Initial Decision of an SEC Administrative Law Judge
In the Matter of
|In the Matter of||:|
|SEABOARD INVESTMENT ADVISERS,||: INITIAL DECISION|
|INC.,||: September 21, 1999|
|and EUGENE W. HANSEN||:|
|APPEARANCES:||Brian Carroll and Kingdon Kase for the Division of|
|Enforcement, Securities and Exchange Commission|
|Eugene W. Hansen, pro se for Respondents|
|BEFORE:||Brenda P. Murray, Chief Administrative Law Judge|
The United States Securities and Exchange Commission ("Commission") instituted this proceeding on September 25, 1998, pursuant to Sections 203(e) and 203(f) of the Investment Advisers Act of 1940 ("Advisers Act"). The Order Instituting Proceedings ("OIP") alleges that on July 9, 1998, the United States District Court for the Eastern District of Virginia entered an injunction against Respondents Seaboard Investment Advisers, Inc. and Eugene W. Hansen ("1998 Injunction") permanently enjoining Respondents from violating Sections 206(1), 206(2), and 206(4) of the Advisers Act and Rule 206(4)-1(a)(5) thereunder, and from violating an earlier Commission Order Making Findings and Imposing Remedial Sanctions and Cease and Desist Order ("1994 Cease and Desist Order"). The OIP alleges further that the District Court ordered Respondent Hansen to pay a civil penalty of $50,000.
I held a hearing on January 25, 1999, in Washington, D.C., for the purposes set out in the OIP.1 The Division of Enforcement ("Division") sponsored the testimony of five witnesses and introduced fifty-three exhibits. The Respondents called three witness and introduced one exhibit.
On March 26, 1999, the Division filed its post-hearing brief. Respondents filed their post-hearing brief on April 23, 1999, and the Division filed its reply brief on May 21, 1999.2
The issues are whether Respondents are permanently enjoined from violating certain provisions of the Advisers Act and, if so, whether it is in the public interest to impose remedial sanctions against Respondents.
My findings are based on the evidence in the record. I applied preponderance of the evidence as the applicable standard of proof. Steadman v. SEC, 450 U.S. 91 (1981). I have considered all proposed findings and conclusions and arguments raised by the parties and accept those that are consistent with this decision.
Eugene W. Hansen
Respondent Hansen was born October 31, 1950. (Div. Ex. 38.) The University of Virginia awarded him a bachelor's degree in 1972. In 1976, he earned a Masters in Business Administration from the University of Virginia's Colgate Darden Graduate School of Business Administration, where he has frequently lectured.3 (Div. Ex. 38; Tr. 305.)
Respondent Hansen served as Portfolio Manager and Vice-President of Virginia Investment Counselors, Inc. from March 1978 until February 1985. (Tr. 302-03; Div. Ex. 49.) He became a chartered financial analyst in 1984, and he passed the National Association of Securities Dealers' ("NASD") Series 65 examination in 1985. (Div. Ex. 3; Tr. 304.) He founded Seaboard Investment Advisers, Inc. ("Seaboard") in February 1985, and he has been the controlling shareholder of the corporation since its formation. (Div. Exs. 4, 49.) He has also served as Chairman of the Board of Directors, Chief Executive Officer, and President of Seaboard. From approximately December 1994 through July 1995, Respondent Hansen also served as Seaboard's Compliance Supervisor. (Div. Ex. 4.)
Following the demise of Seaboard in mid-1997, Respondent Hansen began working with Back Bay Advisors, LLC ("Back Bay"), a registered investment adviser. (Tr. 205; Div. Exs. 46, 50.) At the time of the hearing, Hansen had filed an application with the NASD to become an investment adviser representative associated with Back Bay. (Tr. 276; Div. Ex. 49.)
Seaboard Investment Advisers, Inc.
Seaboard has been registered with the Commission as an investment adviser pursuant to Section 203(a) of the Advisers Act since 1985. In March 1993, Seaboard had over 950 client accounts and managed assets totaling over $1.1 billion. (Div. Ex. 3.) In November 1994, the company reported on Form ADV that it had 948 customer accounts and approximately $1.3 billion in assets under management. (Div. Ex. 38.)
Both the number of accounts and the value of assets under Seaboard's management began to decline rapidly in late 1994 and early 1995. (Div. Exs. 43, 47.) The firm experienced a sharp drop in accounts following the entry of the 1994 Cease and Desist Order. (Div. Exs. 3, 43.) When one of Seaboard's key employees, Stewart M. Powers, resigned from the firm in late December 1994, Seaboard's assets under management fell to $800 million. (Resp. Answer at 2; Div. Exs. 43, 47.) By March 1995, that figure had dwindled to $516 million. (Div. Exs. 43, 44.) As clients continued to close their accounts, Seaboard was forced to cut its work force. (Div. Ex. 44.) In the spring of 1997, Seaboard went out of business. (Tr. 204-05.)
Respondents' Regulatory History
In December 1991, Seaboard and Powers consented to the entry of a cease and desist order by the state of North Carolina prohibiting them from, among other things, soliciting investors in the state without being properly registered. (Div. Ex. 48.)
On October 22, 1993, the Commission instituted public administrative proceedings against Seaboard, Hansen, and Powers. (Div. Ex. 3.) The Division alleged that Seaboard had willfully violated Sections 204 and 206(4) of the Advisers Act and Rules 204-2(a)(16), 204-2(e)(3), and 206(4)-1(a)(5) thereunder, and that Messrs. Hansen and Powers had willfully aided and abetted Seaboard's violations. Specifically, the Commission alleged that Seaboard, Hansen, and Powers fraudulently advertised misleading performance figures covering the period from 1984 through at least the third quarter of 1991. The Commission further alleged that Seaboard, aided and abetted by Hansen and Powers, had violated certain record keeping requirements of the Advisers Act.
The Commission issued the 1994 Cease and Desist Order after accepting Respondents' offers of settlement. (Div. Exs. 2, 3.) Seaboard Inv. Advisers, Inc., 57 SEC Docket 837 (Aug. 3, 1994). The Commission ordered Respondents to: cease and desist from committing or causing any violations and future violations of Sections 204 and 206(4) of the Advisers Act and Rules 204-2(a)(16), 204-2(e)(3), and 206(4)-1(a)(5) thereunder; pay a $1 million civil penalty; adhere to stringent audit requirements on Seaboard's future performance figures; retain a special review person to monitor the company's advertising and record keeping policies and procedures; mail a copy of the 1994 Cease and Desist Order to all of its current consultants and clients, and disclose the material terms of the order to all prospective clients for ten years following the date of the order; and to take miscellaneous additional measures designed to ensure future compliance with federal securities laws.
In August 1995, Seaboard, Hansen, and Powers settled an action brought by Virginia's State Corporation Commission by agreeing to cease and desist from distributing fraudulent advertisements to clients and by paying a civil penalty of $220,000. (Div. Ex. 45.) The allegations in this action concerned the conduct underlying the 1994 Cease and Desist Order. (Div. Ex. 45.)
On September 30, 1996, the Commission commenced an action in the United States District Court for the Eastern District of Virginia charging Respondents with violating Sections 206(1), 206(2) and 206(4) of the Advisers Act and Rule 206(4)-1(a)(5) thereunder, and violating the terms of the 1994 Cease and Desist Order. (Div. Ex. 1.) The Commission's complaint sought to permanently enjoin Respondents from further violations of those laws, and from further violations of the 1994 Cease and Desist Order. In addition, the Commission sought the imposition of civil penalties against Respondents pursuant to Sections 209(e)(1) and 209(e)(4) of the Advisers Act.
The Division put in evidence a certified copy of the consent order in SEC v. Seaboard Inv. Advisers, Inc., No. 2:96CV950 (E.D. Va. July 9, 1998). (Div. Ex. 1.) By that order the District Court: permanently enjoined Respondents from violating Sections 206(1), 206(2), and 206(4) of the Advisers Act and Rule 206(4)-1(a)(5) thereunder; permanently enjoined Respondents from violating the 1994 Cease and Desist Order; and ordered Respondent Hansen to pay a civil penalty in the amount of $50,000 pursuant to Sections 209(e)(1) and 209(e)(4) of the Advisers Act. (Div. Ex. 1.) The order was unaccompanied by findings of fact. (Div. Ex. 1.)
Pursuant to Advisers Act Sections 203(e) and 203(f), proof that a court of competent jurisdiction has enjoined an investment adviser or a person associated with an investment adviser from engaging in conduct related to investment advisory activities provides a sufficient basis for imposing remedial sanctions against the party so enjoined, provided that the sanctions are in the public interest. See SEC v. Teicher, 177 F.3d 1016 (D.C. Cir. 1999); Charles Phillip Elliott, 50 S.E.C. 1273, 1274, 1276-77 (1992); Kimball Securities, Inc., 39 S.E.C. 921, 923-24 (1960). Even where the injunction was entered by consent and without findings of fact, "the action required in the public interest may be inferred from all the circumstances surrounding the injunctive action." Charles Phillip Elliot, 50 S.E.C. at 1277 (footnote omitted).
The Division has proven by a preponderance of the evidence that Respondents were permanently enjoined from engaging in illegal conduct related to investment advisory activities. The only remaining issue is whether remedial sanctions ought to be imposed against one or both Respondents. The Division recommends that I revoke Seaboard's investment adviser registration and bar Hansen from association with an investment adviser.4
The following are relevant considerations in making the public interest determination: the egregiousness of the respondent's actions; the isolated or recurrent nature of the infraction; the degree of scienter involved; the sincerity of the respondent's assurances against future violations; the respondent's recognition of the wrongful nature of his conduct; and the likelihood that the respondent's occupation will present opportunities for future violations. Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981). The severity of a sanction depends on the facts of the particular case and the value of the sanction. See Butz v. Glover Livestock Comm'n Co., 411 U.S. 182, 187 (1973); Hiller v. SEC, 429 F.2d 856, 858-59 (2d Cir. 1970).
The Egregiousness of the Respondents' Actions
Seaboard used industry benchmarks to evaluate the performance of client accounts. (Tr. 37.) To gauge the performance of equity accounts, the firm's researchers looked to the Standard & Poors 500 Index ("S&P 500"); for balanced accounts, they looked to the Lipper Balanced Mutual Fund Index ("Lipper Index"), or they averaged the S&P 500 and the Lehman Brothers Government/Corporate Bond ("Lehman Bond") indices. (Tr. 41, 89; Div. Exs. 52-56.) At the beginning of each quarter, Seaboard sent its clients summaries of how their accounts had fared during the previous quarter. (Tr. 44; Div. Exs. 5-34.) Attached to the summaries was a cover letter, commonly referred to by Seaboard personnel as a "client review letter." (Tr. 44.) In September 1994, pursuant to the 1994 Cease and Desist Order, Hansen and Seaboard's other portfolio managers were trained to follow a new set of policies and procedures in drafting and issuing client review letters. (Tr. 45, 48.) Under the new policy, each client review letter had to be approved by Seaboard's compliance director, Penny Kilpatrick, prior to issuance. (Tr. 46.) At the start of each quarter, Hansen and the other portfolio managers would work together to formulate general information that would be included in every client review letter. (Tr. 46-47.) Once they agreed on the contents of the form letter, the managers would submit the form letter to Kilpatrick for approval. (Tr. 46-47.) In order to tailor the letters to reflect the performance of the individual accounts, the portfolio managers would take the form letter approved by Kilpatrick, and add a few sentences to each letter summarizing the client's specific account performance. (Tr. 47.) If the customizing language materially changed the content of the letter, the portfolio manager was required to submit it to Kilpatrick for additional review; if the new language merely summarized the account's performance data, the letter could be mailed out absent further compliance review. (Tr. 47-48, 101.) The purpose of the procedure was to remove anything from the letters that might constitute the "advertising" prohibited by the 1994 Cease and Desist Order, and to ensure that the portfolio managers had adequately researched all statements comparing account performance data to industry indices. (Tr. 48, 53-54.)
In March 1995, the Commission's Philadelphia District Office examined Seaboard after it received an anonymous letter complaining that Seaboard was in violation of the 1994 Cease and Desist Order. (Tr. 92-93.) The complainant reported that Seaboard was sending clients letters in which the firm misrepresented the rate of return on balanced funds and accounts as reported by Lipper Analytical Services ("Lipper"). (Tr. 93.) The anonymous correspondence was accompanied by three examples of the allegedly misleading letters. (Tr. 99.) Timothy M. Simons, a supervisory staff accountant and branch chief with the Philadelphia office, ascertained prior to the examination that the figure Seaboard had conveyed to some clients by letter was, in fact, erroneous. (Tr. 94-95.) Specifically, the so-called "Lipper letters" stated that, according to Lipper, the average balanced fund lost approximately 7% in 1994; in fact, the average balanced fund lost only 2-2«%. (Tr. 65-66, 100-01; Div. Exs. 5-34.) Attached to each of the letters, however, was a Bloomberg screen print entitled "Lipper Total Return Analysis," which showed the correct Lipper Index figure. (Tr. 111-12; Resp. Ex. 1.)
The examination began on a Monday. (Tr. 95.) Seaboard's client files were examined on Wednesday or Thursday of that week. (Tr. 96.) When he reviewed the client files, Simons found several letters issued in January and February 1995 which contained the Lipper Index misrepresentation. (Tr. 100-01, 109.) No one from Seaboard mentioned the Lipper letters at any time prior to Simons's discovery of the letters in Seaboard's files. (Tr. 98-99, 105-06, 108-09.) When Simons showed the letters to Kilpatrick, she expressed surprise and informed Simons that, although she had seen similar letters, she had neither seen nor approved any containing the Lipper Index comparison. (Tr. 101-02.) No one at Seaboard attempted to demonstrate that the Lipper figure was accurate. (Tr. 103.) Simons testified, however, that he did not think anyone at Seaboard had attempted to cover up the existence of the Lipper letters. (Tr. 132.)
As a result of the examination, the Commission investigators determined that Hansen had issued approximately thirty Lipper letters to Seaboard customers.5 (Tr. 101; Div. Ex. 4.) Although the other portfolio managers had issued client review letters during that period, none of those letters contained the misleading figure. (Tr. 100.) Following the Commission's examination, another Seaboard portfolio manager asked Hansen why he had customized the letters to include the Lipper figure. (Tr. 55-56, 87-88.) Hansen replied that he had done it to help Seaboard. (Tr. 55-56, 87-88.)
The examination revealed that, but for the issuance of the Lipper letters, Seaboard and Hansen were in compliance with the 1994 Cease and Desist Order. (See Tr. 123, 130.) The firm was meeting its clients' goals and objectives, and all of the client contracts were in order. (Tr. 129-30.)
On March 16 and March 17, 1995, Hansen authored and mailed two client review letters to Seaboard clients which the Division has labeled the "Odd Quarter" letters. (Tr. 27-29; Div. Exs. 30, 35.) The Odd Quarter letters contained the following statement:
As you might note, the portfolio has performed exceedingly well in this market environment: Your equities have nearly doubled the comparable market returns over the last three months and your bonds remain higher than the Lehman bond index for the same period.
(Div. Exs. 30, 35.) The Odd Quarter letters were accompanied by quarterly portfolio statements covering the period November 30, 1994 through February 28, 1995. (Div. Exs. 30, 35.) Upon comparing the market indices used by Seaboard against the portfolio statements that accompanied the letters, the Division's expert witness, Professor Victor Andrews, opined that the Odd Quarter letters contained three misrepresentations. (Div. Ex. 56.) First, when compared against the returns reported by the S&P 500, the clients' equity accounts did not even come close to doubling the "comparable market returns." (Div. Ex. 56.) Second, the bond holdings of one of the clients substantially under-performed the market as measured by the Lehman Bond index for the relevant period. (Div. Exs. 35, 56.) Third, the other Odd Quarter letter recipient had no bond holdings whatsoever; the portfolio statement attached to this letter confirms the absence of bonds in the client's portfolio. (Div. Exs. 30, 56.)
Although he does not dispute that the Lipper and Odd Quarter letters contained misrepresentations, Hansen disagrees strongly with several aspects of the foregoing account of the events leading to the 1998 Injunction. (Resp. Answer at 2.) In the Respondents' Answer, Hansen includes the following narrative summary of those events:
The Lipper attribution was incorrect as initially reported, since the index number should have included over 5% of income and re-invested income for the year. For approximately three weeks, numerous letters (probably over 100) were mailed with the incorrect attribution. SEABOARD caught the error internally, made the corrections, and mailed the corrections to all clients. SEABOARD never hid the mistake, and during the audit by the Commission, Hansen directed the Commission to where the auditors could find the erroneous letters. The Compliance Officer at SEABOARD, all officers, and all Directors had access [to] and copies of the letters -- it was never thought to have been incorrect until discovered by an officer and employee in February 1995. Once discovered, the corrections immediately were made. . . .
The second fault/complaint by the Commission also was a mistake on an original draft letter, which was discovered by SEABOARD, properly handled by Compliance, and reported by SEABOARD to the commission [sic]. Hansen was disciplined in accordance with the policies of the company. The draft, like many draft paragraphs, was prepared typed and available before statements and performance calculations for the period were ever prepared by the operations staff. Two letters only escaped detection. SEABOARD spent much effort and expense following the 1994 [Cease and Desist] Order to clarify policies and procedures. The checks and balances effectively caught the errors cited. These were not mistakes that the Commission discovered through their [sic] audit procedures. They were mistakes, however, but they never were purposely or willfully undertaken. There was a break-down in compliance procedures; the error in the system was corrected.
SEABOARD and Hansen will present ample testimony and evidence to prove that Hansen never "deliberately disregarded internal procedures regarding the use of 'advertisements' (letters)." Repeating, all letters were available for review and were supposed to be reviewed by the Compliance Officer. No procedures established were ignored, disregarded, or circumvented by Hansen.
(Resp. Answer at 2-3.) (Emphasis in original.)
The evidence adduced at the hearing contradicts Hansen's version of how and why the Lipper and Odd Quarter letters ended up in the hands of Seaboard clients. Among the many considerations that lead to this conclusion, the following are especially persuasive.
First, with regard to the Lipper figure, Hansen presented no evidence that other portfolio managers at Seaboard or elsewhere factored in the reinvested dividends in calculating returns. I credit the testimony of the Division's expert witness, Professor Andrews, who rejected the reasonableness of the method Hansen ostensibly used in arriving at the erroneous figure. (See Tr. 170-72.) At a minimum, Hansen was extremely reckless in quoting a loss figure higher than approximately 2½%.
Second, I credit the testimony of former Seaboard account manager Bruce DiPietro who recalled that Hansen told him he had included the Lipper figure in an effort to help Seaboard. It is clear from the record that Hansen was scrambling to halt or at least slow the mass exodus of Seaboard clients in early 1995. (See Resp. Answer at 2; Div. Exs. 43, 44.) If Hansen did indeed believe he had correctly calculated the Lipper figure, why didn't he share the good news with the other portfolio managers while they were collaborating on the form letter, or later when they were each customizing their client review letters? Although it is unclear whether Hansen knew the figure he used was misleading, it is clear that he was not entirely confident in its accuracy.
Third, if, as Hansen contends, the Lipper error was discovered and corrective measures were taken prior to the Commission examination, why was Kilpatrick surprised and dismayed when Simons brought it to her attention? She would have been one of the first people at Seaboard to learn of the error subsequent to its discovery. Furthermore, Simons's account of the examination is totally inconsistent with Hansen's claim that he had alerted the examiners to the existence and contents of the Lipper letters prior to the review of Seaboard's client files; I credit Simons's testimony on this issue.
Finally, with regard to the Odd Quarter letters, while it is apparently true that only two letters eluded detection by Seaboard's compliance personnel, the fact remains that the letters did somehow make their way to Seaboard clients. At the time the letters were mailed, Hansen was Seaboard's Compliance Supervisor, and both he and Seaboard were subject to the terms of the 1994 Cease and Desist Order. Thus, at a time when Respondents were obliged to be especially attentive to compliance issues, particularly performance representations in client review letters, they failed to prevent the Odd Quarter letters from being distributed.
The state of Virginia requires those seeking to become representatives of Virginia investment advisers to file a Form U-4 with NASD Regulation's ("NASDR") Central Registration Depository ("CRD"). (Tr. 186-87; Div. Ex. 49.) NASDR compares the information contained in each Form U-4 with any data it already has in the individual's CRD record. (Tr. 187-88.) Following entry of the injunction, on or about October 30, 1998, Hansen submitted a Form U-4 ("October U-4") in order to become an investment adviser representative of Back Bay. (Div. Ex. 49; Tr. 190-91, 212.) NASDR returned the Form U-4 because the Form Hansen had filed was obsolete. (Div. Ex. 49; Tr. 191.) Upon receipt of the updated Form on or about November 9, 1999, Hansen promptly completed the Form and submitted it on or about November 13, 1998 ("November U-4"). (Div. Ex. 49; Tr. 194, 210, 217.)
Form U-4, as revised, contains four sections, two of which relate specifically to the applicant's disciplinary record. (Tr. 188-89; Div. Ex. 49.) Page three of the form contains the following pertinent questions, which require "yes" or "no" answers:
22C Has any domestic or foreign court ever:
(1) enjoined you in connection with any investment related activity?
(2)(a) found that you were involved in a violation of any investment related statute(s) or regulation(s) OR
(2)(b) dismissed, pursuant to a settlement agreement, an investment- related civil action brought against you by a state or foreign financial regulatory authority?
22D Has the U.S. Securities and Exchange Commission . . . ever:
(1) found you to have made a false statement or omission?
(2) found you to have been involved in a violation of its regulations or statutes?
(3) found you to have been a cause of an investment-related business having its authorization to do business denied, suspended, revoked, or restricted?
(4) entered an order against you in connection with investment-related activity?
(5) imposed a civil money penalty on you, or ordered you to cease and desist from any activity?
22I (1) Have you been notified, in writing, that you are now the subject of any investigation, regulatory complaint or proceeding that could result in a "yes" answer to any part of 22A, B, D, E, or F OR (2) have you been named in any pending investment-related civil action that could result in a "yes" answer to any part of 22C?
(Div. Ex. 49.) If an applicant gives an affirmative response to any "Item 22 questions," they must complete a Disclosure Reporting Page ("DRP") "for each event or proceeding" and attach the DRP(s) to the Form U-4. (Div. Ex. 49.) The DRP requires the applicant to answer the following questions, among others, related to each event or proceeding:
(i) Who initiated this event or proceeding? (Enter the name of firm, regulator, court, customer, etc.)
(ii) What type of event or proceeding was this? (i.e., Customer Complaint, Termination, Civil, Administrative, Criminal, Arbitration)
(iii) What were the allegations against you?
(iv) What was the result? (Include felony/misdemeanor, a description of the penalties, amount of fine, payment or settlement, terms of the disposition, length of suspension or restriction, etc.)
(Div. Ex. 49.)
The Item 22 questions in the October U-4 were substantially similar to those contained in the November U-4. (Div. Ex. 49.) On the October U-4, Hansen answered "no" to questions 22C(1) and (2) and 22D(1)(3) and (4); he answered "yes" to questions 22D(2) and (5), and 22I. (Div. Ex. 49 at 3.) Hansen attached two DRPs to the October U-4, one describing the 1998 injunctive action, and a second describing the instant proceeding. (Div. Ex. 49.) With regard to the former, Hansen indicated that the Commission had initiated a "Civil Complaint Action" against him. (Div. Ex. 49.) His summary of the allegations in the injunctive action states, in full:
The [Commission] seeks a permanent injunction against Seaboard and Eugene Hansen, among others, for alleged violations of certain provisions of the [Advisers Act] and is seeking an order directing Seaboard and Hansen to comply with the Commission's Order dated October 1994 and orders requiring Seaboard and Hansen to pay unspecified civil penalties.6
(Div. Ex. 49.) Hansen also stated that the injunctive action had been settled on July 9, 1998. (Div. Ex. 49.) In response to the question concerning the result of the proceeding, he stated: "Seaboard and Hansen agreed to settle the issue with the payment of fifty thousand dollars by July 9, 1999." (Div. Ex. 49.)
On the November U-4, Hansen answered "no" to questions 22C(1), and 22D(3); he answered "yes" to all other pertinent Item 22 questions. (Div. Ex. 49.) He again attached DRPs detailing the 1998 Injunction and the recently initiated administrative proceedings. (Div. Ex. 49.) The November DRPs were virtually identical to those attached to the October U-4. (Div. Ex. 49.)
Both versions of Form U-4 contain the following attestation:
I swear or affirm that I have read and understand the items and instructions on this form and that my answers (including attachments) are true and complete to the best of my knowledge. I understand that I am subject to administrative, civil or criminal penalties if I give false or misleading answers.
(Div. Ex. 49.) Hansen signed this section of the Form on both the October and November submissions. (Div. Ex. 49; Tr. 213.)
The Division called Ann Bushey, an assistant director of NASDR's CRD Public Disclosure Department. Bushey reviewed both the October U-4 and the November U-4. (Tr. 185-86.) She testified that both Forms were incomplete and misleading for the following reasons: (1) Hansen should have answered question 22C(1) in the affirmative; and (2) in responding to the question on the DRP calling for a description of the injunctive action, he should have stated that the 1998 Injunction had been entered. (Tr. 195-98, 210-11, 215-16.) She testified that, while the information about the civil penalty partially satisfied the disclosure requirement, "the key piece of the disclosure has to do with the injunction and the response to 22C(1)." (Tr. 211.) Bushey testified further that the November U-4 was deficient because Hansen failed to answer question 22C(2). (Tr. 199; Div. Ex. 49.)
NASDR notified Hansen of these deficiencies in early December 1998, and he submitted an amended application without delay. (Tr. 198-200.) Hansen answered "no" to 22C(2), but he did not change the 22C(1) response from "no" to "yes," nor did he amend the DRP to reflect the entry of the 1998 Injunction. (Tr. 200.)
The Division contends that Hansen's made material omissions by failing to properly report all of the information concerning the 1998 Injunction in both the October and November U-4s and in subsequent amendments to the November U-4. (Div. Brief at 11.) Although Bushey conceded that the information Hansen provided was correct, and that he responded quickly to NASDR's deficiency notices, Bushey testified that he was nonetheless in the wrong for omitting to state that the 1998 Injunction had been entered. (Tr. 215-17.) Hansen argues that the Division is, in essence, elevating form over substance because he did accurately disclose most of the details of the 1998 Injunction, and he acted quickly to correct any inaccurate statements. (See Tr. 205-09.) He contends that his mischaracterization of the 1998 Injunction as a "settlement" was an honest mistake. (See Tr. 208-11.)
At the time he completed the Forms U-4 and responded to NASDR's deficiency notices, Hansen knew that a federal district court had entered an injunction against him in connection with "investment related activity." He signed a statement that the Forms U-4 were "true and complete" to the best of his knowledge. Upon notification of deficiencies in the submission, he failed to completely correct the errors. Hansen is a learned, seasoned professional who understands the importance of making full disclosure to regulatory bodies. I therefore find that Hansen was at least highly unreasonable in failing to accurately report the injunction information.
Seaboard and Hansen made material misrepresentations to Seaboard clients in the Lipper and Odd Quarter letters. Hansen made material misrepresentations to industry regulators in the October and November U-4s. This conduct is sufficiently egregious to merit the imposition of remedial sanctions in the public interest.
The Degree of Scienter Involved
While the Division has shown that Hansen acted with scienter, it has failed to show that he acted with a high degree of scienter. In other words, although Hansen's conduct was reckless, I find that he did not intentionally endeavor to defraud Seaboard clients by use of the Lipper and Odd Quarter letters, nor did he intentionally mislead regulators by filing incomplete Forms U-4.
At a time when Seaboard was rapidly losing clients and assets, Hansen made a very ill-considered decision to test the boundaries of propriety with the customizing language in his client review letters. Yet, Hansen knew that, even if he managed to somehow slip the letters past Seaboard's compliance department, all client correspondence would be audited by state and federal securities regulators in the near future.7 He and Seaboard had just been forced to pay a $1 million penalty for similar advertising violations, so he was well aware of the consequences of going too far. Caught between the Scylla of looming business failure and the Charybdis of intensified regulatory oversight, Hansen acted inappropriately.
Ultimately, Seaboard was unsalvageable. When Hansen tried to start his investment advisory activities anew with Back Bay, he was less than candid in filling out the October and November U-4s. Hansen was aware of his duty to fully disclose the details of the injunctive action on the U-4s, yet he did not do so. This, too, was inappropriate.
Although his conduct was unacceptable, several factors indicate that it was not driven by a desire to defraud or injure Seaboard's clients. First, Hansen attached copies of the Bloomberg screen bearing a correct Lipper figure to each Lipper letter, thereby showing his clients -- and regulators -- the data from which he derived his incorrect Lipper figure. Although this may have been a bungling attempt to give himself an out in the event that the figure was questioned later, on the basis of the whole record I find that it was simply part of his reckless issuance of the letters. Put differently, Hansen did not have to include the Bloomberg printout, and the fact that he did militates in favor of a finding that he did not intend to deceive his clients.
Second, Hansen attached detailed portfolio performance summaries to the Odd Quarter letters, including the one informing a client whose portfolio held no bonds that his nonexistent holdings had outperformed the market. Thus, the information contained in the letter was blatantly contradicted by the performance summary attached to it. As with the attachment of the Bloomberg screen prints to the Lipper letters, the inclusion of data totally inconsistent with the representation made in this Odd Quarter letter tends to defeat an inference of intentional misconduct.
Third, Simons testified that he did not believe anyone at Seaboard attempted to cover up the existence of the Lipper letters. The letters were on file at Seaboard, and readily available for review by regulators and by Seaboard's own compliance department. Thus, although Hansen did not alert the examiners or Seaboard's compliance personnel to the existence of the letters, he did not destroy the inculpatory evidence or otherwise try to prevent its discovery.
Fourth, although Hansen failed to disclose all of the material details about the 1998 Injunction on the October and November U-4s, he did disclose many of them, including the fact that he and Seaboard had agreed to settle the matter and pay a $50,000 penalty. It is at least plausible that he was genuinely confused as to what the true significance of the entry of an injunction meant, or that he thought he had provided sufficient information concerning the action.
Isolated or Recurrent Nature of the Infraction
As their regulatory history reflects, Respondents have violated state and federal securities laws on several occasions over the past decade, even while subject to Commission cease and desist orders and an injunction. Thus, Respondents have shown a propensity to trivialize both internal compliance procedures and the securities laws.
Sincerity of Assurances Against Future Violations
While Seaboard and Hansen acknowledge that they committed a "touch foul" by distributing the Lipper and Odd Quarter letters, they deny any serious wrongdoing. (Resp. Answer at 4.) In fact, much of their post-hearing brief is a misguided attempt to refute the allegations underlying the 1998 Injunction. They have made no assurances, sincere or otherwise, that they will comply with the federal securities laws in the future.
Opportunities for Future Violations
Hansen has been in the investment advisory industry for over twenty years, and he is presently seeking to become associated with Back Bay. His educational background and his professional accomplishments make it likely that he will continue work for an investment adviser in some capacity. Thus, he will have opportunities in the future to commit violations of the Advisers Act.
Respondents' Civic and Charitable Activities
Seaboard encourages all of its employees to be active in helping to improve their community. (Tr. 285.) Hansen has been involved in numerous charitable activities which include service on the boards of directors of the Mid-Atlantic Chapter of the American Red Cross's Blood Services, Ford's Theater, and the Sugar Plum Bakery, which helps mentally challenged people. (Tr. 308-11.) He is a community board member for the City of Virginia Beach, Virginia. (Tr. 312.) He has served as president of an alumni group organized to raise funds for the University of Virginia's College of Arts and Sciences. (Tr. 314-15.)
Based on the foregoing, I conclude that it is in the public interest to revoke Seaboard's investment adviser registration. The firm has been out of business for over two years, and it has a history of violating state and federal securities laws. Although there appears to be little danger that Hansen or others will attempt to resuscitate the firm, it is in the public interest to eliminate that possibility altogether.
I further conclude that barring Hansen from association with an investment adviser would be unduly harsh and, therefore, not in the public interest. Entry of the injunction and other evidence of misconduct notwithstanding, Hansen's complaint that he and Seaboard "have suffered tremendously based upon the settlements of 1998 and 1994 and feel that any further sanctions by the Commission would be 'piling on'" is somewhat compelling. (Resp. Answer at 1.) Based on all of the evidence, I conclude that, while Hansen must pay much closer attention to compliance policies and procedures, he is not such a threat to the investing public that a bar is warranted. His conduct does merit some sanction, however, and he will therefore be suspended from being associated with an investment adviser for twelve months.
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.351(b), I certify that the record includes the items described in the record index issued by the Commission's Secretary on September 10, 1999.
Based on the findings and conclusions set forth above:
I ORDER, pursuant to Section 203(e) of the Advisers Act, that the registration of Seaboard Investment Advisers, Inc., be, and hereby is, revoked.
I FURTHER ORDER, pursuant to Section 203(f) of the Advisers Act, that Eugene W. Hansen be, and hereby is, suspended from being associated with an investment adviser for a period of twelve months.
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 such party, unless the Commission, pursuant to Rule 360(b)(1), determines on its own initiative to review this initial decision as to any party. If a party 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.
Brenda P. Murray
Chief Administrative Law Judge
-- Citations to the hearing transcript will be indicated by "(Tr. __.)." Division exhibits will be cited by number as "(Div. Ex. __.)," and Respondents's exhibit will be cited as "(Resp. Ex. 1.)." -- The Division's post-hearing and reply briefs will be cited as "(Div. Brief)" and "(Div. Reply)," respectively. The Respondents' post-hearing brief will be cited as "(Resp. Brief)." -- Respondent Hansen has also taught finance, investing, and international marketing at Old Dominion University, where he was a part-time doctoral student in international marketing in January 1999. (Div. Ex. 51; Tr. 305-06.) -- The Division initially recommended that an industry-wide bar be imposed on Hansen. (Div. Brief at 16.) It narrowed its recommendation following the Teicher decision in which the U.S. Court of Appeals for the District of Columbia Circuit held that Section 15(b)(6) of the Securities Exchange Act of 1934 did not give the Commission authority to issue a collateral bar. Teicher 177 F.3d at 1017, 1022. By letter dated June 7, 1999, the Division now submits that Hansen should be barred from association only with an investment adviser. -- Ultimately, the Commission uncovered approximately forty-six Lipper letters. (Div. Exs. 5-34, 56 at 5.) -- The DRP describing the administrative proceeding summarized the allegations as follows: "The Commission issued an Order indicating that [it] wished to review the previous federal settlement by administrative proceeding. SEABOARD and Hansen have denied, for administrative purposes, the [C]omission's actions. The issue remains open." (Div. Ex. 49.) The Division apparently does not find fault with this statement. -- Simons testified that the Commission examined Seaboard once every two to three years. (Tr. 137.)
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