Initial Decision of an SEC Administrative Law Judge
In the Matter of
|In the Matter of||:|
|: INITIAL DECISION|
|RUSSELL W. STEIN,||: September 27, 1999|
|FORD D. ALBRITTON, JR., and||:|
|DOVER AND ASSOCIATES, INC.||:|
|APPEARANCES:||T. Christopher Browne and Eduardo Espinosa for the Division of Enforcement, Securities and Exchange Commission.|
|Vidal Martinez, Walter G. Pettey III, and Stephen Gleboff for Respondents|
|BEFORE:||Lillian A. McEwen, Administrative Law Judge|
Respondent Russell W. Stein, a financial consultant and registered representative associated with Merrill Lynch, was charged with violating the antifraud provisions of the Investment Advisers Act of 1940 by failing to disclose a potential conflict of interest to his consulting clients. Respondents Ford D. Albritton, Jr., and Dover and Associates, Inc., were charged with causing and aiding and abetting Stein's violations. Stein's nondisclosure allegedly caused his employer, Merrill Lynch, to file reports with the Commission that omitted to disclose this potential conflict of interest. Stein was also charged with causing and aiding and abetting Merrill Lynch's disclosure violations. This Initial Decision finds that Stein's actions did not fall within the ambit of the Advisers Act. In the alternative, this Decision concludes that, even if Stein did act as an investment adviser, Stein did not commit fraud against his clients and that he had no potential or real conflict of interest with them. This Decision orders that this proceeding against Respondents Stein, Albritton, and Dover be dismissed.
The United States Securities and Exchange Commission (Commission) instituted these proceedings on May 9, 1997, pursuant to Section 15(b)(6)(A) of the Securities Exchange Act of 1934 (Exchange Act) and Section 203(f) and 203(k)(1) of the Investment Advisers Act of 1940 (Advisers Act). I held a public hearing on August 19-28, 1997, in Houston, Texas. The hearing record consists of the witnesses' testimony and numerous exhibits. I admitted ninety-seven exhibits from the Division of Enforcement (Division) into evidence and forty-four exhibits from Respondents Russell W. Stein, Ford D. Albritton, Jr., and Dover and Associates, Inc. (collectively, Respondents).1 I held a reopened hearing on April 7-8, 1999, in New York, New York. At the reopened hearing, six witnesses testified and I admitted seven exhibits into evidence.
The Order Instituting Proceedings (OIP) alleges that Russell William Stein (Stein), a financial consultant and registered representative in Houston, Texas, willfully violated Sections 206(1) and 206(2) of the Advisers Act and caused and aided and abetted others to violate Section 204, Rule 204 (b)(1) thereunder, and Section 207 of the Advisers Act. The OIP also alleges that Ford D. Albritton, Jr. (Albritton), a resident of Dallas, Texas, and Albritton's company, Dover and Associates, Inc. (Dover) caused and aided and abetted Stein's violation of Sections 206(1) and 206(2) of the Advisers Act. If I conclude that any of the allegations in the OIP are true, I must then determine what, if any, remedial actions are appropriate in the public interest against Stein pursuant to Section 15(b)(6)A of the Exchange Act; what, if any, remedial actions are appropriate in the public interest against Stein, Dover, and Albritton pursuant to Section 203(f) of the Advisers Act; whether, pursuant to Section 203(k) of the Advisers Act, Stein, Dover, and Albritton should be ordered to cease and desist from committing or causing violations and any future violations of any or all of the Sections or Rules specified above; whether, pursuant to Section 203(i) of the Advisers Act and Section 21B(a) of the Exchange Act, Stein should be ordered to pay a civil penalty; and whether, pursuant to Section 203(i) of the Advisers Act, Dover and Albritton should be ordered to pay a civil penalty.
FINDINGS OF FACT
I based the findings and conclusions herein on the entire record and on the demeanor of the witnesses who testified at the hearing. I applied preponderance of the evidence as the applicable standard of proof. See Steadman v. SEC, 450 U.S. 91 (1981). I considered and rejected all arguments and proposed findings and conclusions that are inconsistent with this decision. I find that the following facts were established at the hearing and by the record.
Respondent Russell W. Stein
Russell W. Stein, a 1966 graduate of Texas A&M University with a degree in finance, received a commission as an officer in the United States Army and volunteered for service in Vietnam. (Tr. 1344.) He returned to the United States in 1968 and joined Merrill Lynch in Houston, Texas, as a registered representative. (Tr. 1344-45.) Merrill Lynch, an investment firm registered with the Commission as both a broker-dealer and an investment adviser, employed Stein until 1975, when he left to join Reynolds Securities. (Answer ¶ 1; Am. Answer ¶ 1; Tr. 1368.) Stein returned to Merrill Lynch in 1976. (Tr. 1368.) From about 1985 through May 1995, Stein was a First Vice-President of Merrill Lynch and a listed principal on Merrill Lynch's investment adviser registration. (Answer ¶ 1; Am. Answer ¶ 1.)
In or about 1990, Stein's client base shifted from primarily high net-worth individuals to institutional funds. (Tr. 191-92.) From January 1992 through 1995 (the relevant period), Stein headed a team that, through Merrill Lynch, provided these institutional funds with investment consulting services. (Answer ¶ 2; Am. Answer ¶ 2; Tr. 192, 718-19.) Stein offered four basic consulting services pursuant to Merrill Lynch's Asset Information Management (AIM) program: investment policy formulation, investment manager searches, asset allocation, and investment manager performance measurement. (Tr. 107, 190; Resp. Ex. 28; Div. Exs. 54-60, 62, 64-66.) Institutional funds hire investment managers, also known as money managers, to select the specific securities to buy and sell on their behalf. (Tr. 115.) A large institution typically employs several investment managers to execute its various investment strategies. (Tr. 116, 1404-08.) For example, an institution, through its designated representatives, typically trustees or regents, might employ one investment manager to manage an equity portfolio and another investment manager to manage a fixed income portfolio of bonds. (Tr. 116, 879, 920.) The investment manager search service was an attempt to identify investment managers that would appropriately satisfy the needs of an institution. (Tr. 114-115.) In order to conduct an investment manager search, Stein's team first filled out a questionnaire with input from the client regarding the objectives of the search. (Tr. 118.) The team then forwarded the questionnaire to a Merrill Lynch entity in Princeton, New Jersey, that compiled data on investment managers. (Tr. 118.) Based on the questionnaire, the Princeton entity compiled a "short list" of candidates that was given to the institutions. (Tr. 114, 118-19.) Stein was entitled to add or remove investment managers from the list. (Tr. 118-20.) Stein did not choose or select the investment managers on behalf of the institutions; the institution's trustees or regents made that decision. (Tr. 531, 582, 836, 842, 850-51, 880-81, 916, 920-21, 1411.)
Respondents Ford D. Albritton and Dover and Associates, Inc.
Stein and Respondent Ford D. Albritton, both Texas A&M University alumni, are friends who have known each other professionally since the late 1960's. (Tr. 328-30.) Albritton, a Texas businessman who served two terms as a member of Texas A&M's Board of Regents, declared personal bankruptcy in 1991. (Tr. 327-28.) After Albritton's bankruptcy, Stein asked him about his future business plans. (Tr. 330.) Albritton explained that he would be interested in a professional opportunity that enabled him to draw upon his vast network of contacts in Texas. (Tr. 330) Stein subsequently introduced Albritton to several investment management firms. (Tr. 336-67.) During 1991 and 1992, Stein introduced Albritton to four investment management firms in addition to AC&F. Monroe Luther is a principal of Eagle Management and Trust (Eagle) and has known Albritton for over twenty years. (Tr. 336-67.) In or about 1991, Stein reintroduced Albritton and Luther, and thereafter, Eagle hired Albritton as a solicitor. (Tr. 266, 335-37; Div. Ex. 75.) Eagle assigned Albritton the responsibility of maintaining its Texas Iron Workers Pension Fund (TIW), Texas A&M University System, University of Texas, and Fish Foundation accounts. (Tr. 269.) Albritton worked for Eagle in 1992 and 1993, during which time Eagle paid him a total of $100,000. Albritton, however, provided few, if any, account maintenance services on behalf of Eagle. (Tr. 1373, 1375, Div. Exs. 75-78.) In 1993, Eagle refused to renew Dover's contract. (Div. Ex. 76.) Stein also introduced Albritton to representatives of Criterion Investment Management Company (Criterion), Cisneros Asset Management (Cisneros), and Ameritrust. (Tr. 273, 338, 653-54, 857, 1250.)
Stein also informed Albritton that a San Antonio investment management firm, AC&F, needed a solicitor. (Tr. 330-31.) He arranged for Albritton to meet with representatives of the firm, which is registered with the Commission as an investment adviser. (Answer ¶ 4; Am. Answer ¶ 4; Tr. 330-31.) Stein introduced Albritton to AC&F. (Jt. Ex. 1; Tr. 331, 1474.) Specifically, Stein stated that Albritton was a "close personal friend" of his and recommended that Ed Austin (Austin), an AC&F principal hire him. (Tr. 242, 249; Jt. Ex. 2 at 33.) Austin knew that Albritton and Stein were "very close, personal friends" and acknowledged that Stein "was very important to AC&F as a consultant." (Jt. Ex. 2 (II) at 55.) Austin hoped that Stein would recommend AC&F to his consulting clients. (Jt. Ex. 2 (II) at 57.)
After Stein introduced Albritton to AC&F, Albritton founded Dover in September 1991. (Tr. 249, 333.) Albritton formed Dover, a Texas corporation, in order to conduct his work as a solicitor for AC&F. (Tr. 249, 333.) In December 1991, Albritton registered as an investment adviser with the Texas State Securities Board. (Tr. 249, 332.) The following month, January 1992, he registered Dover as a securities dealer. (Tr. 249, 332.) Dover's business is restricted to solicitation activities. (Tr. 332.) Dover, wholly owned by Albritton and located at his home address in Dallas, Texas, employs two individuals, Albritton himself and a part-time secretary. (Tr. 325.)
AC&F and Dover entered into a "Solicitation Agreement" on January 8, 1992. (Jt. Ex. 1; Div. Exs. 1-11, 67-71, 79.) AC&F retained Dover to perform maintenance and solicitation activities on behalf of the firm. (Div. Exs. 67-71.) Under the terms of the Solicitation Agreement, AC&F paid Dover a quarterly retainer fee and a referral fee for any advisory fees AC&F collected from a client attributable to Dover. (Div. Exs. 67-71.) AC&F never provided Albritton with a job description nor did it otherwise specify how Albritton was to provide the solicitation and maintenance services. (Tr. 1477; Div. Exs. 67-71.) At the time Albritton signed the Solicitation Agreement, AC&F had already provided investment management services for the Texas A&M University System and for the TIW. (Answer ¶ 4; Am. Answer ¶ 4; Tr. 195; Div. Exs. 48, 49, 54, 57-61.) After AC&F hired Albritton, three of the institutional clients (the University of Texas System, the Fish Foundation, Lower Colorado River Authority (LCRA)) hired AC&F as an investment manager. (Div. Ex. 50-53.) AC&F assigned Albritton the responsibility of maintaining all the accounts for which Stein, on behalf of Merrill Lynch, provided investment consulting services. (Jt. Ex. 2 (I) at 50; Div. Ex. 73; Am. Answer ¶ 5.) Dover was not responsible for maintaining any other AC&F accounts. (Am. Answer ¶ 5; Jt. Ex. 2 (I) at 92, 100; Jt. Ex. 2 (II) at 27-28; Div. Ex. 73.) Together, the Stein accounts placed over $250 million under AC&F's control and during the relevant period AC&F collected more than $2.6 million in advisory fees from them. (Am. Answer ¶ 5; Div. Ex. 73.)
During the relevant period, AC&F paid Albritton/Dover a total of $641,000. (Div. Exs. 72, 78.) Albritton and Stein worked as a team and the "primary way" Albritton maintained AC&F clients was to stay in touch with Stein. (Tr. 260-63, 366.) Stein helped Albritton maintain clients for AC&F. (Tr. 282.) In this regard, Stein and Albritton spoke on a regular basis and Stein provided Albritton with information regarding the boards of AC&F's clients. (Tr. 281-83.) AC&F knew that when Albritton visited the AC&F's offices, Stein usually accompanied him. (Tr. 1478.)
Stephen Stein and Mayfair Services
In October 1991, Stein's son, Stephen, an accomplished hunter, founded Mayfair Services (Mayfair), a hunting outfitter in southern Texas. (Tr. 397.) Before Stephen established Mayfair, he worked for H&C enterprises as a janitor and commission only salesperson. (Tr. 396, 512.) During the fall of 1991, Stein informed Albritton that Stephen had formed Mayfair and that AC&F expected Albritton to provide hunting services to the firm's clients. (Tr. 398-400, 1493, 1495.) Stephen unsuccessfully approached AC&F on November 14, 1991, and offered to provide the firm with hunting services, without any involvement by Albritton. (Resp. Ex. 4; Tr. 510-11.)
In or about October 1991, Albritton and Stephen attended a Texas A&M football game. (Tr. 1486-87, 1492.) During the game, they discussed the possibility of Mayfair providing Dover with hunting services. (Tr. 1486-87, 1492.) Later that year, Albritton hired Stephen/Mayfair to provide Dover with hunting services and informed Stein of the decision. (Tr. 375-76, 397, 1512.) Stephen used the Dover contract as collateral to obtain a capitalization loan for Mayfair. (Tr. 406; Div. Exs. 74, 90.) Between 1992 and March 1993, Stephen billed Albritton as necessary and Albritton, who had not established any billing protocol, paid him. (Tr. 472; Div. Ex. 89.) Albritton was generally unaware of what particular hunting services he paid Stephen for. (Tr. 1503-05.) In 1993, Stephen stopped providing Albritton with invoices and Albritton paid him a flat fee. (Tr. 473.) During the relevant period, Albritton paid Stephen a total of $248,381, which constituted 95% of Stephen's income during this period. (Tr. 478-89; Div. Ex. 78.)
Stein's Loans to Albritton and Stephen
In the early 1980's, Texas A&M's Twelfth Man Organization generated a list of the school's alumni who had donated the most money to the school. (Tr. 1468-69.) Albritton, a well-known alumnus of Texas A&M and former member of the University's Board of Regents, was third on the list. (Tr. 328, 1468-69.) Texas A&M rewarded him with a skybox at Kyle Field, the University's football stadium. (Tr. 1468-69.) In order to keep the skybox, Albritton was required to make an annual contribution of $18,600 to the Texas A&M athletic department. (Tr. 1469.)
During the relevant period, Stein loaned Albritton money. (Tr. 309, 1471.) On January 7, 1993, Stein wired Albritton $20,000 and eleven days later, on January 18, Albritton borrowed another $7500. (Tr. 303-05; Div. Exs. 82, 84.) In February 1993, Albritton approached Stein about the skybox at Kyle Field. (Tr. 1471.) Albritton's financial status interfered with his ability to make the annual contributions necessary to keep the skybox. (Tr. 1470-71.) In lieu of repaying the loans, totaling approximately $27,500 at the time, Albritton and Stein agreed to apply the payments towards the skybox fees, in exchange for which Stein received a right of first refusal to the skybox. (Tr. 1469, 1471-72.) Later that month, Stein loaned Albritton $15,000. In 1995, Stein furnished Albritton with a $20,000 check with the word "Football" written on it. (Div. Exs. 83, 85; Tr. 303, 1367.) Furthermore, in October 1994, Stein guaranteed a $150,000 line of credit for Bridgeport Cable, a telephone company owned by Albritton, Stephen Stein, and John Landry. (Tr. 315, 322.)
Since 1992, Stein has also loaned approximately $68,700 to Stephen for the operating cash flow needs of Mayfair. (Am. Answer ¶ 7; Tr. 317.) Although Mayfair had other clients, its primary source of income during the relevant period was Dover. (Tr. 491.) Dover, in turn, paid Mayfair out of the money it received from AC&F. (Tr. 1491.) During 1992 and 1993, Stephen Stein repaid his father a total of $35,000 with the money he earned from Mayfair, Stephen's only source of income. (Tr. 317-18, 407.) As of May 1995, Stephen still owed Stein $33,795. (Am. Answer ¶ 7.) Albritton never informed AC&F that he borrowed money from Stein or that Dover paid Mayfair for hunting services. (Jt. Ex. 2 (I) at 58-59; Jt. Ex. 2 (II) at 98, 109-13; Jt. Ex. 3 at 57, 60.) Furthermore, Albritton and Stein assured AC&F that Stein would not receive any of the money from AC&F's payments to Dover. (Jt. Ex. 2 (II) at 104; Jt. Ex. 3 at 61-63.)
Albritton's Services for AC&F
During the relevant period, Albritton/Dover provided very few, if any, solicitation and maintenance services on behalf of AC&F. Although Albritton was hired to provide solicitation services for AC&F, he solicited only one new account during the duration of his employment. (Tr. 345; Jt. Ex. 2 (I) at 92, 100; Jt. Ex. 2 (II) at 29.) In this regard, Albritton met with Walter Davis, a trustee of the Texas Workers Compensation Insurance Fund. (Tr. 1484.) Although Albritton wanted to solicit the Boy Scouts of America, Dresser Industries, and Halliburton, he had no contacts with these institutions. (Tr. 1517-18.) Albritton did nothing personally to maintain AC&F's Fish Foundation, Robert Cruikshank, and LCRA accounts. (Jt. Ex. 2 (1) at 50; Tr. 346-47, 349, 356, 922, 1215, 1220, 1476.) During his tenure with AC&F, Albritton did not increase the amount of assets that existing accounts placed with the firm either. (Tr. 345; Jt. Ex. 2 (I) at 92, 100; Jt. Ex. 2 (II) at 29.)
Albritton had very few contacts with, and provided few, if any, services for TIW, the Texas A&M University System, or the University of Texas System. Although Albritton did meet with representatives from these accounts, few of the board members and other key officials from the TIW, the Texas A&M University, and the University of Texas System had ever met with Albritton. (Tr. 543, 575, 558, 565, 597, 887.) Two members of TIW's board did not even know who Albritton was. (Tr. 558, 565.) With respect to the Texas A&M University System, Albritton concluded that there was nothing else to do beyond "reviewing the numbers," a task he performed with Stein. (Tr. 359-60.)
Albritton never took any AC&F clients out to lunch or dinner. (Tr. 368.) In fact, he provided few entertainment services, if any, for the accounts that AC&F hired him to maintain. Albritton did, however, entertain a staff employee from the University of Texas System and a few unidentified persons from TIW at his Kyle Field skybox. (Tr. 367-68.) Although Albritton paid Stephen to provide hunting services to AC&F clients, Stephen did not take anyone from the Texas A&M University System, the Fish Foundation, the University of Texas System, or the LCRA hunting (Tr. 375, 409-10, 471.) The only AC&F clients Stephen took hunting were TIW representatives. (Tr. 385-86, 417-45.) Albritton could not recall any AC&F or Eagle clients who actually went hunting with Stephen, except James Martin, a TIW representative. (Tr. 388.) Furthermore, Austin could not recall anyone whom Albritton entertained. (Jt. Ex. 2 (II) at 34.) On three occasions, Albritton gave advice to AC&F. (Tr. 1479-84.)
Albritton suggested that AC&F make sure that its performance information remained before Texas A&M's Board of Regents. (Tr. 1480.) Albritton never personally contacted the Board of Regents himself. (Tr. 1480.) The University of Texas System wanted to replace AC&F with a different investment management firm. (Tr. 1481.) Albritton told Stein that AC&F had great numbers and that the University of Texas had just hired AC&F a few months earlier. (Tr. 1481.) Albritton told Stein that if he were in their position he "would feel kind of silly to have made a decision like that, and some five, six, seven, eight months later say, no, they need to be replaced. Either I am making a mistake at that point in time or I made a grievous mistake in the beginning to choose them." (Tr. 363, 1208, 1481.) Albritton asked Stein to communicate his advice to the University. (Tr. 1481.) The third instance occurred in or about the fall of 1994, when the Governor of Texas was about to make three new appointments to the politically lopsided Asset Management Committee at the University of Texas System. (Tr. 1482.) Albritton told Stein that he should find a way to "take the politics out" of the structure. (Tr. 364, 1482, 1210.)
Pursuant to the AIM program, Stein provided his institutional clients with Merrill Lynch's reviews of their present investment managers' performance. (Tr. 108.) In order to provide this service, Stein's team instructed the client's custodian bank to forward a statement of the client's assets to an "analysis group." (Tr. 109-10.) The analysis group, a subcontracted service in California, formatted the custodial information into a detailed quantitative report. (Tr. 109-10.) Merrill Lynch forwarded a printout of the report, typically forty to sixty pages in length, to Stein's team. (Tr. 109-11.) The team created an executive summary of the report that Stein ultimately reviewed with the client. (Tr. 109-11.) In addition, Stein provided the institutions with asset allocation services. (Tr. 107.) This service was an attempt to identify the appropriate apportionment of a fund's assets among its various investment alternatives. (Tr. 121-22.) Of course, some of these alternatives were limited by state law or tax considerations.
The OIP alleges that Stein defrauded several of his institutional clients. These clients had either already employed AC&F, or during the relevant period decided to employ AC&F. AC&F is an investment management firm, registered with the Commission as an investment adviser and based in San Antonio, Texas. The first client included in the OIP is the Texas A&M University System, which operates an endowment fund with approximately $800 million in assets. (Div. Exs. 57-61; Tr. 193, 203-08.) The Texas A&M University System, Stein's first investment consulting client, hired Merrill Lynch in 1990 to provide it with all four of the AIM consulting services. (Div. Exs. 57-61; Tr. 193, 203-08, 877, 879.) Stein performed manager searches for the Texas A&M University System, the first of which resulted in the University's retention of five investment managers, including AC&F and Eagle. (Tr. 203, 206-08, 881-83; Div. Exs. 49, 58, 80-81.) Stein also reviewed the performance of its investment managers, including the performance of AC&F, and assisted it with allocating its assets. (Tr. 879-81.) In 1991, the endowment fund invested approximately 75% of its equity allocation with AC&F. (Tr. 883.)
The second client included in the OIP is TIW, for whom Stein began performing investment consulting services in 1991. (Div. Exs. 54-56; Tr. 516.) TIW has several hundred million dollars in assets and, like the Texas A&M University System, employed AC&F as a money manager. (Tr. 518, 524; Div. Ex. 48.) However, TIW had hired AC&F before it hired Merrill Lynch. (Tr. 524; Div. Ex. 48.) Stein assisted TIW with allocating its assets between several investment managers and reviewed TIW's investment managers' performance, including that of AC&F. (Tr. 525.) In February 1991, TIW increased the amount of assets it allocated to AC&F and to Eagle. (Tr. 201-02, 1289; Div. Ex. 86.)
Stein also allegedly defrauded the Fish Foundation, a charitable organization with approximately $29 million in assets. (Tr. 913.) Stein began performing investment consulting services for the Fish Foundation in or about August 1991, conducting investment manager searches and presenting AC&F as one of the investment management firms for it to consider. (Tr. 231, 914-15, 835-36, 914, 1288; Div. Exs. 50, 62.) The Fish Foundation hired AC&F in 1992. (Tr. 231, 915, 836, 1288; Div. Ex. 50.) The Fish Foundation's trustees determined how to allocate its assets; however, it looked to Stein for input. (Tr. 914-16.) Stein assisted the Fish Foundation with evaluating the investment performance of its investment managers, including the performance of AC&F. (Tr. 915, 919, 922.)
The fourth institution Stein allegedly defrauded is the University of Texas System, which manages a $7 billion endowment for the University of Texas and its component institutions. (Tr. 587-89.) Stein, through Merrill Lynch, provided the University of Texas System with investment consulting services. (Tr. 590; Div. Exs. 64, 65.) It hired Merrill Lynch in or about January 1992 to provide it with asset allocation services and to review its major fund groups' performance. (Tr. 590.) Stein supported the University of Texas System's asset management committee's decision to hire AC&F. (Tr. 232-35, 842.) The University of Texas System hired AC&F on March 9, 1993. (Div. Ex. 52.) In addition, Stein did not render advice to the University that formed the primary basis for its investment decisions. (Tr. 592.)
The fifth institution described in the OIP is the LCRA. The LCRA is a political subdivision of the State of Texas and is responsible for managing the lower Colorado River basin. (Tr. 930.) LCRA manages a pension fund comprised of approximately $135 million in assets. (Tr. 935.) LCRA hired Merrill Lynch on January 1, 1994, to provide it with all four of the AIM consulting services. (Tr. 933-35; Div. Ex. 66.) As part of these services, Stein conducted investment manager searches on behalf of the LCRA. (Tr. 120-21, 236-37, 1216.) During one search, Stein added AC&F to the "short list" of investment management firms generated in New Jersey. (Tr. 120-21; 236-37, 1216.) Subsequently, LCRA hired AC&F. (Tr. 934-35.) In addition, Stein assisted LCRA with allocating its assets among its several money managers, including AC&F. (Tr. 935.) He also helped it review the investment performance of its investment managers. (Tr. 935, 998.)
During the time that Stein provided services to the five institutions he failed to inform any of them of the financial arrangements between himself and Albritton. (Tr. 526, 551-52, 597, 845, 887-88, 917, 936, 1538-84, 1594-95, 1599). Nor did Stein inform any of his consulting clients of the financial arrangements between himself and Stephen/Mayfair. (Tr. 527, 597, 846, 887-88, 917, 936.) Specifically, John Bosworth of TIW; Greg Anderson of Texas A&M; Christopher Daniel of the Fish Foundation; Robert Cruikshank, a Regent of the University of Texas; Thomas Ricks of the University of Texas System, and John Meismer of LCRA were not informed that AC&F paid Dover approximately $641,00 or that Dover paid Stephen/Mayfair $248,000. (Tr. 526, 596, 848, 887, 916, 935.) Stein did tell two representatives of the Texas A&M University, and a representative of the University of Texas System, that Albritton/Dover employed Stephen and Mayfair, however. (Tr. 1197-1205, 1270, 1272.) AC&F was also aware that Albritton paid Stephen for providing hunting services to Dover. (Tr. 499-502, 1484-85.)
CONCLUSIONS OF LAW
Stein did not violate Sections 206(1) or 206(2) of the Investment Advisers Act of 1940. Section 202(a)(11) of the Advisers Act defines the term "investment adviser" as:
any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as a part of a regular business, issues or promulgates analyses or reports concerning securities.
If Stein's activities fall within the definition of those of an investment adviser, he is subject to its proscriptions. The Division alleges that Stein willfully violated Sections 206(1) and 206(2) of the Advisers Act. "Willfully" as used in the OIP means intentionally committing the act that constitutes the violation. There is no requirement that the actor also be aware that he is violating the federal securities laws. See Steadman v. SEC., 603 F.2d 1126, 1135 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981); Arthur Lipper Corp. v. SEC, 547 F.2d 171, 180 (2d Cir. 1976); Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965). Section 206(1) of the Advisers Act makes it unlawful for an investment adviser to employ any device, scheme or artifice to defraud any client or prospective client. Section 206(2) makes it unlawful for an investment adviser to engage in any transaction, practice, or course of business that operates as a fraud or deceit upon any client. I conclude that Stein, although he was a listed principal on Merrill Lynch's investment adviser registration, did not provide investment advisory services to the clients in the instant case. Applicability of the Investment Advisers Act to Financial Planners, Pension Consultants, and Other Persons Who Provide Investment Advisory Services as a Component of Other Financial Services, 39 S.E.C. Docket 653, 659 & n.6 (Oct. 8, 1987)(hereinafter Applicability Release)..
Like the consultants in Hudson Valley Planning Inc., 1978 SEC No-Act. Lexis 793, (pub. avail. Feb. 25, 1978.), Stein and his team prepared reports for clients who were already investing and who already had investment advisers. In its no-action letter, the Division of Investment Management cited these two factors as significant in its decision that Hudson Valley did not have to register as an investment adviser. See also, Hoskins & Sutter, 1984 SEC No-Act. Lexis 1518 (pub. avail. Jan. 6, 1984.) The AIM program that Stein administered for the institutional clients consisted of the use of a team and subcontractors to generate performance statistics that might be useful to the regents and trustees who were responsible for spending, preserving, and increasing the assets of the institutions. Unlike the brokerage firms in William Bye, Inc., 1972 SEC No-Act. LEXIS 3144 (pub. avail. Apr, 26, 1972.), and FPC Securities, Corp., 1974 No-Act. Lexis 900 (pub. avail. Dec. 1, 1974), Stein did not make recommendations to his clients concerning their retention of investment managers. Stein did not recommend any single investment manager to any of his clients. Thus, the decision of the institutional clients to use AC&F was not made by relying on the advice of Stein. Furthermore, Similarly, their decisions as to investment policy, asset allocation, and investment manager performance were made after reviewing charts, lists, and comparisons generated by AIM team members from a variety of sources. The Division has not proved by a preponderance of the evidence that Stein actually performed services that fall within the ambit of the Advisers Act. The record does not allow me to infer that he did either.
The Division concedes that the mere fact that Stein was a listed principal on Merrill Lynch's investment adviser registration does not dispose of the issue as to whether his actions on behalf of his clients cause him to fall within the definition of an investment adviser in the instant case. I have concluded that Stein acted in a mere consultant capacity for the institutional clients. Therefore, he is not subject to the Advisers Act and he did not have a fiduciary or agency relationship with them. Thus, he did not violate the Advisers Act in his activities with them.
I also conclude, however, that even if Stein did act as an investment adviser within the meaning of the Advisers Act as to the institutional clients, he committed no fraud against them and he had no potential or real conflict of interest with them. The same conclusion applies to Cruikshank, the individual client for whose IRA rollover account Stein performed investment advisory services. Although the Division introduced evidence as to Stein's services on behalf of Cruikshank, I conclude that those activities were not relevant to the allegations in the instant case. The OIP refers only to institutional clients and Cruishank's IRA account was a personal one.
If Stein is not subject to the Advisers Act and if Stein did not violate Sections 206(1) or 206(2) of the Advisers Act, I must conclude that neither Albritton nor Dover violated the Advisers Act. Albritton and Dover were charged as aiders and abettors of Stein's conduct. See, Woodward v. Metro Bank of Dallas, 522 F.2d 84, 94-95 (5th Cir. 1975); Longden v. Sunderman, 737 F.Supp. 968, 976 (N.D.Tex. 1990.) In order to impose liability on Albritton/Dover for an aiding and abetting violation, I must conclude that three elements were established: (1) a primary or independent securities law violation that has been committed by some other party; (2) awareness or knowledge by the aider and abettor that his or her role was part of an overall activity that was improper; and (3) that the aider and abettor knowingly and substantially assisted the conduct that constitutes the violation. Woods v. Barnett Bank, 765 F.2d 1004, 1009 (11th Cir. 1985); Investors Research v. SEC, 628 F.2d 168, 178 (D.C. Cir. 1980); IIT v. Cornfield, 619 F.2d 909, 922 (2d Cir. 1980); Russo Securities, Inc., 65 SEC Docket 1990, 1998 & n.16 (Oct. 1, 1997); Donald T. Sheldon, 51 S.E.C. 59, 66 (1992), aff'd., 45 F.3d 1515 (11th Cir. 1995.) By failing to prove Stein's culpability, the Division failed to establish the first element of the aiding and abetting violation.
The failure of proof also extends to Merrill Lynch's alleged obligation to include information on its Form ADV. Pursuant to Section 204 of the Advisers Act, the Commission is empowered to promulgate rules specifying the records to be maintained and the reports to be disseminated by investment advisers. Form ADV is the application for registration with the SEC as an investment adviser. It is a report within the meaning of Sections 204 and 207. Rule 204-1(b) requires a registered investment adviser to amend its Form ADV in the event that any of the information contained therein becomes inaccurate for any reason. Section 207 of the Advisers Act makes it unlawful for any person to make willfully any untrue statement of material fact in any registration application or report filed with the Commission or to omit willfully to state any material fact required to be stated therein.
Part II, Item 13.A of Form ADV asks, "Does the applicant or a related person have any arrangements, oral or in writing, where it is paid cash by or receives some economic benefit (including commissions, equipment or non-research services) from a non-client in connection with giving advice to clients?" In the instant case, the non-client who might render "some economic benefit" to Stein "in connection with giving advice to clients" would be AC&F, of course. Item 13.A thus relates to a quid pro quo that might run between the non-client beneficiary and the investment adviser. This interpretation of Item 13.A is substantiated by the examples provided in the form, including "commissions, equipment, or non research services." This kind of arrangement running from AC&F to Stein via Albritton and Stephen could not have occurred, however. First, it could not have occurred because the loans from Stein did not take place until about two years after AC&F had already come to the attention of the clients or Stein had already made the referrals by the time the loans were made. The referrals occurred mainly in 1991 and the loans to Albritton commenced in 1993. Second, it could not have occurred because AC&F was not aware of the financial transactions among Stein, Albritton, and Stephen, until some time after 1993.
For fiscal years 1992-1995, Merrill Lynch filed Forms ADV that properly contained a "no" answer in response to Item 13.A. It also filed Forms ADV with the Commission which failed to state these facts. In light of Stein's financial relationship with Albritton, Albritton's Solicitation Agreement with AC&F, and Albritton/Dover's employment of Stephen/Mayfair, the Division contends that this answer was false and that Merrill Lynch failed to file timely amendments to its Form ADV disclosing these matters. The Division also contends that Merrill Lynch violated Section 204 and Rule 204-(b)(1) thereunder and Section 207 of the Advisers Act. I disagree with the Division's contentions, and I conclude that Stein had no duty to disclose his financial relationship with Albritton, not only because Stein was not acting as an investment adviser, but also because the facts do not establish an actual or potential conflict of interest.
The Division contends that the fees paid by AC&F constitute a benefit to Stein, since the fees paid to Dover by AC&F and to Stephen Stein by Dover facilitated their ability to repay Stein. It reasons that in accordance with industry standards, Stein was expected to disclose, to Merrill Lynch and to the institutional clients, his financial dealings with Albritton and with his son Stephen as conflicts of interest. I do not agree and I conclude that even if Stein were acting as an investment adviser, he was not obligated to reveal the transactions because they were not material and did not create a present or potential conflict of interest. Sections 206(1) and 206(2) establish a fiduciary duty for investment advisers to act only for the benefit of their clients. Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979). As a fiduciary, Stein would owe his clients "an affirmative duty of good faith, and full and fair disclosure of all material facts." SEC v. Capital Gains Research Bureau, 375 U.S. 180, 194 (1963). His duty to disclose would include disclosure of facts that might incline him to consciously or unconsciously render advice that was not disinterested. Id. at 191-92; Fleet Investment Advisers, Inc., Investment Advisers Act Rel. No. 1821 (Sept. 9, 1999). The facts would have to be disclosed "so that the client (could) make an informed decision as to whether to enter into or continue an advisory relationship with the adviser or whether to take some action to protect himself against the specific conflict of interest involved." Applicability Release, 39 S.E.C. Docket at 667-68. Failure to disclose these facts would be deemed a fraud or deceit within the meaning of Sections 206(1) and 206(2) of the Advisers Act. Capital Gains Research Bureau, 375 U.S. at 200. A fact is material if there is a substantial likelihood that a reasonable investor would consider it important. Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988.) In order to fulfill the materiality requirement "there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available." Id.; TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).
Scienter is an element of a Section 206(1) violation of the Advisers Act; it is a "mental state embracing the intent to deceive, manipulate, or defraud." Steadman v. SEC, 603 F.2d 1126, 1134 (5th Cir. 1979), aff'd., 450 U.S. 91 (1981); SEC v. Steadman, 967 F.2d 636, 641 (D.C. Cir. 1992.); Aaron v. SEC, 446 U.S. 680, 686 n.5 (1980) (quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976)). Recklessness can satisfy the scienter requirement of Section 206(1). Steadman, 967 F.2d at 641; Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1034 (7th Cir. 1977). Reckless conduct is conduct that is "`highly unreasonable' and which represents `an extreme departure from the standards of ordinary care . . . to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it.'" Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 47 (2d Cir. 1978) (quoting Sanders v. John Nuveen & Co., 554 F.2d 790, 793 (7th Cir. 1977)). Scienter is not required to establish a violation of Section 206(2) of the Advisers Act. Capital Gains, 375 U.S. at 195. Negligence alone is sufficient to establish the violation. Id. Nondisclosure by a fiduciary constitutes reckless conduct sufficient to establish scienter. Abell v. Potomac Insurance Co., 858 F.2d 1104 (5th Cir. 1988) vacated on other grounds, 492 U.S. 918 (1989).
The Division's interpretation of the facts in the instant case is flawed in several respects. First, it wishes me to infer from Stein's loan of money to Albritton that Stein therefore had a selfish reason to refer Albritton to AC&F for a job that he knew Albritton was not capable of performing, simply to ensure that the loan was repaid to him by Albritton. It also wishes me to infer that Stein recommended AC&F for this reason. No facts were adduced at the hearing that would enable me to infer this. For example, there was no proof that Albritton would have been unable to repay Stein within a reasonable time without the contract at AC&F; no proof that the barter of the skybox at the Stadium was not a fair exchange; no proof that Stein demanded the loan be repaid by a certain time; and no proof that Albritton was unqualified for the position at AC&F. The Division makes much of the paucity of work that Albritton performed, and of the inability of AC&F to justify Albritton's/Dover's salary. However, it would be absurd to hold Stein responsible for AC&F's ultimately independent decision to hire Albritton or their decision to retain him for several years. Nothing in the record suggests that Stein made the employment of Albritton a condition precedent for his inclusion of AC&F on the list of possible managers.
Second, the Division wishes me to infer that the fees paid to Stephen through Albritton were actually fees paid to Stein in exchange for Stein's referral of Albritton to AC&F and for Stein's recommendation of AC&F to his clients. No facts allow for this inference. Albritton was not required to retain Stephen. Stephen is an independent adult and hunting trips are not an unusual way to entertain clients or prospective clients in Texas.
The fees paid to Stephen and the loans from Stein to Stephen and Albritton are connected to the services performed for the institutional clients in an independent, attenuated fashion. Thus, I must conclude that they constitute facts that are not material. Because they are not material facts, Stein was not obligated to reveal them to the clients even if he performed the services of an investment adviser. Indeed, no witness testified that they would have considered them important or that they would have altered the mix of the information they had. I am persuaded that the Respondents acted in good faith; that none of the clients were at risk of harm; and that the law does not allow me to hold the Respondents to the standard that the Division describes. Thus, the case must be dismissed.
CERTIFICATION OF THE RECORD
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. Section 201.351(b), I certify that the record includes the items set forth in the (1) record index issued by the Secretary of the Commission on February 10, 1998, and (2) supplemental record index issued by the Secretary of the Commission in September 13, 1999.
Based on the findings and conclusions set forth above, IT IS ORDERED that this proceeding against Respondent Russell W. Stein, Respondent Ford D. Albritton, Jr., and Respondent Dover and Associates, Inc., be, and it hereby is, dismissed.
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 21 days after service of the decision. It shall become the final decision of the Commission as to each party who has not filed a petition for review pursuant to Rule 360(d)(1) within 21 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.
Lillian A. McEwen
Administrative Law Judge
-- Citations to the Exhibits offered by the Division and the Respondents, the transcript of the hearing, the Respondents' Answer, the Respondents' Amended Answer, and the Joint Exhibits will be noted as "Div. Ex. ___," "Resp. Ex. ___," "Tr. ___," "Answer ___," "Am. Answer ___," and "Jt. Ex. ____," respectively.
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