Initial Decision of an SEC Administrative Law Judge
In the Matter of
In the Matter of
ROBERT BRUCE LOHMANN
September 19, 2002
|APPEARANCES:||James A. Kidney and Valerie Szczepanik for the Division of Enforcement, Securities and Exchange Commission.
Martin J. Auerbach for Respondent Lohmann.
|BEFORE:||James T. Kelly, Administrative Law Judge|
On September 28, 2001, the Securities and Exchange Commission (SEC or Commission) issued an Order Instituting Cease-and-Desist and Public Administrative Proceedings (OIP) against Robert Bruce Lohmann (Lohmann or Respondent) pursuant to Sections 15(b)(6) and 21C of the Securities Exchange Act of 1934 (Exchange Act) and Section 203(f) of the Investment Advisers Act of 1940 (Advisers Act).
The OIP alleges that Lohmann engaged in insider trading violations prior to the November 24, 1997, public announcement that MAPCO, Inc. (MAPCO), would be acquired by The Williams Companies (Williams). It further asserts that, at the time of the purported misconduct, Lohmann was a registered securities professional and employed as a supervisor of equity trading at Royal Alliance Associates, Inc. (Royal Alliance), a registered broker, dealer, and investment adviser. The OIP charges that Lohmann illegally tipped other persons, including a co-worker who traded MAPCO stock based on Lohmann's recommendation. The OIP further asserts that at the time of the tip, Lohmann knew, or was reckless in not knowing, that the information he received came from an inside source at MAPCO. The OIP alleges that Lohmann willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. As relief for this misconduct, the Commission's Division of Enforcement (Division) seeks a cease-and-desist order, a civil penalty of $10,000, and an order barring Lohmann from association with a broker, dealer, or investment adviser.
I held a public hearing in New York City on April 17 and 18, 2002. The Division and Lohmann have filed proposed findings of fact, conclusions of law, and briefs, and the matter is ready for decision.1 I have based my findings and conclusions on the entire record and on the demeanor of the witnesses who testified at the hearing. I have applied "preponderance of the evidence" as the applicable standard of proof. See Steadman v. SEC, 450 U.S. 91, 97-104 (1981). I have considered and rejected all arguments, proposed findings, and proposed conclusions that are inconsistent with this decision.
FINDINGS OF FACT
Relevant Persons And Entities
Lohmann is forty-four years old and resides in Amityville, New York (Tr. 251, 266). He was employed by Royal Alliance, a broker, dealer, and investment adviser, from December 1984 to April 1998 (Tr. 256, 360; DX 11). In November 1997, Lohmann held a salaried position as a supervisor in Royal Alliance's trading room (Tr. 256, 259). Apart from this case, Lohmann has never been the subject of any professional disciplinary proceeding, disciplinary action, or customer complaint (Tr. 360).
In 1997, MAPCO and Williams were public companies whose shares traded on the New York Stock Exchange (DX 1 at 3). By the beginning of the week of November 17, 1997, negotiations for Williams to acquire MAPCO had reached a material stage (Stipulation No. 1). Among other things, the two companies had entered a confidentiality agreement (DX 2). They had also exchanged confidential information and completed their due diligence analysis. The chief executive officers of each company had met on two or more occasions to discuss merging, and investment bankers had completed their examination of the proposed transaction (Stipulation No. 1). On November 18, 1997, the senior officers of MAPCO and Williams agreed to final terms and planned to present the proposal to their respective boards of directors (Stipulation No. 1). The acquisition was not publicly announced until Monday morning, November 24, 1997 (DX 1). It was valued at approximately $2.7 billion (DX 1).
Patrick Joseph Danaher (Danaher) is a resident of Kingwood, Texas (Tr. 96). In the fall of 1997, Danaher was employed as a manager of crude oil supply and trading at a MAPCO subsidiary in Houston, Texas (Tr. 97, 100). Danaher spent much of his workday on the telephone, talking with others in the oil business (Tr. 198). Danaher did not know Lohmann in the fall of 1997 (Tr. 85, 176-78).
John Thomas Doherty (Doherty) is a resident of Laurel Hollow, New York (Tr. 46). In the fall of 1997, Doherty was a physical crude oil trader employed by Syntex Energy Resources, LLC (Syntex), in New York City (Tr. 46-48). MAPCO was a customer of Syntex's and Doherty spoke with Danaher by telephone several times a day (Tr. 47-49, 168). Doherty had known Danaher for approximately seventeen years, and the two men were personal and business friends (Tr. 167). Doherty and Lohmann had been friends since childhood (Tr. 266-67).
The Price Performance Of MAPCO
Between November 3 and November 14, 1997, MAPCO common stock traded in a narrow range, at approximately $33 per share, and with a low volume (DX 3). On November 20, 1997, the trading volume in MAPCO common stock rose 295% above its fifty-day average trading volume (RX 1). MAPCO closed at $34.375 per share, up $0.75 for the day (RX 1). On November 21, 1997, MAPCO common stock closed at $38.125 per share, up $3.75 for the day (DX 3). Trading volume was 1,045,900 shares (DX 3). MAPCO's options volume, which was typically below one hundred contracts per day, was well above 1,000 contracts on November 21 (RX 2). One market observer opined that MAPCO's "out-of-the-money calls [were] jacked up to the moon," adding that the bidding began on November 20 (RX 2). On November 24, 1997, the day the merger was publicly announced, MAPCO's common stock traded as high as $44 per share and closed at $43.4375 (DX 3). Trading volume on November 24 was 3,485,100 shares (DX 3).
Danaher Learns Of The MAPCO-Williams Merger
On or before November 20, 1997, Danaher learned through his employment that Williams planned to acquire MAPCO (Tr. 110-11; Stipulation No. 3). Danaher knew that the presidents of MAPCO and Williams had met at a New York law firm that specialized in mergers and acquisitions (Tr. 140-47). He also knew that MAPCO had retained an investment bank to study the proposed merger (Tr. 148-50). Danaher even telephoned the brother of the president of Williams to probe for further information about the prospective merger (Tr. 159-60).
Danaher had a personal interest in learning if a merger would occur. As an incentive to move to Houston, MAPCO had provided him with stock options (Tr. 161-62, 165). He was concerned what would happen to those options if MAPCO were merged out of existence (Tr. 164-66). Through his inquiries, Danaher learned that the options would vest and that he had nothing to worry about.
MAPCO's Code of Business Conduct (Code) was a handbook provided to all employees in April 1997 (DX 4). Section IV.C of the Code dealt with the securities laws and insider trading. The Code prohibited employees of MAPCO and its subsidiaries from communicating "material inside information" about MAPCO or any other company associated with such information to "any person." The Code stated that information should be deemed to be non-public "if it is received under circumstances which suggest that it is not yet in general circulation. Information should not be considered to have been publicly disclosed until a reasonable time after it has been made public (for example, by a press release)" (DX 4, Section IV.C). Danaher stated that he "probably received" a copy of the Code, but he did not remember reading it (Tr. 135-36). Although MAPCO provided personnel who could counsel employees about the Code, Danaher did not consult with any such personnel (Tr. 138; DX 4).
Danaher Tips Doherty, Who Trades
Danaher and Doherty talked as many as ten to fifteen times per day in the regular course of business (Tr. 168). Beginning in September or October 1997, Danaher informed Doherty that MAPCO was shopping itself around to prospective purchasers (Tr. 58, 168-69). Danaher's information came from his co-workers in Houston, and Danaher kept Doherty apprised of new developments as he learned of them (Tr. 153, 168, 170). Danaher informed Doherty about MAPCO's potential acquisition because he was Doherty's friend and thought the information might be valuable (Tr. 174-75). Among other things, Danaher told Doherty about the meeting of the presidents of MAPCO and Williams in New York (Tr. 171-72). Doherty later told the Commission's investigative staff that Danaher was "boisterous" and "chest pounding" when he conveyed information about MAPCO's search for a merger partner (Tr. 59-60). Doherty characterized Danaher as behaving like the television detective "Columbo" because of his aggressive collection of information about the merger (Tr. 66, 75). Doherty also told the Commission's staff that Danaher was his only source of information about MAPCO (Tr. 58, 64, 78-83).
Based on the information provided to him by Danaher, Doherty bought MAPCO call options (Tr. 58-59; DX 5). On October 22, 1997, Doherty purchased twenty call option contracts (DX 5). On November 20, 1997, he purchased an additional fifty call options (DX 5).
On Thursday evening, November 20, Danaher's supervisor at MAPCO explicitly told Danaher and several of his co-workers that Williams was acquiring MAPCO and that the information was confidential and non-public (Tr. 119-27; Stipulation No. 3).
Doherty told Lohmann in a telephone conversation on November 21 that his source at MAPCO "called [him] last night at home" (DX 7 at 7). I find as a fact that Danaher called Doherty at home on the night of November 20, after Danaher's meeting with his supervisor at MAPCO. In the November 21 telephone conversation, Doherty also told Lohmann that the merger would be announced the following Monday at 8 a.m., and that it would be priced at $46 per MAPCO share (DX 7 at 7). This turned out to be highly accurate information (DX 1).2
Doherty Tips Lohmann
As previously noted, Doherty and Lohmann have been friends since childhood (Tr. 266-67). Before the MAPCO transaction, Doherty had given Lohmann three to five stock tips over a five-year period (Tr. 267-68).
Doherty tipped Lohmann the information Doherty obtained from Danaher (Tr. 64, 266, 269-70). In a series of telephone conversations between Lohmann and Doherty on November 20 and 21, 1997, Doherty informed Lohmann of: (1) the impending MAPCO acquisition by Williams; (2) the fact that the takeover would result in a $46 per share valuation of MAPCO stock; (3) the fact that the public announcement would occur on Monday, November 24, 1997, at 8 a.m.; (4) the fact that the information was non-public; and (5) the fact that the information came from an employee at MAPCO (DX 7 at 1-9).
Doherty placed his first call to Lohmann at 10:06 a.m. on November 20, 1997 (DX 7 at 1). During the call, Doherty told Lohmann that "I'm giving you the tip of the day" (Tr. 269-70; DX 7 at 1). He also described MAPCO, told Lohmann it would be taken over, and stated that the acquisition would be announced "next week, but it may be today." At approximately 10:32 a.m. on November 20, Lohmann called Doherty and learned that Williams would offer $46 per share for MAPCO stock (DX 7 at 2).
Doherty did not tell Lohmann that the information about the acquisition came from an insider at MAPCO until they spoke a third time. At 3:46 p.m. on November 20, the following conversation occurred (DX 7 at 5):
Doherty: Bob, it's a done deal. It's a done at $46. It's not public yet.
Doherty: The stock is just going to open up at $46 at some point. Soon as the announcement comes out.
Lohmann: You got a machine in front of you?
Doherty: No. I basically [called?] one of the head guys at MAPCO. I said as long as this isn't inside information [laughter].
Lohmann: Right, we didn't talk.
Doherty: We didn't talk.
The following day, Lohmann and Doherty talked further about the imminent merger. At approximately 10:25 a.m. and 12:30 p.m on November 21, 1997, Doherty told Lohmann that his source had called the previous night to confirm that the deal would be announced the following Monday at $46 per share. The transcript of the 10:25 a.m. conversation is as follows (DX 7 at 7):
Doherty: Well, the announcement's on Monday.
Lohmann: Oh, really.
Doherty: 8:00 a.m. This is your last day to buy the stock. He called me last night at home, so . . . .
In their 12:30 p.m. conversation, Doherty again told Lohmann that he was relying on inside information from a friend he had previously described as "one of the head guys at MAPCO." In relevant part, the transcript shows (DX 7 at 8-9):
Doherty: Did I tell you there will be an announcement on Monday morning?
Lohmann: You did.
Doherty: OK. That's what this friend told me last night.
Lohmann: Well, just get off the taped phone.
Doherty: Yeah, that's what I kept telling him. I go, will you stop telling me all this, I already have the stock.
Lohmann Trades For His Own Account
And Tips Others Who Do Not Trade
At 10:14 a.m. on November 20, shortly after his first conversation with Doherty, Lohmann bought twenty MAPCO call option contracts for $5,128 (Tr. 270, 305; DX 6). The OIP does not charge Lohmann with insider trading for his own purchase of MAPCO securities.
At 10:33 a.m. on November 20, Lohmann telephoned one of his friends, Ed Mollica, nicknamed "Fatso," and recommended MAPCO to him (Tr. 311-14; DX 7 at 2-3). Mollica did not trade in MAPCO securities.
A short time later, at 10:51 a.m. on November 20, Lohmann spoke with another Royal Alliance employee, Ron Butler (Butler), about MAPCO (Tr. 277-79, 314-16; DX 7 at 3-4). Butler discussed the prospect of writing MAPCO put options, and Lohmann testified that Butler did so (Tr. 315-17). The OIP does not charge Lohmann with insider trading liability for Butler's transaction.
The following day, after speaking twice more with Doherty, Lohmann had telephone conversations with two business associates, Nick Gianakouros and Joe Dattolo, concerning MAPCO (Tr. 333-35, 341-42; DX 7 at 8-9). The conversations took place at about 11:45 a.m. and 1:30 p.m., respectively (DX 7 at 8-9). Lohmann told both men the price of the acquisition and the date it would be publicly announced. By this time, Lohmann knew that the information he had received from Doherty about the imminent merger was non-public and came from a source inside MAPCO. Neither Gianakouros nor Dattolo traded in MAPCO securities.
Lohmann Tips Jeffrey Sklar, Who Trades
Jeffrey Sklar (Sklar) worked at Royal Alliance from August 1996 through August 1998 (Tr. 234, 245). In November 1997, he was the firm's marketing manager, helping to design graphics, plan corporate meetings, and update the firm's brochures and forms (Tr. 234, 246). Sklar was twenty-five years old at the time, and new to the brokerage industry (Tr. 235; DX 9). Sklar and Lohmann were casual office acquaintances (Tr. 241). Sklar found Lohmann friendly and he asked Lohmann general questions about the business from time to time (Tr. 234-35).
On July 22, 1997, Sklar had opened a Royal Alliance brokerage account (Tr. 235, 238; DX 9). Sklar was a novice investor, with a modest salary and a limited net worth (Tr. 236, 285; DX 9). He had owned common stock in a pharmaceutical company for a month, but wanted to sell it because he had become disenchanted with the company (Tr. 235-36, 248). On November 21, 1997, Sklar and Lohmann met in the hallway or at the water cooler, and Sklar casually asked Lohmann what securities he liked (Tr. 237, 283, 286). Lohmann told Sklar that he had just bought MAPCO and he opined that "the stock acts great" (Tr. 283). Lohmann also said: "A little birdie told me something good is going to happen" with MAPCO (Tr. 236, 283, 286).3 The exact time of this conversation is uncertain (Tr. 286).
Sklar, a credible witness, was "hazy" on the details of his conversation with Lohmann (Tr. 236). He could not recall whether Lohmann had told him that the price of MAPCO was going to go up, that MAPCO was going to be acquired, that the MAPCO-Williams merger would be announced the following Monday, or that MAPCO would be sold at a particular price (Tr. 240-42). Lohmann could not recall telling Sklar that MAPCO was a takeover target (Tr. 283-84). Sklar had never heard of MAPCO before his conversation with Lohmann, and the only reason he purchased MAPCO stock was because Lohmann told him about the company and that something good was going to happen (Tr. 236, 248).
Following his conversation with Lohmann, Sklar sold his pharmaceutical stock and used the proceeds to purchase twenty shares of MAPCO at $37.8125 per share (Tr. 235-38, 248; DX 9). Lohmann's handwriting appears on Sklar's order ticket (Tr. 288-91; DX 9). Lohmann executed the transaction at 3:50 p.m. on November 21, ten minutes before the market closed (Tr. 288, 298; DX 9). Sklar paid commissions of $25.00 to Royal Alliance on the purchase (DX 9). Sklar sold his MAPCO shares on November 26, 1997, two days after the merger was publicly announced, at $43.3125 per share (DX 9). He also paid commissions of $25.00 to Royal Alliance on the sale (DX 9). Lohmann did not share in these commissions (Prehearing Conference of April 15, 2002, at 9-11; Tr. 292).
Sklar's gross profits on the round trip transaction in MAPCO were $110 (Tr. 244-45; DX 9). After subtracting commissions, his net profits were $60. Sklar did not talk to Lohmann about having had a successful trade in MAPCO (Tr. 240). Sklar conferred no direct financial benefit on Lohmann as a result of the trade and was never in a position to do so at Royal Alliance (Tr. 241-42, 368). Sklar testified that, because the MAPCO transaction was successful, he concluded that Lohmann "was good at what he did" (Tr. 243-44).
Once The Merger Is Publicly Announced,
Lohmann Solicits Accolades From Butler
On November 24, Lohmann telephoned Butler to inform him of the public announcement of the MAPCO-Williams merger and to solicit a "thank you" from Butler (DX 7 at 10-11). The following conversation took place:
Lohmann: Yeah but did you see the news?
Lohmann: Check the news on your machine on [MAPCO].
Butler: Wow. Nice.
Lohmann: Who's the best, huh?
Butler: Yeah. Great.
Lohmann: I'll have you know, you're the only guy I called.
Butler: Fantastic. That's good.
Lohmann: We'll see what happens.
Lohmann Deceives The Commission's Investigators
On March 31, 1998, during its investigation of this matter, the staff of the Commission interviewed Lohmann via telephone while Lohmann was at his trading desk at Royal Alliance (Tr. 349-50; DX 8, DX 10). Lohmann bluffed his way through the interview by lying. Among other things, Lohmann claimed during the interview that he had purchased MAPCO options in November 1997 because of charts and graphs, as well as his favorable view of the energy sector of the market (DX 8 at 5-7, 11). Lohmann denied that he had received any information about the MAPCO-Williams merger prior to its public announcement (DX 8 at 17-18). He further stated that he did not know of anyone else who had purchased MAPCO in the week before the merger was announced (Tr. 351-54; DX 8 at 36). Lohmann did acknowledge that he had recommended MAPCO to Sklar (Tr. 354; DX 8 at 36). He also told the staff that he discussed his purchase with his wife and may have discussed it with others (DX 8 at 20-21).
Shortly after the interview, Lohmann had a change of heart (Tr. 351-52, 359-60). He informed Royal Alliance's management of the Commission's call. He also contacted the Commission's staff and corrected his prior statements (Tr. 359). At the hearing, Lohmann explained that his initial lack of candor with the Commission's investigators had been due to nervousness and a desire not to implicate Doherty, a lifelong friend, in wrongdoing (Tr. 351).
Lohmann's Subsequent Work History
Royal Alliance permitted Lohmann to resign in April 1998 (Tr. 360). He was unemployed for the next six months (Tr. 360-61). From October 1998 to January 1999, Lohmann worked for First Montauk Securities, a broker and dealer, as an operations clerk (Tr. 255-56, 360-62). His duties at First Montauk included preparation of order tickets, confirmations, customer correspondence, and the execution of purchases and sales. He did not have any customers of his own (Tr. 255-56, 361). From February to September 1999, Lohmann was a day trader at Monroe Securities. He traded the firm's capital, using the firm's trading model, but he never received any compensation (Tr. 254, 361-62). Lohmann was without steady employment or earned income for about fifteen months.
From December 1999 to the present, Lohmann has been employed as assistant branch manager and branch manager of SJP Investors in Great Neck, New York. SJP Investors is affiliated with H.D. Brous & Company (H.D. Brous), a registered broker and dealer, as an office of supervisory jurisdiction. Lohmann is responsible for operational matters and trade inquiries at the branch office (Tr. 10, 251-52). He does not have any customers of his own, but he speaks with the customers of the other registered representatives in the branch (Tr. 15, 20, 252, 255). Lohmann is considered a valuable employee in his current position (Tr. 8-45).
DISCUSSION AND CONCLUSIONS
Paragraph II.E.20 of the OIP alleges that Lohmann willfully violated Section 10(b) of the Exchange Act and Rule 10b-5. According to the OIP, Lohmann tipped others regarding material, non-public information concerning MAPCO's impending takeover at a time when he was under a duty to refrain from doing so.
In relevant part, Section 10(b) of the Exchange Act provides that it shall be unlawful for any person:
To use or employ, in connection with the purchase or sale of any security . . . , any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
Pursuant to its rulemaking power under Section 10(b), the Commission promulgated Rule 10b-5, which provides that it is unlawful in connection with the purchase or sale of any security for any person:
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statement made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.
Insider trading is one of the "deceptive devices" prohibited by Section 10(b) of the Exchange Act and Rule 10b-5. Three key opinions, Chiarella v. United States, 445 U.S. 222 (1980), Dirks v. SEC, 463 U.S. 646 (1983), and United States v. O'Hagan, 521 U.S. 642, 652 (1997), define the scope of insider trading under these provisions. To hold Lohmann liable as a tipper under Section 10(b) and Rule 10b-5, the Division must show, by a preponderance of the evidence that: (1) Danaher was a MAPCO insider who possessed material, non-public information about MAPCO; (2) Danaher disclosed the material, non-public information to Doherty in breach of Danaher's duty to MAPCO; (3) Doherty disclosed the material, non-public information to Lohmann; (4) Lohmann knew or should have known that a MAPCO insider violated his duty of trust by relaying the takeover information; (5) Lohmann recommended MAPCO to Sklar and others while in possession of material, non-public information; and (6) Lohmann acted with scienter. See Dirks, 463 U.S. at 663-64; SEC v. Thrasher, 152 F. Supp. 2d 291, 304 (S.D.N.Y. 2001).
A fact is material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision and if disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available. See Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).
Courts have interpreted broadly the requirement of Section 10(b) and Rule 10b-5 that violations must occur "in connection with" the purchase or sale of a security. See SEC v. Zandford, 122 S. Ct. 1899, 1903 (2002); Superintendent of Ins. v. Bankers Life & Cas. Co., 404 U.S. 6, 12 (1971); In re Ames Dep't Stores, Inc., Stock Litig., 991 F.2d 953, 964-65 (2d Cir. 1993). The jurisdictional requirements of these provisions are also interpreted broadly, and are satisfied by intrastate telephone calls and even the most ancillary mailings. See SEC v. Softpoint, Inc., 958 F. Supp. 846, 865 (S.D.N.Y. 1997).
Scienter is defined as "a mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). It may be established by a showing of recklessness. David Disner, 52 S.E.C. 1217, 1222 & n.20 (1997) (citing Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990) (en banc)). The en banc Ninth Circuit adopted the standard of recklessness articulated by the Seventh Circuit in Sunstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir. 1977): "[A] highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it."
Willfulness is shown where a person intends to commit an act that constitutes a violation. There is no requirement that the actor also be aware that he is violating any statutes or regulations. See Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000); Arthur Lipper Corp. v. SEC, 547 F.2d 171, 180 (2d Cir. 1976).
Most of these issues are uncontested. During the second half of 1997, Danaher was an employee of a MAPCO subsidiary and thus an "insider" with a fiduciary duty to his employer and its shareholders to abstain from disclosing inside information. Danaher was Doherty's source for information about MAPCO's merger. During the week of November 17 through November 21, 1997, Danaher conveyed to Doherty information about the potential acquisition price and the imminence of a public announcement. This information was both material and non-public. Danaher had been a friend of Doherty's for many years, and Danaher intended his tips about MAPCO to be a gift to Doherty-a part of their accustomed pattern of trading valuable information. Doherty, in turn, told Lohmann that MAPCO was going to be acquired, the acquisition price, the fact that a public announcement was imminent, and that the information was non-public. Doherty had been a friend of Lohmann's for many years, and Doherty intended his tips about MAPCO to be a gift to Lohmann. Lohmann recommended MAPCO to Sklar and others less than one business day before the merger announcement.
Lohmann acquired a derivative duty to MAPCO under Dirks not to trade or recommend MAPCO to others no later than his third telephone conversation with Doherty on November 20, 1997. The Royal Alliance tapes show that Lohmann fully appreciated that Doherty's source at MAPCO was violating a duty to his employer in divulging the information about the merger. Lohmann responded to the news that the information was not yet public with "Shhh" and "Right, we didn't talk." The following day, Doherty telephoned Lohmann again and confirmed that the announcement would be on Monday, November 24. Lohmann's response, "Well, just get off the taped phone," demonstrates that he appreciated the illegal nature of the information. Clearly, Lohmann acted with scienter when he recommended MAPCO to Sklar and others.
Respondent focuses on three issues. First, Lohmann contends that any material information he may have possessed about MAPCO was already public when he spoke with Sklar. Second, Lohmann argues that no tipping violation occurred because, whatever material non-public information he may have possessed about MAPCO, he conveyed none of that information to Sklar. Third, Lohmann maintains that benefit to the tipper is a required element of tipping liability, and he asserts that he received no benefit from Sklar. Each of these defenses will be addressed below.
The Non-Public Information Requirement
Citing an article in the financial press, rumors in the marketplace that MAPCO was a takeover or merger candidate, and heavy trading volume in MAPCO common stock and options on Friday, November 21, Lohmann argues that the information he received from Doherty had already been widely disseminated by the time of his conversation with Sklar, thus relieving him of liability (Lohmann Br. at 8-10; DX 3; RX 2).
Information becomes public when disclosed "to achieve a broad dissemination to the investing public generally and without favoring any special person or group," Dirks, 463 U.S. at 653 n.12, or when, although known only by a few persons, their trading on it "has caused the information to be fully impounded into the price of the particular stock," United States v. Libera, 989 F.2d 596, 601 (2d Cir. 1993). Moreover, "[t]o constitute non-public information under the [Exchange Act], information must be specific and more private than general rumor." United States v. Mylett, 97 F.3d 663, 666 (2d Cir. 1996).
Lohmann bases his defense on an article published by Reuters News Service on Friday, November 21, citing "vague takeover rumors" and "speculation that there's going to be some sort of a deal" involving MAPCO (RX 2). The Reuters article was not published until Friday evening (RX 3). Because the article reported MAPCO's closing price for the day, it was obviously published after Lohmann had spoken with Sklar and had executed Sklar's trade.
Lohmann possessed information that was more specific and more private than any market rumors. See SEC v. Falbo, 14 F. Supp. 2d 508, 522 (S.D.N.Y. 1998). He passed his specific information about the date of the announcement and the acquisition price to Gianakouros and Dattolo (DX 7 at 8-9). I infer that Lohmann did not recommend that Sklar buy MAPCO because of market rumors, but because of the specific, credible information he had received from Doherty-information that he knew originated at MAPCO. Such confirmation of market rumor or press speculation satisfies the non-public element of insider trading. See SEC v. Mayhew, 121 F.3d 44, 51 (2d Cir. 1997).
In the alternative, Lohmann argues that the information he possessed regarding MAPCO was public because it was already built into the price of MAPCO stock, which had risen on Thursday, November 20, and Friday, November 21. I agree that MAPCO rose on heavier than usual trading volume on those two days (DX 3). However, after the merger was announced on Monday, November 24, volume in MAPCO was more than three times the number of shares traded on Friday, November 21, and the price of MAPCO increased another $5.00 per share (DX 3). I agree with the Division that the information about the merger had not been fully impounded into the price of MAPCO stock before Lohmann tipped Sklar. See Mayhew, 121 F.3d at 51.
The Specificity Of The Tip
Lohmann next argues that, whatever information he may have possessed about a potential takeover of MAPCO, he conveyed none of that information to Sklar (Lohmann Br. at 5-8). He contends that the information he actually communicated ("the stock acts great" and "a little birdie told me something good is going to happen") is insufficient to prove liability. I agree with Lohmann that his first statement-"the stock acts great"-conveyed only information that was already public and immediately verifiable (Tr. 362-63; DX 3, RX 1). Liability turns exclusively on his second statement to Sklar.
Unfortunately for Lohmann, "it does not take very much specificity for a tipper to violate" Section 10(b) and Rule 10b-5. See 3 Alan R. Bromberg and Lewis D. Lowenfels, Securities Fraud & Commodities Fraud, § 7.5 (1041) (2d ed. 2001); see also SEC v. Lum's, Inc., 365 F. Supp. 1046, 1059 (S.D.N.Y. 1973) (citing SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 848, 852 (2d Cir. 1968) (en banc) (calling a security "a good buy" and "recommending" it, when done by a person having material, non-public information, is a tip and a Rule 10b-5 violation)). In SEC v. Geon Indus., Inc., 531 F.2d 39, 42, 48 (2d Cir. 1976), a corporate insider, Neuwirth, told his friend, Alpert, he was going to England for an auto show and "perhaps looking at some people in view of a merger." In sustaining the district court's finding that Neuwirth was liable for a tipping violation, the Second Circuit stated: "However little Neuwirth said to Alpert, and however low its real value may have been in view of the pitfalls ahead, it was more than Rule 10b-5 permits. For an insider in [Neuwirth's] position, silence is indeed golden." Id. at 48. In SEC v. Moran, 922 F. Supp. 867, 894 (S.D.N.Y. 1996), the court held: "Encouragement to continue to purchase a stock, even if the specific advantageous information is not included in the conversation, and a resulting purchase of the security can be a violation of the prohibition against insider trading."
Under Texas Gulf Sulphur, 401 F.2d at 848, a person having material, non-public information about a security must either disclose the information to the market or "abstain from . . . recommending" the security to others. It is immaterial that Lohmann's usual role at Royal Alliance was confined to taking orders from other registered representatives and executing trades. In this instance, he encouraged a specific customer to purchase a particular security. In my judgment, that is enough to qualify as a "recommendation." A tipper need not be a retail broker who usually deals with customers. In Texas Gulf Sulphur, one of the tippers was a geologist, and his tip was confined to opining that the company's stock was "a good buy." See 401 F.2d at 852.
I conclude that Lohmann's tip to Sklar was specific enough to satisfy the requirements of Section 10(b) and Rule 10b-5. I also conclude that the recommendation was material, within the meaning of Basic and Northway, in that there was a substantial likelihood that a reasonable investor would have considered it important in making an investment decision. In addition, a reasonable investor would have viewed disclosure of the information as having significantly altered the total mix of available information.
It takes a higher level of specificity to establish a tippee violation than a tipper violation. See 3 Bromberg and Lowenfels, Securities Fraud & Commodities Fraud, § 7.5 (1141); see also SEC v. Monarch Fund, 608 F.2d 938, 942 (2d Cir. 1979); SEC v. Platt, 565 F. Supp. 1244, 1253-59 (W.D. Okla. 1983). However, those cases are not controlling here. The Division has never even suggested that Sklar was anything more than an innocent tippee.
Benefit To The Tipper
Under Dirks, an insider breaches a fiduciary duty in transmitting material non-public information if the insider gains a personal benefit from giving the information. In the words of the United States Supreme Court:
[T]he initial inquiry is whether there has been a breach of duty by the insider. This requires courts to focus on objective criteria, i.e., whether the insider receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings. . . . The elements of fiduciary duty and exploitation of non-public information also exist when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.
Dirks, 463 U.S. at 663-64.
The OIP alleges that Danaher tipped Doherty for his own personal benefit (OIP ¶ II.D.15); that Doherty for his direct or indirect benefit purchased MAPCO and tipped Lohmann (OIP ¶ II.16); and that Lohmann for his direct or indirect benefit tipped others (OIP ¶ II.D.19). Only the last of these allegations is contested.
The Division devotes a considerable amount of energy arguing with itself about whether it should or should not be required to prove a benefit to Lohmann, as the tipper. Before the hearing, the Division equivocated on this issue (Prehearing Conference of Dec. 14, 2001, at 8-11; Div. Prehearing Br. at 19-20). After the hearing, the Division asserted that it should not have to show that Lohmann benefited from his tip to Sklar, but that, if it were required to do so, it could (Div. Br. at 11-12; Div. Reply Br. at 4-8).
First, the plain language of the OIP binds the Division. The charging document alleges that Lohmann for his direct or indirect benefit tipped others (OIP ¶ II.D.19). If the Division does not demonstrate a benefit to Lohmann, that charge must be dismissed.
Second, the notion that the Division would use this administrative proceeding as the test case for scaling back the Supreme Court's holding in Dirks is an afterthought. It is completely unfair to Lohmann to wait until the reply brief-which Lohmann had no opportunity to answer-to present its argument on this point in a detailed and coherent fashion.
Third, no appellate court has yet decided whether a benefit to the tipper is required for liability under Section 10(b) and Rule 10b-5 in a case brought under the "misappropriation theory" of insider trading. See SEC v. Sargent, 229 F.3d 68, 77 (1st Cir. 2000) (noting the issue, but sidestepping it). The district courts are divided. Some have stated that there is no tipper benefit requirement. See SEC v. Yun, 130 F. Supp. 2d 1348, 1353 (M.D. Fla. 2001), appeal pending, 11th Cir., No. 01-14490-HH; SEC v. Willis, 777 F. Supp. 1165, 1172 n.7 (S.D.N.Y. 1991); SEC v. Musella, 748 F. Supp. 1028, 1038 n.4 (S.D.N.Y. 1989), aff'd, 898 F.2d 138 (2d Cir. 1990). Others have reached the opposite result. See SEC v. Gonzalez de Castilla, 145 F. Supp. 2d 402, 414 (S.D.N.Y. 2001); SEC v. Trikilis, 1992 WL 301398 at *3 (C.D. Cal. July 28, 1992), vacated, 1993 WL 43571 (C.D. Cal. Jan. 22, 1993); United States v. Santoro, 647 F. Supp. 153, 170 (E.D.N.Y. 1986), aff'd, 880 F.2d 1319 (2d Cir. 1989); SEC v. Gaspar, 1985 WL 521 at *16-17 (S.D.N.Y. Apr. 16, 1985). In any event, Lohmann did not misappropriate any inside information from Doherty. Doherty gave the information to Lohmann, out of friendship and consistent with the two men's practice of sharing tips with each other over a five-year period. The "misappropriation theory" has no role to play in this proceeding (Division's Prehearing Brief at 10; Div. Br. at 4 (discussing Lohmann's liability under the "classical theory" of insider trading)). The exception on which the Division relies has no validity apart from the "misappropriation theory."
Lohmann did not receive any pecuniary gain from recommending MAPCO to Sklar or from executing Sklar's trades in MAPCO. Lohmann was a salaried employee of Royal Alliance. He did not share in the commissions that Royal Alliance charged Sklar.
Lohmann did not receive any reputational benefit that was likely to translate into future earnings. Sklar was in no position to confer any future earnings benefit upon Lohmann. Sklar was twenty-five years old, with a limited net worth. He could only afford to buy shares in odd lots. At the time, Sklar had bought and sold only one other security.
Building on the testimony that Sklar thought Lohmann "was good at what he did," the Division theorizes that Lohmann could benefit by developing a reputation as a good stock picker, a reputation that "might" also result in a higher salary (Div. Reply Br. at 8). I accept the Division's premise that the tippee need not be the source of the future benefit, and that the benefit might instead come from the tipper's employer. Nonetheless, the Division's theory is pure conjecture. Royal Alliance paid Lohmann a salary for taking orders from other registered representatives and then executing those orders. Lohmann sometimes received bonuses (Tr. 256). However, the Division did not develop the record as to Royal Alliance's reason for awarding bonuses, and I decline to infer that the bonuses had anything to do with Lohmann's skill as a stock picker.
The benefit element of Dirks, 463 U.S. at 464, is satisfied when the tipper "makes a gift of confidential information to a trading relative or friend." That is the prong of the test that governs here. Lohmann and Sklar were friendly, if casual, office acquaintances. After Dirks, it is clear that Lohmann could not have traded MAPCO securities on Friday afternoon, November 21, and then gifted the eventual profits to Sklar. By the same token, Lohmann was forbidden to gift the profits indirectly by giving Sklar a tip so that Sklar could make the trade. On the basis of that gift, Lohmann is liable.
The weight of the evidence demonstrates that Lohmann willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, as charged in the OIP.
To protect the public interest, the Division seeks a cease-and-desist order, an order barring Lohmann from association with a broker, dealer, or investment adviser, and a civil penalty of $10,000 (Div. Br. at 3, 12-18; Div. Reply Br. at 8-10). Lohmann believes the charges should be dismissed. However, if liability is established, he requests that sanctions be limited to a cease-and-desist order, a censure, and a civil penalty (Resp. Br. at 3, 12-13). Lohmann maintains that he has learned the error of his ways and contends that a bar from the industry is not required to protect the investing public.
The public interest analysis requires that several factors be considered, including: (1) the egregiousness of the respondent's actions; (2) the isolated or recurrent nature of the infractions; (3) the degree of scienter involved; (4) the sincerity of the respondent's assurances against future violations; (5) the respondent's recognition of the wrongful nature of his conduct; and (6) the likelihood that the respondent's occupation will present opportunities for future violations. See Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981). The severity of sanctions depends on the facts of each case and the value of the sanctions in preventing a recurrence of the violative conduct. See Berko v. SEC, 316 F.2d 137, 141 (2d Cir. 1963). Sanctions should demonstrate to the particular respondent, the industry, and the public generally that egregious conduct elicits a harsh response. See Arthur Lipper, 547 F.2d at 184. Registration sanctions are not intended to punish a respondent, but to protect the public from future harm. See Leo Glassman, 46 S.E.C. 209, 211-12 (1975).
The parties have stipulated, for purposes of relief only, that there were rumors in the marketplace concerning a possible merger involving MAPCO which increased on November 21, 1997, and that there had been rumors in the prior two years that MAPCO might be involved in a merger. None of these rumors, so far as is known, included specific price information (Stipulation No. 2).
The Commission views insider trading violations as extremely serious. Although only one of Lohmann's tippees traded on the basis of Lohmann's recommendation, the misconduct was not isolated. Once Lohmann had learned material, non-public information about MAPCO, he could hardly wait to share it with close friends, business colleagues, and even to recommend MAPCO to a casual office acquaintance. The degree of Lohmann's scienter was high, and may best be measured by his own taped comments. In response to Doherty's admonition that the information about MAPCO was not yet public, Lohmann replied, "Shhh." In response to Doherty's remark, "I said, as long as this isn't inside information," Lohmann replied, "Right, we didn't talk." If more evidence is needed, it may be found in the final Lohmann-Doherty conversation, where Lohmann stated: "Well, just get off the taped phone." I believe that Lohmann now recognizes the wrongful nature of his conduct (Tr. 367). However, his assurances of future compliance are tied directly to the recognition that this proceeding could result in a bar from the securities industry. It is the potential registration sanction, not the underlying misconduct, that Lohmann regrets the most. Lohmann no longer trades stocks or options for his own account (Tr. 367-68). However, in his current position with H.D. Brous, Lohmann talks frequently with other registered representatives, traders, and customers. As long as Respondent remains a registered industry professional, the opportunity for future violations will exist.
In relevant part, Section 21C(a) of the Exchange Act authorizes the Commission to impose a cease-and-desist order upon any person who "is violating, has violated, or is about to violate" any provision of the Exchange Act or any rule or regulation thereunder.
In KPMG Peat Marwick LLP, 74 SEC Docket 384, 428-38 (Jan. 19, 2001), recon. denied, 74 SEC Docket 1351 (Mar. 8, 2001), petition denied, 289 F.3d 109 (D.C. Cir. 2002), the Commission considered the standard for issuing cease-and-desist relief. It concluded that it would continue to consider the Steadman factors in light of the entire record, noting that no one factor is dispositive. It explained that the Division must show some risk of future violation. However, it also ruled that such a showing should be "significantly less than" required for an injunction and that, "absent evidence to the contrary," a single past violation ordinarily suffices to establish that the violator will engage in the same type of misconduct in the future. See 74 SEC Docket at 430, 435. On reconsideration, the Commission specifically disclaimed any notion that issuance of a cease-and-desist order is "automatic" on a finding of past violation. See 74 SEC Docket at 1360.
Lohmann tipped three persons after learning that Doherty was providing information from a MAPCO insider. He tipped two of them after he received a second warning from Doherty. When these facts are coupled with the discussion of the Steadman factors above, I conclude that there is a risk of future violations, and that a cease-and-desist order is fully warranted.
Bar From Association With A
Broker, Dealer, Or Investment Adviser
In relevant part, Section 15(b)(6) of the Exchange Act empowers the Commission to impose a sanction against a person associated with a broker or dealer if such a person willfully violated the Exchange Act or the rules or regulations thereunder. Section 203(f) of the Advisers Act permits identical relief against a person associated with an investment adviser if such a person committed the same violation. Specifically, the Commission may censure, place limitations on the activities or functions of such an associated person, suspend that person for a period not exceeding twelve months, or bar that person from being associated with a broker, dealer, or investment adviser if the Commission finds, on the record and after notice and opportunity for hearing, that such censure, placing of limitations, suspension, or bar is in the public interest.
Section 3(a)(18) of the Exchange Act defines a "person associated with a broker or dealer" as including "any employee of such broker or dealer." Section 202(a)(17) of the Advisers Act defines a "person associated with an investment adviser" as including "any employee of such investment adviser." Royal Alliance was registered as a broker, dealer, and investment adviser in November 1997 (DX 11). As an employee of Royal Alliance who willfully violated Section 10(b) of the Exchange Act and Rule 10b-5, Lohmann is subject to a sanction under Section 15(b)(6) of the Exchange Act and Section 203(f) of the Advisers Act.
Stephen J. Posner (Posner) testified as a character witness for Lohmann. Posner has been active in the securities industry for over thirty years, and he was instrumental in hiring Lohmann for H.D. Brous (Tr. 8-11). Posner trusts Lohmann to handle his business. He also finds Lohmann to be upstanding and honorable on a personal level (Tr. 18-19). Posner opined that Lohmann lives a modest lifestyle and "is not a flashy Wall Street guy" (Tr. 18-19). Posner underwent surgery in the summer of 2001. During Posner's lengthy recuperation, Lohmann was in charge of the Great Neck office (Tr. 16-18). Posner stated that Lohmann handled matters very professionally during his absence from the office: there were no complaints or problems, and plenty of compliments (Tr. 17-18). In Posner's judgment, it would be very deleterious to H.D. Brous's customers if Lohmann were barred from the industry, and it would be difficult to replace Lohmann (Tr. 19-22, 41). Posner urges the Commission to impose no more than a censure (Tr. 42). H.D. Brous is willing to provide enhanced supervision of Lohmann, but it would be up to the Commission to structure any enhanced supervisory program (Tr. 24, 43-44).
The Commission's opinion in Martin B. Sloate, 52 S.E.C. 1233 (1997), demonstrates that registration sanctions for insider trading violations should generally be lengthy. In Sloate, the Commission considered the Division's appeal from the Initial Decision of an Administrative Law Judge. The ALJ sanctioned a securities industry professional who had been permanently enjoined from insider trading violations by imposing a bar with a right to reapply after one year. On appeal, the Commission sanctioned the respondent by imposing a bar with a right to reapply after five years. As here relevant, the Commission stated: "[A] registered securities professional who engages in the serious misconduct of insider trading should be excluded for a longer period of time [than one year]." Id. at 1236. Three recent Commission settlement orders have also imposed lengthy registration sanctions on persons enjoined from insider trading violations.4
With respect to Stipulation No. 2, I do not consider the widespread rumors of a MAPCO merger on November 21, 1997, to be a mitigating factor. Lohmann did not advise his tippees to buy MAPCO because of market rumor. The word "rumor" is not mentioned even once in the taped conversations Lohmann had with his tipper or with his tippees. Some of the so-called rumors represented insider trading by others. The Division has successfully prosecuted several individuals, including Danaher and Doherty, for such trading. See SEC v. Danaher, No. 01-CV-8431 (TPG) (S.D.N.Y.), filed Sept. 10, 2001; SEC Litig. Rel. No. 17124 (Sept. 10, 2002) (summarizing Danaher's settlement); SEC Litig. Rel. No. 17373 (Feb. 22, 2002) (summarizing Doherty's settlement) (official notice).
Posner's testimony was obviously sincere. However, the Commission has very recently considered a situation where several former or current clients of an investment adviser expressed their satisfaction with a respondent's investment advisory services and criticized the Division's efforts to bar that respondent for antifraud violations. The Commission nonetheless imposed a bar, holding that "the public interest determination extends beyond the consideration of particular investors to the public-at-large." See Christopher A. Lowry, 2002 WL 1997959 at *6; 2002 SEC LEXIS 2346 at *20 (Aug. 30, 2002).
As a general matter, I also conclude that, if a respondent offers an enhanced supervisory program as an alternative to a bar or suspension, it is the duty of the respondent to structure the proposal and to show by a preponderance of the evidence that it satisfies the public interest. It is not the Division's responsibility to structure the enhanced supervisory program for the respondent. Lohmann has not met his burden on this issue here.
Consistent with the Commission's opinions in Sloate and Lowry, and after considering the Steadman factors, I conclude that Lohmann should be barred from association with a broker, dealer, or investment adviser.5
Civil Monetary Penalty
Under Section 21B(a) of the Exchange Act and Section 203(i) of the Advisers Act, the Commission may assess a civil monetary penalty if it finds that a respondent has willfully violated the Exchange Act or the rules or regulations thereunder. The Commission must also find that such a penalty is in the public interest. See Section 21B(c) of the Exchange Act and Section 203(i) of the Advisers Act. Six factors are relevant to the public interest determination: (1) fraud; (2) harm to others; (3) unjust enrichment; (4) prior violations; (5) deterrence; and (6) such other matters as justice may require. See First Secs. Transfer Sys., Inc., 52 S.E.C. 392, 395-97 (1995). Not all the public interest factors may be relevant in a given case, and the six factors need not all carry equal weight. In its discretion, the Commission may consider evidence of a respondent's ability to pay. See Section 21B(d) of the Exchange Act and Section 203(i)(4) of the Advisers Act.
Section 21B(b) of the Exchange Act and Section 203(i)(2) of the Advisers Act specify a three-tier system identifying the maximum amount of a penalty. For each "act or omission" by a natural person, the maximum amount of a penalty in the first tier is $5,000; in the second tier, it is $50,000; and in the third tier, it is $100,000.6 A second-tier penalty is statutorily permissible in this proceeding because Lohmann's violation was willful and involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement.
There is no issue of inability to pay the $10,000 penalty sought by the Division (Prehearing Conference of April 15, 2002, at 2).
Of the six public interest factors identified in the relevant statutes, four may be resolved summarily. Lohmann's violation involved fraud and the reckless disregard of a regulatory requirement. The harm to others, and specifically to the market, was not great. It may be quantified at $110, the amount by which Sklar profited on his MAPCO trade and also the amount lost by the investor who sold MAPCO shares to Sklar. Lohmann did not enrich himself financially, and he has not committed any prior violations over his lengthy career in the securities industry.
The fifth public interest factor, the need for deterrence, presents a more complex question. Section 21B(c)(5) of the Exchange Act and Section 203(i)(3)(E) of the Advisers Act permit the Commission to consider "the need to deter [the violator] and other persons from committing such acts or omissions." The need to deter through a civil penalty is an abstract concept that is difficult to quantify. However, it cannot be considered in a vacuum, apart from the cease-and-desist order and the associational bar already imposed. The issue to consider is whether these other two sanctions, by themselves, provide inadequate deterrence. If so, then the marginal additional deterrence of a third sanction would be warranted in the public interest. Based on the facts and circumstances before me, I conclude that the need for deterrence has been fully satisfied by a cease-and-desist order and an associational bar.7
The sixth public interest factor permits the Commission to consider "such other matters as justice may require." See Section 21B(c)(6) of the Exchange Act and Section 203(i)(3)(F) of the Advisers Act. This is the statutory wild card, see First Securities Transfer, 52 S.E.C. at 396 n.15, and it plays an important role in this case.
Congress amended the Exchange Act in 1984 and again in 1988 to increase the sanctions against those who trade in securities while in possession of material non-public information. In 1984, Congress authorized the Commission to seek from federal district courts civil monetary penalties for insider trading violations. See Insider Trading Sanctions Act of 1984 (ITSA), Pub. L. No. 98-376, § 2, 98 Stat. 1264 (1984) (now codified in Section 21A(a)(2) of the Exchange Act). For tippers, the maximum civil penalty under Section 21A(a)(2) "shall not exceed three times the profit gained or loss avoided as a result of such unlawful, purchase, sale, or communication." In 1988, Congress augmented that authority by authorizing the Commission to bring an action in federal district court seeking civil monetary penalties against the controlling persons who fail to take adequate steps to prevent insider trading. See Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA), Pub. L. No. 100-704, § 3, 102 Stat. 4677 (1988) (now codified in Section 21A(a)(3) of the Exchange Act). For such controlling persons, the civil penalty under Section 21A(a)(3) "shall not exceed the greater of $1,000,000 or three times the amount of the profit gained or loss avoided as a result of such controlled person's violation."8
In 1990, Congress expanded the civil monetary penalty provisions of the Exchange Act in two respects. First, Congress authorized the Commission to seek and the federal courts to impose civil monetary penalties for violations of the Exchange Act other than insider trading. See Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (Remedies Act), Pub. L. No. 101-429, § 201, 104 Stat. 936 (1990) (now codified in Section 21(d)(3)(A) of the Exchange Act). Second, Congress authorized the Commission to impose civil monetary penalties in certain administrative proceedings under the Exchange Act and, as here relevant, the Advisers Act. See Remedies Act, Pub. L. No. 101-429, §§ 202, 401, 104 Stat. 937, 946 (now codified in Section 21B of the Exchange Act and Section 203(i) of the Advisers Act).
In 1984, Congress determined that civil penalties of not more than triple the profit gained or loss avoided would achieve the degree of deterrence that it wished to exist for insider trading violations. The Congressional findings in ITSFEA specifically stated that "additional methods are appropriate to deter and prosecute violations" of the prohibitions on insider trading. See Pub. L. No. 100-704, § 2(3). Enactment of ITSFEA in 1988 shows that, when Congress wanted to craft statutory language to deter insider trading violations by imposing civil penalties at more than triple the profit gained or loss avoided, it knew how to do so. In 1990, however, in connection with the Commission's request for statutory authority to impose civil monetary penalties in administrative proceedings, former Commission Chairman Richard C. Breeden told Congress that the Commission's experience with civil monetary penalties against insider trading had been "extremely positive" and that ITSA "has not had adverse consequences for [the Commission's] enforcement program."9
I hold that, when determining the appropriate civil penalty for an insider trading violation under Section 21B(c) of the Exchange Act and/or Section 203(i)(3) of the Advisers Act, justice requires that those two statutory provisions must be read in conjunction with Sections 21A(a)(2) and (a)(3) of the Exchange Act and with the Congressional findings about the need to deter controlling persons in ITSFEA § 2(3).10
If the Division had brought a civil injunctive action against Lohmann for insider trading in federal district court, as it did against Danaher and Doherty, Lohmann's exposure to a civil penalty sanction under Section 21A(a)(2) of the Exchange Act would have been capped at $330, or three times the profit gained by Sklar on his MAPCO trade. The $10,000 penalty the Division seeks in this administrative proceeding is more than ninety times the profit gained by Sklar and/or the quantifiable harm to others. It is more than thirty times the maximum civil penalty the Division could have obtained for this specific insider trading violation in federal district court. That disparity is a matter that justice requires me to consider. Cf. Softpoint, 958 F. Supp. at 868 (stating that the court was "deeply troubled" by a "fundamental inconsistency" in the manner in which the Commission sought civil money penalties in an insider trading case).
When the $10,000 civil penalty sought in this administrative proceeding is compared with the $330 penalty obtainable in federal district court, the $10,000 penalty may well be constitutionally excessive.11 That is another matter that justice requires me to consider.
Five of the six statutory factors thus favor Lohmann. While the antifraud violation was serious, the facts and circumstances persuade me that a cease-and-desist order and an associational bar fully vindicate the public interest. I exercise my discretion and decline to impose a civil penalty.
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.351(b), I certify that the record includes the items set forth in the record index issued by the Secretary of the Commission on May 15, 2002.
Based on the findings and conclusions set forth above,
IT IS ORDERED THAT Robert Bruce Lohmann cease and desist from committing or causing any violation or future violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; and
IT IS FURTHER ORDERED THAT Robert Bruce Lohmann is barred from association with any broker, dealer, or investment adviser.
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 Initial 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 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
1 The hearing transcript, as amended by my Order of May 30, 2002, will be cited as "Tr. ___." The hearing exhibits offered by the Division and by Respondent will be cited as "DX ___" and "RX ___," respectively. The Division's Proposed Findings of Fact and Conclusions of Law and the Division's Post-Hearing Brief, both filed June 24, 2002, will be cited as "Div. Prop. Find. ___" and "Div. Br. ___," respectively. Respondent's Proposed Findings of Fact and Conclusions of Law and Respondent's Post-Hearing Memorandum, both filed July 25, 2002, will be cited as "Resp. Prop. Find. ___" and "Resp. Br. ___," respectively. The Division's Post-Hearing Reply Brief, filed August 1, 2002, will be cited as "Div. Reply Br. ___."
Royal Alliance routinely taped telephone conversations to and from its trading room, including many of the key conversations in this proceeding (Tr. 298-99; DX 10). At my request, the parties prepared transcripts of the relevant tapes before the hearing. See Order of December 14, 2001. The parties then agreed on the wording of the transcripts (DX 7). See Order of February 26, 2002. When the tapes were played at the hearing, they were audible to the parties and to me, even though the official transcript states that many passages were garbled or inaudible. See Order of May 9, 2002. In such instances, I have relied upon DX 7 and the parties' joint proposed transcript changes, rather than on the official transcript. See Order of May 30, 2002. This procedure is acceptable to both parties (Div. Prop. Find. # 21 & n.2; Resp. Prop. Find. # 10).
2 At the hearing and during the investigation, Danaher could not recall if he telephoned Doherty after the November 20 meeting with his supervisor (Tr. 185, 215-21). Danaher also testified that he never told Doherty what price Williams would pay to acquire MAPCO or when the acquisition would be publicly announced (Tr. 222). This was deceitful testimony, and I give it no weight whatsoever. At the hearing, the Division played the tape of the November 21 telephone conversation between Doherty and Lohmann. As soon as Danaher heard the tape, he knew he had been caught in a lie. Danaher got a panic-stricken look on his face and wondered aloud whether he needed a lawyer (Tr. 185-87).
Doherty told the Commission's investigative staff that Danaher had given him a price range, but not a specific price, at which the acquisition would occur (Tr. 62, 71-72). Doherty also told the Commission's staff that Danaher had informed him during the week of November 17-November 21 that the announcement of the merger could come as soon as the next week (meaning the week of the actual announcement) or as late as the end of the calendar year (Tr. 60-62, 72-73). Doherty invoked the Fifth Amendment and did not testify at the hearing on any matters related to MAPCO. Notwithstanding Danaher's and Doherty's representations to the contrary, I find as a fact that Danaher told Doherty the date of the announcement and the price of the acquisition during the November 20 call.
3 This critical conversation did not occur on a taped telephone line in Royal Alliance's trading room. The record thus depends entirely on the recollections of Sklar and Lohmann.
4 See Benjamin J. Maldonado, III, 76 SEC Docket 1661 (Dec. 27, 2001) (settled case) (bar with a right to reapply after five years); Ricardo Ballesteros Gutierrez, 75 SEC Docket 600 (June 13, 2001) (same); Cristan Kinnard Blackman, 74 SEC Docket 2132 (Apr. 19, 2001) (same). Settled cases are of limited value as precedent. However, the Commission has recently reiterated that those who offer to settle may properly receive lesser sanctions than they otherwise might have received. See Stonegate Secs., Inc., 76 SEC Docket 111, 116 n.21 (Oct. 15, 2001) (emphasizing the importance of pragmatic considerations such as the avoidance of time-and-manpower-consuming adversary proceedings).
5 The Division urges that Lohmann's lack of candor with the Commission's investigative staff constitutes an aggravating factor (Div. Br. at 16). However, the Commission has made clear that uncharged misconduct provides no basis for enhanced sanctions. See Int'l S'holders Servs. Corp., 46 S.E.C. 378, 386 n.19 (1976). It would have been a very simple matter to include such a lack-of-candor allegation in the OIP, yet the Division elected not to do so. The omission is all the more conspicuous when the present OIP is compared with the OIP in Administrative Proceeding No. 3-10843, Rodona Garst, 2002 SEC LEXIS 1885 (July 24, 2002) (official notice). Paragraph II.E of the Garst OIP alleges: "Garst initially gave false sworn testimony to the Commission staff about her role regarding the e-mail messages." I have not considered the lack-of-candor evidence, either in determining the degree of Lohmann's scienter or when imposing sanctions in the public interest.
6 As required by the Debt Collection Improvement Act of 1996, the Commission increased the maximum penalty amounts for violations occurring after December 9, 1996, and, again, for violations occurring after February 2, 2001. See 17 C.F.R. §§ 201.1001, 201.1002. For a natural person, the adjusted maximum penalty amounts for misconduct occurring in November 1997 were $5,500 (tier one), $55,000 (tier two), and $110,000 (tier three), respectively. See 17 C.F.R. § 201.1001.
7 The Commission has imposed both associational bars and substantial civil penalties in aggravated cases. See Sandra K. Simpson, 77 SEC Docket 1983, 2009-10 (May 14, 2002); Quest Capital Strategies, Inc., 76 SEC Docket 131, 146 (Oct. 15, 2001); First Securities Transfer Sys., Inc., 52 S.E.C. 392, 395-97 (1995). However, Section 21B(a) of the Exchange Act and Section 203(i)(1) of the Advisers Act make it clear that civil penalty sanctions are discretionary, not mandatory. The public interest factors here are more in Lohmann's favor.
8 Taken together, the two provisions create an anomaly: if insider trading generates less than $333,333 in profit gained or loss avoided, the controlling person's civil penalty may be greater than the controlled violator's civil penalty. A $100,000 profit could mean a $1,000,000 penalty for the controlling person, in contrast to a $300,000 penalty for the controlled person. See 3 Bromberg & Lowenfels, Securities Fraud & Commodities Fraud, § 7.4 (1032)(2).
9 Hearings before the Subcommittee on Securities of the Committee on Banking, Housing and Urban Affairs, United States Senate, concerning S. 647, The Securities Law Enforcement Remedies Act of 1989, S. Hrg. No. 101-935, 101st Cong., 2d Sess. at 40 (1990) (Statement of Richard C. Breeden, Chairman, SEC, at 7).
10 In analyzing Sections 21A and 21B of the Exchange Act, I have applied the following principles of statutory construction: (1) all parts of a statute should be construed together; (2) it is assumed that whenever the legislature enacts a provision it has in mind previous statutes relating to the same subject matter, and, in the absence of any express repeal or amendment, the new provision is presumed to be in accord with the legislative policy embodied in those prior statutes; (3) where a conflict exists, the more specific statute controls over the more general one; and (4) statutes on the same subject matter, although in apparent conflict, should be construed to be in harmony if reasonably possible. See Norman J. Singer, Statutes and Statutory Construction, §§ 51.01, 51.02 (6th ed. 2000).
11 The Excessive Fines Clause of the Eighth Amendment to the United States Constitution reaches punitive sanctions levied in nominally civil proceedings. See United States v. Bajakajian, 524 U.S. 321, 331 n.6 (1998); Austin v. United States, 509 U.S. 602, 621-22 (1993). Two questions are pertinent: (1) is the statutory provision a fine, i.e., does it impose punishment? and (2) if so, is the fine excessive? The first question determines whether the Eighth Amendment applies, and the second determines whether the Eighth Amendment has been violated.
A fine that serves purely remedial purposes cannot be considered excessive under any circumstances. See Austin, 509 U.S. at 621-22. Unless a civil penalty solely serves a remedial purpose, however, it may be considered punitive and thus subject to scrutiny under the Excessive Fines Clause. See id. If a fine or forfeiture is punitive, the court must then determine whether it is constitutionally excessive. The test is whether the fine is grossly disproportional to the gravity of the offense. See Bajakajian, 524 U.S. at 334.
One court has already held that the civil penalty provisions in Section 20(d) of the Securities Act of 1933 and Section 21(d) of the Exchange Act are not solely remedial under Austin. See United States v. Morse, 1997 WL 181043 at *3; Fed. Sec. L. Rep. (CCH) ¶ 99,488 at 97,305-06 (S.D.N.Y. Apr. 14, 1997).
Of course, civil penalties under the Remedies Act are not considered to be punishment for purposes of a Fifth Amendment double jeopardy claim. See SEC v. Palmisano, 135 F.2d 860, 864-66 (2d Cir. 1998); SEC v. McCaskey, Fed. Sec. L. Rep. (CCH) ¶ 91,747 at 98,506 (S.D.N.Y. Mar. 26, 2002) (Magistrate Judge); Boleslaw Wolny, 53 S.E.C. 590, 598 (1998). However, labels like "punishment" or "penalty" have different meanings in different contexts. See United States v. Ursery, 518 U.S. 267, 286 (1996) ("Austin, it must be remembered, did not involve the Double Jeopardy Clause at all. Austin was decided solely under the Excessive Fines Clause of the Eighth Amendment, a constitutional provision which we never have understood as parallel to, or even related to, the Double Jeopardy Clause of the Fifth Amendment."). See also Hudson v. United States, 522 U.S. 93, 102-03 (1997). Thus, Morse's application of Austin to the civil penalty provisions of the Remedies Act survives both Hudson and Palmisano.
The structure of Section 21B of the Exchange Act and Section 203(i) of the Advisers Act is identical to the structure of the two civil penalty provisions analyzed in Morse. If the reasoning of Morse were applied in this proceeding, then the two statutory provisions could not be deemed solely remedial under Austin and the Division's requested civil penalty would be subject to analysis for "gross disproportionality." Cf. United States v. Mackby, 261 F.3d 821, 829-31 (9th Cir. 2001); Cole v. U.S. Dept. of Agriculture, 133 F.3d 803, 807-09 (11th Cir. 1998); United States v. Serfling, 1998 U.S. Dist. LEXIS 3566 at *15-17 (N.D. Ill. Mar. 3, 1998).
The Division's proposed civil penalty is not immune from scrutiny under the Excessive Fines Clause simply because it is beneath the tier-two maximum of $55,000. A sanction that is within statutory limits can still be unconstitutional under the Eighth Amendment principle of proportionality. No sanction is per se constitutional. The limit stated by the legislature receives appropriate deference, but it is not a barrier to the reach of the Constitution. Cf. Marrero v. Dugger, 823 F.2d 1468, 1472 n.7 (11th Cir. 1987).
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