Levine, and the other consultants. (Div. Ex. 96 at 158-59.) He signed nearly all of the 107 S-8 registration statements filed with the Commission. ( See Div. Exs. 6a-6ccccc.) Although he knew Schlien and other consultants were receiving large quantities of stock solely in exchange for "services rendered," he contends that he did not know what services they were providing to warrant these payments. (Div. Ex. 96 at 157-69.) I do not credit his testimony on this issue. He worked with Schlien and ACN from the time of the merger throughout the relevant period. (Div. Exs. 15a; 84 at 28.)
In addition to managing Sky's books and coordinating the raising of capital, Foster also reviewed several of Sky's press releases prior to their publication. (Div. Ex. 96 at 188-89.) He routinely served as spokesman for the company in press releases. (Div. Exs. 1g, 1cc, 1ee, 1gg, 1hh, 1 ll , 1pp, 1ss, 1uu, 1eee.) Furthermore, several misleading Forms 8-K filed with the Commission bear Foster's signature. (Div. Exs. 2k, 2v, 2dd, 2ee.) He also signed the lease agreement for the Evergreen Mine, and was involved in negotiating an extension of that lease. (Div. Ex. 96 at 83-85.)
Because of his direct involvement in Sky's operations, Foster knew that many of the statements and projections contained in the Commission filings, tout sheets, and press releases were untrue. (Div. Exs. 96 at 64-68, 70-76.) For example, Foster was quoted in an April 20, 1994 press release stating, "Events appear to be on schedule to make the previously published $3,000,000 pre-tax earnings estimate for the Tallulah's first twelve months of operation a reality." (Div. Ex. 1ss.) This estimate is featured prominently in the July 1994 Wall Street Watch. (Div. Ex. 9a.) The 1994 Form 10-K, filed two months after the press release and roughly one month before the Wall Street Watch mailing, claimed that Tallulah was in full time production. (Div. Ex. 2s at 1.) Foster admitted in his September 1994 investigative testimony that "hearsay" formed the foundation of his belief that Tallulah was being mined at the time these statements were made. (Div. Ex. 96 at 66.)
III. CONCLUSIONS OF LAW: VIOLATIONS OF THE ANTIFRAUD PROVISIONS
The OIP alleges that various Respondents furthered three schemes involving the offer, purchase, and sale of Sky stock in violation of the antifraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. (OIP ¶¶ IV-VI.) In the first, each Respondent except Strategic and Moler is charged with violating the antifraud provisions by, among other things, making false statements concerning Sky in an effort to deceive investors. In the second, Strategic and Moler allegedly violated the antifraud provisions by charging excessive undisclosed markups in sales of Sky stock to customers. (OIP ¶ IV-VI.) In the third, Gilbert Marshall and Usher also allegedly violated the antifraud provisions by charging illegal markups in sales of Sky stock to customers. (OIP ¶ IV-VI.) This Section contains conclusions of law as to the first scheme. The findings of fact and conclusions of law concerning the second and third schemes are set forth in Section VIII below
Section 17(a) of the Securities Act is a comprehensive prohibition against using the mails or the instruments of interstate commerce to perpetrate fraud in the offer or sale of securities. Section 17(a)(1) makes it unlawful "to employ any device, scheme, or artifice to defraud." Section 17(a)(2) prohibits the use of false statements or omissions of material fact to obtain money or property. Section 17(a)(3) forbids any person from engaging "in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon" a purchaser of securities. Section 10(b) of the Exchange Act and Rule 10b-5 thereunder make it unlawful for any person, directly or indirectly, in connection with the purchase or sale of a security, to make an untrue statement of material fact; omit to state a material fact; use any device, scheme or artifice to defraud; or engage in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person. These antifraud provisions are catchalls expressly designed to thwart misrepresentation and manipulation in securities trading. See Affiliated Ute Citizens v. United States , 406 U.S. 128, 151 (1972); SEC v. Texas Gulf Sulphur Co. , 401 F.2d 833, 859 (2d Cir. 1968) (en banc); SEC v. Softpoint, Inc. , 958 F. Supp. 846, 861 (S.D.N.Y. 1997). They are thus liberally construed to embrace a wide range of misconduct. Softpoint , 958 F. Supp. at 862.
The Division must establish scienter as an element of Section 17(a)(1), Section 10(b) and Rule 10b-5 violations, but it need not establish scienter for Section 17(a)(2) and (a)(3) violations. Aaron v. SEC , 446 U.S. 680, 697, 701-02 (1980). The Supreme Court has defined scienter as "a mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder , 425 U.S. 185, 193 n.12 (1976). Scienter is established by showing that the respondents acted intentionally or with severe recklessness. Hackbart v. Holmes , 675 F.2d 1114, 1117 (10th Cir. 1982). Recklessness is defined as "an extreme departure from the standards of ordinary care . . . which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it." Meyer Blinder , 50 S.E.C. 1215, 1229-30 (1992) (quoting Sundstrand Corp. v. Sun Chem. Corp. , 553 F.2d 1033, 1045 (7th Cir. 1977)). For purposes of Sections 17(a) and 10(b) and Rule 10b-5, proof of scienter need not be direct but may be "a matter of inference from circumstantial evidence." Herman & MacLean v. Huddleston , 459 U.S. 375, 390 n.30 (1983); Pagel, Inc. , 803 F.2d at 946; Meyer Blinder , 50 S.E.C. at 1230 (1992); see also SEC v. Lorin , 877 F. Supp. 192, 198 (S.D.N.Y. 1995) (proof of scienter where securities manipulation is the gravamen of the action need not be established through direct evidence), aff'd in part, vacated in part 76 F.3d 458 (2d Cir. 1996).
Courts have interpreted broadly the requirement of Section 10(b) and Rule 10b-5 that violative conduct must occur "in connection with" the purchase or sale of a security." Superintendent of Ins. of N.Y. v. Bankers Life and Cas. Co. , 404 U.S. 6, 12 (1971); In re Ames Dep't Stores Inc. Stock Litig. , 991 F.2d 953, 964-66 (2d Cir. 1993). In general, "fraud can be committed by any means of disseminating false information into the market on which a reasonable investor would rely." Ames Dep't Stores , 991 F.2d at 967; SEC v. Hasho , 784 F. Supp. 1059, 1106 (S.D.N.Y. 1992). Where the fraud involves public dissemination of documents such as press releases, quarterly and annual reports, and other documents which an investor would presumably rely upon, the "nexus" requirement is generally satisfied by proof of the means of dissemination and the materiality of the misrepresentation or omission. SEC v. Rana Research, Inc. , 8 F.3d 1358, 1362 (2d Cir. 1993); Ames Dep't Stores , 991 F.2d at 963, 965; see also SEC v. Antar , 15 F. Supp. 2d 477, 528 (D.N.J. 1998) (Section 10(b) and Rule 10b-5 liability may flow from misstatements and omissions in press releases, news articles, and quarterly and annual public filings); Softpoint , 958 F. Supp. at 862 (S.D.N.Y. 1997) (officer and director violated Section 10(b) and Rule 10b-5 by disseminating false statements and omissions in press releases and quarterly and annual filings).
The test for materiality is whether there is a substantial likelihood that under all circumstances, a reasonable shareholder would consider the omitted or misstated information significant in making an investment decision. Basic Inc. v. Levinson , 485 U.S. 224, 231-32 (1988) (citing TSC Industries, Inc. v. Northway, Inc. , 426 U.S. 438, 449 (1976)). Finally, the jurisdictional requirements of the antifraud provisions are interpreted broadly, and are satisfied by intrastate telephone calls and even the most ancillary mailings. Softpoint , 958 F. Supp. at 865.
A. The Promoter Respondents
The OIP charges Schlien, Jones, Levine, Georgeson, and ACN with willfully violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by reason of their participation in the fraudulent scheme involving the sale of Sky stock. (OIP ¶¶ IV-VI.)
The Division argues that the promoter Respondents circulated fraudulent tout sheets to advance the Sky scheme. (Division Brief at 35.) As detailed above in the Findings of Fact, Schlien, Levine, Georgeson, Jones, and ACN participated directly in the distribution of tout sheets. In so doing, they made misstatements of material facts and omitted to state material facts with the intent to defraud the investing public. I thus conclude that they acted with scienter.
The materiality element is easily satisfied by the misinformation in the tout sheets concerning reserves, production, and revenues. Reasonable investors would, and did in fact, consider these things in deciding whether to invest in the company. ( See Tr. 1154-55, 1159-60.) The nexus requirement is satisfied as well. The tout sheets were part of a "leads program" specifically designed to direct investors to broker-dealers. The material misstatements and omissions were related to the intrinsic value of Sky stock.
The Division argues further that the promoter Respondents participated in the scheme by manipulating the market for Sky stock. (Division Brief at 35-40.) "Any activities that falsely persuade the public that activity in an over-the-counter security is the reflection of a genuine demand instead of a mirage' are outlawed" by Sections 17(a) of the Securities Act and 10(b) of the Exchange Act. SEC v. Kimmes , 799 F. Supp. 852, 859 (N.D. Ill. 1992) (quoting SEC v. Resch-Cassin & Co. , 362 F. Supp. 964, 975 (S.D.N.Y. 1973)). In order to prove that the Respondents manipulated the market in furtherance of the scheme, the Division must show that these Respondents used or employed, in connection with the purchase or sale of Sky stock, a manipulative or deceptive device or contrivance. Such deceptive devices and contrivances "may include the following: the use of wash sales; the use of undisclosed nominees; the use of material misrepresentations in newsletters and otherwise." Kimmes , 799 F. Supp. at 859 (citations omitted).
The wash trades "operated as a fraud and deceit on the marketplace by creating a deceptive appearance of market activity, accomplished by an intentional interference with the free forces of supply and demand." Adrian C. Havill , Exchange Act Rel. No. 40726, 1998 WL 823070, at *4 (Nov. 30, 1998) (citing Ernst & Ernst , 325 U.S. at 205). The practice of "taking out the low bid" or "cleaning the street" was another artifice these Respondents employed to influence the price of Sky stock. In addition, the promoter Respondents used nominee accounts, false public statements and filings, and captive or cooperative brokers to manipulate and control the market for the stock. This conduct stimulated "the so-called market price of the stock while making it appear to be the product of the independent forces of supply and demand when, in reality, it was completely a creation of [the Respondents'] subterfuge." Resch-Cassin , 362 F. Supp. at 978. I conclude that all of the promoter Respondents knew the activities detailed above were aimed at manipulating the price of Sky stock, and carried out such operations with the intent to deceive the public. 52 I further conclude Respondents Schlein, Jones, Levine, ACN, and Georgeson committed manipulative acts in furtherance of the scheme, and acted with the requisite mental state.
B. The Broker-Dealer Respondents
The OIP alleges that Gilbert Marshall, Usher, Lehl, Smith Benton, Zaman, and Hellen willfully 53 violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. (OIP ¶¶ IV-VI.)
The Division argues that the broker-dealer Respondents violated these provisions by recommending, or allowing sales agents under their direction to recommend the purchase of Sky stock to their customers. 54 (Division Brief at 42-48.) Broker-dealers willfully violate the antifraud provisions of Section 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder when they recommend a security without having an adequate and reasonable basis for doing so. Hanly v. SEC , 415 F.2d 589, 595-97 (2d Cir. 1969); Distribution by Broker-Dealers of Unregistered Securities , Exchange Act Release No. 6721 (Feb. 2, 1962). In order to have a reasonable basis, the broker-dealer must conduct a reasonable investigation. Hanly , 415 F.2d at 595. They must undertake critical analysis and careful scrutiny of the information concerning the security they are recommending. See V.F. Minton Securities, Inc. , 51 S.E.C. 346, 349-51 (1993). They "may not rely blindly on the issuer for information concerning a company." Hanly , 415 F.2d at 596. Securities issued by smaller "start-up" companies "obviously require more thorough investigation." Id. If the due diligence inquiry uncovers inconsistencies in the company's public filings and press releases, irregularities in its financial statements, repeated failure to realize projected goals, or other red flags, the broker-dealer must disclose this information to its customers. Id. ; Richard C. Spangler, Inc. , 46 S.E.C. 238, 245 (1976).
The Division has proven that sales agents at Gilbert Marshall and Smith Benton withheld vital information and made material misstatements to induce customers to purchase Sky stock. The agents participated in the Wall Street Watch leads program, and mailed copies of the tout sheets to their customers. Equally clear is the fact that reasonable investigation of the company would have alerted the broker-dealer Respondents to the fact that Sky and its promoters were making material misrepresentations and omitting to state material facts to investors and potential investors in connection with the purchase and sale of Sky stock. The following are a few of the many red flags they ignored: (1) contradictory claims in press releases and Commission filings regarding mining production and revenues from operations; (2) the going concern qualification in the company's financial statements focusing on the nature of Sky's assets; (3) exaggerated valuation figures for the Russian certificates of deposit and mining properties; (4) the recording of the Russian certificates on the last day of the company's fiscal year which gave the company $40 million worth of additional assets and additional equity; (5) the frequent changing of independent auditors; and (6) the large-scale, sustained increase in the amount of common stock issued by the company. (Tr. 118, 154-159.)
Gilbert Marshall and Usher challenge the government's allegations of fraudulent sales practices. They contend that Gilbert Marshall agents had a reasonable basis for recommending the stock because "[i]n the totality of the circumstances [Sky was] a NASDAQ stock with a high daily trading volume and 20-30 market makers, audited financial statements showing assets well in excess of liabilities . . . and decent prospects for the future." 55 (Gilbert Marshall Brief at 20.) They further contend that the red flags cited by the Division were not apparent, if ever, until after the firm had terminated its association with the Denver office. (Gilbert Marshall Brief at 11-20.) Their arguments are not persuasive.
First, the fact that the NASD did not detect the Sky fraud does not justify or excuse the failure of the broker-dealer Respondents to properly investigate the company. See Ko Securities , 66 SEC Docket 81, 88 n.23 (Dec. 11, 1997) (citations omitted). Second, the presence of several market makers and an active market in the security does not serve as a substitute for due diligence. These factors may reflect nothing more than a successful manipulation scheme. 56 Third, Usher had no "right to rely" on the financial statements he received from the company, whether audited or not, because those statements contained several of the red flags Usher had an obligation to detect and investigate. Broker-dealers are not allowed to base their recommendation on irregular financial statements. Richard C. Spangler , 46 S.E.C. at 248 n.36. Finally, several of the red flags were apparent from the Form 10-Qs and press releases issued prior to the 1994 Form 10-K, 57 as well as from the 1994 Form 10-K itself. (Tr. 154-57.) These documents were publicly available long before Usher and Gilbert Marshall severed their ties to the Denver office. Indeed, Usher admits he noticed many of these irregularities when he reviewed the due diligence package. (Tr. 834-35, 838-39, 845-46, 853.) He decided to ignore the red flags because Sky was a young company, as though its developmental status justified a less thorough investigation. This determination went against the clear directive of Hanly and the long line of subsequent decisions by courts and the Commission holding that unproven, speculative companies demand a heightened level of scrutiny. Hanly , 415 F.2d at 596; Frank W. Leonesio , 48 S.E.C. 544, 548 (1986).
Zaman, Usher, Lehl, and Hellen, as managers, knowingly participated in the scheme by allowing and encouraging the sales people to make unreasonable recommendations. 58 See V.F. Minton , 51 S.E.C. at 350; Gilbert F. Tuffli, Jr. , 46 S.E.C. 401, 407 (1976). These Respondents and/or the agents under their control communicated with customers through telephone calls and through tout sheets and press releases sent through the mails, thus the jurisdictional means requirement is met. Hasho , 784 F. Supp. at 1105. All the broker-dealer Respondents knew, or were reckless in not knowing, that their customers were being misled. Gilbert Marshall, Smith Benton, Usher, Lehl, Zaman, and Hellen therefore acted with scienter. The misinformation conveyed to the customers was material, as it surely "would have been viewed by the reasonable investor to have changed the total mix of information made available." See Basic Inc. , 485 U.S. at 231-32. The recommendations were clearly made in connection with the purchase or sale of Sky securities. See Hasho , 784 F. Supp. at 1106; Ames Dep't Stores , 991 F.2d at 967 & n.7.
C. Jerry L. Foster
The OIP alleges that Fosterviolated the antifraud provisions in that he made untrue statements of material facts and omitted to state material facts to the public, investors and prospective investors through Sky press releases, promotional materials, and Forms 10-Q, 10-K, and 8-K. (OIP ¶ IV.B.)
Foster claims he acted without the requisite mental state, in that he relied in good faith upon others who misled him. (Foster Brief at 1-3.) He argues that he was entitled to trust the opinions of Sky's independent auditors when he signed the annual reports containing materially false statements and omissions. (Foster Brief at 2.) As to the six unaudited quarterly reports and the numerous Form 8-K filings he prepared and/or signed, Foster contends that he was justified in accepting valuation figures and other information supplied by employees and consultants of the company. (Foster Brief at 3.)
His argument is without merit. As a director and officer of a public corporation, Foster had a duty to make sure the information he filed with the Commission was free of errors. SEC v. Fehn , 97 F.3d 1276, 1289-90 (9th Cir. 1996). Management is ultimately responsible for the accuracy of the company's financial statements, whether audited or not. "If a company officer knows that the financial statements are false or misleading and yet proceeds to file them, the willingness of an accountant to give an unqualified opinion with respect to them does not negate the existence of the requisite intent or establish good faith reliance." SEC v. Goldfield Deep Mines Co. , 758 F.2d 459, 467 (9th Cir. 1985) (quoting United States v. Erickson , 601 F.2d 296, 305 (7th Cir. 1979)). Moreover, the record reveals that Foster occupied a decidedly unsheltered position in the company hierarchy throughout the relevant period, and I do not credit his testimony to the contrary. Foster intentionally engaged in the scheme described above and thereby deceived the public, investors, prospective investors, and broker-dealers. I therefore conclude that Foster acted with scienter.
Foster does not dispute the materiality of the facts stated in and omitted from the Commission filings, tout sheets, and press releases. The documents contained misstatements and omissions concerning, among other things: Sky's financial condition; projected earnings and income; assets, expenses, and losses; payments of cash and stock to consultants and promoters; and methods of raising capital. These misstatements and omissions were material within the meaning of the antifraud provisions. "[M]aterial facts include not only information disclosing the earnings and distributions of a company but also those facts which affect the probable future of the company and those which may affect the desire of investors to buy, sell, or hold the company's securities." San Leandro Emerg. Med. Group Profit Sharing Plan v. Philip Morris Cos. , 75 F.3d 801, 810 (2d Cir. 1996) (quoting Texas Gulf Sulphur , 401 F.2d at 849). The valuation practices alone would clearly be of great importance to any reasonable investor.
The nexus element of Section 10(b) and Rule 10b-5 is likewise met. The scheme to convert Sky stock to cash was directly related to the purchase and sale of securities. Foster's conduct goes to the heart of that scheme, and therefore satisfies the "in connection with" requirement of Section 10(b) and Rule 10b-5. See Softpoint , 958 F. Supp. at 862-63. He intentionally created and circulated materially misleading press releases and Commission filings. It is clear that the deceptive publications "were directed at investors and broker dealers, in short to sales in the marketplace. Corporate officers and agents are liable for injecting such false and deceptive publications into the marketplace." SEC v. International Chem. Dev. Corp. , 469 F.2d 20, 27 n.3 (10th Cir. 1972) (citations omitted).
D. Jurisdictional Means
The jurisdictional means element is easily satisfied as to each Respondent by, among other things: the mailing of the Commission filings, tout sheets, and press releases; the wiring of funds between brokerages and the Respondents' bank accounts; and the interstate and intrastate telephone calls Respondents made to investors, potential investors, broker-dealers, and each other. See Softpoint , 958 F. Supp. at 865.
Based upon the findings of fact as set out herein, I conclude that Respondents Foster, Schlien, ACN, Levine, Jones, Georgeson, Smith Benton, Zaman, Hellen, Gilbert Marshall, Usher, and Lehl, individually and together, knowingly participated in the scheme to defraud involving the offer, purchase, and sale of Sky stock, and in so doing willfully violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
IV. FINDINGS OF FACT AND CONCLUSIONS OF LAW: TOUTING WITHOUT DISCLOSURE OF CONSIDERATION FROM SKY
In addition to the antifraud charges, Schlien, ACN, Levine, and Jones allegedly violated Section 17(b) of the Securities Act. (OIP ¶ IX.) Section 17(b) makes it unlawful to use the mails or other means of interstate commerce to publish or distribute any circular "which, though not purporting to offer a security for sale, describes such security for a consideration received or to be received, directly or indirectly, from an issuer, underwriter, or dealer, without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof."
The Wall Street Watch tout sheets do state, in very fine print, that "the publisher and its affiliates may have a position in Sky or receive compensation for dissemination of information on the company." 59 (Div. Exs. 9a, 9b (emphasis added).) None of the tout sheets disclose the amount of consideration the promoter Respondents received for publishing and distributing the brochures. (Div. Exs. 9a, 9b, 10a-10d.) In fact, ACN, Schlien, and Levine traded heavily in Sky stock, which they received from the company as compensation for their promotional work. ( See supra Section II.C, and infra Section V.A.) Although Jones did not receive stock, he was paid to arrange the Wall Street Watch mailing and to distribute the brochures. (Div. Exs. 7f; 7g at 10-11; Tr. 635-36.)
Thus, the disclaimer fails to satisfy the statutory requirement of full disclosure. Respondents failed to state the fact that they had received, and would receive, compensation from the company. United States v. Amick , 439 F.2d 351, 364-65 (7th Cir. 1971); Continental Capital & Equity Corp. , 61 SEC Docket 1051, 1056 (Feb. 26, 1996.) They also failed to disclose the amount of consideration they had received and expected to receive. In so doing, Respondents Schlien, Levine, ACN, and Jones willfully violated Section 17(b) of the Securities Act.
V. FINDINGS OF FACT AND CONCLUSIONS OF LAW: PUBLIC DISTRIBUTION OF UNREGISTERED SECURITIES
The OIP alleges that the promoter and broker-dealer Respondents violated Sections 5(a) and 5(c) of the Securities Act in that they, directly or indirectly, made use of means or instruments of transportation or communication in interstate commerce or of the mails to offer to sell, sell, and deliver after sale, shares of common stock of Sky to the public, when no registration statement was filed or in effect as to the public sale of those securities. (OIP ¶ III.) The Division argues that "[a]lthough Sky registered its issuance of [s]tock to Schlien and his nominees pursuant to Form S-8, the subsequent re-distribution to the public of this stock by" the promoter Respondents "was not registered." (Division Brief at 40.) The Division argues further that the broker-dealer Respondents and their associated persons violated the registration provisions by failing to determine whether they were participating in an unregistered distribution prior to trading in Sky stock. (Division Brief at 51.)
A. Distribution of Unregistered Securities: The Promoter Respondents
Sections 5(a) and 5(c) of the Securities Act make it unlawful for any person to use the means of interstate commerce to sell a security "[u]nless a registration statement is in effect as to [such] security," or to offer to sell or offer to buy a security "unless a registration statement has been filed as to such security." The registration statement allows an issuer, underwriter, or dealer to make only the offers and sales described in the statement. SEC v. Cavanagh , 155 F.3d 129, 133-34 (2d Cir. 1998) (holding that shares registered pursuant to Form S-8 registration statement when issued to management were not still registered when resold to third parties). A prima facie case for a violation of Section 5 is established by a showing that: (1) no registration statement was in effect or had been filed as to the securities; (2) the respondents, directly or indirectly, sold or offered to sell the securities; and (3) the offer or sale was made through the use of interstate facilities or the mails. SEC v. Continental Tobacco, Inc. , 463 F.2d 137, 155 (5th Cir. 1972). Once the Division has established a prima facie case for a violation of Section 5, the burden shifts to the defendant to show that the securities offered were exempt from the registration requirement. SEC v. Ralston Purina Co. , 346 U.S. 119, 126 (1953). The claimed exemption must be strictly construed against the claimant. Quinn and Co. v. SEC , 452 F.2d 943, 946 (10th Cir. 1971) (footnotes omitted). As with the antifraud provisions, the jurisdictional means requirement is liberally construed to encompass intrastate telephone calls and tangential mailings. Softpoint , 958 F. Supp. at 861 (citations omitted).
During the relevant period, Sky registered approximately 30 million shares of stock with the Commission on 107 Form S-8 registrations or amendments. (Div. Exs. 6a-6bbbbb.) Respondents ACN, Schlien, and Levine, and their nominees received and sold at least 19 million of those shares through the Canaccord accounts. (Div. Ex. 7a.) After receiving their S-8 stock from the company, these Respondents did not register their shares with the Commission for sale on the open market. (Div. Ex. 81; Tr. 1025.) However, a few days after each filing, the these Respondents sold the stock into the market. (Div. Ex. 7d.) Once the stock was sold, part of the proceeds, ostensibly payments for the exercise of stock options, were wired back to Sky's bank accounts. 60 (Div. Exs. 7d; 7f; 7g; 96 at 49-50.)
Form S-8 permits an issuer to issue stock as compensation to consultants, "provided that bona fide services shall be rendered by [the] consultants . . . and such services must not be in connection with the offer or sale of securities in a capital-raising transaction." See General Instruction A.1(a) to Form S-8 . Consultants receiving S-8 stock may not be used as conduits to investors. See Steven M. Scarano , 67 SEC Docket 2794 (Sept. 9, 1998); James Ray Ross , 67 SEC Docket 1260 (June 26, 1998); Timothy J. Brannon , 67 SEC Docket 0249 (May 4, 1998); Brent W. Berry , 65 SEC Docket 3017 (Dec. 3, 1997); Spectrum Info. Techs. , 64 SEC Docket 2103 (June 25, 1997). In short, Form S-8 may not be misused to "circumvent the registration requirement by devious and sundry means" and thereby deprive public investors of the protection registration provides. North Am. Research and Dev. Corp. , 424 F.2d 63, 71 (2d Cir. 1970).
In the circumstances described herein, Sky's registration of common stock on Form S-8 covered only sales of stock to Schlien, ACN, Levine, and the various nominal consultants controlled by Schlien. No registration statements were in effect as to the subsequent sales from the Canaccord accounts. The promoter Respondents effected the public distribution of approximately 19 million shares of Sky common stock through the means and instrumentalities of interstate commerce. I conclude that the Division has made out a prima facie case that the promoter Respondents violated Section 5 of the Securities Act. Therefore, these Respondents must show that they qualify for an exemption from Section 5.
Section 4(1) of the Securities Act exempts from registration "transactions by any person other than an issuer, underwriter, or dealer." Section 2(a)(11) of the Securities Act provides, in pertinent part:
The exemption created by Section 4(1) is not available to Schlien, ACN, Levine, Jones, and Georgeson because they acted as "underwriters" under Section 2(a)(11) of the Securities Act. See Quinn and Co. , 452 F.2d at 945-46; Ingenito v. Bermec Corp. , 441 F. Supp. 525, 536 (S.D.N.Y. 1977). Schlien, ACN, and Levine purchased securities from Sky, the issuer, intending to sell the securities. They also offered and sold for Sky as part of the distribution. Jones and Georgeson participated directly in this "undertaking": Jones placed orders to sell stock from Canaccord accounts; Georgeson facilitated the sale of stock to Smith Benton and its customers.
Respondents Schlien, ACN, Levine, and Jones argue that "no  distribution occurred and therefore registration was not required" because "there was not a large number of shares in any individual transaction and the number of shares which came into the market did not disrupt the market." (Promoter Brief at 9; Promoter Findings ¶¶ 51-53.) In support of this contention, these Respondents rely solely on the opinion of their expert witness, Gary Lipson. I do not credit his opinion.
It is well established that a distribution "is the entire process by which in the course of a public offering the block of securities is dispersed and ultimately comes to rest in the hands of the investing public." R.A. Holman & Co. v. SEC , 366 F.2d 446, 449 (2d Cir. 1966) (quoting Lewisohn Copper Corp. , 38 S.E.C. 226, 234 (1958)); see also Kimmes , 799 F. Supp. at 859 (holding that the use of undisclosed nominees in an initial public offering extends the period of the distribution until the stock comes to rest in the hands of the investing public). Furthermore, both the amount of shares sold by these Respondents, and the percentage of the total issue of Sky stock they sold, are sufficient to constitute a public distribution. See Quinn and Co. , 452 F.2d at 946. The exceedingly narrow definition of "distribution" urged by these Respondents is untenable. Accordingly, I conclude the process of moving the S-8 shares into the hands of the public did constitute a distribution.
These Respondents do not cite any other viable basis for exemption. They participated in the transmission process between the issuer and the public, distributing stock that was neither registered nor exempt from registration using the jurisdictional means. Thus, I conclude that Schlien, ACN, Jones, Levine, and Georgeson willfully violated Sections 5(a) and 5(c) of the Securities Act.
B. Unregistered Distribution of Securities: The Broker-Dealer Respondents
Broker-dealers and registered representatives violate the registration requirement of Sections 5(a) and 5(c) when they sell unregistered stock without reasonably investigating whether the security is properly registered. Quinn and Co. , 452 F.2d at 946-47; Jacob Wonsover , Exchange Act Rel. No. 41123, 1999 WL 100935, at *9-10 (Mar. 1, 1999); Terry T. Steen , 67 SEC Docket 0837, 0841-43 (June 2, 1998). Although Section 4(4) of the Securities Act, the so-called "broker's exemption," excludes "brokers' transactions executed upon customers' orders" and may shield brokers from liability for participating in an unregistered distribution, the exemption is not available when the broker knows or has reasonable grounds to believe that his principal is an underwriter. Jacob Wonsover , 1999 WL 100935, at *7 (footnote omitted); Robert G. Leigh , 50 S.E.C. at 193 (1990). The broker must make whatever inquiries are necessary under the circumstances to make sure the transaction is not part of an unlawful distribution. Distribution by Broker-Dealers of Unregistered Securities , Exchange Act Release No. 6721 (Feb. 2, 1962); Owen V. Kane , 48 S.E.C. 617, 621 (1986), aff'd , Kane v. SEC , 842 F.2d 194 (8th Cir. 1988).
The broker-dealer Respondents were offered substantial blocks of a little-known security at below-market prices by persons who were reluctant to disclose exactly where the securities came from. In addition, the surrounding circumstances raised serious doubts as to whether or not the ostensible sellers were merely intermediaries for controlling persons or statutory underwriters. A searching inquiry was called for, but was not carried out. The securities were, in fact, unregistered. The broker-dealer Respondents and their agents used the mails and means of interstate commerce to sell the Sky stock. I therefore conclude that Smith Benton, Zaman, Hellen, Usher, Lehl, and Gilbert Marshall willfully violated Sections 5(a) and 5(c) of the Securities Act.
VI. FINDINGS OF FACT AND CONCLUSIONS OF LAW: FALSE FILING VIOLATIONS
The Division alleges that Foster, as a Sky control person willfully caused violations of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder, in that he directly or indirectly made untrue statements of material facts and omitted to state material facts about Sky in the company's filings with the Commission. (OIP ¶ VII.)
Pursuant to Section 13(a) of the Exchange Act, issuers subject to the Exchange Act's reporting provisions must file such information, reports and documents as the Commission's rules require. Exchange Act Rules 13a-1, 13a-11, and 13a-13 require the filing of annual reports, current reports, and quarterly reports, respectively. Rule 12b-20 requires that statements and reports contain all information necessary to ensure that statements made in them are not materially misleading. In addition, courts interpreting Section 13 of the Exchange Act have consistently held that "the reporting provisions of the Exchange Act are clear and unequivocal, and they are satisfied only by the filing of complete, accurate and timely reports." SEC v. Savoy Indus. , 587 F.2d 1149, 1165 (D.C. Cir. 1978) (interpreting Section 13(d)) (citations omitted); see also SEC v. Gallagher , 1989 U.S. Dist. LEXIS 9556, at *22-23 (E.D. Pa. 1989) (holding that controller who signed fraudulent quarterly and annual reports, and helped deceive independent auditors into approving fraudulent financial statements, aided and abetted company's violations of Sections 13(a) and 13(b)(2)(A), and of Rules 12b-20, 13a-1 and 13a-13); SEC v. World-Wide Coin Investments Ltd. , 567 F. Supp. 724, 759 (N.D. Ga. 1983) (holding that directors who prepared or reviewed misleading and erroneous quarterly and annual reports and took "no steps to ensure disclosure or to correct misleading disclosures" aided and abetted company's violations of Section 13(a) and Rules 12b-20, 13a-1, 13a-11, 13a-13).
Sky violated Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13 by filing materially false and misleading Forms 8-K, 10-Q, 10-K, and 10-KSB with the Commission. (Div. Exs. 2a-2hh.) As Sky's principal financial officer, secretary, and a board member, Foster was responsible for making sure these filings were accurate. Foster prepared, reviewed, and/or signed the filings. Accordingly, I conclude that Foster willfully caused violations of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder.
VII. FINDINGS OF FACT AND CONCLUSIONS OF LAW: THE ACCOUNTING RECORDS VIOLATIONS
The OIP further alleges that Foster, as a Sky control person, willfully caused violations of Section 13(b)(2)(A) of the Exchange Act and Rule 13b2-1 thereunder, in that he falsified Sky accounting records by understating Sky's net loss. (OIP ¶ VIII.) According to the Division, Foster failed to record as an expense the value of stock issued to persons such as Schlien for no consideration, or for consideration below the market value of such stock, in exchange for services. (Division Brief at 34.)
Under Section 13(b)(2)(A) of the Exchange Act, issuers must "make and keep books, records, and accounts, which . . . accurately and fairly reflect the transactions and dispositions of the[ir] assets." Rule 13b2-1 prohibits any person from falsifying or causing falsification of any book, record, or account subject to Section 13(b)(2)(A). As established above in Section II.B.1(d), Sky's accounting records failed to reflect expenses related to the sale of S-8 stock for less than the market value of the stock.
In answer to the allegation that he falsified Sky's accounting records, Foster claims that he was not familiar with "reporting techniques required under the law." (Foster Brief at 1-2.) Patten testified that, like the valuation practices discussed above, the accounting principle underlying the duty to report these expenses and the resulting losses is rudimentary. (Tr. 146.) Like the overvaluation of assets on its financial statements, the under-reporting of tens of millions of dollars in expenses and losses was material. (Tr. 148.) I credit Patten's opinion on this issue. Foster, a certified public accountant, knew the consultants were receiving enormous quantities of Sky stock in exchange for services. (Div. Exs. 2s at 52; 7e; 7g; 96 at 9-10, 44-5, 49-50, 157-69, 173-74.) He chose to ignore the wide disparity between the fair market values of the stock and the services, and in so doing chose to contravene GAAP. (Tr. 145-46, 149.) Foster was responsible for ensuring the accuracy of Sky's financial reports and the propriety of its accounting practices, but he failed to do so. I therefore conclude that Foster willfully caused violations of Section 13(b)(2)(A) of the Exchange Act and Rule 13b2-1 thereunder by falsifying Sky's accounting records.
VIII. EXCESSIVE UNDISCLOSED MARKUPS
The OIP alleges that Strategic and Moler charged excessive undisclosed markups 61 of between 10% and 30% in approximately 111 sales of Sky stock to customers between December 21, 1993 and February 17, 1994. (OIP ¶ IV.B.5.) The OIP further alleges that Gilbert Marshall and Usher sold Sky stock with markups of between 10% and 80% in approximately 350 transactions between March 24, 1994 and July 31, 1994. (OIP ¶ IV.B.6.) The Division argues that neither Strategic nor Gilbert Marshall made a market in Sky stock, and that both firms improperly used the inter-dealer price of the stock to calculate the markups they charged their customers. (Division Brief at 48-50.)
A. Applicable Law
Broker-dealers violate the antifraud provisions of the Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder when, acting with scienter, they charge retail customers markups of more than 10% above the prevailing market price at the time the customers make their purchases. D.E. Wine Investments, Inc. , 66 SEC Docket 0763, 0766 & n.3 (Jan. 6, 1998) (citations omitted); Alstead, Dempsey & Co. , 47 S.E.C. 1034, 1035 (1985). Thus, the pivotal question in cases involving allegations of excessive markups is how to determine the "prevailing market price." The answer often depends, as it does in the instant case, on whether the dealer is a market maker. See Grandon v. Merrill Lynch & Co. , 147 F.3d 184, 189 (2d Cir. 1998). "A market maker in a competitive market . . . is entitled to base its retail prices on the inter-dealer prices it and other market makers charge or pay other non-market makers in contemporaneous trades." D.E. Wine , 66 SEC Docket at 0766; Alstead, Dempsey , 47 S.E.C. at 1035. For dealers who do not make a market in the security, however, contemporaneous cost is the appropriate basis for calculating markups. D.E. Wine , 66 SEC Docket at 0766 n.6.
The term "market maker" is defined in Section 3(a)(38) of the Exchange Act as "any dealer who, with respect to a security, holds himself out (by entering quotations in an inter-dealer communications system or otherwise) as being willing to buy and sell such security for his own account on a regular or continuous basis." This means the dealer must engage in "actual wholesale trading activity in the security in question, i.e., regularly or continuously buying the security from other dealers at or around its bid quotation and selling it to other dealers at or around its ask quotation" to qualify as a market maker for markup purposes. Century Capital Corp. of South Carolina , 50 S.E.C. 1280, 1281 n.5 (1992), aff'd 22 F.3d 1184 (D.C. Cir. 1994).
In the instant case, the Division has calculated the contemporaneous cost for Gilbert Marshall and Strategic trades based on the purchase closest in time to the retail sale, even if the acquisition occurred after the retail sale. (Div. Exs. 7p, 7q.) The Commission has endorsed this approach, which gives respondent broker-dealers the benefit of the doubt. D.E. Wine , 66 SEC Docket at 0767 (footnote omitted); Hibbard, Brown & Co., Inc. , 58 SEC Docket 2769, 2780 n.37 (Mar. 13, 1995) aff'd 92 F.3d 1172 (3d Cir. 1996) (unpublished table decision).
Finally, where respondents are closely involved in the pricing of a security for a broker-dealer, they may be held personally liable for excessive markups. See Richard R. Perkins , 51 S.E.C. 380, 383-84 (1993) (holding trader and salesman personally liable for excessive markups on grounds that both were closely involved in the pricing of the security and were aware of the market for the security); Hibbard, Brown , 58 SEC Docket at 2782-83 (head trader and president).
B. Strategic and Moler
In 1993 and 1994 Strategic was a broker-dealer registered with the Commission and headquartered in Denver, Colorado. (Strategic Answer.) Moler has been the President and CEO of Strategic since January 1992. During the relevant period he was responsible for the direction and management of the firm. (Tr. 1287, 1296.) Moler supervised all Strategic trading during this time, and personally approved all firm trades in Sky. (Tr. 1298.)
At the hearing, Strategic and Moler moved to exclude from evidence Division Exhibit 7p. (Tr. 1070.) Exhibit 7p is the schedule of markups Strategic charged its customers during the period in question. It was prepared by Norman Black (Black), who testified as a summary witness for the Division. (Tr. 982, 994.) The motion was denied. (Tr. 1071.) At the close of the Division's case-in-chief, Strategic and Moler moved to dismiss the claim against them. (Tr. 1395-97.) They argued that the only evidence against them is Exhibit 7p and Black's testimony, that material omissions and errors in 7p render it unreliable, and that, therefore, the claim should be dismissed for failure of proof. (Tr. 1397.) The motion was denied, but Strategic and Moler were allowed to renew the motion at the close of all evidence. (Tr. 1400.) Strategic and Moler renew the motion to dismiss in their post-hearing brief. (Strategic Brief at 2.) They reiterate their contention that Exhibit 7p contains material inaccuracies such that it should not be credited as evidence that Strategic charged excessive markups. (Strategic Brief at 2, 7-15.) For the reasons set forth below, the renewed motion to dismiss is denied.
Black testified that Exhibit 7p does not reflect purchases from retail customers which the firm was required to make when customers refused to pay for Sky stock they had ordered - so-called "sell-out" purchases. (Tr. 1051.) With the exception of sell-out purchases, Exhibit 7p reflects all of Strategic's trading in Sky stock with broker-dealers and retail customers. (Tr. 1051-52.) The omission of sell-out purchases from the Exhibit, and the Division's failure to include these purchases in its calculation of cost and markup figures was proper. In determining a broker-dealer's contemporaneous cost of acquisition, the relevant purchase is not the one necessitated by the customer's refusal to pay, but the one executed earlier to meet the customer's purchase order. All such initial trades are included in Exhibit 7p, thus the Division's cost and markup calculations are supported by an adequate foundation.
During the period December 21, 1993 through February 17, 1994, Strategic and Moler purchased approximately 1.6 million shares of Sky, most of them from the Canaccord accounts. (Div. Exs. 7h; 7p at 6.) It sold to other dealers on only two occasions, and those sales totaled only 15,000 shares. (Div. Ex. 7p at 1, 6.) Moler concedes that Strategic's markups of Sky stock in retail sales to customers were based on the prevailing inter-dealer price. (Tr. 1301.)
Strategic was not a market maker because it did not make a two-sided market. See Century Capital , 50 S.E.C. at 1281-82. Its trading activity was limited almost exclusively to buying Sky stock from other dealers with a view toward selling it to its retail customers. The two sales to other broker-dealer were separated by an interval of nearly three months, and amounted to less than .01% of the total number of Sky shares traded by the firm. (Div. Ex. 7p.) Thus, these sales do not satisfy the requirement that Strategic's actual wholesale trading be regular or continuous. Id. ; Sherman, Fitzpatrick & Co. , 51 S.E.C. 1048, 1052-53 (1994). It was required to base its markups on contemporaneous cost. By basing its markups on the inter-dealer price, the firm charged its customers excessive markups on approximately 115 transactions, realizing trading profits of $68,469. (Div. Ex. 7p.) Strategic and Moler did not disclose this material fact to the customers it overcharged. ( See Tr. 1131).
Moler was aware of the need to engage in sales to other broker-dealers in order to qualify as a market maker. (Tr. 1304-05.) He was also aware of the legal consequences of basing Strategic's markups on the inter-dealer price when using contemporaneous cost was called for. 62 I therefore conclude Strategic and Moler acted with scienter in charging Strategic customers excessive undisclosed markups. See Hibbard, Brown , 58 SEC Docket at 2783. I further conclude that Strategic and Moler willfully violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
C. Gilbert Marshall and Usher
During the period March 24, 1994 and July 31, 1994, Gilbert Marshall bought approximately 5.4 million shares of Sky stock. (Div. Ex. 7q.) Of those shares, Gilbert Marshall sold to other broker-dealers on only six occasions. These sales amounted to a minute fraction (approximately .03%) of the total number of shares traded by the firm. (Div. Ex. 7q.)
Gilbert Marshall was not a market maker for purposes of calculating markups for the same reason Strategic was not a market maker: the firm failed to make regular or continuous sales to other broker dealers. It was required to base its markups on its contemporaneous cost of acquisition, but Usher chose instead to base them on the prevailing inter-dealer price. (Tr. 818, 823, 869.) Gilbert Marshall and Usher correctly contend that contemporaneous cost is an appropriate indicator of the prevailing market price only where there is a lack of countervailing evidence that some other figure -- namely, the inter-dealer price -- should be used instead. (Gilbert Marshall Brief at 21.) They fail, however, to offer persuasive evidence that contemporaneous cost was an inferior measure of the prevailing market price for Sky in this instance. ( See Gilbert Marshall Brief at 21-23.)
Usher was responsible for setting the retail prices at Gilbert Marshall. (Tr. 748-49, 778, 866.) He was in close contact with the firm's trader. (Tr. 866.) Usher approved all trades and reviewed all order tickets every day. (Tr. 748.) Testimony from Gilbert Marshall sales agents and customers reveals that the markups were not disclosed to customers. (Tr. 1131, 1152-53, 1174, 1180, 1196, 1242, 1259, 1275-76, 1367.) I conclude Usher knew or was reckless in not knowing the firm's customers were paying fraudulently excessive undisclosed markups on approximately 338 sales of Sky stock. By overcharging customers, Usher and Gilbert Marshall realized gains of approximately $211,947. Accordingly, I conclude that Gilbert Marshall and Usher willfully violated the antifraud provisions of the Securities Act and the Exchange Act by charging excessive undisclosed markups.
IX. FAILURE TO SUPERVISE
In the alternative to the alleged substantive violations of the antifraud and registration, the OIP further charges Usher and Zaman with failing reasonably to supervise certain persons under their supervision with a view to preventing violations of Sections 5 and 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. (OIP ¶ X.)
X. SUMMARY OF CONCLUSIONS
The Division requests that disgorgement of illegally obtained profits be ordered pursuant to: Exchange Act Section 21C(e) against Foster; Securities Act Section 8A(e) and Exchange Act Section 21C(e) against Schlien, ACN, Levine, Jones, and Georgeson; and Securities Act Section 8(A)(e) and Exchange Act Sections 21B(e) and 21C(e) against Smith Benton, Zaman, Hellen, Gilbert Marshall, Usher, Lehl, Strategic and Moler. (OIP ¶ XI.B; Division Brief at 59.)
Section 8A(e) of the Securities Act and Sections 21B(e) and 21C(e) of the Exchange Act provide that the Commission may enter an order requiring disgorgement, including reasonable interest. 63 Disgorgement seeks solely to deprive the wrongdoer of his or her ill-gotten gains. See Hibbard, Brown , 58 SEC Docket at 2787 & n.64 (citing Hateley v. SEC , 8 F.3d 653 (9th Cir. 1993)); Toney L. Reed , 51 S.E.C. 1009, 1013 (1994) (same); Kenneth L. Lucas , 51 S.E.C. 1041, 1046 (1994) (citing SEC v. First City Financial Corp. , 890 F.2d 1215, 1230 (D.C. Cir. 1989); Hateley , 8 F.3d at 655). The primary purpose of disgorgement is not to compensate investors, rather, the purpose is to "deprive a wrongdoer of his unjust enrichment and to deter others from violating the securities laws." 64 First City , 890 F.2d at 1230, 1232 n.24; SEC v. Tome , 833 F.2d 1086, 1096 (2d Cir. 1987). Disgorgement may not be used punitively. Kenneth L. Lucas , 51 S.E.C. at 1046 n.24 (citing First City , 890 F.2d at 1231; SEC v. Blatt , 583 F.2d 1325, 1335 (5th Cir. 1978); SEC v. Manor Nursing Centers, Inc. , 458 F.2d 1082, 1104 (2d Cir. 1972)).
Disgorgement can be exercised only over property causally related to the wrongdoing. First City , 890 F.2d at 1231. When calculating disgorgement, however, "separating legal from illegal profits exactly may at times be a near-impossible task." Id. (citing Elkind v. Liggett & Myers, Inc. , 635 F.2d 156, 171 (2d Cir. 1980)). Disgorgement, therefore, "need only be a reasonable approximation of profits causally connected to the violation." Id. The Commission recently held that, in some instances, "the nature of the misconduct . . . requires [findings of] specific and particular facts about each customer" who was defrauded in order to fairly calculate an amount to be disgorged. Joseph J. Barbato , Exchange Act Rel. No. 41034, 1999 WL 58922, at *13 (Feb. 10, 1999). Where the fraud is systematic and pervasive, however, the Commission is not required to demonstrate a precise nexus between the violative conduct and the disgorgement figure. First City , 890 F.2d at 1232 (citing CFTC v. British Am. Commodity Options Corp. , 788 F.2d 92 (D.C. Cir. 1989)).
Once the government presumptively shows that its disgorgement figure reasonably approximates the amount of unjust enrichment, the burden shifts to the respondent to clearly demonstrate that the disgorgement figure is not a reasonable approximation. SEC v. Lorin , 76 F.3d 458, 462 (2d Cir. 1996); SEC v. Patel , 61 F.3d 137, 140 (2d Cir. 1995); First City , 890 F.2d at 1232. Any risk of uncertainty as to the disgorgement amount "should fall on the wrongdoer whose illegal conduct created that uncertainty." First City , 890 F.2d at 1232 (citations omitted). Furthermore, the "gains" targeted for disgorgement need not be limited to "profits"; they may include all illegal payments received. SEC v. Blavin , 760 F.2d 706, 713 (6th Cir. 1985); see also Great Lakes Equities Co. , 775 F. Supp. 211, 214 (E.D. Mich. 1991) (the benefit or unjust enrichment of a respondent includes not only what it gets to keep in its pocket after the fraud, but also the value of the other benefits the wrongdoer receives through the scheme). In calculating the disgorgement amount, the Commission is not required to take into account expenses incurred by the respondent in the course of perpetrating the scheme. Great Lakes , 775 F. Supp. at 214-15.
The Commission has stated that disgorgement "may be ordered only against those who received such unjust enrichment." Kenneth L. Lucas , 51 S.E.C. at 1046 (footnotes omitted) (citing First City , 890 F.2d at 1231; Hateley , 8 F.3d at 656). In cases where an individual respondent's actions are inextricably interwoven with those of a business entity, joint and several liability is appropriate. Great Lakes , 775 F. Supp. at 214-15; SEC v. R.J. Allen & Assocs., Inc. , 386 F. Supp 866, 881 (S.D. Fla. 1974). Where an enterprise serves as a vehicle for fraud, disgorgement of salaries may be ordered. CFTC v. British Am. Commodity Options Corp. , 788 F.2d at 94; Kelley v. Carr , 567 F. Supp. 831, 840 (W.D. Mich. 1983).
B. Civil Money Penalty
The Division seeks imposition of monetary penalties against Usher, Lehl, Smith Benton, Zaman, Hellen, Moler pursuant to Exchange Act Section 21B(a). (OIP ¶ XI.B; Division Brief at 61, 72-77.)
The assessment of a penalty pursuant to Section 21B of the Exchange Act depends on a finding that such assessment is in the public interest. New Allied Dev. Corp. , 63 SEC Docket 807, 821 (Nov. 26, 1996); First Sec. Transfer Sys., Inc. , 60 SEC Docket 441, 446 (Sept. 1, 1995). A three-tier system for assessing the maximum amount of penalty is specified in Section 21B(b). For each violation, the maximum amount of penalty in the first tier is $5,000 for a natural person or $50,000 for any other person; in the second tier it is $50,000 for a natural person or $250,000 for any other person; 65 and in the third tier it is $100,000 for a natural person or $500,000 for any other person. 66
Factors that may be considered in determining whether a penalty is in the public interest and determining the amount of the penalty are specified in Section 21B(c). See New Allied , 63 SEC Docket at 821; First Sec. , 60 SEC Docket at 446, 447 n.15 (Section 21B(a) requires that the public interest finding supports the amount of a particular assessment, not merely the general decision to assess a penalty, and, therefore, allows the assessment of lesser amounts up to the maximum). These factors include: (i) whether the violation involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement; (ii) the harm to other persons resulting either directly or indirectly from such violation; (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 person has been found to have violated the federal securities laws, or has been enjoined by a court for such violations; (v) the need to deter such person and other persons from committing such violations; and (vi) such other matters as justice may require.
C. Cease and Desist
The Division seeks cease and desist orders as to all Respondents. (OIP ¶ XI.C; Division Brief at 63-64.) The Commission may impose a cease and desist order pursuant to Section 8A(a) of the Securities Act and Section 21C(a) of the Exchange Act if the Commission finds that any person is violating, has violated, or is about to violate any rule or regulation. An order may issue absent a finding that a Respondent is apt to commit violations in the future, though evidence suggesting the probability of prospective violations may be relevant in deciding whether to issue an order.
Sections 15(b) and 19(h) of the Exchange Act authorize the Commission to order a wide range of sanctions restricting the ability of brokers, dealers and those associated with, or seeking to become associated with, brokers or dealers, to serve in the securities industry if the Commission determines that person has committed certain wrongful acts. 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, or a member of a national stock exchange or of a registered securities association. Meyer Blinder , 65 SEC Docket 1970, 1974-75 (Oct. 1, 1997). Collateral bars are appropriate "in cases where it is contrary to the public interest to allow someone to serve in any capacity in the securities industry." Id. at 1981. 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. Misconduct that could be committed in various capacities within the securities professions is sufficient to satisfy the "flows across" requirement. Ted Harold Westerfield , Exchange Act Rel. No. 41126, 1999 WL 100954, at *5 & n.30 (Mar. 1, 1999). 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." Meyer Blinder , 65 SEC Docket at 1981.
The Division recommends the imposition of collateral sanctions on Usher, Lehl, Zaman and Hellen. (Division Brief at 71-76.) It further recommends that Strategic's broker-dealer registration be suspended for 90 days, and that Moler be barred from association with any broker or dealer with a right to reapply in 18 months. (Division Brief at 77.)
E. Public Interest
The governing standard in assessing the propriety of administrative sanctions is whether the sanctions serve the public interest. See Terry T. Steen , 67 SEC Docket at 0844. The public interest analysis demands that several factors be considered, including: (1) the egregiousness of the respondent's actions; (2) the isolated or recurrent nature of the infraction; (3) the degree of scienter involved; (4) the sincerity of the respondent's assurances against future violations; (5) the respondent's recognition of the wrongful nature of his conduct; and (6) the likelihood that his occupation will present opportunities for future violations. Steadman v. SEC , 603 F.2d 1126, 1140 (5th Cir. 1979) (quoting Blatt , 583 F.2d at 1334 n.29 (5th Cir. 1978)), aff'd on other grounds , 450 U.S. 91 (1981). 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 , 46 S.E.C. at 254 n.67 (1976). Sanctions should demonstrate to the particular respondent, the industry and the public generally that egregious conduct will elicit a harsh response. Arthur Lipper Corp. v. SEC , 547 F.2d 171, 184 (2d Cir. 1976).
F. Individual Respondents
Public Interest . Foster was responsible for a series of false Commission filings and he engaged in additional misconduct that advanced the fraudulent scheme. Foster is a CPA who used his expertise to perpetrate a systematic and pervasive fraud on public investors over a span of several years. His misconduct merits strong condemnation.
Disgorgement . As Sky's Executive Vice President, Foster was compensated at a rate of $42,000 per year. (Div. Ex. 96 at 160.) The Division seeks disgorgement of his salary from 1993 and 1994 in the amount of $84,000, plus prejudgment interest. Foster claims he did not receive much of that salary. (Div. Ex. 96 at 160; Foster Brief at 4.) He bears the burden of establishing that the Division's estimate is unreasonable.
The company's 1995 Form 10-KSB shows that Foster was still owed $54,675 in salary for the 1993 and 1994 fiscal years. (Div. Ex. 2hh at 38; Foster Brief at 4.) In his investigative testimony, which was taken in September 1994, he states: "I am making $42,000 a year of which I'm owed 50-some of that." (Div. Ex. 96 at 160.) Thus, Foster's testimony is consistent with the annual report. This is sufficient to establish that the Division's estimate is unreasonable. It is clear, however, that Foster did receive some payment from the Company for his participation in the scheme. As a control person of a corporation used to perpetrate a fraud, any salary he received constitutes ill-gotten gains and is subject to disgorgement. In addition, Foster's conduct provides a sufficient causal nexus to the funds targeted for disgorgement. He received payments from Sky as compensation for, at a minimum, the preparation and review of fraudulent Commission filings. I therefore find it appropriate and in the public interest for Foster to disgorge $29,325, which sum represents the salary he received in 1993 and 1994, plus prejudgment interest. 67
Cease and Desist . Foster states that he "gladly consent[s]" to a cease and desist order, and assures the Commission that he "no longer acts or intends to act as Financial Officer with respect to any company with registered securities." (Foster Brief at 3.) Consequently, I find it appropriate to order Foster to cease and desist from violating and Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; and from causing violations of Section 13(a), 13(b)(2)(A), and Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13, and 13b2-1 thereunder of the Exchange Act.
2. Schlien and ACN
Public Interest . Schlien is a repeat violator of state and federal securities laws. 68 By his conduct in furtherance of the Sky scheme he has demonstrated his ability to defraud the public out of millions of dollars. His past conduct makes it likely that he will attempt to engage in illegal conduct in the future.
Schlien, acting as ACN's alter ego, orchestrated a deceptive public relations campaign designed to create a market for the sale of millions of shares of unregistered stock. The scheme involved both the widespread distribution of tout sheets, and manipulation of the market through illegal trading practices. He also established a network of broker-dealers willing to solicit purchasers.
Disgorgement . The Division has established that Schlien and ACN received $2,606,729, which was causally connected to the public distribution of unregistered Sky stock and the fraudulent scheme. This amount includes funds that went to ACN from the Canaccord accounts. (Div. Ex. 7f; 7g.) Schlien and ACN have failed to clearly demonstrate that this figure is an unreasonable approximation of the amount by which they were unjustly enriched. Accordingly, I find that Schlien and ACN should be ordered to disgorge that amount, plus prejudgment interest. Schlien and ACN are jointly and severally liable for the amount of disgorgement.
Cease and Desist . Schlien and ACN shall also be ordered to cease and desist from committing further violations of Sections 5(a), 5(c), 17(a) and 17(b) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Public Interest . Levine was an indispensable Schlien operative who recruited nominees, published tout sheets, and performed other functions designed to further the fraud and the related public distribution of unregistered Sky stock. He was involved with the enterprise from its infancy, admits no wrongdoing, and shows no contrition.
Disgorgement . The Division recommends that Levine be ordered to disgorge $79,350 he received from Schlien and ACN, plus prejudgment interest. (Division Brief at 70.) The bulk of the amount sought, $70,850, came from ACN's bank account. 69 (Div. Ex. 7f; 7g at 8.) He contends that disgorgement of the $70,850 is inappropriate because the Division has failed to show "that all of the monies in [the ACN account] were generated from the sales of Sky stock." (Promoter Brief at 14.) As set out above in Section XII.A, there must be a causal relationship between the wrongdoing and the property targeted for disgorgement. However, separating legal from illegal profits may be exceptionally difficult, and the Division is only required to show the amount sought is a reasonable approximation of profits causally linked to the violation. In the instant case, the Division has easily met its burden. Division Exhibit 7g shows that, between November 1993 and December 1994, wires from Canaccord into the ACN bank account totaled $1,053,000. (Div. Ex. 7g at 4-5.) Checks to Levine drawn on the same account during that period total $70,850. (Div. Ex. 7g at 8.) The funds in the Canaccord account were proceeds from the public distribution of unregistered Sky stock; the subsequent disbursement to Levine was compensation for his participation in the distribution and the attendant scheme to defraud. This evidence is more than sufficient to meet both the "reasonable approximation" threshold, as well as the nexus requirement. Levine bears the burden of showing that it is unreasonable. See Lorin , 76 F.3d at 462; Patel , 61 F.3d at 140; First City , 890 F.2d at 1232. He offers no evidence in support of this contention. Thus, his argument fails.
It is appropriate and in the public interest to order Levine to disgorge the full amount sought by the Commission, $79,350, plus prejudgment interest.
Cease and Desist . Levine will also be ordered to cease and desist from further violations of Sections 5(a), 5(c), 17(a) and 17(b) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Public Interest . Jones has been sanctioned several times for violating state and federal securities laws. 70 In the instant proceeding, Jones not only refuses to acknowledge any wrongful conduct on his part, he stops just shy of denying any involvement with Schlien. The evidence shows that he played a pivotal role in furthering the scheme to condition and manipulate the market for Sky stock, and in the distribution of unregistered shares of the stock.
Disgorgement . Jones received $4,546,500 from the sales of unregistered Sky stock. In his post-hearing brief, Jones argues that BBL was the recipient of these payments, that BBL is not a respondent in this action, and that there are insufficient grounds for piercing the corporate veil to reach Jones personally for disgorgement. (Promoter Brief at 13.) I am not persuaded by his argument. First, the Division has shown that Jones personally received $1,951,500 out of the funds that were deposited into BBL's NationsBank account. (Div. Ex. 7f; 7g at 10-11.) Second, the Division has demonstrated that BBL was a vehicle Jones used to advance the Sky fraud. Jones and BBL were one and the same. It is of no consequence that BBL is not a respondent in this proceeding. Thus, Jones' misdeeds defeat his attempt to shield himself and his ill-gotten gains with the corporate form.
The Division has established that Jones received $4,546,500, which was causally connected to his participation in the unregistered distribution of Sky stock and the fraudulent scheme. Proceeds from the sale of the stock were routed through the Canaccord accounts and into the accounts of Jones and BBL. Jones has failed to clearly demonstrate that this figure is an unreasonable approximation of the extent to which he was unjustly enriched. It is therefore appropriate to order disgorgement of the amount of ill-gotten gains transferred to BBL and Jones, plus prejudgment interest.
Cease and Desist . Jones will also be ordered to cease and desist from committing or causing any violations or future violations of Sections 5(a), 5(c), 17(a) and 17(b) of the Securities Act and Section 10(b) and Rule 10b-5 of the Exchange Act.
Public Interest . Georgeson engaged in significant promotional activities in furtherance of the scheme. He transmitted information to Schlien and Jones that he knew would be used to manipulate the price of Sky stock, distributed tout sheets to broker-dealers, and participated in the unregistered distribution. He has a history of violating securities laws. 71
Disgorgement . The Division has established that Georgeson was unjustly enriched by $273,572 as a direct result of his participation in the unregistered distribution of Sky stock and the fraudulent scheme. (Div. Ex. 7f; 7g at 12.) Georgeson has failed to demonstrate that this figure is unreasonable, and he will therefore be ordered to disgorge the $273,572 he received plus prejudgment interest.
Cease and Desist . In addition, Georgeson will be ordered to cease and desist from committing further violations of Sections 5(a), 5(c), and 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
6. Smith Benton
Public Interest . Smith Benton and its agents furthered the scheme to defraud, and also participated in the unregistered distribution of Sky stock. The firm has a history of violating securities laws. 72 Smith Benton withdrew its registration as a broker-dealer by filing a Form BD-W dated April 22, 1998 with the Commission and the NASD. ( See Smith Benton Brief at 2.)
Disgorgement . Smith Benton realized $536,921 from the sale of shares of Sky stock. The entire amount of the proceeds the firm received as a result of its participation in the scheme to defraud and the unregistered distribution is subject to disgorgement. The firm has failed to show that this amount is unreasonable. Smith Benton will, therefore, be held jointly and severally liable with Zaman to disgorge the amount of the proceeds from the firm's sale of Sky stock, $536,921, plus prejudgment interest.
Penalty . A third-tier civil monetary penalty of $250,000 will be assessed against the firm based upon the public interest factors mentioned above, and my specific finding that Smith Benton's violation involved fraud and resulted in substantial losses or created the risk of substantial losses to other persons. It also resulted in substantial pecuniary gain to Smith Benton.
Cease and Desist . A cease-and-desist order will not be issued as to Smith Benton because it has withdrawn its registration.
Public Interest . The evidence shows that, in the instant matter, Zaman recommended or allowed agents under his control to recommend Sky to Smith Benton customers without a reasonable basis. At a minimum, he condoned the fraudulent sales practice of using Wall Street Watch to solicit customers. He also ignored bright red flags indicating the shares being sold were unregistered. In fact, he did almost nothing to investigate a security he must have regarded as highly suspect. Furthermore, Zaman not only failed to accept responsibility for his misconduct, he blamed Hellen, Georgeson, the NASD, the Commission, the Department of Justice, and Smith Benton customers for the damage he caused. (Tr. 898, 905, 938, 964, 1589, 1598-1601.) Zaman has a history of violating securities laws. 73
Disgorgement . Zaman is jointly and severally liable with Smith Benton for the amount of disgorgement, $536,921, and prejudgment interest. This amount represents the ill-gotten gains Zaman and Smith Benton received as a result of their participation in the unregistered distribution of Sky stock as well as the scheme to defraud.
Civil Penalty . It is appropriate and in the public interest for Zaman to pay a third tier civil money penalty of $175,000. This amount is based on the factors cited in the public interest analysis above, and on my specific finding that Zaman's violations involved fraud and resulted in substantial pecuniary gain to him, and resulted in substantial losses or created the risk of substantial losses to other persons.
Cease and Desist . It is also necessary to order Zaman to cease and desist from committing further violations of Sections 5(a), 5(c), and 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Collateral Bar . Zaman's misconduct with regard to Sky stock is the type that flows across various securities professions, and is sufficiently egregious to merit a sweeping prohibition in order to protect the public. Notwithstanding his representation in his post-hearing brief that he has "no intention of ever rejoining the securities industry," (Smith Benton Brief at 2), and the fact that the Commission has already imposed a collateral bar on him, I shall issue an order barring Zaman from association with any broker, dealer, investment adviser, investment company, municipal securities dealer, or a member of a registered securities association or of a national stock exchange based on his conduct in furtherance of the scheme to defraud involving Sky stock.
Public Interest . Hellen fraudulently recommended Sky to his own customers, and exhorted Smith Benton sales agents to do likewise. He also participated in the unregistered public distribution of Sky stock. He has a history of violating securities laws. 74
Disgorgement . The Division has shown that Hellen received $12,962 in payments from Smith Benton for his participation in the fraudulent scheme and the unregistered distribution of Sky stock. He has failed to demonstrate that this amount is an unreasonable estimate of his ill-gotten gains. I will, therefore, order Hellen to disgorge $12,962 he received from Smith Benton.
Civil Penalty . Hellen will be ordered to pay a third-tier civil monetary penalty in the amount of $150,000. This amount is supported by the public interest analysis set out above, and my finding that Hellen's violations involved fraud and resulted in substantial losses or created the risk of substantial losses to other persons.
Cease and Desist . Hellen will be ordered to cease and desist from further violation of Sections 5(a), 5(c), and 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Collateral Bar . By his particularly egregious conduct in furtherance of this scheme Hellen has shown that he is inclined to exploit the investing public. His behavior is clearly the type that is likely to flow across all areas of the securities industry. Hellen will be barred from association with any broker, dealer, investment adviser, investment company, municipal securities dealer, or a member of a registered securities association or of a national stock exchange.
9. Gilbert Marshall
Public Interest . Gilbert Marshall has been sanctioned for violations of state and federal securities laws on numerous occasions. 75 Along with Usher, the firm played a substantial role in advancing the fraudulent sale of unregistered Sky stock. They also perpetrated a separate fraudulent scheme involving illegal markups.
Disgorgement . Lehl's branch of Gilbert Marshall sold $5,435,183 worth of Sky stock to customers during the relevant period. These proceeds constitute ill-gotten gains the firm received as a result of its participation in the fraudulent schemes, and the unregistered distribution of Sky stock. The firm has failed to show that this amount is unreasonable. It will be ordered jointly and severally with Usher to disgorge this amount, plus prejudgment interest.
Cease and Desist and Revocation . Gilbert Marshall represents that it is out of business. (Gilbert Marshall Brief at 28.) According to Commission records, Gilbert Marshall attempted to withdraw its broker-dealer registration in June 1997. The Form BD-W it filed was defective, however, and the Commission's request to cure the defects and resubmit the Form was ignored. Gilbert Marshall is, therefore, still registered with the Commission. It is necessary and in the public interest to revoke Gilbert Marshall's registration. Thus, a cease-and-desist order will not be issued as to Gilbert Marshall.
Public Interest . The Division has demonstrated that Usher failed to adequately and reasonably investigate Sky before authorizing his agents to recommend it to customers. He also disregarded evidence that the agents were engaging in fraudulent sales tactics, including the use of tout sheets and scripts, to sell Sky. He charged Gilbert Marshall customers excessive undisclosed markups on hundreds of transactions. Although Gilbert Marshall is no longer in business, Usher has indicated that he will continue to seek work in the securities industry. ( See Tr. 745-46.)
Usher has violated securities laws in the past. 76 He contends that his disciplinary troubles and those of Gilbert Marshall arise out of the activities of the Denver branch over a fairly short period of time. (Gilbert Marshall Brief at 28.) While I acknowledge these contentions are accurate, the weight of the evidence shows that Usher facilitated and allowed fraudulent conduct to occur in that branch office.
Disgorgement . Usher and Gilbert Marshall received $5,435,183 in proceeds from the sale of Sky stock. This sum constitutes ill-gotten gains Usher and the firm received as a result of their participation in the schemes to defraud and the unregistered distribution of Sky stock. Usher has failed to show that this amount is an unreasonable approximation of the benefits he and the firm received as a consequence of his misconduct. Usher will therefore be ordered to disgorge $5,435,183 plus prejudgment interest.
Penalty . It is appropriate and in the public interest to order Usher to pay a third-tier civil penalty of $250,000. This amount is based on the factors cited in the public interest analysis above, and on my specific finding that Usher's violations involved fraud and resulted in substantial pecuniary gain to him, and resulted in substantial losses or created the risk of substantial losses to other persons.
Cease and Desist . Usher will be ordered to cease and desist from further violation of Sections 5(a), 5(c), and 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Bar . Usher's misconduct is the type of that tends to flow across the securities industry, and it is sufficiently egregious as to merit imposition of a collateral bar. He defrauded Gilbert Marshall customers out of millions of dollars. Usher will be barred from association with any broker, dealer, investment adviser, investment company, municipal securities dealer, or a member of a registered securities association or of a national stock exchange.
Public Interest . When Strategic would no longer allow Lehl to sell Sky stock, he left that firm for one that permitted him to continue selling it. He ran the sales operation at the Denver office of Gilbert Marshall, where he and his sales force defrauded their customers. After Lehl left Gilbert Marshall in September 1994, Schlien got him a job as a promoter for a Sky subsidiary called Jockey Club. (Div. Exs. 2hh at 3; 91 at 168, 184-86.) As of May 3, 1995, he was working on a mass mailer for Jockey Club, which he described as "[s]omething similar" to Wall Street Watch. (Div. Ex. 91 at 188-89.) He has a history of violating securities laws. 77
Disgorgement . The Division has shown that Lehl received a total of $269,759 for his role in the fraudulent scheme and the unregistered distribution. He has failed to show that this amount is an unreasonable approximation of his ill-gotten gains. He will be ordered to disgorge that amount plus prejudgment interest.
Civil Penalty . Lehl will be ordered to pay a third-tier civil monetary penalty of $350,000. This amount is supported by the public interest analysis set out above, and my finding that Lehl's violations involved fraud and resulted in substantial losses or created the risk of substantial losses to other persons. In addition, Lehl realized substantial pecuniary gains as a result of his conduct.
Cease and Desist . Lehl will be ordered to cease and desist from further violations of Sections 5(a), 5(c), and 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Collateral Bar . Lehl's conduct is, by its nature, likely to flow across other areas of the securities industry, and it is sufficiently egregious to warrant imposition of an industry-wide bar. He directly cheated his own customers, and encouraged sales agents under his control to cheat their customers. He has shown flagrant disregard for the laws and regulations governing the securities industry. Consequently, Lehl will be barred from association with any broker, dealer, investment adviser, investment company, municipal securities dealer, or a member of a registered securities association or of a national stock exchange.
12. Strategic and Moler
Public Interest . These Respondents charged Strategic customers excessive undisclosed markups on approximately 115 transactions involving Sky stock, from which they derived considerable revenues. Moler was in charge of the firm's pricing policies, and was well aware of the governing legal standards for pricing the stock.
Disgorgement . Strategic and Moler will be ordered to jointly and severally disgorge the amount they received as a result of charging customers excessive undisclosed markups, $68,469, plus prejudgment interest. These Respondents have failed to demonstrate that this amount is an unreasonable estimation of the extent to which they benefited from the markups scheme.
Penalty . Moler's conduct involved fraud and the intentional disregard of a regulatory requirement; it resulted in substantial pecuniary gain to Moler and resulted in substantial losses or created the risk of substantial losses to other persons. The Division recommends, and I will order, that a $50,000 third-tier penalty be assessed against Moler.
Cease and Desist . Respondents Strategic and Moler will be ordered to cease and desist from further violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Suspension of Registration and Bar . The Division recommends a 90-day suspension of Strategic's broker-dealer registration. It also recommends that Moler be barred from association with any broker or dealer with a right to reapply in 18 months. (Division Brief at 77.) Under the circumstances, it is in the public interest to order the suspension and the bar.
Based on the findings and conclusions set forth above, pursuant to Section 8A of the Securities Act and Sections 15(b), 19(h), 21B, and 21C of the Exchange Act, I ORDER the following.
(1) Respondent Jerry L. Foster shall disgorge $29,325, plus prejudgment interest from January 1, 1997 through the last day of the month preceding the month in which payment of disgorgement is made.
(2) Respondent Jerry L. Foster shall cease and desist from committing any violations or future violations of Sections 17(a) of the Securities Act, and Section 10(b) and Rule 10b-5 thereunder of the Exchange Act; he shall cease and desist from committing or causing any violations or future violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, 13a-13, and 13b2-1 thereunder.
(3) Respondent Robert Schlien and American Capital Network, Inc. shall, jointly and severally, disgorge $2,606,729, plus prejudgment interest from July 1, 1995 through the last day of the month preceding the month in which payment of disgorgement is made.
(4) Respondents Robert Schlien and American Capital Network, Inc. shall cease and desist from committing any violations or future violations of Sections 5(a), 5(c), 17(a) and 17(b) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
(5) Respondent Melvin L. Levine shall disgorge $79,350, plus prejudgment interest from July 1, 1995 through the last day of the month preceding the month in which payment of disgorgement is made.
(6) Respondent Melvin L. Levine shall cease and desist from committing any violations or future violations of Sections 5(a), 5(c), 17(a) and 17(b) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
(7) Respondent William David Jones shall disgorge $4,546,500, plus prejudgment interest from July 1, 1995 through the last day of the month preceding the month in which payment of disgorgement is made.
(8) Respondent William David Jones shall cease and desist from committing any violations or future violations of Sections 5(a), 5(c), 17(a) and 17(b) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
(9) Respondent Philip M. Georgeson shall disgorge $273,572, plus prejudgment interest from July 1, 1995 through the last day of the month preceding the month in which payment of disgorgement is made.
(10) Respondent Philip M. Georgeson shall cease and desist from committing any violations or future violations of Sections 5(a), 5(c), and 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
(11) Respondents Michael Zaman and Smith, Benton & Hughes, Inc. shall, jointly and severally, disgorge $536,921 plus prejudgment interest from November 1, 1994 through the last day of the month preceding the month in which payment of disgorgement is made.
(12) Respondent Smith, Benton & Hughes, Inc. shall pay a civil penalty of $250,000.
(13) Respondent Michael Zaman shall pay a civil penalty of $175,000.
(14) Respondent Michael Zaman shall cease and desist from committing any violations or future violations of Sections 5(a), 5(c), and 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
(15) Respondent Michael Zaman is barred from association with any broker, dealer, investment adviser, investment company, municipal securities dealer, or a member of a registered securities association or of a national stock exchange.
(16) Respondent George T. Hellen shall disgorge $12,962, plus prejudgment interest from November 1, 1994 through the last day of the month preceding the month in which payment of disgorgement is made.
(17) Respondent George T. Hellen shall pay a civil penalty of $150,000.
(18) Respondent George T. Hellen shall cease and desist from committing any violations or future violations of Sections 5(a), 5(c), and 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
(19) Respondent George T. Hellen is barred from association with any broker, dealer, investment adviser, investment company, municipal securities dealer, or a member of a registered securities association or of a national stock exchange.
(20) Respondents Gilbert Marshall & Co. and Michael A. Usher shall disgorge, jointly and severally, $5,435,183, plus prejudgment interest from December 1, 1994 through the last day of the month preceding the month in which payment of disgorgement is made.
(21) The registration of Respondent Gilbert Marshall & Co. is revoked.
(22) Respondent Michael A. Usher shall pay a civil penalty of $250,000.
(23) Respondent Michael A. Usher shall cease and desist from committing any violations or future violations of Sections 5(a), 5(c), and 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
(24) Respondent Michael A. Usher is barred from association with any broker, dealer, investment adviser, investment company, municipal securities dealer, or a member of a registered securities association or of a national stock exchange.
(25) Respondent Daniel R. Lehl shall disgorge $269,759 plus prejudgment interest from October 1, 1994 through the last day of the month preceding the month in which payment of disgorgement is made.
(26) Respondent Daniel R. Lehl shall pay a civil penalty of $350,000.
(27) Respondent Daniel R. Lehl shall cease and desist from committing any violations or future violations of Sections 5(a), 5(c), and 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
(28) Respondent Daniel R. Lehl is barred from association with any broker, dealer, investment adviser, investment company, municipal securities dealer, or a member of a registered securities association or of a national stock exchange.
(29) Respondents Strategic Resource Management, Inc. and William A. Moler shall disgorge, jointly and severally, $68,469, plus prejudgment interest from March 1, 1994 through the last day of the month preceding the month in which payment of disgorgement is made.
(30) Respondent William A. Moler shall pay a civil penalty of $50,000.
(31) Respondents Strategic Resource Management, Inc., and William A. Moler shall cease and desist from committing any violations or future violations of Section 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
(32) The registration of Respondent Strategic Resource Management, Inc. is suspended for 90 days.
(33) Respondent William A. Moler is barred from association with any broker or dealer with a right to reapply in 18 months.
The dates set for the commencement of interest accrual on the disgorgement figures are the first days of the months following the end of the period during which each Respondent's violations occurred. The rate of interest shall be that established under Section 6621(a)(2) of the Internal Revenue Code, compounded quarterly. 17 C.F.R. § 201.600(b).
Payment of penalty and disgorgement 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 and the proceeding designation, Administrative Proceeding No. 3-9201, 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.
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.
1 The accounting records and false filings allegations made against Respondent Jerry L. Foster (Foster) relate to the period from April 1993 to December 1996. (OIP ¶¶ VII, VIII.)
Of the eighteen Respondents charged in the OIP, fourteen remain in the proceeding. Respondents Sky Scientific, Inc. (Sky), Walter Arlan Dorow, Jr. (Dorow), and Douglas A. Glaser (Glaser) defaulted.
Sky Scientific, Inc.
, 65 SEC Docket 2579 (Nov. 7, 1997);
Walter A. Dorow
, 65 SEC Docket 2278 (Oct. 22, 1997);
Douglas A. Glaser
, 64 SEC Docket 0575 (Apr. 3, 1997). Respondent Thomas Patrick Meehan (Meehan) entered a settlement with the Commission on August 18, 1997.
Thomas Patrick Meehan
, 65 SEC Docket 0542 (Aug. 18, 1997).
3 I will refer to Division exhibits as "(Div. Ex. __ )" and to Respondents' exhibits as "([Name] Ex. __ )." I will refer to the transcript as "(Tr. __ )" or "(Tr. [Date] __ )."
4 I will refer to the Respondents' post-hearing filings as follows: the post-hearing brief of Jones, ACN, Schlien, and Levine will be cited as "(Promoter Brief __ )"; Foster's post-hearing brief will be cited as "(Foster Brief __ )"; the post-hearing brief filed by Strategic and Moler will be cited as "(Strategic Brief __ )"; the post-hearing brief of Gilbert Marshall and Usher will be cited as "(Gilbert Marshall Brief __ )"; the post-hearing brief of Smith Benton and Zaman will be cited as "(Smith Benton Brief __ )." Respondents Jones, ACN, Schlien, and Levine also filed proposed findings of fact and conclusions of law, which will be cited as "(Promoter Findings __ )."
5 The Division's post-hearing, reply, and supplemental briefs will be cited as "(Division Brief __ )," "(Reply Brief __ )," "(Supp. Brief Concerning Jones __ )," and "(Supp. Brief Concerning Smith Benton & Zaman __ )" respectively. The Division's proposed findings of fact and conclusions of law will be cited as "(Division Findings __ )."
6 Respondents Gilbert Marshall and Usher opposed the Division's prehearing motion to admit Glaser's testimony. The Respondents argued that admitting the transcript would deprive them of an opportunity to cross examine Glaser. (Response of Gilbert Marshall 8/18/97 at 2.) At the hearing, Respondents Schlien, Levine, Jones, and ACN joined Gilbert Marshall and Usher in objecting to the admission of the Glaser transcript. (Tr. 830.)
7 The findings set forth in this Section are incorporated by reference into the other Sections of the decision, with the exception of Sections VIII and XI.F.12; likewise, additional findings contained in the other Sections are incorporated into this Section by reference, with the exception of findings related solely to alleged markups violations.
8 Dorow was chairman and CEO of Sky from at least March 29, 1993 until at least June 13, 1995. (Div. Exs. 2s at 51; 2hh at 37.) He invoked the Fifth Amendment and refused to testify at the hearing in this matter. (Tr. 739-40.)
9 A shell corporation is one which has "ceased active operations, or which [has] little or no assets . . . and which [has] a substantial number of shares outstanding, generally in the hands of the public." Spin Offs of Securities and Trading in the Securities of Inactive or Shell Companies , 1 Fed. Sec. L. Rept. (CCH) ¶ 3055 at 3063 (July 2, 1969).
10 At various times during the relevant period, Sky also dabbled in other businesses, including a financial services company and the "first riverboat casino" in Moscow, Russia. (Div. Exs. 1aa, 9a-9c.)
11 The public company retained the name Winners Circle until November 1993 when it was changed to Sky Scientific, Inc. (Div. Exs. 1x; 2s at 28.) The entity will be referred to as "Sky" or "the company" in the decision.
12 Market capitalization is the "value of a corporation as determined by the market price of its issued and outstanding common stock. It is calculated by multiplying the number of outstanding shares by the current market price of a share." Barron's Dictionary of Finance and Investment Terms 323-24 (4th ed. 1995).
13 Between May 31, 1993 and November 30, 1994 Sky issued approximately 63.5 million shares of common stock. Twenty-four million of those shares were unrestricted, and registered on Form S-8 filings. (Div. Exs. 7a, 7b.) Form S-8 permits an issuer to issue stock to employees, consultants, and advisors who render bona fide services to the issuer, provided the services are not rendered in connection with the offer or sale of securities in a capital-raising transaction. General Instruction A.1(a) to Form S-8 . Advantages of using Form S-8 to register securities include: (1) elimination of the need to file an additional prospectus; (2) automatic effectiveness of the registration upon filing and; (3) simplified procedures for the registration of additional securities. See Susan Cooper Philpot, Form S-8: Registered Offerings Under Employee Benefit Plans , 1081 PLI/Corp. 449, 453 (1998).
14 Notwithstanding the repeated and massive infusions of stock into the market, the price never dropped below $.38 per share during 1993 or 1994. (Div. Exs. 2s at 23; 2hh at 15; 7a.)
15 This service supplies the investing public and securities professionals with information about public companies. (Tr. 76-79, 1147.)
16 The July 1994 Wall Street Watch went so far as to claim, in large bold type, $3.7 billion in "proven gold reserves" and "probable reserves" of $5 billion "or more." (Div. Ex. 9a (emphasis added.))
17 The company failed to make regular payments toward the purchase of one of its most prized properties -- the Bowerman Project, with its nine mines containing $192 million in "probable reserves" -- and was removed from the property in December 1993. (Div. Exs. 9a, 30c; Tr. 369-70.)
18 Achuff did observe that a processing mill was under construction on the Tallulah property. (Tr. 560.)
19 Forest Service employee Albert W. Buchter visited the Evergreen property during 1992, 1993, and 1994. He testified that no mining activities occurred on the property during that time. (Tr. 320-22.) Garst visited the Tallulah property frequently during 1994, and he testified that neither full-time mining nor milling took place on the property. (Tr. 284-96, 301, 307.) Roger Hall, a geologist Sky hired to evaluate the Danner property, visited Danner in January 1994. He reported to the company that at least two years of extensive exploration would be required to determine whether the property could be mined. (Div. Ex. 35; Tr. 266-74, 279.)
20 Specifically, these practices are proscribed by Accounting Principles Board (APB) Opinion Nos. 16 and 29.
21 I also credit Patten's opinion that many of the irregularities in Sky's financial statements caused by the company's accounting practices constitute "red flags." (Tr. 118, 154-59.) This issue is addressed in greater detail below.
22 Sky also gave promissory notes in exchange for assets. (Tr. 127.)
Andrey Koslov, Deputy Chairman and Chief of the Securities Division of the Central Bank of Russia, declared the certificates to be fraudulent. According to Koslov, they "are not actual deposit certificates issued by a bank of the Russian Federation." (Div. Ex. 44 at 2.)
24 Patten cited Auditing Standard No. 59 in defining a going concern qualification. (Tr. 121-22.) Auditing Standard No. 59 states, in pertinent part: "If, after considering identified conditions and events and management's plans, the auditor concludes that substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time remains, the audit report should contain an explanatory paragraph." The Auditors Consideration of An Entity's Ability to Continue as a Going Concern, Statement on Auditing Standards No. 59, § 2 (American Inst. of Certified Pub. Accountants 1988).
25 See Auditing Standard No. 59 at § 6.
26 Unless otherwise indicated, Schlien and ACN are collectively referred to as "Schlien."
27 The Commission has defined "wash trades" as securities transactions that involve no change in the securities' beneficial ownership. Swartwood, Hesse, Inc. , 50 S.E.C. 1301, 1306 n.12 (1992) (citation omitted).
28 Levine had no written consulting agreement with Sky. (Div. Ex. 86 at 51.)
29 For a definition of S-8 stock, see note 13 above.
30 The Canaccord accounts and the function they served in advancing the scheme are described in greater detail below in Section II.C.3.
31 Out of the $12,593,339 raised from sale of Sky stock from Canaccord accounts, $4,333,500 was wired into BBL's NationsBank account. BBL received an additional $213,000 from ACN's Citibank account. (Div. Ex. 7f; Tr. 635-36.) Jones personally received at least $1,951,500 of those funds. (Div. Ex. 7f; 7g at 10-11.)
32 Georgeson was doing business under the name Capital Communications. (Div. Ex. 7f, 7g, 57a; Tr. 658.)
33 Georgeson also received a commission on the amount of Sky stock sold by another brokerage firm, Patterson Travis. (Tr. 687.)
34 Georgeson was not involved in the production of the tout sheets, but did participate in their distribution.
35 The Chicago Financial Services newsletters had a similar "coupon" attached. (Div. Exs. 10a, 10b, 10d.)
36 Weinstein asserted his Fifth Amendment privilege and refused to answer any questions when called by the Division as a witness in this matter. (Tr. 420-26.)
37 Gilbert Marshall purchased 7,781,690 shares; Smith Benton purchased 2,515,000 shares; Strategic purchased 1,488,000 shares. (Div. Ex. 7h.)
38 Georgeson defined "cleaning the street" as slang for "buying up what somebody's selling." (Tr. 681.) He understood that the purpose of the exercise was to raise the market price of the security. (Tr. 688.)
39 Hellen recommended Sky stock to his own customers, and at least four of them bought Sky on the basis of his recommendation. (Tr. 1421.)
40 While Zaman testified that Smith Benton maintained a due diligence file for Sky, he and Smith Benton did not introduce any documentary evidence in their case-in-chief. (Tr. 1580, 1591-92.) "NASDAQ" refers to the NASD's Automated Quotation System.
41 Hellen later modified his testimony. He stated that he contacted his brother-in-law, whom he regards as "an expert on mining." This "expert" told Hellen that the Danner property "was an old mine that's been mined." (Tr. 1452.) Hellen did not contact either the Forest Service or BLM. (Tr. 1449.) He made plans to drive to the mine sites but had "a real hard time" arranging the trip. (Tr. 1449-50.)
42 From about November 1993 to about July 1994, Glaser was a promoter for Sky. (Div. Ex. 89 at 13-14, 44, 46-47.) Glaser became a registered representative at Gilbert Marshall and in about September 1994, through a wholly owned corporation, bought Lehl's branch. Glaser offered and sold Sky stock, and directed other registered representatives who offered and sold Sky stock at Gilbert Marshall until about November 1994 when he left Gilbert Marshall. From about November 1994 through at least June 1995, Glaser continued to offer and sell Sky stock to public investors. Douglas A. Glaser , 64 SEC Docket 0575 (Apr. 3, 1997).
43 Schlien told Parker that he would be taking a management position at Sky in the near future. (Tr. 1080, 1107.)
44 Meehan was a registered representative at Strategic beginning in about May 1992. In about November 1993, Meehan began to offer and sell Sky stock to investors through a branch office of Strategic. In about March 1994, he left Strategic and became a registered representative at Gilbert Marshall, where he was named branch manager. He continued to offer and sell Sky stock, and supervised other registered representatives who offered and sold Sky stock until he left Gilbert Marshall in November 1994. Thomas Patrick Meehan , 65 SEC Docket 0542 (Aug. 18, 1997).
45 Usher felt that Lehl and Meehan were "good people" because Meehan's record was spotless and Lehl had "one minor, little thing" on his record, which Usher claims he investigated. (Tr. 760-61.) The "little thing" was a disciplinary action pending with the NASD for excessive markups. (Tr. 765.) Usher did not put any special supervisory procedures in place to monitor Lehl because Lehl did not determine markups at Gilbert Marshall, and the conduct he was being disciplined for was not significant in Usher's view. (Tr. 765-66.) In June 1994 the Commission upheld the NASD's disciplinary action against Lehl. Daniel R. Lehl , 56 SEC Docket 2817 (June 10, 1994.) Usher is uncertain whether he knew of this action by the Commission. (Tr. 766.)
46 Meehan was designated the branch manager because he had passed the Series 24 supervisory examination, but Lehl had not. (Tr. 1355.)
47 Virtually all of the remainder of this office's sales were of another stock Schlien was promoting called Tuscan Industries. (Div. Exs. 7i, 7j.)
48 None of the other branches of Gilbert Marshall concentrated their sales in one stock. The Denver office was also unique in that it put its customers virtually 100% in stocks, whereas other branch offices diversified their clients' portfolios, distributing their investments among mutual funds, annuities, and so forth. (Tr. 782.)
49 Usher never made an effort to ascertain what the Gilbert Marshall representatives were telling customers about Sky. (Tr. 791, 810-12.)
50 Usher estimated the sell-outs cost the firm $5000 - $10,000 per week. (Tr. 785.)
51 Lehl testified that he brought Usher a "full due diligence package" on the company and discussed it with him at length. (Div. Ex. 90 at 65.) No one from Gilbert Marshall visited any of the mine sites. Lehl claimed he planned to visit, not to investigate, but simply because he wanted to see what he had read so much about. (Div. Ex. 90 at 72.)
52 As demonstrated by the evidence, Schlien's actions were inextricably interwoven with those of ACN. I therefore conclude that Schlien was ACN's alter ego. See SEC v. Great Lakes Equities Co. , 775 F. Supp. 211, 214 (E.D. Mich. 1991) (citations omitted).
53 Sections 15(b)(4) and 15(b)(6) of the Exchange Act provide that sanctions may be imposed on a broker-dealer or an associated person of a broker dealer who has "willfully" violated the securities laws. Willfulness does not require an intent to violate the law, nor does it require "deliberate or reckless disregard of a regulatory requirement." See Jacob Wonsover , Exchange Act Rel. No. 41123, 1999 WL 100935, at *9 (Mar. 1, 1999). It is sufficient if the respondent intends to commit the act which constitutes the violation. Arthur Lipper Corp. v. SEC , 547 F.2d 171, 180 (2d Cir. 1976); Tager v. SEC , 344 F.2d 5, 8 (2d Cir. 1965); James E. Ryan , 47 S.E.C. 759, 761 n.9 (1982). Where, as here, the scienter requirement of the antifraud provisions is satisfied, the willfulness standard is also met. V.F. Minton Securities, Inc. , 51 S.E.C. 346, 352 (1993).
54 Gilbert Marshall and Usher, along with Strategic and Moler, also allegedly charged their customers excessive undisclosed markups in violation of the antifraud provisions. My findings and conclusions concerning the markup allegations are set out in Sections VIII below.
55 Zaman pointed to these same factors, among others, in explaining his decision to make a market in Sky. See supra Section II.D.1(c).
Edward J. Mawod & Co.
the Commission stated:
57 Usher admits he did not receive or review any of the press releases the company issued in 1993. (Usher Ex. B; Tr. 839-40.) He thus ignored more than thirty releases covering well over half the public company's time in existence. Under the circumstances, this was unreasonable.
58 Lehl and Hellen also recommended Sky to their own customers. See supra Section II.D.2(b) and note 39. Usher and Zaman are also liable as the presidents of Gilbert Marshall and Smith Benton, respectively. Meyer Blinder , 50 S.E.C. at 1231 n.69 (citation omitted).
59 The Chicago Financial Services tout sheets contain a slightly different, but equally insufficient, disclaimer. (Div. Exs. 10a-10d.)
60 Sky received over one-third, or $4.5 million, of the $12.6 million in net proceeds from the sale of S-8 stock out of the Canaccord accounts. (Div. Exs. 7f, 7g.)
61 The markup on a security is the difference between the price charged to the customer and the prevailing market price. SEC v. First Jersey Sec., Inc. , 101 F.3d 1450, 1469 (2d Cir. 1996).
62 While Strategic was selling Sky, Strategic and Moler were the subjects of a pending NASD disciplinary proceeding charging them with markups violations in connection securities other than Sky. The Commission eventually dismissed the charges on the grounds that Strategic did make a two-sided market, was a market maker, and was not required to use acquisition cost to calculate markups. Strategic Resource Management, Inc. , 60 SEC Docket 2902, 2905-06 (Dec. 21, 1995).
63 Rule 600(a) of the Commission's Rules of Practice, 17 C.F.R. § 201.600(a), mandates that prejudgment interest be assessed "on any sum required to be paid pursuant to an order of disgorgement."
Section 8A of the Securities Act and Section 21C of the Exchange Act expressly authorize the Commission:
65 In order to assess a second tier penalty, the violation must involve fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement. Exchange Act Section 21B(b)(2).
66 In order to assess a third tier penalty, (i) the violation must involve fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement; and (ii) the violation must have 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 violation. Exchange Act Section 21B(b)(3).
67 Foster states in his post-hearing brief: "The imposition of this [$84,000] disgorgement penalty would result in bankruptcy and other severe financial hardships for Foster . . . ." (Foster Brief at 4.) The Division interprets this as a claim of inability to pay disgorgement, and correctly cites the Commission's recent Terry T. Steen opinion in arguing that Foster failed to satisfy his burden of proof as to his inability to pay disgorgement. See Terry T. Steen , 67 SEC Docket 0846-48. Under Rule 630 of the Commission's Rules of Practice, 17 C.F.R. § 201.630, Foster was required to produce evidence of an inability to pay, and to follow certain procedures set out in the Rule. Foster neither followed the proper procedures, nor offered any evidence in support of his contention.
68 The Commission entered a settlement with Schlien in August 1989. By the terms of the settlement Schlien was barred from associating with any broker-dealer, municipal securities dealer, investment adviser, or investment company, and allowed to reapply after 18 months. (Div. Ex. 12c.) Shortly thereafter, the State of Florida ordered Schlien permanently barred from associating with any dealer or investment adviser doing business in Florida. (Div. Ex. 12g.) Then in 1992 the United States District Court for the Southern District of Florida issued a permanent injunction against Schlien prohibiting him from committing additional violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rules 10b-5 and 10b-6 thereunder. (Div. Ex. 12b.) In a subsequent administrative proceeding, the Commission barred Schlien from association with any broker, dealer, municipal securities dealer, investment company or investment adviser. (Div. Ex. 12f.) Despite these frequent and serious clashes with securities regulators, when he testified before the Commission in September 1994, Schlien pretended to have only a dim recollection of his recent troubles. (Div. Ex. 84 at 22-23.)
69 The remaining $8,500 was wired directly from ACN's Canaccord account into Levine's bank account. (Div. Ex. 7g at 8.)
70 In April 1989, the NASD entered into a settlement with Jones under which he was censured and fined $1000. (Div. Ex. 12v.) When Jones subsequently applied to the State of Florida for registration as a broker, Florida allowed him to register but, citing the recent NASD sanctions, imposed significant restrictions on his business activities. (Div. Ex. 12h.) In May 1993, the Commission in an administrative proceeding barred Jones from acting in a supervisory capacity for any broker or dealer for a period of two years. (Div. Ex. 12d.) Most recently, Jones was convicted in the United States District Court for the District of Nevada of securities fraud, conspiracy, and wire fraud. (Supp. Brief Concerning Jones.)
71 The NASD censured and fined Georgeson on September 12, 1989. (Div. Ex. 12w.) On July 5, 1990, the Commission barred Georgeson from association with any broker, dealer, investment adviser, investment company, municipal securities dealer or broker, or government securities dealer or broker, with a right to reapply in one year. (Div. Ex. 12e.) That same day, the United States District Court for the District of Columbia issued a permanent injunction against him prohibiting him from violating Section 15(b) of the Exchange Act. (Div. Ex. 12a.)
72 Smith Benton was censured and fined by the NASD in February 1997. (Div. Ex. 12aa.) In June 1998 the United States District Court for the Central District of California entered a permanent injunction against Smith Benton based on its violations of the registration and antifraud provisions of the federal securities laws. (Supp. Brief Concerning Smith Benton & Zaman.)
73 On February 4, 1997, he was censured and fined by the NASD. (Div. Ex. 12aa.) In June 1998 the United States District Court for the Central District of California entered a permanent injunction against Zaman based on its finding that Zaman had violated the registration and antifraud provisions of the federal securities laws. (Supp. Brief Concerning Smith Benton & Zaman.) On September 29, 1998, Zaman entered into a settlement with the Commission based upon the injunction. Pursuant to that settlement, the Commission imposed a collateral bar on Zaman. Mike Zaman , 68 SEC Docket 0338 (Sept. 29, 1998).
74 The NASD censured and fined Hellen on November 21, 1991. (Div. Ex. 12bb.)
75 From October 1995 through January 1997, Gilbert Marshall was sanctioned by securities regulators in the following states: Arizona, Texas, Colorado, Massachusetts, Virginia, Alabama and Ohio. (Div. Exs. 12j-12m, 12o-12t.) The NASD has censured and fined Gilbert Marshall three times. (Div. Exs. 12x, 12y, 93.)
76 Usher has been sanctioned for violating Colorado and Alabama state securities laws, and he has been disciplined by the NASD twice. (Div. Exs. 12r, 12x, 93.)
77 Lehl was sanctioned by the NASD's National Business Conduct Committee in May, 1993 for charging excessive markups. (Div. Ex. 12dd.) He appealed that decision to the Commission, which upheld the sanctions in an order issued June 10, 1994. (Div. Ex. 12ee.) The Tenth Circuit Court of Appeals affirmed the Commission's order. Lehl v. SEC , 90 F.3d 1483 (10th Cir. 1996.) On November 19, 1996, Lehl was censured and fined by the NASD in connection with practices he used in selling Sky stock. (Div. Ex. 12z.)