Monetta Financial Services, Inc., Robert S. Bacarella,and Richard D. Russo
Securities Act of 1933
Rel. No. 8239 / June 9, 2003
Securities Exchange Act of 1934
Rel. No. 48001 / June 9, 2003
Investment Advisers Act of 1940
Rel. No. 2136 / June 9, 2003
Investment Company Act of 1940
Rel. No. 26070 / June 9, 2003
Admin. Proc. File No. 3-9546
In the Matter of MONETTA FINANCIAL SERVICES, INC., |
ORDER IMPOSING REMEDIAL SANCTIONS
On the basis of the Commission's opinion issued this day, it is
ORDERED that Monetta Financial Services, Inc. and Robert S. Bacarella shall cease and desist from committing or causing any violations or any future violations of Section 206(2) of the Investment Advisers Act of 1940; and it is further
ORDERED that respondent Monetta Financial Services, Inc. be, and hereby is, censured; and it is further
ORDERED that Robert S. Bacarella be, and hereby is, suspended from associating with any investment adviser and from associating with any investment company for 90 days effective at the opening of business on June 23, 2003; and it is further
ORDERED that Monetta Financial Services, Inc. and Robert S. Bacarella be, and hereby are, assessed civil money penalties of$200,000 and $100,000, respectively. Each respondent's payment of the civil money penalty shall be: (a) made by United States postal money order, certified check, bank cashier's check, or bank money order; (b) made payable to the Securities and Exchange Commission; (c) delivered by hand or courier to the Comptroller, Securities and Exchange Commission, 6432 General Green Way, Alexandria VA 22312; and submitted under cover letter that identifies the particular respondent in this proceeding, as well as the Commission's administrative proceeding file number. A copy of this cover letter and money order or check shall be sent to Wendy D. Fox, Securities and Exchange Commission, Midwest Regional Office, 175 West Jackson Boulevard, Suite 900, Chicago, Illinois 60604; and it is further
ORDERED that this proceeding is dismissed with respect to Richard D. Russo.
By the Commission.
Jonathan G. Katz
Secretary
Endnotes
1 15 U.S.C. § 77q.
2 15 U.S.C. § 78j.
3 17 C.F.R. § 240.10b-5.
4 15 U.S.C. § 80b-6.
5Paul W. Henry, a director of the Monetta Fund, and William M. Valiant, a trustee of the Monetta Trust, were also respondents below. The law judge found that Henry willfully violated Securities Act Section 17(a), Exchange Act Section 10(b), Exchange Act Rule 10b-5, Section 17(j) of the Investment Company Act of 1940 ("IC Act"), and IC Act Rule 17j-1. The law judge suspended Henry from association with a registered investment company for 30 days, imposed a $10,000 civil money penalty on him, and ordered him to disgorge $10,187.50, plus prejudgment interest. The law judge dismissed the proceedings as to Valiant.
Neither Henry nor the Division appealed the initial decision. See Monetta Financial Services, Inc., Initial Decision Rel. No. 162 (Mar. 27, 2000), 72 SEC Docket 72. The Commission gave notice that the law judge's decision was final as to Henry and Valiant. Exchange Act Rel. No. 42768 (May 9, 2000), 72 SEC Docket 1120.
6 Rule of Practice 451(d), 17 C.F.R. §201.451(d), permits a member of the Commission who was not present at oral argument to participate in the decision of the proceeding if that member has reviewed the oral argument transcript prior to such proceeding. Commissioners Atkins and Campos have reviewed the transcript of the oral argument.
7 In 1987, Bacarella also formed Monetta Brokerage, Inc. ("Monetta Brokerage"), a registered broker-dealer affiliated with MFS. In 1993, Bacarella was the secretary, treasurer, a director, and a shareholder of Monetta Brokerage.
8 In 1993, there were five directors of the Monetta Fund: Bacarella; Paul W. Henry (a director and former vice president of the Monetta Fund, a director of MFS, and shareholder in Monetta Brokerage); John W. Bakos (a director of MFS, former vice president of the Monetta Fund, and a shareholder in the Monetta Brokerage); John Rozinsky (compliance director for MFS, Monetta Fund, and Monetta Trust, a director of MFS, vice president, trustee, and treasurer of the Monetta Trust, and vice president, director, and a shareholder in Monetta Brokerage); and Mark F. Ogan.
IC Act Section 2(a)(19)(A) defines an "interested person" of an investment company to include, among others, any affiliated person of the investment company or any interested person of any investment adviser of the investment company. IC Act Section 2(a)(3) includes within the definition of an "affiliated person" any officer of director or owner of 5% or more of the entity's voting securities. A director who is an "interested" person of an investment company is disqualified from being considered a "disinterested" or "independent" director. See, e.g., Role of Independent Directors of Investment Companies, Investment Company Act Rel. No. 24082 (Oct. 14, 1999), 70 SEC Docket 2529 ("Proposing Release") at n.21 and accompanying text.
All of the directors, except Ogan, were "interested persons," as defined by the IC Act, of the Monetta Fund. Bacarella was an officer of the Monetta Fund and a 71% shareholder, officer, and director of MFS, the Monetta Fund's adviser. Henry was an officer of the Monetta Trustand a director of MFS. Bakos was a director of MFS. Rozinsky was an officer of the Monetta Fund and an officer and director of MFS.
9 At year-end 1991, the Monetta Fund had net assets of $57 million.
10 There were seven Trustees of the Monetta Trust: Bacarella, Rozinsky, James Boves (vice president, trustee, and portfolio manager of the Monetta Trust), William Valiant, Russo, Ogan, and John L. Guy, Jr. Four of the trustees were "interested persons" of the Monetta Trust: Bacarella, Rozinsky, and Boves were officers of the Monetta Trust and officers and directors of MFS. Valiant was a director of MFS. The Monetta Trust designated Russo as one of three independent trustees, along with Ogan and Guy.
11 We will refer to the Monetta Fund, Mid-Cap Fund and the Bond Fund collectively as the "Fund Clients."
The Government Money Market Fund did not receive allocations of shares in initial public offerings. This fund is a money market fund that invested only in U.S. Government securities maturing in less than 13 months. Its activities are not at issue in this proceeding.
12 These accounts were maintained by natural persons, individual retirement accounts, and individual companies.
13 In 1993, the average increase from offering price to opening day trading price for all IPOs was 11.6%. For the IPOs Bacarella selected for the Fund Clients, the average increase was 24.9%, and for the accounts of Valiant, Henry, and Russo, which are at issue here, the average increase was 34.2%.
14 According to its Form ADV, MFS was retained under a so-called "wrap fee" arrangement offered through broker-dealers. Various broker-dealers would recommend retention of MFS as investment adviser, pay MFS' advisory fee on behalf of the client, monitor and evaluate MFS' performance, execute the client's portfolio transactions without commission charge, and provide custodial services for the client's assets, all for a single fee paid by the client to the broker-dealer.
According to Bacarella, the members of an underwriting syndicate would refuse to deliver shares of an IPO to a broker-dealer that was not a member of the syndicate. Since the assets of the wrap accounts were held at a particular broker-dealer, which might not be a member of the syndicate,MFS did not allocate IPOs to its "wrap account" customers.
15 Beyond the requirement that a client maintain an Old Kent account, we cannot determine from the record why each of these clients received IPO allocations. Aside from Valliant, Henry, and Russo, the only information we have about the remaining accounts is the account names and the amounts of the IPO allocations to each account. We cannot determine the scope of their pre-existing advisory dealings with MFS, whether they had any relationship with MFS or Bacarella beyond that of adviser-client, and whether any other of MFS' individual clients were offered the opportunity to open an Old Kent account and declined.
16 Bacarella claimed that, as a general rule, if MFS were offered more than 10,000 shares of a particular IPO, Bacarella would give the Monetta Fund preference in allocation of the IPO shares. If MFS were offered less than 10,000 shares, Bacarella would normally give preference to MFS' smaller eligible accounts, although, if the portfolio manager expressed interest, a fund might obtain shares from such an allocation.
17 Allocations made to the Fund Clients during 1993 demonstrate that the guidelines were not always followed. The Monetta Fund received 10,000 or more shares in only fourteen out of twenty-nine IPOs allocated to it during this period. In seventeen allocations, the Mid-Cap Fund received 10,000 or more shares on two occasions, and the Bond Fund received three allocations, all for 1,000 or fewer shares. In threeinstances when MFS received 10,000 or more shares in an IPO, none of the shares were allocated to the Fund Clients.
18 Between 1993 and the hearing Tim Cekal died. He did not testify during the Division's investigation.
19 There is some confusion as to the number of IPOs in which MFS participated between January and September 1993. Our review of the record identifies fifty-three IPOs received by MFS, although there is little or no data for three of those allocations. The Initial Decision stated that MFS participated in fifty-one IPOs, a number used in one expert's report. That number (fifty-one), however, appears to include one IPO that was allocated to another adviser affiliated with MFS. The Division's expert based his bootstrap analysis on fifty IPOs. See discussion following note 51 infra.
20 But see text following note 25 infra.
21 Russo maintained a solo general practice concentrating in residential real estate, criminal defense, personal injury,estate planning, general civil litigation, and organization of small corporations. He testified that he never practiced securities law.
22 Russo was also a member of the Monetta Trust audit committee. Russo received compensation of $100 for every meeting he attended. From January, 1993 through September, 1993, Russo received $300 in compensation for his service as a trustee.
23 Between February 1993 and September 1993, Russo received allocations in the following IPOs:
| Company | Shares | Transaction Dates | Fund Shares* |
|---|---|---|---|
| Powersoft | 200 | 2/93 | n/a |
| Wall Data | 100 | 3/93 | M Fund 48,000 |
| Parallan Computer | 1,000 | 3/93 | M Fund 10,000 |
| BHC Financial | 1,000 | 4/93 | M-Cap 4,000/Bond 700 |
| Catalyst Semiconductor | 1,000 | 5/93 | n/a |
| Papa Johns Int'l | 1,000 | 6/93 | M Fund 4,000 |
| Wonderware | 1,000 | 7/93 | M Fund 6,000 |
| Cyrix Corp. | 2,500 | 7/93 | n/a |
| Netmanage, Inc. | 500 | 9/93 | M Fund 10,000 |
* M Fund = Monetta Fund; M-Cap = Mid-Cap Fund; Bond = Bond Fund.
John Alogna, who made the investment decisions for the Mid-Cap Fund, testified that, he did not express interest inpurchasing shares for the Mid-Cap Fund in the Powersoft, Wall Data, Parallan, Catalyst, Papa Johns, Wonderware, Cyrix, or Netmanage IPOs. Russo was not a director of the Monetta Fund.
24 IC Act Rule 17j-1 requires "interested persons" (within the meaning of IC Act Section 2(a)(19)) of a fund to make certain initial, quarterly, and annual transaction and holdings reports to their funds. These reports detail the title, number of shares, and principal amount of the securities held, and the name of any broker-dealer or bank with whom the "interested person" maintained an account in which any securities were held. Because Russo was an independent trustee, he was not an "interested person" required to file a 17j-1 report.
25 Valiant also owned shares in Monetta Brokerage.
26 Valiant received allocations in the following IPOs:
| Company | Shares | Transaction Dates | Fund Shares |
|---|---|---|---|
| 3 Do Co | 1,000 | 5/93 | n/a |
| Papa Johns Int'l | 500 | 6/93 | M Fund 4,000 |
| Sunglass Hut | 500 | 6/93 | M Fund 3,000 |
| Broadband Technology | 500 | 6/93 | M Fund 5,000/M Cap 5,000 |
27 Henry owned 2.22% of the voting shares of MFS and 2.55% of the voting shares of Monetta Brokerage. He was a brokerage client of Monetta Brokerage.
28 In 1993, Henry received shares in the following IPOs:
| Company | Shares | Transaction Dates | Fund Shares |
|---|---|---|---|
| BHC Financial | 1,000 | 4/93 | M-Cap 4,000/Bond 700 |
| Auspex | 500 | 5/93 | n/a |
| Papa Johns Int'l | 500 | 6/93 | M Fund 4,000 |
| Sunglass Hut | 500 | 6/93 | M Fund 4,000 |
29 The NASD's Free-Riding and Withholding interpretation requires every participating broker-dealer in a public offering to make a "bona fide" distribution to the public. In 1993, this interpretation prohibited the sale of any "hot" security to, among others, any senior officer or employee or other person who might influence a registered investment company or registered investment advisory firm. NASD Manual (July 1994), ¶ 2151.06 at p. 2032.
30 Graham v. SEC, 222 F.3d 994, 100 (D.C. Cir. 2000); Donald T. Sheldon, 51 S.E.C. 59, 62 (1992), aff'd 45 F.3d 1515 (11th Cir. 1995).
31 375 U.S. 180 (1963).
32 Id. at 191.
33 Investment Trusts and Investment Companies, Report of the Securities and Exchange Commission, Pursuant to Section 30 of the Public Utility Holding Company Act of 1935, on Investment Counsel, Investment Management, Investment Supervisory, and Investment Advisory Services, H.R. Doc. No. 76-477 (1939) ("SEC Report").
34375 U.S. at 187, citing SEC Report at 28.
35 Id. at 194.
36 Respondents' argument that their actions were in furtherance of their ongoing duty to their individual clients is undercut by Bacarella's allocation of IPOs to Henry. Henry opened his Old Kent account only after he became a director of the Monetta Fund. Henry had learned of the opportunity to receive these IPO allocations because of his status as an MFS and Monetta Fund affiliate.
37 MFS' and Bacarella's argument that they had a duty to allocate IPO shares equitably among both the Fund Clients and individual accounts necessarily concedes that IPOs are limited and valuable opportunities, which could not be offered to every client. In any given IPO allocation, one client likely would have to be preferred over another.
38 MFS and Bacarella argue that the fact that MFS would allocate shares of IPOs was disclosed in public filings. However, MFS' Forms ADV, which address the purchase of securities by affiliates of MFS, does not disclose that Fund Client directors or trustees might compete for securities with the Fund Clients.
The Fund Clients filed Forms N-1A that state that MFS may purchase or sell the same class of securities for the Fund Client and other advisory clients and that if it does so on the same day, MFS will "allocate [the securities] in a manner considered equitable." This statement does not reveal that the Director-Clients were among MFS' "other advisory clients."
Only Valiant reported his transactions pursuant to IC Act Rule 17j-1. Russo was not required to make such a filing, and Henry failed to disclose his IPO transactions.
39 Both Boves and Rozinsky testified that Bacarella did not inform them of any of the IPO allocations to Valiant, Henry, or Russo before October 1993. Rozinsky stated that he had seen Valiant's IC Act Rule 17j-1 reports and that he knew what IPOs were. Rozinsky further stated that he did not realize that Valiant was receiving IPOs from MFS because Rozinsky was aware that Valiant had "brokerage relationships" outside of the Monetta companies.
40 Proposing Release, 70 SEC Docket at 2530.
41 Id. at 2530-31.
42 15 U.S.C. § 80a-15(c).
43375 U.S. at 200, quoting U.S. v. Mississippi Valley Generating Co., 364 U.S. 520, 549 (1961).
44 Bacarella claims that John Alogna, Portfolio Manager for The Mid-Cap Fund and James Boves, Portfolio Manager for the Intermediate Bond Fund and a trustee of the Monetta Trust, allocated two IPOs in 1993 while he was on vacation. Nothing in the record confirms this claim. In fact, although Bacarella met with Alogna and Boves daily, Boves testified that Bacarella never informed him that Russo, Valiant, or Henry were receiving IPOs.
45 Bacarella testified that he allocated IPOs in accordance with certain internal guidelines. However, he admittedly did not always follow these guidelines. It appears that no records were kept to show how determinations were made concerning the allocations. Because Bacarella failed to inform the remaining directors or trustees about allocations to the Director-Clients, the Fund Clients' Boards could not monitor Bacarella's determinations or seek improvements in IPO allocations.
46 The essential elements for an effective reliance on advice of counsel defense are that a person: (1) made a disclosure to counsel of the intended action; (2) requested counsel's advice as to the legality of the intended action; (3) received counsel's advice that the conduct would be legal; and (4) relied in good faith on that advice. Markowski v. SEC, 34 F.3d 99, 104-05 (2d Cir. 1994).
47 Olsen testified that she would have wanted to know, among other things, the basis for any allocation and the nature of the underlying client relationship.
48 See Anthony Tricarico, 51 S.E.C. 457, 460 (1993).
To bolster his claim, Bacarella elicited the testimony of three MFS employees, Rozinsky, Valerie Lefevre, and Maria DeNicolo. Rozinsky gave what the law judge described as contradictory testimony at the hearing. She found more reliable his investigatory testimony in which Rozinsky stated that he had no clear recollection of even being aware that any Fund Client director or trustee had received shares of IPOs until after October 31, 1993. We find no reason to disturb the law judge's assessment. See Michael J. Fee, 50 S.E.C. 1124, 1125 (1992)(investigatory testimony can be favored over live testimony).
Lefevre testified that Rozinsky told her that the Fund Clients' attorney had stated that it was proper for Valiant to receive allocations of IPO shares. However, Lefevre could not recall when the conversation occurred or what particular transaction she was discussing. In any event, since Rozinsky was not aware of the allocations until October, his conversation with Lefevre could not have occurred before that date.
The law judge also found DeNicolo's testimony to be suspect. DeNicolo claimed that, while she was cleaning up the room following the January 1993 meeting of the trustees of the Monetta Trust, she overheard Bacarella ask Olsen whether, since Valiant was now a director, it would be a problem for him to continue to receive IPOs. DeNicolo stated that Olsen told Bacarella that, as long as Valiant was not an officeror employee, it would not be a problem. The law judge discounted DeNicolo's testimony, noting that she appeared to be fiercely loyal to Bacarella, and that her livelihood was tied directly to Bacarella's continued success. We further note that DeNicolo's description of the conversation with Olsen differed from Bacarella's testimony that he asked Olsen about both Valiant and Russo.
49 Bacarella's failure to inform the examiners about the allocations further undercuts his insistence that he had an opinion of counsel that the allocations were permissible. If he had had such an opinion, it would be reasonable immediately to bring it to the attention of the examiners.
50 As noted, the law judge also found that Bacarella aided and abetted and was a cause of MFS' violations of Advisers Act Section 206(1). It appears that these findings are based on her conclusions that Respondents violated Securities Act Section 17(a), Exchange Act Section 10(b), and Exchange Act Rule 10b-5. Because we dismiss those violations for the reasons set forth below, we also dismiss the alleged violations of Advisers Act Section 206(1).
51 The Commission has the authority to bring an action in district court against, among others, a fund's adviser or a director if that person has engaged or is about to engage in a breach of fiduciary duty involving personal misconduct in respect of any registered investment company. IC Act Section 36(a), 15 U.S.C. §80a-35. Because this case was brought as an administrative proceeding, rather than in district court, the issue of whether Respondents violated their fiduciary duties under the Investment Company Act is not before us.
52 In 2001, the Commission adopted rules making clear the requirements that investment companies disclose in various investment company filings material transactions and relationships with the companies' independent directors. Role of Independent Directors of Investment Companies, Exchange Act Rel. No. 43786 (Jan. 2, 2001), 74 SEC Docket 3.
53 The Division also notes that MFS waived fees for the Director-Clients accounts. MFS responds that it waived advisory fees for all advisory accounts under $100,000 and, in 1993, also waived fees for the Bond Fund and Money Market Fund.
54 Once a registration statement is filed, underwriters may begin soliciting "indications of interest" from investors. These indications are non-binding requests from investors for allocations of shares in the offering.
55 Respondents complain that the law judge determined that Bacarella knew which IPOs were hot and preferentially allocated them with that knowledge before evidence on that issue was produced. They further claim that the law judge improperly placed the burden upon them to prove that Bacarella could not know which IPO was likely to be hot.
Statements by a presiding officer based on prior proceedings or information do not evidence bias. Liteky v. United States, 510 U.S. 540, 555 (1994); SEC v. First City Fin. Corp., 890 F.2d 1215, 1222 (D.C. Cir. 1989) ("We presume that a judge will set aside personal views - which given human nature are always present - and find the relevant facts solely on the evidence presented. An appellant therefore must show that a judge's mind was <irrevocably closed' on the issue before the court."). Moreover, we have performed an independent review of the record and come to the same conclusion: an experienced professional can discern when a particular IPO is more likely than not to open at a premium once secondary trading begins.
Respondents also claim that the law judge was biased against them because their pre-hearing motions were denied. These claims are baseless. Denials of pre-hearing motions are not by themselves evidence of bias, and Respondents do not identify what in the denials were improper. Moreover, the law judge who conducted the hearing was different from the law judge who decided the pre-hearing motions.
56 Bootstrapping takes a series of occurrences that are not normally distributed, and creates a distribution for the data. It then uses statistical measures, such as standard deviation, to generate statistical analyses. MFS and Bacarella claim that "bootstrapping" is "junk science." However, bootstrapping is a reputable and useful statistical method. See, e.g., Michael R. Chernick, Bootstrap Methods: A practitioner's guide, at 161-244 (1999); Bradley Efron and Robert Tibshirani, An Introduction to the Bootstrap (1993).
57 We find that Respondents' statistical analysis was equally flawed. Respondents' expert performed a series of statistical tests that purported to test the difference in means among different groups of allocations. However, the difference-in-means test assumes that the sample is normally distributed. Even that expert's own analysis demonstrates clearly that her data were not normally distributed. Furthermore, the expert performed her tests on extremely small samples (including one sample composed of a single IPO). The difference in means test is more effective on larger samples.
58 The Division further argues that, by receiving IPO allocations, the Director-Clients usurped corporate opportunities owed to the Fund Clients. The Division asserts that this usurpation is evidenced by the fact that Respondents received "hotter" or better IPOs, and that the Fund Clients received less hot, or even cold IPOs. For the reasons stated above, we disagree.
The record on this point is otherwise incomplete. For example, as discussed above, we cannot determine whether the Director-Clients received treatment that was any different from MFS' other individual adviser clients, see text following n.50 supra. We also do not have evidence of any relationship between MFS and other firms that allocated IPOs to MFS. See text accompanying n.12, supra. We thus are unable to make a further determination as to whether Director-Clients usurped that opportunity. We note that the Fund Clients received 83% of the IPO shares received by MFS, while the Director-Clients received only 1.6 percent andthat the Mid-Cap Fund's portfolio manager testified that he did not express interest in 8 of the 9 IPOs allocated to Russo.
In 1999, we stated that allocation of IPOs presented the potential for conflicts of interest between an individual and the fund, including whether the possibility that the individual is misappropriating an opportunity that should have been offered to the fund. See Personal Investment Activities of Investment Company Personnel, Securities Act Rel. No. 7728 (Aug. 27, 1999), 70 SEC Docket 1191, 1196 (requiring investment personnel obtain prior approval from their fund or adviser before directly or indirectly acquiring any beneficial ownership in an IPO).
59 See Butz v. Glover Livestock Comm'n Co., 411 U.S. 182, 185 (1973) (holding that an agency's choice of sanction is "peculiarly a matter of administrative competence") (internal quotations omitted).
60 Donald T. Sheldon, 51 SEC at 86, quoting Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd, 450 U.S. 91 (1981).
61 15 U.S.C. Section 80b-3(k).
62 KPMG Peat Marwick LLP, Exchange Act Rel. No. 43862 (Jan. 19, 2001), 74 SEC Docket 384, 436, petition denied, 289 F.3d 109 (D.C. Cir. 2002).
63 We have considered all of the contentions advanced by the parties. We reject or sustain them to the extent that they are inconsistent or in accord with the views we express here.