Initial Decision of an SEC Administrative Law Judge
In the Matter of
In the Matter of
DANIEL L. ZESSINGER
AUGUST 2, 1996
William P. Hicks, William A. Rees, and Cheryl C. Nichols for the Division of Enforcement, Securities and Exchange Commission, Atlanta District Office
Daniel L. Zessinger, pro se
Carol Fox Foelak, Administrative Law Judge
1. The Securities and Exchange Commission (Commission) initiated this proceeding by an Order Instituting Proceedings (OIP) on September 28, 1995, pursuant to Section 8A of the Securities Act of 1933 (Securities Act) and Sections 15(b), 19(h), and 21C of the Securities Exchange Act of 1934 (Exchange Act). The OIP alleged that Respondent Zessinger was convicted on his pleas of guilty in state and federal courts of violations related to securities fraud arising out of his activities as a registered representative associated with a broker-dealer from about November 1990 to May 1992. The OIP further alleged that during that time period he engaged in misconduct with regard to an account of an elderly widow, including churning, unsuitable transactions, and misrepresentation, that violated Section 17(a)(1), (2) and (3) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
2. I held a hearing at the U.S. Penitentiary, Marion, IL, on March 13 and 14, 1996.1 The Division of Enforcement (Division) called three witnesses from whom testimony was taken. The Division also called the Respondent as a witness, but he declined to testify on the ground that anything he could say might be used to incriminate him.2 The Respondent called two witnesses. A number of exhibits were received into evidence.3
3. Pursuant to the requirements of the Administrative Procedure Act4, I considered the following post hearing pleadings: (a) the Division's Proposed Findings of Fact and Conclusions of Law and Post Hearing Brief in Support, dated April 26, 1996; (b) the Respondent's untitled post hearing brief, dated April 25, 1996; (c) the Division's Reply Brief, dated May 22, 1996; and (d) the Respondent's undated Reply Brief, received June 12, 1996.
4. My findings and conclusions are based on the record and my observations of the witnesses' demeanor.5 I applied preponderance of the evidence as the applicable standard of proof.
FINDINGS OF FACT AND CONCLUSIONS OF LAW
5. Respondent Daniel L. Zessinger was born October 14, 1960, and is a college graduate. Div. Exs. 6; 9 at 2-3. He was associated with Prudential Securities, Inc. (Prudential), a broker-dealer registered with the Commission, as a registered representative between approximately November 1990 and May 1992 in the St. Louis, MO, area. Div. Ex. 8 at 6. See also my March 1, 1996, Order and Zessinger's Answer. Prior to his employment at Prudential, Zessinger was employed at PaineWebber, Inc. Tr. 37; Div. Ex. 8 at 6. He was incarcerated at the time of the hearing at the Marion, IL, Federal Prison Camp serving a 33 month sentence. Div. Ex. 6.
6. Zessinger has been convicted twice of crimes that are felonies within the meaning of Section 15(b)(4)(B) of the Exchange Act. Both convictions arose from fraudulent activities while a registered representative with Prudential.
7. Zessinger was convicted on his May 24, 1994, plea of guilty to one count of mail fraud, in violation of 18 U.S.C. Sections 1341 and 1342, United States v. Daniel L. Zessinger, Case No. 4:94 CR132DJS (E.D. Mo.) (U.S. v. Zessinger). He was sentenced August 19, 1994, to 33 months' imprisonment followed by three years' supervised release and payment of restitution of $104,350 to be made within five years following release. Div. Exs. 6, 7, 9; see also Zessinger's Answer. Div. Exs. 6-10 are stipulations of facts in U.S. v. Zessinger, as well as the criminal information, the transcript of the plea and judgment, and the sentence.6
8. Zessinger was convicted on his August 13, 1993, plea of guilty of two counts of securities fraud in violation of Section 409.101, RSMo. State of Missouri v. Danny Lee Zessinger, Cause No. 93CR-000197 (Missouri v. Zessinger). He was sentenced October 15, 1993, to seven years' imprisonment, suspended, and restitution. Div. Exs. 1, 2; see also Zessinger's Answer. His sentence was later modified to run concurrently with the federalsentence. Div. Ex. 3. Div. Exs. 1-3 and 5 are the indictment,7 transcript of the plea and judgment, and sentences in Missouri v. Zessinger.8
9. The convictions were based on Zessinger's defrauding Prudential customers from about November 1990 through May 1992. Div. Ex. 5, 7, 8; Div. Ex. 9 at 9-10. He acknowledged that he did this knowingly. Div. Ex. 8 at 6-7; Div. Ex. 9 at 10. His victims included elderly customers with limited assets who had entrusted their retirement funds to him; some were unsophisticated investors who were unable to understand the monthly statements Prudential sent them. Div. Ex. 10.
10. Among other things, Zessinger effected unauthorized transactions in customers' accounts; ignored customers' instructions to sell securities; purchased securities for customers which were unsuitable or excessively risky in view of their financial circumstances and investment objectives; misrepresented to customers that unauthorized trades in their accounts had been canceled; and misrepresented to customers that they were making money on their investments when, in fact, they were losing money. Div. Ex. 5, 7, 8; Div. Ex. 9 at 9-10. The losses caused by Zessinger's fraudulent conduct were between $350,000 and $500,000. Zessinger attempted to conceal his scheme by selling fictitious mortgages and using the funds,without the knowledge of the investors, to cover losses in other investors' accounts. Div. Ex. 8.
MILDRED WEIR'S ACCOUNT
11. Zessinger also violated Section 17(a)(1), (2) and (3) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder in connection with the account of Mildred Weir at Prudential between November 1990 and May 1992. As discussed infra, his fraudulent course of conduct included material misrepresentations, churning, and unsuitable recommendations; he acted willfully and with scienter. His activities with reference to the Weir account were not part of U.S. v. Zessinger or Missouri v. Zessinger. Div. Exs. 7, 5. See also Zessinger's Reply Brief at 1.
12. Mildred Weir Now deceased, Mildred Weir was a ninety year old widow with modest assets, incapable of handling her affairs, due to Alzheimer's disease and other afflictions, when the account was opened in 1990. Tr. 32-36. Her son Martin Weir had recently taken over her financial affairs and obtained her power of attorney9 after his sister, who had been caring for their mother, became seriously ill. Tr. 107, 67. He opened a joint account with Mildred Weir's assets, in the names of Mildred G. Weir and Martin B. Weir (Mildred Weir account). The assets were needed to finance Mildred's living expenses, and he told Zessinger that she would be going into a nursing home shortly. Tr. 38. In 1991, Mildred moved into anursing home and Zessinger was told that the funds in the account were needed to pay nursing home expenses. Tr. 53-54.
13. Martin Weir Martin had a high school education and limited investment experience. Tr. 29-32. His work from 1955 to 1993 was service, installation and sales of heating and air conditioning equipment. For a few years, around 1965 to 1970, he and a partner owned a heating and air conditioning business. Tr. 29-30, 55-57. Martin's testimony and demeanor generally demonstrated a lack of knowledge and sophistication concerning investment matters. Tr. 31-32, 41, 44-49, 52, 55-57, 60, 67-69, 75. For example, he does not have a correct understanding of what common stock is. Tr. 31-32. He does not know what a short sale is. Tr. 52. He did not know what a margin agreement was and did not understand margin trading. Tr. 44. Martin's business experience did not include investment or financial expertise. He left all the book work for the business he owned to his partner and secretary. Tr. 55-57. As an employee, he left computations of such things as the commissions he earned and his expense account to others. Tr. 57-58.
14. Theresa Weir Martin's wife Theresa completed the ninth grade; she was employed outside the home for 16 years as a clerk. Tr. 103-4. She also was inexperienced in investment matters when she and her husband first encountered the Respondent. Tr. 104. She did not know what margin trading was. Tr. 105, 115. She accompanied Martin to meet with the Respondent when the Mildred Weir account was opened. Tr. 106-7. She, more than Martin, reviewed and filed the account statements for the account. Tr. 107, 110-12. She also spoke on the phone and took part in meetings with Zessinger. Tr. 109-14.
15. Credibility Martin and Theresa Weir's testimony was generally credible and demonstrated their lack of sophistication in investment matters when dealing with the Respondent. Their testimony was consistent with other evidence of record. For instance, their testimony that Martin specified a conservative investment objective for Mildred's account was consistent with her circumstances and with his initial choice to invest her money in a certificate of deposit (CD).
Martin specified a conservative objective; Zessinger knew Mildred's situation.
16. Mildred Weir's assets were in a savings account when the Weirs saw a PaineWebber advertisement offering a CD10 at a better rate. Tr. 36, 105-7. The Mildred Weir account was opened with Zessinger at PaineWebber in September 1990, and the initial transaction was the purchase of the CD. Tr. 36, 39. The account was transferred to Prudential when Zessinger moved there. Tr. 39-41. The funds put into the account were all Mildred's, the life savings earned by her late husband. Tr. 34, 38, 43. Her only other assets were a house worth about $42,000. Her only other income was Social Security. Tr. 33, 34.
17. When he opened the account, Martin told Zessinger that the investment objective was conservative, that Mildred had Alzheimer's disease, and that she needed the assets to live on. Tr. 38, 39. Martin credibly disavowed ever having told Zessinger or otherwise consented to an investment objective of speculation in the Mildred Weir account, whether at PaineWebber or Prudential. Tr. 39, 43, 45, 52, 206-7. See also Tr. 78-85.
18. Zessinger argues in his Post Trial Brief at 3-6, and Reply Brief at 3-4, that Martin consistently specified a speculative objective for the account. He argues that a conservativeobjective is inconsistent with the evidence, Tr. 82-83, that Mildred's principal would be used up after four or five years of nursing home expenses. To the contrary, a conservative objective is more consistent with Mildred's financial condition than a speculative objective. Zessinger also notes that the Weirs received confirmations and monthly account statements. Tr. 110-12. In light of the Weirs' lack of investment knowledge, as well as Zessinger's misrepresentations, discussed infra, my finding that Martin specified a conservative objective is not inconsistent with the disclosure of speculative investments in these records.
19. Zessinger also argues in his Post Trial Brief at 3, that Martin was accustomed to trading in new issues and low-priced speculative stocks. The record, however, supports a finding to the contrary. The only reference in the record to such securities is Martin's testimony that, approximately 30 years ago, he had traded in four or five new issues or low-priced securities, based on his previous broker's recommendation. The previous broker had made all investment decisions on Martin's behalf, and when he died, Martin sold all these securities, except one. Tr. 31-32.
20. Zessinger also argues what might have been his evidence had he chosen to testify, i.e., that Martin chose a speculative objective, not a conservative objective, when he opened the account, and that Zessinger considered Martin, not Mildred, the client. As noted above, adverse inferences can be drawn from his silence. Baxter v. Palmigiano, 425 U.S. 308, 318-319 (1976).
21. I have not, however, drawn a negative inference from Zessinger's silence. The Weirs' credible unrebutted11 testimony was that Martin chose a conservative objective. Zessinger affirmatively chose not to testify to the contrary. Having made that choice, he cannot attempt to argue that Martin authorized a different objective.
22. Zessinger knew, while effecting transactions in the Mildred Weir account, that Mildred Weir was an elderly widow unable to manage her own affairs, that she was expected to move into a nursing home, and that the account held virtually her entire life savings. Tr. 39, 40.
Zessinger effected unauthorized transactions.
23. When he transferred the account to Prudential, Zessinger had the Prudential opening account documentation carried over to Martin's house by a courier for immediate signature on a Saturday. Tr. 40-41, 69. Martin was wallpapering. Tr. 75. Martin recalled that the papers were not "filled out" but that the places he was to sign were marked with an "X." Tr. 69. Martin signed the papers without reading them because he trusted Zessinger and Prudential. Tr. 75-76.
24. A total of $117,913.82 was deposited into the account at Prudential, primarily in the CD, which matured January 30, 1991. Tr. 141; Div. Exs. 36, 24. Soon after the CD was redeemed, Zessinger began trading on margin. Div. Ex. 24; Tr. 143. Between December 1990 and May 1992, Zessinger effected 109 trades in the account, purchasing securities valued at $1,039,737. Div. Ex. 33.
25. Martin never knowingly signed a margin agreement or verbally authorized Zessinger to engage in margin trading in the account. Tr. 41. Martin did not even know what a margin agreement was and did not understand margin trading. Tr. 44. Nor did his wife, Theresa, understand margin trading. Tr. 103-5. Zessinger's claim in his Post Trial Brief at 3, that Martin knew he had signed a margin agreement and understood margin trading, is unsupported by any evidence. The Weirs' credible unrebutted testimony is to the contrary.
26. In early 1991, Martin discovered that Zessinger was buying stocks in the account. Tr. 44-45. Neither Martin nor Theresa authorized any of the 109 trades Zessinger effected in the account. Tr. 41-47, 53, 111. However, they acquiesced due to Zessinger's misrepresentations.
27. The Mildred Weir account lost over $65,000 during the time it was handled by Zessinger. Tr. 154-55; Div. Ex. 32. Yet when they questioned him, Zessinger always assured the Weirs that the trading in the account was profitable. Tr. 45, 49, 109, 113. Zessinger argues to the contrary in his Post Trial Brief at 4, but the Weirs' testimony on this point is credible and unrebutted.
28. The Weirs received confirmation statements and monthly account statements, which were primarily retained by Theresa. Tr. 108, 110-12. Neither Martin nor Theresa understood them. Tr. 47, 112. Nonetheless, it appeared to them that the account was unprofitable and they met with Zessinger on several occasions. Tr. 49.
29. Zessinger responded by telling Martin and Theresa to disregard the account statements and not to worry because Prudential was attempting to correct computer billing errorsor was "changing over the accounting." Tr. 47, 49. Zessinger told the Weirs, "Don't worry about the statements, we're going to change them." Tr. 43.
30. Zessinger also used a computer display12 to convince the Weirs that the account was profitable when it was not. Tr. 49, 112. As Martin expressed it, "He'd punch it up on the computer screen and [show] we made good money. . . . And well, when a guy pushes buttons on the computer and it comes up on the screen and he shows it to you . . . [a]nd I'm in Prudential's building, I'm thinking . . . that's secure." Tr. 45. Moreover, both Martin and Theresa trusted Zessinger. Tr. 89, 119.
31. Based on the Weirs' level of sophistication and their demeanor, I conclude that the disclosure in the confirmations and monthly statements does not undercut their claim that the Respondent always assured them that the account was profitable. When a customer lacks the skill or experience to interpret confirmations, monthly statements or other such documents, courts have generally refused to find that they relieve a broker of liability for misconduct. Karlen v. Ray E. Friedman & Co. Commodities, 688 F.2d 1193, 1198-1200 (8th Cir. 1982); see also Hecht v. Harris, Upham & Co., 283 F. Supp. 417, 434-39 (N.D. Cal. 1968), modified on other grounds, 430 F.2d 1202 (9th Cir. 1970).
32. Martin continued to feel uneasy about Zessinger's trading and asked him to sell everything in the account so he could determine its true value. Tr. 114. Zessinger told theWeirs that he could not liquidate the account because to do so would adversely affect "the market." Tr. 50, 94, 114.
33. The Weirs then attempted to liquidate the account in May 1992 through another broker, who told them the account was unprofitable and had been churned. Tr. 50-51, 114-15. They were devastated emotionally and financially by the losses because they were no longer able to pay Mildred Weir's expenses for nursing home care. Tr. 118-19. Zessinger never apologized to the Weirs. Tr. 54.
34. Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit false and misleading statements and omissions of material facts made in connection with the purchase or sale of securities. Section 17(a) of the Securities Act prohibits fraudulent conduct in the offer or sale of securities. A violation of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder requires proof that the misrepresentations or omitted facts were material. "[M]ateriality depends on the significance the reasonable investor would place on the withheld or misrepresented information." Basic, Inc. v. Levinson, 485 U.S. 224, 240 (1988). See also TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).
35. I conclude that Respondent Zessinger made material misrepresentations in connection with his trading in the Mildred Weir account. He repeatedly told the Weirs that the account was making money when, in fact, it was losing money. He also misrepresented to the Weirs that the Mildred Weir account statements indicating losses were erroneous and that the value of the account was greater than that shown on the statements. Clearly whether the Mildred Weir account was profitable is a material fact which would have been very significant to the Weirs; Mildred Weir was dependent on her assets in the account to pay her nursing home bills. After they first discovered Zessinger had engaged in unauthorized trading and confronted him, Martin and Theresa acquiesced in Zessinger's continuing to trade because he consistently told them that the account was profitable. The Weirs' acquiescence in the Respondent's continued trading was clearly the result of his misrepresentations of profitability.
36. Churning occurs when a securities broker enters into transactions and manages a customer's account for the purpose of generating commissions and in disregard of his customer's interests. Miley v. Oppenheimer & Co., 637 F.2d 318, 324 (5th Cir. 1981); McNeal v. PaineWebber, Jackson and Curtis, Inc., 598 F.2d 888, 890 n. 1 (5th Cir. 1979). The three elements of churning are: (1) control of the account by the broker, either explicit (discretionary trading) or de facto (through acquiescence, trust, or reliance); (2) excessive trading in the account in light of the customer's investment objectives; and (3) scienter on the part of the broker. Miley v. Oppenheimer & Co., 637 F.2d at 324; Mihara v. Dean Witter & Co., Inc., 619 F.2d 814, 821 (9th Cir. 1980); Shad v. Dean Witter, Reynolds, Inc., 799 F.2d 525, 529 (9th Cir. 1986). Churning in itself violates Rule 10b-5. Mihara v. Dean Witter & Co., 619 F.2d at 821.
37. The "break even" or "cost to equity maintenance factor" and the average annualized portfolio turnover rate are tests used to measure excessive trading in an account. 38. The cost to equity maintenance factor is the percentage of return on the customer's average net equity needed to pay broker-dealer commissions and other expenses, such as margin interest. See Goldberg, Fraudulent Broker-Dealer Practices, Para. 2.9[b] at 2-59 to 2-62. A break even or cost to equity maintenance factor of 8% is generally presumptive of excessivetrading and a 12% ratio is considered conclusive, according to the Division's expert witness, Mary E. Calhoun. Tr. 169-70.
39. The average annualized portfolio turnover rate measures the number of times the account turns over in a given year. A turnover rate of six indicates excessive trading in an account. Mihara v. Dean Witter & Co., 619 F.2d at 821. See Goldberg, Fraudulent Broker-Dealer Practices, Para. 2.9[b] at 2-43 to 44. Tr. 166-67.
40. Mary E. Calhoun testified as an expert witness on behalf of the Division regarding churning and suitability in reference to the Mildred Weir account.13 She analyzed various documents pertaining to the account, such as monthly account statements, trade confirmations, correspondence, and source documents describing commission information. She also interviewed Martin and Theresa Weir. Tr. 131.
41. As Calhoun testified: Zessinger executed 109 transactions in an 18 month period. Div. Ex. 33. Purchases totaled $1,039,737 based on an investment contribution of only $117,913.82. Tr. 141; Div. Exs. 33, 37. Margin interest and fees totaled $5,841. Div. Exs. 33, 37. The average account equity was $67,771. Tr. 151; Div. Exs. 33, 37. Trading in the account generated gross commissions of $48,349. Div. Ex. 33, 28. The parties stipulated that Zessinger received 40% of this amount, or $19,340. Tr. 194, 202. Losses exceeded $65,000. Tr. 154-55; Div. Ex. 32.
42. Based on the above analysis of trading, Calhoun opined that Zessinger churned the Mildred Weir account. Tr. 178-79. Calhoun's opinion was based on the following:
a. The Mildred Weir account had an annualized turnover rate of 10.2, computed by dividing the total purchases in the account by the average equity. This turnover rate equates to the entire account turning over more than ten times per year. Tr. 153.
b. For conservative investors, a turnover rate of two suggests excessive trading; four is presumptively excessive trading; and six is conclusive of excessive trading. Tr. 167.
c. The 10.2 turnover rate in the Mildred Weir account represents extremely heavy trading and is well above the excessiveness threshold for conservative investors. Tr. 166-67; See also Mihara v. Dean Witter & Co., 619 F.2d at 821.
d. The break even or cost to equity maintenance ratio was also used to evaluate the trading. Tr. 168. That ratio compares the annualized cost of commissions and margin interest to the average equity in the account. With regard to the Mildred Weir account, the commissions and margin interest totaled $54,190. Annualized, that figure equals 53.3% of the average equity. In other words, the account would have had to earn a return of 53.3% just to break even. Tr. 168-70.
e. An 8% equity maintenance ratio is presumptive of excessive trading and a 12% ratio is considered conclusive for conservative investors. Tr. 170.
f. The vast majority of securities purchased in the account were held less than three months. Tr. 168. Specifically, 36.1% were held one month or less; 72.1% were held three months or less; 88.5% were held six months or less; and all were held less than nine months. Tr. 146; Div. Ex.41. The average holding period was 36 days. Div. Ex. 33; Tr. 148.
43. Calhoun pointed out examples of trading whose only purpose could be to generate commissions. There was short term trading in mutual funds such that the sales load caused a substantial loss on sale. Tr. 177-78. There was in and out trading whose only purpose could have been to generate commissions, such as a sale of 5,000 shares of Sage Analytics on January 15, 1992, at $1.06 and repurchase of the 5,000 shares nine days later at $1.75. Tr. 179-80.
44. Calhoun opined that the trading was grossly excessive. This was in light of both the nature of the trading -- with extremely heavy trading, extremely heavy use of margin and extremely high cost -- and the investor's very conservative investment profile. Tr. 173-74.
45. In Calhoun's view, additionally, there was no rational basis for the trading other than to generate commissions. Tr. 179-81. Zessinger disputes this, in his Post Trial Brief at 7, on the basis that he discounted commissions on trades in the account. Tr. 239-44, 195. The possibility, however, that Respondent Zessinger could have consumed even more assets in the account does not negate the conclusion that the purpose of the trading was to generate commissions. Moreover, there is no basis in the record for any other reason for the trading.
46. Calhoun's opinion that Zessinger churned the Mildred Weir account is accepted. The elements of de facto control, excessive trading, and scienter are present. The Respondent exercised de facto control over the account. Zessinger, not the Weirs, made investment decisions in the account. He was able to do this because the Weirs were unsophisticated and trusted him, and because he was able to mislead them about the profitability of the account.
47. Zessinger's trading in the account was clearly excessive. The average holding period for securities in the account was only 36 days. The annualized average portfolio turnover rate was 10.2. The cost to equity maintenance ratio was 53.3%. All of these figuresconclusively establish the excessive nature of the trading. Further, as Calhoun opined, the only rational basis for Zessinger's trading in the account was to generate commissions.
48. Zessinger's argument, in his Post Trial Brief at 6 and Reply Brief at 4-5, that the trading was not excessive for a speculative investment objective is rejected because of the finding, supra, that the investment objective was conservative.
49. Scienter, that is, "a mental state embracing intent to deceive, manipulate, or defraud,"14 was clearly present in light of the misrepresentations that were part of Respondent's entire course of dealing with the Weirs and which enabled him to continue trading in the account for many months.
50. The term "unsuitable trading" derives from Article III, Section 2 of the NASD15 Rules of Fair Practice, which states "in recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs." Unsuitable trading may be part of a course of fraudulent conduct that violates Section 10(b) of the Securities Act and Rule 10b-5 thereunder (although not violative taken byitself). Mauriber v. Shearson/American Express, Inc., 567 F. Supp. 1231, 1237 (S.D.N.Y. 1983); Clark v. John Lamula Investors, Inc., 583 F.2d 594, 600 (2d Cir. 1978).
51. Calhoun analyzed the trading in the Mildred Weir account for suitability. She classified the securities from the speculative high risk end of the spectrum to the good quality investment grade end. Tr. 159.
52. 82.4% of the securities purchased were classified as speculative high risk. Tr. 159. These included low-priced stocks, junk bonds, Liquid Yield Option Notes (LYONS) and REMICS.16 LYONS are debt securities which are convertible into common stock, but pay no rate of interest. They are speculative because, among other things, there is no interest rate to buffer their movement. Tr. 164-65. REMICs are similar to collateralized mortgage obligations (CMOs).17 Zessinger also sold securities short.18 Tr. 159-67. Speculative securities represented 86.9% of losses, totaling $58,257. Tr. 166; Div. Ex. 32. At one point, 138% of the equity in the account (with margin) was invested in one CCC rated junk bond. Tr. 176.
53. An analysis of suitability must consider the investor's financial situation, understanding of the risk, and investment objectives. The trading in the Mildred Weir accountwas not suitable. Tr. 159, 172-74. In spite of the Mildred Weir account's conservative investment objectives, 82.4% of the securities purchased in the account by Zessinger were speculative and high risk in nature. At one point, 138% of the equity in the account (with margin) was invested in one CCC rated junk bond. Zessinger also effected short sales and traded on margin. As Calhoun opined, the trading was so far on the high risk end of the spectrum, with extremely heavy trading, extremely heavy use of margin, and extremely high cost, that it was not suitable for the Mildred Weir account.19 Tr. 174. The manifest unsuitability bolsters the conclusion that the Respondent churned the account.
Conclusion: Zessinger willfully violated the antifraud provisions of the securities laws.
54. In conclusion, Zessinger's activities with respect to the Mildred Weir account constitute willful violations of the antifraud provisions of the securities laws. Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit generally the use of fraudulent practices with regard to the offer, purchase, or sale of securities by the use of the mails or any means or instrumentality of interstate commerce. Among other things, they make it unlawful for any person to employ any device, scheme, or artifice to defraud. Zessinger's fraudulent course of conduct included churning, unsuitable recommendations, and misrepresentations of material facts.
55. Proof of scienter, "a mental state embracing intent to deceive, manipulate, or defraud," is required to establish violations of Section 17(a)(1) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Aaron v. SEC, 446 U.S. 680, 686 n.5(1980); see also Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). Scienter is found where a broker acts with "intent to defraud or with willful and reckless disregard for the [customer's] interest." Miley v. Oppenheimer & Co., Inc., 637 F.2d at 324. That is clearly the case here.
56. Imposition of administrative sanctions requires consideration of: the egregiousness of the defendant's actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant's assurances against future violations, the defendant's recognition of the wrongful nature of his conduct, and the likelihood that the defendant's occupation will present opportunities for future violations.
Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981). The amount of a sanction depends on the facts of each case and the value of the sanction in preventing a recurrence. Berko v. SEC, 316 F.2d 137, 141 (2d Cir. 1963); Leo Glassman, 46 S.E.C. 209, 211 (1975); Richard C. Spangler, Inc., 46 S.E.C. 238, 254 n. 67 (1976).
57. The activities for which Zessinger was convicted were egregious, and involved an organized scheme to defraud investors using a wide variety of fraudulent practices. The stipulated facts in U.S. v. Zessinger, the indictment in Missouri v. Zessinger, and the facts established regarding the Weir account describe such fraudulent practices as churning; undisclosed margin trading; purchasing securities for customers which were unsuitable for those customers; unauthorized trading; and misrepresenting to customers that account statements showing losses were in error. Investors lost over $300,000 as a result of just one of Zessinger's fraudulent schemes.
58. The violations were not isolated. In fact, the violations occurred over an extensive period of time, involved numerous different securities and customers, and clearly reflected Zessinger's intent to perpetrate a systematic, organized fraud.
59. The Respondent has not acknowledged the wrongfulness of his conduct and has given no assurances against future violations.
60. Zessinger preyed on elderly and unsophisticated investors. His fraudulent conduct had a disastrous impact.
61. By his unlawful conduct, Zessinger has demonstrated that he lacks the honesty required of a securities professional. He should be barred from association with any broker or dealer.
62. A severe sanction is also warranted to deter others from similar activities.
63. For the above reasons, a severe sanction is warranted in this case. It is in the public interest to bar Respondent Zessinger from association with any broker or dealer;20 pay a $100,000 third tier penalty pursuant to Section 21B(b)(3) of the Exchange Act, since his acts involved fraud and deceit and resulted in substantial losses; disgorge $19,340, representing commissions he received from the Mildred Weir account, plus prejudgment interest; and be ordered to cease and desist from committing or causing violations or future violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
CERTIFICATION OF RECORD
64. Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. Section 201.351(b) (1996), I hereby certify that the record consists of the items set forth in the record index issued by the Secretary of the Commission on June 10, 1996. Specifically the record includes transcribed testimony from five witnesses and approximately 26 exhibits offered by the Division and 15 by the Respondent. It also includes the Division's Proposed Findings of Fact and Conclusions of Law and Post Hearing Brief in Support, dated April 26, 1996; Zessinger's untitled post hearing brief, dated April 25, 1996; the Division's Reply Brief, dated May 22, 1996; and Zessinger's undated Reply Brief received June 12, 1996.
65. Based on the findings and conclusions set forth above, I ORDER, pursuant to Sections 15(b) and 19(h) of the Exchange Act, that Daniel L. Zessinger be and hereby is barred from association with any broker or dealer.
66. I FURTHER ORDER, pursuant to Section 21B of the Exchange Act, that Daniel L. Zessinger pay a penalty of $100,000.
67. I FURTHER ORDER, pursuant to Section 21C(e) of the Exchange Act, that Daniel L. Zessinger pay disgorgement in the amount of $19,340 plus prejudgment interest in the amount of $7,652, pursuant to Rule 600 of the Commission's Rules of Practice on the first day after this decision becomes final. Interest on amounts not timely paid shall continue to accrue, pursuant to Rule 600.21
68. Payment of the penalty and disgorgement shall be made by United States postal money order, certified check, bank cashier's check or bank money order payable to the Securities and Exchange Commission and sent to the Comptroller, Securities and Exchange Commission, Mail Stop 2-5, 450 Fifth St., N.W., Washington, D.C. 20549. "Daniel L. Zessinger, A.P. No. 3-8838" should appear on the remittance. A copy of the remittance should be sent to the Securities and Exchange Commission, Atlanta District Office, Office of Enforcement, 3475 Lenox Road, N.E., Suite 1000, Atlanta, GA 30326-1232.22
69. I FURTHER ORDER, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, that Daniel L. Zessinger cease and desist from committing or causing violations or future violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
70. 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. Section 201.360 (1996). Pursuant to that rule, a petition for review of this initial decision may be filed within 21 days after service of the decision. It shall become the final decision of the Commission as to each party who has not filed a petition for review pursuant to Rule 360(d)(1) within 21 days after service of the initial decision upon him, unless the Commission, pursuant to Rule 360(b)(1), determines on its own initiative to review this initial decision as to any party. If a party timely files a petition for review, or the Commission acts to review as to a party, the initial decision shall not become final as to that party.
Carol Fox Foelak
Administrative Law Judge
August 2, 1996
|1||Prior to the hearing the Division filed a Motion for Summary Disposition which I granted in part, based on admissions in Respondent Zessinger's Answer, and denied in part in a March 1, 1996, ORDER DENYING MOTION FOR SUMMARY DISPOSITION AND DENYING MOTION FOR PREHEARING CONFERENCE (March 1, 1996, Order).|
|2||I advised him that in the instant administrative proceeding, unlike a criminal trial, a negative inference could be drawn from his silence. He acknowledged that he understood this. Tr. 210-11.|
|3||Citations to the transcript of the hearing will be noted as "Tr. __" and to exhibits offered by the Division or Respondent as "Div. Ex. __" or "Resp. Ex. __," respectively.|
|4||See, specifically, 5 U.S.C. Section 557(c).|
|5||I have considered and rejected all the arguments and proposed findings that are inconsistent with this decision.|
|6||Div. Ex. 11, consisting of victim impact statements, also pertains to U.S. v. Zessinger. I have not, however, relied on Div. Ex. 11 in reaching this decision.|
|7||The Commission considers the allegations contained in a civil complaint which resulted in the entry of a judgment on consent, without admitting or denying the allegations of the complaint (and in which the judgment was unaccompanied by findings of fact) when determining the appropriate sanction in the public interest under Section 15(b) of the Exchange Act. See, e.g., Charles Phillip Elliott, 52 SEC Docket 2011, 2013 n. 5, 2015 n. 12 (1992). The same reasoning applies, a fortiori, to allegations contained in an indictment or criminal information to which the defendant pleaded guilty.|
|8||I have not relied on Div. Ex. 4, the State's Sentencing Memorandum in Missouri v. Zessinger.|
|9||Martin signed various documents relating to the account on her behalf: "Mildred Weir Martin Weir P/A." See, e.g., Div. Exs. 13-18; Tr. 74.|
|10||The CD was issued by the First National Bank of Chicago. Div. Ex. 24 at 1.|
|11||The sole evidence of record to support a choice of a speculative objective is Resp. Ex. 8, the Prudential account opening form. This document does not have Martin's signature (or aspace for a client's signature), but purports to bear Zessinger's signature. It lists the investment objective as growth and speculation. Since Zessinger declined to testify concerning the creation of this document, it is entitled to little weight in rebutting the Weirs' testimony that a conservative objective was specified.|
|12||Lisa Low served as sales assistant to Respondent Zessinger at Prudential. Tr. 223-24. According to her credible testimony, he could have displayed information from an account on his computer screen but could not have changed the information on his screen. Tr. 230. The fact that Respondent could not change the numbers on a display of information from the actual Weir account is not, however, inconsistent with his use of a computer display to convince the Weirs the account was profitable.|
|13||Ms. Calhoun's qualifications as an expert are established at Tr. 125-30.|
|14||Aaron v. SEC, 446 U.S. 680, 686 n.5 (1980); see also Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976).|
|15||The NASD (National Association of Securities Dealers) is a self-regulatory organization, operating under SEC supervision, of firms in the over-the-counter market. One of its basic purposes is to establish and enforce fair and equitable rules of securities trading.|
|16||Martin does not know what a LYON or REMIC is. Tr. 52.|
|17||A REMIC (real estate mortgage investment conduit) is a pass-through vehicle to issue multiclass mortgage-backed securities. REMICs may be organized as corporations, partnerships or trusts. Interests in REMICs may be senior or junior, debt or equity. Practically, issuers have more flexibility than with CMOs; they can separate mortgage pools into different risk classes as well as different maturity classes. Whereas CMOs normally have AAA bond ratings, REMICs represent a range of risk levels. Barron's Dictionary of Finance and Investment Terms (4th ed. 1995).|
|18||Martin does not know what a short-sale is. Tr. 52.|
|19||Zessinger admitted in his answer that he effected unsuitable trades in the Mildred Weir account. See my March 1, 1996, Order.|
|20||The Division asked that the Respondent also be barred from association with a municipal securities dealer, investment company or investment adviser. Those sanctions, however, are provided for in statutory sections other than Sections 15(b) and 19(h) of the Exchange Act, the sole authority cited for this proceeding. The issue of whether a collateral bar can be imposed is currently before the Commission.|
|21||Interest is computed at the underpayment rate of interest established under Section 6621(a)(2) of the Internal Revenue Code, 26 U.S.C. Section 6621(a)(2) and compounded quarterly, pursuant to Rule 600. Interest is computed through July 31, 1996, from June 1, 1992, the month following the end of the activities from which Zessinger received the ill-gotten gains.|
|22||Pursuant to Rule 610, the Division shall submit a proposed plan for the administration and distribution of disgorgement funds within 60 days of payment.|
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