Initial Decision of an SEC Administrative Law Judge
In the Matter of
|In the Matter of
May 8, 2002
A. Coates and Christopher C. Ehrman for the Division of Enforcement,
Securities and Exchange Commission.|
Tammy Albarran, David B. Bayless, Cynthia J. Cole, and Susan H. Mac Cormac for Respondent.
|Before:||James T. Kelly, Administrative Law Judge.|
The Securities and Exchange Commission (SEC or Commission) issued its Order Instituting Proceedings (OIP) on January 3, 2002, pursuant to Section 12(j) of the Securities Exchange Act of 1934 (Exchange Act). WSF Corporation (WSF or Respondent) is a Delaware corporation headquartered in Honolulu, Hawaii, and its common stock is registered with the Commission pursuant to Section 12(g) of the Exchange Act. The OIP alleges that WSF has not filed its annual report on Form 10-KSB for the year ended December 31, 2000. The OIP also alleges that WSF has not filed its quarterly reports on Form 10-QSB for the periods ending March 31, 2001, June 30, 2001, and September 30, 2001. As a result, the OIP charges that WSF failed to comply with Section 13(a) of the Exchange Act and Exchange Act Rules 13a-1 and 13a-13.
The Commission instituted this proceeding to determine whether the allegations are true, to afford Respondent an opportunity to establish any defenses to such allegations, and to decide whether the registration of WSF's common stock should be suspended for a period not exceeding twelve months or revoked. On the same day the Commission issued the OIP, it also temporarily suspended trading in WSF's common stock for ten days under Section 12(k) of the Exchange Act. See WSF Corp., 76 SEC Docket 1746 (Jan. 3, 2002).
By letter dated February 11, 2002, attorney David B. Bayless entered his appearance on behalf of WSF. Mr. Bayless acknowledged that WSF had received service of the OIP. He further stated that WSF did not intend to file an answer. On February 13, 2002, I issued an order deeming WSF in default for failing to answer the OIP. I also directed WSF to show cause why I should not revoke the registration of its common stock pursuant to Section 12(j) of the Exchange Act. See Rules 155(a)(2) and 220(f) of the Commission's Rules of Practice. On February 25, 2002, WSF submitted its response to the order to show cause. Among other things, WSF stated that it "did not wish to contest liability," but "did not intend to give up its right to contest the remedy sought" in the OIP.
FINDINGS OF FACT AND CONCLUSIONS OF LAW
As provided by Rules 155(a)(2) and 220(f) of the Commission's Rules of Practice, and as confirmed by Mr. Bayless's submissions of February 13 and February 25, 2002, WSF is in default because it has failed to answer the OIP within the time allowed. Accordingly, I find that the following allegations in the OIP are true:
As of the date of the OIP, WSF had not filed its annual report on Form 10-KSB for the year ended December 31, 2000. WSF also had not filed its quarterly reports on Form 10-QSB for the periods ending March 31, 2001, June 30, 2001, and September 30, 2001.
As of the date of the OIP, WSF management had informed the staff of the Commission's Division of Enforcement (Division) that WSF still had not retained a public auditor for its financial statements for the year ended December 31, 2000. Moreover, based on financial statements from earlier periods, it did not appear that WSF had sufficient financial resources to retain a new outside auditor. Nor did WSF have sufficient documents from which to prepare financial statements, according to statements WSF management made to the Commission's Division of Corporation Finance. Nevertheless, WSF continued to communicate with the investing public through postings on the Internet.
As a result of the foregoing, WSF failed to comply with Section 13(a) of the Exchange Act and Exchange Act Rules 13a-1 and 13a-13.
Under Section 12(j) of the Exchange Act, the Commission is authorized "as it deems necessary or appropriate for the protection of investors" to revoke the registration of a security or to suspend the registration of a security for a period not exceeding twelve months if it finds that the issuer of such security has failed to comply with any provision of the Exchange Act or the rules and regulations thereunder. Section 12(j) contemplates that the issuer should have "notice and opportunity for hearing" before any such sanction is imposed.
The Parties Consented To A Sanctions Hearing By Telephone
On February 28, 2002, I held a telephonic conference with counsel for the Division and for WSF. Because WSF's failure to comply with Section 13(a) of the Exchange Act and Exchange Act Rules 13a-1 and 13a-13 was uncontested, the parties agreed that the only issue to be decided at the hearing was the appropriate sanction under Section 12(j) of the Exchange Act. The Division took the position that registration of WSF's common stock should be revoked. WSF contended that it was attempting in good faith to obtain the funds to engage an outside auditor and to file the overdue reports in question. It therefore argued that only a short suspension of the registration of its common stock was warranted.
After discussion, the parties agreed that the Commission's determination of the appropriate sanction should be guided by the public interest factors identified in Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981). Under Steadman, several issues should 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 its conduct; and (6) the likelihood of future violations. No one factor is controlling.
I held the sanctions hearing on March 12 and 13, 2002, receiving testimony from six witnesses. The Division filed twelve exhibits and WSF filed six exhibits. Counsel for the Division, the court reporter, and the undersigned were in the Commission's hearing room in Washington, D.C. Respondent's witnesses and counsel participated by telephone from California, and one witness for the Division participated by telephone from Colorado. Both parties consented to the telephonic hearing procedure. The hearing room was open to the public, and those in the hearing room could listen to the witnesses by speakerphone (Prehearing Conference of Feb. 28, 2002, at 3-5, 15-19; Order of Mar. 1, 2002, at 2).1 The parties have submitted proposed findings of fact, conclusions of law, briefs, and reply briefs, and the sanctions issue is now ready for decision. I have applied preponderance of the evidence as the standard of proof. Steadman v. SEC, 450 U.S. 91, 97-104 (1981).
Division's Motion To Strike Expert Testimony Of Gil Livnah
At the sanctions hearing, WSF offered expert opinion testimony from Gil Livnah (Livnah) about the importance of liquidity to shareholders in a publicly-traded company and the likely harm to such shareholders caused by the revocation of registration of the company's securities. Livnah's background includes six years as an investment banker and four years as a corporate attorney, and he is experienced with mergers and acquisitions, restructuring transactions, and general corporate finance (Statement of Qualifications dated Mar. 11, 2002). Over the Division's objection, I accepted Livnah's testimony (Transcript pages 90-95) (hereafter, "Tr. ___"). I offered the parties an opportunity to revisit the issue in their posthearing pleadings, and encouraged them to address the applicability, if any, of Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579 (1993), and Kumho Tire Co. v. Carmichael, 526 U.S. 137 (1999) (Tr. 95).
The Division has now moved to strike Livnah's testimony. Citing Daubert and Kumho Tire, the Division argues that nothing in Livnah's experience gives him any special knowledge concerning the subject on which he opined. It also contends that his testimony is unreliable because it was not the product of any reliable principles or methods. In opposition, WSF contends that Livnah is qualified to render his opinions and that the opinions are relevant and reliable.
Daubert provides that a trial judge must perform a gatekeeping function to determine the admissibility of expert testimony. Daubert, 509 U.S. at 589. While not setting out a definitive checklist, Daubert identified four criteria for evaluating the admissibility and reliability of expert testimony: (1) whether the methods upon which the testimony is based are testable; (2) the known or potential rate of error associated with the test; (3) whether the method has been subject to peer review; and (4) whether the method is generally accepted in the relevant scientific community. Daubert, 509 U.S. at 593-94. Although Daubert was limited to scientific testimony, Kumho Tire extended Daubert's reach to include virtually all expert testimony. Kumho Tire, 526 U.S. at 149.
The Commission has not yet considered the applicability of Daubert and Kumho Tire, which are based on Rule 702 of the Federal Rules of Evidence, to adjudicatory proceedings conducted under its Rules of Practice. But see Elliott v. CFTC, 202 F.3d 926, 934 (7th Cir. 2000) ("Daubert and Kumho Tire were decided in the context of admissibility, but the principle for which they stand-that all expert testimony must be reliable-should apply with equal force to the weight a[n agency] factfinder accords expert testimony."); Peabody Coal Co. v. McCandless, 255 F.3d 465, 469 (7th Cir. 2001) (citations omitted):
Daubert does not apply directly in black lung cases, because it is based on Fed. R. Evid. 702, which agencies need not follow. Agencies relax the rules of evidence because they believe that they have the skill needed to handle evidence that might mislead a jury. They have a corresponding obligation to use that skill when evaluating technical evidence. Neither the ALJ nor the [Benefits Review Board of the Department of Labor] did this, however . . . . An agency must act like an expert if it expects the judiciary to treat it as one.
I affirm my bench ruling admitting Livnah's testimony into the record, because the Commission has expressed a preference for inclusiveness in doubtful cases. See City of Anaheim, 71 SEC Docket 191, 193-94 & nn.4-8 (Nov. 16, 1999). That is not the end of the matter, however, because Elliott and Peabody Coal make it clear that Daubert and Kumho Tire are as much about the reliability of expert testimony as they are about its admissibility. Cf. Charles D. Tom, 50 S.E.C. 1142, 1145 (1992) (holding that, in determining when to admit and whether to rely on hearsay evidence, the Commission evaluates its probative value, its reliability, and the fairness of its use).
Livnah did not testify about any specific, significant experience he has concerning the impact of stock registration revocation on shareholders. WSF argues only that Livnah's decade of experience as an investment banker and corporate attorney "has taught him the factors that are important to investors," such as liquidity (WSF Opposition to Motion to Strike, at 2). I therefore agree with the Division that Livnah offered opinions beyond the scope of his demonstrated experience. In addition, I conclude that Livnah's testimony was not the product of reliable principles or methods, as required by Daubert. As a general matter, of course, liquidity is preferable to illiquidity. But Livnah did not analyze the actual liquidity of WSF's common stock, which is listed in the "pink sheets." He made assumptions about WSF's ability to meet its obligations and to comply with Commission requirements that lacked a foundation in the record. Consistent with Daubert and Kumho Tire, I have given Livnah's opinions minimal weight in reaching this Initial Decision.
The Protection Of Investors
In its brief, WSF describes itself as a company that is asset rich, but cash poor. It argues that revoking the registration of an issuer's securities is the "death penalty" for any public company. WSF maintains that imposing such a sanction here would be punitive to its current shareholders, because it is now "poised" to return to compliance with the periodic reporting requirements of the Exchange Act. Respondent also contends that the Commission has never previously revoked the registration of an issuer's securities for a "mere" failure to file periodic reports if the issuer was an "operational" company with "real" assets. Finally, it argues that the Commission should have brought a cease-and-desist proceeding, not a registration revocation proceeding.
First, I do not share WSF's rather narrow focus on the ability of its current shareholders to liquidate their stock by selling to others. The Commission must consider the interest of the investing public at large, including those members of the public who might be on the buy side if WSF's current shareholders are selling. Second, WSF's argument that a cease-and-desist proceeding under Section 21C of the Exchange Act would have been more appropriate than a Section 12(j) proceeding is interesting, but irrelevant. The claim finds some support in the academic literature. See 4 Louis Loss & Joel Seligman, Securities Regulation 1892 (3d ed., rev. vol. 2000) (opining that involuntary revocation of a security's registration is draconian, harmful to innocent security holders, and unnecessary because other regulatory tools are available to the Commission to ensure the filing of adequate reports). However, the fact that the Commission might have chosen a different path does not mean that an ALJ is free to second-guess the path that the Commission actually selected. Third, the Commission has not been hospitable to claims that it has not brought proceedings against other similarly-situated wrongdoers. See Richard J. Puccio, 52 S.E.C. 1041, 1046 (1996). To establish a claim of selective prosecution, a respondent must demonstrate not only that he was unfairly singled out, but also that his prosecution was motivated by improper considerations such as race, religion, or the desire to prevent the exercise of a constitutionally-protected right. Id. No such showing was made here. Respondent asserts that its argument involves more than simply a selective prosecution claim (Tr. 41, 139-45, 148-55). I fail to appreciate the distinction that Respondent attempts to draw. Fourth, testimony presented at the sanctions hearing provides a colorable basis for questioning WSF's self-portrait as an operational company with real assets. Prospective investors and current shareholders can make that decision for themselves, provided, of course, that they have access to current, audited financial statements.
WSF contends that its violations of the periodic reporting requirements are not egregious, or at least, not as significant as violations of the antifraud provisions of the Exchange Act might be. I do not accept the premise that the violations in question are trivial. The purpose of the periodic filings is to supply the investing public with current, accurate financial information about an issuer so that the investing public may make informed decisions. As stated in SEC v. Beisinger Indus. Corp., 552 F.2d 15, 18 (1st Cir. 1977) (quoting legislative history):
The reporting requirements of the [Exchange Act] is the primary tool which Congress has fashioned for the protection of investors from negligent, careless, and deliberate misrepresentations in the sale of stock and securities. Congress has extended the reporting requirements even to companies which are "relatively unknown and insubstantial."
I therefore conclude that the violations involve an important provision of the Exchange Act.
I also conclude that WSF's violations are not isolated. I reject Respondent's claim that the Division cannot go beyond the four corners of the OIP to show that a stiffer sanction is warranted because the violations alleged in the OIP were not isolated. In addition to failing to file its annual report for calendar year 2000, WSF has also failed to file annual reports for calendar years 1991, 1992, and 2001 (Tr. 10, 12, 14; Division Exhibit 12) (hereafter, "DX ___"). In addition to failing to file the three quarterly reports identified in the OIP, WSF has also failed to file its quarterly report for the period ending June 30, 1993. Most of Respondent's other annual and quarterly reports in the last ten years were filed well after their due dates (DX 1).
The most recent annual report WSF filed was for calendar year 1999. In November and December 2000, the Commission's Division of Corporation Finance wrote two detailed comment letters to WSF, expressing several concerns about the 1999 annual report (DX 2, DX 4). As of this date, WSF has yet to address many of the questions posed by the Commission's staff in the first comment letter, and it still has not even answered the second comment letter (Tr. 29-32, 135-36, 163; DX 3). Clearly, WSF's failure to comply with Exchange Act Section 13(a) in a timely manner is a chronic problem.
Violations of Exchange Act Section 13(a) do not require a finding of scienter. By defaulting on the issue of liability, and by the testimony of its officers at the sanctions hearing, Respondent has tacitly recognized the wrongful nature of its failure to file the periodic reports at issue.
Before WSF can file its delinquent annual report, it must have its financial statements audited by a qualified outside auditor. WSF has provided letters from auditors that it might retain (Respondent's Exhibits B and C) (hereafter, "RX ___"). However, WSF has not retained an auditor (Tr. 21). Respondent takes the position that there would be no point to committing the necessary funds as long as there is any prospect that the Commission might revoke the registration of its common stock (Tr. 136-37, 179).
WSF has made repeated representations to the public, through Internet postings, that it intends to bring itself into compliance with Exchange Act Section 13(a) (DX 5-DX 8). I accept that WSF's management had a good faith belief in these representations when it made them. However, time has proven them to be inaccurate. WSF made similar representations to me. WSF and International Development Corporation Center (IDCC) negotiated a letter of intent in February 2002, at about the time I issued my order to show cause (RX A). Under the terms of that letter, WSF and IDCC were negotiating for IDCC to provide WSF with the necessary funds to pay for an audit and satisfy several other financial obligations. However, WSF terminated its negotiations with IDCC shortly before the sanctions hearing (Tr. 61, 64-66, 70-71). I infer that WSF's quarterly report for the period ending March 31, 2002, is unlikely to be filed on time. I conclude that WSF's ongoing failure to comply with Section 13(a) is quite likely to continue in the future.
Respondent expresses frustration that the Division has failed to address its argument that suspension, rather than revocation, is the more appropriate sanction (WSF Reply Br. at 1, 10). It is not at all clear that the Commission is foreclosed from imposing the maximum permissible sanction unless it first demonstrates that a lesser sanctions will not suffice to protect investors. Compare Rizek v. SEC, 215 F.3d 157, 161 (1st Cir. 2000) (holding that the Commission is not required to "[explain] to the satisfaction of a court why no lesser remedy will do" before imposing a permanent bar) with Steadman, 603 F.2d at 1139-40 (holding that "the greater the sanction the Commission decides to impose, the greater is its burden of justification"). A temporary trading suspension under Section 12(k) has already proven to be an ineffective sanction. If I were to suspend the registration of WSF's common stock for a fixed period (whether twelve months or less), and if WSF were to fail to bring itself into compliance during that fixed period, the suspension order would expire automatically. It could not be extended beyond twelve months, and it could not be converted into a revocation. To revoke the registration of WSF's common stock at that juncture, the Commission would have to initiate a fresh administrative proceeding. There is no persuasive evidence that WSF can or will remedy its violations in the near future. Based on my determination that WSF's violations have not been isolated, and are likely to continue in the future, I do not believe that suspension of registration for a fixed term will adequately protect the investing public.
As a result of WSF's failure to make the required filings, there is no current, reliable, audited information regarding WSF's operations or financial condition. The investing public has no way of knowing if the missing periodic reports really mask significant financial problems and/or potential inaccuracies in WSF's 1999 financial statements. Viewing the Steadman factors in their entirety, it is necessary and appropriate for the protection of investors to revoke the registration of WSF's common stock.
Pursuant to Rule 351(b) of the Commission's Rules of Practice, I certify that the record includes the items set forth in the record index issued by the Secretary of the Commission on March 29, 2002, as amended on May 7, 2002.
Based on the findings and conclusions set forth above, IT IS ORDERED THAT the registration of the common stock of WSF Corporation is revoked.
This Order shall become effective in accordance with and subject to the provisions of Rule 360 of the Commission's Rules of Practice. Pursuant to that Rule, a petition for review of this Initial Decision may be filed within fourteen days after service of the Initial Decision.2 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 fourteen days after service of the Initial Decision on that party, unless the Commission, pursuant to Rule 360(b)(1), determines on its own initiative to review this Initial Decision as to that party. If a party timely files a petition for review, or the Commission acts to review on its own motion, the Initial Decision shall not become final as to that party.
James T. Kelly
Administrative Law Judge
| Paragraph IV of the OIP required that the hearing be held "before" an Administrative Law Judge (ALJ). Hearings "before" an ALJ need not be "in the physical presence of" the ALJ. Cf. Bigby v. INS, 21 F.3d 1059, 1063-64 (11th Cir. 1994) (holding that when credibility determinations are not in issue, an immigration judge may hold a hearing by telephonic means). Witness credibility is not an issue here. |
|Rule 360(b) permits an ALJ to grant the parties up to twenty-one days after service of the Initial Decision to petition for Commission review. Most Initial Decisions routinely grant the maximum twenty-one days. A shorter period of fourteen days is established here because the issues are straightforward and the public interest considerations in timely resolution of this controversy are strong.|
|Home | Previous Page||