SECURITIES AND EXCHANGE COMMISSION
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 41816 / September 1, 1999
Admin. Proc. File No. 3-9639
In the Matter of the Application of
75-54 168 St.
Hillcrest, NY 11366
For Review of Disciplinary Action Taken by the
NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.
OPINION OF THE COMMISSION
REGISTERED SECURITIES ASSOCIATION -- REVIEW OF DISCIPLINARY PROCEEDINGS
Violations of Rules of Fair Practice
Alleged misappropriation of customer's funds
Registered representative, during association with two separate member firms of registered securities association, made unsuitable recommendations to customers and engaged in excessive trading in customers' accounts. Representative was also charged with misappropriating funds from one customer's account. Held, association's findings of excessive trading and unsuitability sustained, findings of misappropriation reversed, and sanctions imposed affirmed in part and reversed in part.
Rafael Pinchas, pro se.
Alden S. Adkins, Susan L. Beesley, and James S. Wrona, for NASD Regulation, Inc.
Appeal filed: June 29, 1998
Last brief filed: November 2, 1998
Rafael Pinchas appeals from a National Association of Securities Dealers, Inc. ("NASD") disciplinary action based on Pinchas' dealings with two customers between May 1989 and August 1992. Pinchas was registered as a general securities representative with Prudential-Bache Securities, Inc. from May 1989 to May 1990, and was associated with Lew Lieberbaum & Co., Inc. from May 1990 to August 1992. Pinchas is not currently associated with any member firm.
The NASD found that Pinchas made unsuitable recommendations and engaged in excessive trading in both customers' accounts in violation of NASD Conduct Rules 2110, 2120, 2310, 2510, and 2860(b)(19), and that he misappropriated funds from one account in violation of Conduct Rules 2110 and 2330. 1 The NASD censured Pinchas, fined him $219,821, and barred him from association with any member of the NASD in any capacity. We base our findings on an independent review of the record.
A. Kuo Fen Chen Wang
Kuo Fen Chen Wang is hearing-disabled. She immigrated to the United States from Taiwan in April 1985 with her husband andthree children. During the relevant period Wang worked as a service attendant at the Marriott Hotel in Manhattan. Her husband worked part-time as a carpenter and painter. Their combined income for the years 1988 through 1990 was $6,845, $19,652, and $19,202, respectively.
When Wang opened her account with Pinchas in December 1989, she did not read or write English and had only a limited command of American Sign Language. Wang received Marriott securities through an employee stock-compensation plan, but she did not have any experience investing in stocks, bonds, or options. Before her involvement with Pinchas, Wang's only individual investment decision was to purchase a certificate of deposit at the Chase Manhattan Bank in New York, using money from the sale of her house in Taiwan. Wang's sister-in-law helped Wang complete the required Chase Manhattan forms.
A friend from work introduced Wang to Pinchas. Pinchas, who is profoundly deaf, persuaded Wang to take the majority of her money out of Chase Manhattan and invest it with him. Pinchas told Wang that he could get her "a lot of interest" on her money, informing her that if she deposited $50,000, she would earn $7,500 in interest in a year. Wang also understood from Pinchas that the principal would remain unchanged. Relying on these representations, on December 18, 1989, Wang gave Pinchas $48,929.39 to open a margin account.
Pinchas completed Wang's new account card. He stated that her annual income was $14,000, and her net worth, excluding residence, was $50,000. He further represented that she had a year of experience in trading stocks and bonds and that her investment objective was long-term growth.
Pinchas frequently traded in Wang's account at Prudential, repeatedly purchasing and selling the same securities, with particular activity in Federal National Mortgage Association ("FNMA") warrants and common stock. In the six months after Wang opened her Prudential account, Pinchas made 17 purchases and 13 sales. Twelve of these 30 transactions involved FNMA warrants, which Pinchas bought and sold six times. As a result of Pinchas' trades, by the end of January 1990, the net value of Wang's account fell from $48,929.39, to $13,288.39.
On January 10, 1990, pursuant to a letter of authorization ("LOA") purportedly signed by Wang, $6,000 was transferred from Wang's Prudential account to the account of Rafik Rabayev, a client of Pinchas, whose wife is a distant relative of Pinchas. 2 Wang testified that she neither knew Rabayev nor authorized the transfer of funds. The District Business ConductCommittee ("District Committee") did not "find Wang's testimony to be sufficiently credible [with respect to the transfer of the $6,000] to make a finding that there was a conversion."
In June 1990, Pinchas moved to Lieberbaum and arranged to transfer Wang's account there. Wang's new account form at Lieberbaum stated that Wang's income was $20,000, her net worth was $80,000, and her investment objective was growth. Wang's account at Lieberbaum, unlike her account at Prudential, provided that Pinchas would have discretionary authority over the account.
When Wang transferred her account from Prudential to Lieberbaum, her account had a net value of $34,899.37 and consisted of 2000 FNMA warrants and 2000 shares of Home Shopping Network common stock. By the end of July 1990, the net value of the account had declined to $23,679. By February 1991, when Wang's account closed, the net value of the account had declined to $3,477.
During the eight months that Wang's Lieberbaum account was open, Pinchas made 35 purchases for the account, of which 33 were options purchases. He also made 28 sales, of which 19 were options sales. Six of the remaining 11 transactions involved FNMA warrants. The gross commissions generated in Wang's Prudential and Lieberbaum accounts totaled $17,968.55, and the combined margin interest totaled $3,220.78. The accounts had a realized loss of $48,335.22, with gross commissions comprising 37% of that loss.
B. Phyllis Schimel
Phyllis Schimel opened an account with Pinchas at Prudential on July 28, 1989. 3 At the time, Schimel was 47 years old with no dependents. Like Wang, Schimel is hearing-disabled. Schimel also has impaired vision. Schimel attended high school for three years. A psychological evaluation performed in 1992 to assess her intellectual, academic, and emotional abilities revealed that Schimel could read at the fourth-grade level and perform arithmetic at a beginning sixth-grade level. After she left school, she worked as a keypunch operator at several companies for nine and one-half years. She has not worked since the early 1970's.
Schimel had limited securities investment experience. In 1986, Schimel's father opened two accounts for Schimel at Merrill Lynch Pierce Fenner & Smith, Inc. Schimel's father established these accounts to provide income for Schimel in the event of his death. Schimel's father made all of the investment decisions in the accounts. Although her father and her Merrill Lynchregistered representative, Jeffrey Berman, tried to teach Schimel about the stock market, Schimel had difficulty grasping the concepts. Schimel's father died in April 1988. After her father's death, at Berman's recommendation, Schimel consolidated her accounts into a wrap account 4 with a portfolio manager.
Without Berman's or the portfolio manager's knowledge, Schimel opened a margin account with Pinchas in 1989. At the time, she reported an annual income in the range of $30,000 to $60,000, and a net worth of $500,000. She derived her income from her Merrill Lynch account, interest on bank accounts, an investment in a parking garage, and Social Security. The new account form reported that Schimel's investment objective was long-term growth. Schimel transferred the securities in her Merrill Lynch account to her Prudential account with Pinchas in March 1990. At that time, the net market value of the Merrill Lynch account was $208,495.
At Prudential, Schimel executed an options trading form stating that her investment objective was "investment hedging" and authorizing the writing of covered calls. Schimel stated that she had a hard time reading the form before she signed it and that Pinchas did not explain to her the contents of the form. Schimel signed the form because she trusted Pinchas and he assured her that he would "take care" of everything.
During the 11 months Schimel's Prudential account was active, Pinchas made 59 purchases and 80 sales in the account. The majority of these transactions involved repeated purchases and sales of the same securities. For example, on March 20, 1990, Pinchas sold 100 shares of Boeing stock that had been transferred to Prudential from Merrill Lynch on March 9, 1990. On March 30, 1990, he purchased 500 shares of Boeing stock, only to sell those shares approximately two weeks later on April 16, 1990. He purchased another 500 shares of Boeing stock on May 7, 1990, which he sold on May 18, 1990. Similarly, Pinchas bought and sold Compaq Computer Corporation stock three times between April 5, 1990 and May 7, 1990. Pinchas also repeatedly bought and sold in Schimel's account the securities of Summit Technology, MCI, Microsoft, UAL Corp., and Upjohn, as well as FNMA warrants.
Schimel transferred her account to Lieberbaum in June 1990. Schimel signed a new account form, which described her investment objectives as growth and speculation. Schimel granted Pinchasdiscretionary trading authority to purchase and sell securities, commodities, and options. 5
Pinchas actively traded options in Schimel's account, usually buying call options shortly before the expiration date. By July 1990 -- a month after Schimel's account began trading in options -- the total value of her account had declined from $240,465 to $184,265. When Schimel closed her account in August 1991, her account was worth only $594.63.
Schimel's Prudential and Lieberbaum accounts generated total gross commissions of $76,362.51, and combined margin interest of $11,295.81. The realized loss in the accounts was $199,719.17, with gross commissions comprising 38% of that loss.
The NASD found that Pinchas engaged in excessive equity trading and made unsuitable recommendations in both Wang's and Schimel's accounts. 6 The NASD further found that Pinchas had misappropriated customer funds from Wang's Prudential account.
A. Excessive Trading
Excessive trading occurs when a securities professional has control over trading in an account and the level of activity in that account is inconsistent with the customer's objectives and financial situation. 7 Pinchas asserts that Wang and Schimel either ordered him, or gave him permission, to execute the trades in their accounts and that they had full knowledge and understanding of the trading activity in those accounts. However, the record establishes that Pinchas had formal discretionary authority over the accounts at Lieberbaum and exercised de facto control over Wang's and Schimel's accounts at Prudential. De facto control can be established if a customer relies on a broker's advice because the customer is unable to evaluate the broker's recommendations and exercise independentjudgment. 8 Schimel's and Wang's lack of sophistication gave Pinchas virtually complete control over their accounts. Wang was unable to read and write English, 9 had only the equivalent of a high-school-level education, and had practically no experience with investments. 10 She testified that she never understood the trading activity in her Prudential account. Schimel had only elementary-school-level skills in reading and arithmetic. She could not grasp even simple trading and securities concepts, despite repeated attempts by her father and her registered representative at Merrill Lynch to explain those concepts to her. Schimel also stated during her on-the-record interview with NASD staff that Pinchas normally effected trades without her knowledge.
Pinchas asserts that he did not have control over Wang's and Schimel's accounts because the supervisors at Prudential and Lieberbaum approved the trading ticket orders for the accounts. However, a registered representative is responsible for his actions and cannot shift that responsibility to the firm or his supervisors. 11
The level and type of trading activity in Wang's and Schimel's accounts were, to put it mildly, inconsistent with their objectives and financial situations. Wang and her husband's total annual income never exceeded $20,000 during the relevant period. Wang invested with Pinchas the majority of her savings, which consisted mainly of the proceeds from the sale of her house in Taiwan. Wang wanted income without risk to her principal and testified that Pinchas told her she could earn interest on her investments while the principal remained intact. Schimel relied upon the proceeds from her investments as a chief source of her income. She specifically informed Pinchas that she did not want him to deviate from the relatively conservative income-generating investment strategy that her father and her Merrill Lynch representative had followed.
Pinchas disregarded Wang's and Schimel's interests and engaged in aggressive "in and out" trading, 12repeatedly purchasing stocks and then selling them after relatively short holding periods. In and out trading is "a practice extremely difficult for a broker to justify" and can, by itself, provide a basis for finding excessive trading. 13 Nothing in the record reveals any justification for Pinchas' type of trading activity in Wang's and Schimel's accounts.
There are other indicators that Pinchas engaged in excessive equity trading in Wang's and Schimel's accounts. One such indicator of excessive trading is the turnover rate, which reflects the number of times during a given period that the securities in an account are replaced by new securities. 14 Wang's Prudential account had an average monthly equity of $28,008.62 with an actual turnover rate of 8.31 and an annualized turnover rate of 16.63. Schimel's Prudential account, showing an average monthly equity of $80,834.98, had an even higher actual turnover rate of 19.29, with an annualized turnover rate of21.04. 15 A turnover rate of 6 generally indicates excessive trading, although we have found that even lower turnover levels can indicate excessive trading. 16 The turnover rates for Wang's and Schimel's Prudential accounts demonstrate excessive trading in those accounts. 17
Another indicator of excessive trading is the cost-to-equity ratio, which is the percentage of return on the customer's average net equity needed to pay broker-dealer commissions and other expenses. 18 In other words, the cost-to-equity ratio measures the amount an investment would have to appreciate to break even. 19 Wang's Lieberbaum account had a 110% cost-to-equity ratio, while Schimel's Lieberbaum account demonstrated a cost-to-equity ratio of 61%. We have previously found that a cost-to-equity ratio in excess of 20% indicates excessivetrading. 20 The cost-to-equity ratios for Wang's and Schimel's Lieberbaum accounts, which far exceeded 20%, demonstrate that excessive trading occurred in these
accounts. 21 Accordingly, we sustain the NASD's finding
that Pinchas engaged in excessive trading in Wang's and
Schimel's brokerage accounts.
B. Unsuitable Recommendations
Before recommending a transaction, a registered representative must have reasonable grounds for believing, on the basis of information furnished by the customer, and after reasonable inquiry concerning the customer's investment objectives, financial situation, and needs, that the recommended transaction 22 is not unsuitable for the customer. 23
There is no evidence in the record that Pinchas made appropriate inquiries about Wang's and Schimel's investment objectives, financial situations, or needs. This absence was consistent with Pinchas' general practice not to inquire about a customer's financial situation. For example, he told NASD investigators that he did not ask his clients "what they have, how much money they have or anything like that."
Although Pinchas argues that these trades were suitable for Wang and Schimel, neither woman's situation made her an appropriate candidate for Pinchas' aggressive, speculative trading. As described above, the level and type of trading in these accounts, including the in-and-out-trading, were unsuitable given the situations and objectives of these customers. Moreover, in assessing the suitability of the trades, we like the NASD, have concluded that Pinchas' trading for these accountsincluded the inappropriate purchase and sale of warrants and options and trading on margin. 24 While Pinchas claims that Wang was "financially knowledgeable" and had "money," Wang had emigrated from Taiwan recently with a high-school level education, little knowledge of securities or financial transactions, and a minimal, at best, grasp of the English language. Schimel was unemployed, lived on a fixed income, had little formal education, and was a novice at securities trading.
Pinchas argued before the NASD that Wang insisted that her investment be multiplied quickly so that she could purchase a house. Wang denied Pinchas' assertion. However, even if Wang had desired Pinchas to double her money, that desire would not have relieved Pinchas from his duty to recommend only those trades suitable to her situation. 25
Additionally, depending on a particular customer's situation and account objectives, excessive trading, by itself, can violate NASD suitability standards by representing an unsuitablefrequency of trading. 26 As discussed above, Pinchas' in and out trading activity of buying and selling the same securities in a short period of time demonstrated excessive trading. 27 We find that such excessive trading represented an unsuitable frequency of trading, thereby demonstrating violations of Pinchas' suitability obligations. For all the reasons discussed above, we accordingly sustain the NASD's ruling that Pinchas violated the NASD rules by making unsuitable recommendations in Wang's and Schimel's brokerage accounts.
C. Misappropriation of Funds
Pinchas challenges the NASD's finding that he misappropriated funds from Wang's Prudential account. 28 On January 10, 1990, an LOA, purportedly signed by Wang, was executed to transfer $6,000 from Wang's Prudential account to Rabayev's Prudential account. The NASD's complaint specifically charged that Pinchas misappropriated this money from Wang's account for the benefit of Rabayev, who subsequently gave the money to Pinchas. The complaint also charged that Wang "did not intend to, nor did she knowingly authorize the transfer of the $6,000 from her account." 29
Wang testified that she neither knew Rabayev nor authorized the transfer. Rabayev testified that, with a mutual acquaintance, William Cotsifas, acting as an interpreter between Rabayev and Wang, Rabayev agreed to allow Wang to transfer $6,000 into his account so she could engage in options trading. The District Committee did not find Wang's testimony regarding the $6,000 transfer to be consistent or sufficiently credible to support a finding of misappropriation. Instead, the District Committee found that Pinchas either knew of the transfer, or should have known of the transfer, and concluded that Pinchas misused the $6,000, most likely by paying off the preexisting deficit in Rabayev's account. 30
On appeal, the National Adjudicatory Council ("NAC") found that Pinchas misappropriated the funds. The NAC rejected the District Committee's credibility determination, finding Wang's testimony both credible and consistent. In particular, the NAC relied in great part upon Wang's testimony that she did not know Rabayev or authorize the transfer and upon Pinchas' inconsistent testimony.
While we may sympathize with the NAC's belief that there may have been misconduct with respect to the $6,000 transfer, we have repeatedly held that the credibility determinations of an initial fact-finder are entitled to considerable weight and deference unless the record contains substantial evidence to the contrary. 31 The District Committee panel members were able to observe Wang as she testified and judge from her demeanor the credibility of her testimony. Because Wang never testified before the NAC, the NAC never had this opportunity. Nor does the NAC cite other evidence that might outweigh the DistrictCommittee's credibility determination and would support the NAC's determination that Wang did not authorize the transfer.
Without Wang's testimony, there is insufficient evidence to support the NAC's finding that Wang did not consent to the $6,000 transfer, as charged in the complaint. 32 Rabayev's testimony supports Pinchas' story of her consent to the transfer, and Wang agreed that the signature on the LOA was at least partially hers. The lack of definitive, credible evidence demonstrating by a preponderance of the evidence misappropriation by Pinchas forces us to set aside the NASD's finding that Pinchas misappropriated funds from Wang's Prudential account.
Pinchas argues that the doctrine of laches should protect him from the action by the NASD. A successful laches defense requires both 1) a lack of diligence by the party against whom the defense is asserted, and 2) prejudice to the party asserting the defense. 33 Pinchas has demonstrated neither element.
The investigation against Pinchas started in May 1991 when Wang complained to the NASD. NASD Regulation staff reviewed documents, conducted an on-the-record interview of Wang and two on-the-record interviews of Pinchas, and interviewed Lieberbaum managers and Frank Stabile, Wang's friend who introduced her to Pinchas. The NASD filed a complaint against Pinchas in April 1993 regarding Pinchas' handling of Wang's accounts.
In the meantime, in May 1992, the American Stock Exchange, Inc., informed NASD staff that it received a complaint against Pinchas by Schimel. NASD staff immediately contacted Schimel, but Schimel initially declined to cooperate with the investigation because she was in arbitration proceedings with Prudential. In 1993, shortly after the original complaint had been filed against Pinchas, Schimel reconsidered her decision. Thereafter, NASD staff conducted an on-the-record interview of Schimel and analyzed account information and prepared account-trading-activity schedules for the Wang and Schimel accounts. In February 1995, the staff filed an amended complaint including charges related to Pinchas' handling of Schimel's accounts. The hearing based on the amended complaint began in December 1996.
We do not find a lack of diligence on the part of the NASD in investigating and bringing its charges against Pinchas. NASD staff gathered a large number of documents and information from disparate sources. The staff also had to arrange for interpreters to be on hand to be able to communicate with complainants and witnesses who were hearing-impaired, did not understand English, or who shared both conditions, 34 as well as contending with Schimel's initial reluctance to cooperate with the investigation.
Nor has Pinchas demonstrated that he was prejudiced by any delay caused by the extended investigation. Pinchas learned about the NASD's investigation into his handling of Wang's accounts shortly after Wang complained to NASD Regulation staff, and the NASD requested information from him in June 1991. In June 1992, NASD staff questioned Pinchas about his handling of Schimel's accounts. Pinchas does not identify any additional evidence that he could have obtained had the case been brought earlier.35 Accordingly, we reject Pinchas' argument that the NASD's action is barred by the doctrine of laches.
B. Fairness of Proceedings
Pinchas raises various challenges to the fairness of the NASD's proceeding against him.
1. Pinchas complains that the NASD brought this action against him without producing any written complaints from Wang and Schimel. Pinchas cites to former NASD Rule 8120, 36which permitted a customer to institute a disciplinary action against a member. However, the instant complaint was instituted by the NASD, not the customers, under former NASD Rule 8130. Thus, Rule 8120 is not applicable to this proceeding.
2. Pinchas contends that Schimel, who did not appear as a witness at the hearing, was reluctant to lodge a complaint against Pinchas, and "was forced to do so under  unusual circumstances." The record reflects, however, that Schimel volunteered her cooperation after completing an arbitration settlement with one of Pinchas' former firms. 37
3. Pinchas contends that a member of the NASD staff "had a biased, anti-Pinchas attitude" and hired biased interpreters for the on-the-record interviews that the staff conducted of him. Pinchas does not identify the individual to whom he refers. This contention apparently arises from Pinchas' attempt at the hearing to demonstrate that his explanation of how $6,000 was transferred out of Wang's account was somehow altered at his April 1992 interview by either the stenographer or the interpreter. There is no evidence to support Pinchas' assertions. In any event, we have dismissed the misappropriation charge with respect to Wang's account.
4. Pinchas contends that the hearing panel's attorney-advisor hindered him from obtaining relevant evidence from witnesses. However, Pinchas does not identify either the nature of this evidence or the witnesses from whom he desired to obtain the evidence. Our review of the record, moreover, does not reveal any attempt by the attorney-advisor to hinder Pinchas from obtaining any evidence. Rather, the record reflects that the attorney-advisor made repeated efforts to explain the proceedings and NASD requirements to Pinchas.
5. Pinchas contends that an unidentified panel member engaged in private conversation with opposing counsel and that another unidentified panel member fell asleep during the hearing. 38 Pinchas does not provide greater detail aboutthese alleged incidents. There is no evidence in the record concerning any instance in which any panel member engaged in conversation with NASD counsel without Pinchas being present, nor is there anything in the record suggesting that the panel did anything other then give their full attention to the matter. On the contrary, at one point during NASD staff's questioning of a witness, Pinchas informed the panel that the slow response of the witness's answers was making him tired and stated that he "would actually take a little nap at this point." The panel chairman "implore[d]" Pinchas to "try to stay awake."
6. Pinchas makes general allegations of conspiracy and bias by the NASD staff, the hearing panel, and the attorney-advisor. We find such allegations to be unsubstantiated by
the record. The hearing panel, its attorney-advisor, and the NASD staff treated Pinchas with utmost courtesy during the investigation and hearing. In response to numerous requests from Pinchas, the attorney-advisor and staff provided information and documents. The hearing panel took pains to explain to Pinchas hearing procedure and repeatedly gave Pinchas wide latitude in questioning witnesses, often overruling objections from opposing counsel that the hearing panel acknowledged were valid. The panel set up a sophisticated transcription process that involved two sign language interpreters, a court reporter, and computer screens for all parties, which recorded the transcribed record as it was created. We reject Pinchas' general claims of conspiracy and bias on the part of the staff, the panel, and the panel's attorney-advisor. 39
Pinchas does not argue that the sanctions imposed against him are inappropriate. The NASD censured Pinchas, fined him $219,821, and barred him from association with any member firm in any capacity. The amount of the fine consisted of: $50,000 for excessive trading in Wang's accounts, $9,423 in net commissions on Wang's accounts, $50,000 for unsuitable recommendations to Wang, $20,000 for improper use of Wang's funds, $50,000 for excessive trading in Schimel's accounts, and $40,398 in net commissions on Schimel's accounts.
Because we have dismissed the allegation that Pinchas misappropriated funds from Wang's account, we must set aside the NASD's $20,000 fine for that charge. However, the remaining sanctions are amply supported by the evidence, as demonstrated above. Additionally, the NASD imposed sanctions within the range set forth by its Sanction Guidelines. 40 Based on the circumstances here, we do not find the remaining sanctions imposed to be excessive or oppressive.
An appropriate order will issue. 41
By the Commission (Chairman LEVITT and Commissioners JOHNSON, HUNT, CAREY and UNGER).
Jonathan G. Katz
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 41816 / September 1, 1999
Admin. Proc. File No. 3-9639
In the Matter of the Application of
75-54 168 St.
Hillcrest, NY 11366
For Review of Disciplinary Action Taken by the
NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.
ORDER SETTING ASIDE IN PART AND SUSTAINING IN PART DISCIPLINARY ACTION TAKEN BY REGISTERED SECURITIES ASSOCIATION
On the basis of the Commission's opinion issued this day, it is
ORDERED that the findings by the National Association of Securities Dealers, Inc., that Rafael Pinchas engaged in excessive trading and unsuitable recommendations be, and they hereby are, sustained; and it is further
ORDERED that the Association's findings that Rafael Pinchas engaged in misappropriation are set aside; and it is further
ORDERED that the Association's sanctions are sustained, except that the fine is reduced by the amount of $20,000.
By the Commission.
Jonathan G. Katz
-- Conduct Rule 2110 requires that associated members observe "high standards of commercial honor and just and equitable principles of trade."
Conduct Rule 2120 prohibits a member from purchasing or selling any security "by means of any manipulative, deceptive or other fraudulent device or contrivance."
Conduct Rule 2310 requires that a member have "reasonable grounds for believing that [a trading] recommendation is suitable" for a customer and directs the member to make "reasonable efforts to obtain information" concerning the customer's financial situation and needs.
Conduct Rule 2510 requires a member to obtain written authorization from the customer before exercising any discretionary authority in the customer's account and specifically forbids trades "excessive in size or frequency in view of the financial resources and character of such account."
Conduct Rule 2330 prohibits representatives from making "improper use of a customer's securities or funds."
Conduct Rule 2860(b)(19) applies specifically to the trading of options and requires that a recommended options transaction not be unsuitable for the customer.
-- The NASD refers to Rabayev as Pinchas' cousin. Pinchas testified at the hearing that, although he refers to Rabayev as his cousin, it is Rabayev's wife who is a fourth or fifth cousin to Pinchas.
-- Although Schimel did not appear before the District Committee hearing panel, she gave an on-the-record interview to the NASD Regulation staff during the investigation process.
--In a wrap account, a client is typically provided with portfolio management, execution of transactions, asset allocation, and administrative services for a single fee based on the assets under management. Kenneth C. Krull, Securities Exchange Act Rel. No. 40768 (December 10, 1998), 68 SEC Docket 2324, 2329-30 & n.12.
-- The options information form and agreement Schimel signed at Lieberbaum stated that Schimel had 30 years of experience in trading stocks and bonds and three years of experience trading in options. Schimel denied having any experience in the stock market, stating that only her father had stock market experience.
-- Because the NASD found Pinchas' equity trading in Schimel's and Wang's accounts to be excessive, the NASD did not consider whether the options trading in which he engaged was also excessive.
-- Clyde J. Bruff, Securities Exchange Act Rel. No. 40583 (Oct. 21, 1998), 68 SEC Docket 768, 771, appeal filed, No. 98-71512 (9th Cir. Dec. 21, 1998).
-- See Follansbee v. Davis, Skaggs & Co., Inc., 681 F.2d 673, 676-77 (9th Cir. 1982) (even if a broker does not have formal discretionary authority, the account may be under the broker's control if his customer is unable to evaluate his recommendations and to exercise an independent judgment); see also Bruff, 68 SEC Docket at 772 (broker's control of account established where client's lack of sophistication with investing placed her in position where she had to rely upon broker's advice).
-- Catholic Charities and LaGuardia Community, two independent nonprofit agencies which had tested Wang, stated by letters dated May 28, 1991, and May 29, 1991, respectively, that Wang had limited ability to communicate either in English or in American Sign Language. Pinchas admitted during an on-the-record investigatory interview conducted by NASD staff that Wang did not understand English very well.
-- Wang testified that she had no previous investment experience before opening her account at Prudential. Pinchas also admitted during an on-the-record interview with NASD Regulation staff that Wang had no investment experience prior to her account at Prudential.
-- See Justine Susan Fischer, Securities Exchange Act Rel. No. 40335 (Aug. 19, 1998), 67 SEC Docket 2414, 2420-21 & n.4 (broker not excused from responsibility of making suitable trading recommendations by stating that her employer and supervisor authorized and approved her strategy); see also Larry Ira Klein, 52 S.E.C. 1030, 1038 n.30 (1996) (salesman cannot use an employer's general approval as a substitute for an individual determination that a security was suitable for his clients).
--"The term _in and out' trading denotes the sale of all or part of a customer's portfolio, with the money reinvested in other securities, followed by the sale of the newly acquired securities." Costello v. Oppenheimer & Co., Inc., 711 F.2d 1361, 1369 n.9 (7th Cir. 1983).
-- See id. at 1369.
-- Shearson Lehman Hutton Inc., 49 S.E.C. 1119, 1122 (1989). The turnover rate is computed by dividing the aggregate amount of purchases in an account by the average monthly investment. The average monthly investment is the cumulative total of the net investment in the account at the end of each month, exclusive of loans, divided by the number of months under consideration. Id. at 1122 n.10.
-- The turnover ratios were not computed on Wang's and Schimel's Lieberbaum accounts because of the options trading in those accounts.
-- See Craighead v. E.F. Hutton & Co., Inc., 899 F.2d 485, 490 (6th Cir. 1990) (excessive trading generally is thought to exist when there is an annual turnover rate in an account in excess of six); Arceneaux v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 767 F.2d 1498, 1502 (11th Cir. 1985) ("The courts which have addressed this issue have indicated that an annual turnover rate in excess of six reflects excessive trading."); Mihara v. Dean Witter & Co., Inc., 619 F.2d 814, 821 (9th Cir. 1980)("While there is no clear line of demarcation, courts and commentators have suggested that an annual turnover rate of six reflects excessive trading.") (citing authority); see also Donald A. Roche, Securities Exchange Act Rel. No. 38742 (June 17, 1997), 64 SEC Docket 2042, 2047 (finding turnover rate of 3.3 to be excessive); Frederick C. Heller, 51 S.E.C. 275, 277 (1993) (finding excessive trading where annualized turnover ratio was 6.4); Shearson Lehman Hutton Inc., 49 S.E.C. 1119, 1122 (1989) (finding excessive trading where turnover rate was 7.4); Samuel B. Franklin & Company, 42 S.E.C. 325, 330 (1964) (finding turnover rates of 3.5 and 4.4 to be excessive).
-- Where a broker has de facto control of investment decisions in an account, as was the case here, excessive trading may be found based solely on the turnover rate in an account. David A. Gingras, 50 S.E.C. 1286, 1289 (1992).
-- I Stuart C. Goldberg, Fraudulent Broker-Dealer Practices, § 2.9[b] (1978).
-- See id.
-- See Peter C. Bucchieri, 52 S.E.C. 800, 805 (1996) (finding excessive trading in account with cost-to-equity factors of 21% to 30%); Michael David Sweeney, 50 S.E.C. 761, 765 (1991) (finding excessive trading in account with cost-to-equity factors of 22% to 44%); see also Frederick C. Heller, 51 S.E.C. at 277 (excessive trading demonstrated where break-even return was 36%, annualized turnover ratio was 6.4, and investments were held for short periods); Shearson Lehman Hutton Inc., 49 S.E.C. at 1122 (excessive trading in account where break-even return was 50% and turnover rate was 7.4).
-- See id.
-- Transactions that were not specifically authorized by a client but were executed on the client's behalf are considered to have been implicitly recommended within the meaning of the NASD rules. Paul C. Kettler, 51 S.E.C. 30, 32 n.11 (1992).
-- Id. at 32.
-- The stated objective on Wang's new account form at Prudential was long-term growth. The Prudential options agreement recited that her objective was income. Wang's new account form at Lieberbaum later stated her investment objective was growth. Schimel's new account form at Prudential did not state her investment objective, but her Prudential options agreement stated that her objective was investment hedging. Her new account form at Lieberbaum stated that her objectives were growth and speculation and her options agreement stated that she was interested in growth and trading profits.
However, both women stated that Pinchas either told them what to say on the form and/or filled out the forms himself. Pinchas admitted to NASD investigators that he filled out Wang's new account forms and options agreements, and Schimel stated that Pinchas filled out the annual income and net worth spaces on her Prudential new account form after having her sign it. Wang and Schimel further stated that he induced them to sign the forms without making certain they understood them. Given their limited understanding of the securities market, it is doubtful that Schimel and Wang would have understood the meaning of each of the objectives stated on their account forms.
-- See Gordon Scott Venters, 51 S.E.C. 292, 294-95 (1993) (broker had duty to stop recommending speculative investments when he learned about his customer's age and situation, despite customer's leaning towards such investments).
-- Kettler, 51 S.E.C. at 32; see also Bruff, 68 SEC Docket at 774 (excessive trading is itself a form of unsuitability); Donald A. Roche, Securities Exchange Act Rel. No. 38742 (June 17, 1997) 64 SEC Docket 2042, 2048 (excessive trading, without more, is a type of violation of broad suitability rules promulgated by self-regulatory organizations).
-- Pinchas also contends that the NASD staff mishandled the misappropriation of funds issue, stating that in the beginning the staff accused him of "grand larceny" and of forging Wang's signature on the LOA for the transfer. The record does not support this contention. Both the original complaint and the amended complaint against Pinchas allege only that he misappropriated funds from Wang's account and never alleged that he committed grand larceny or forgery.
Additionally, Pinchas complains that the staff "strangely" did not present at his hearing a claim by Schimel that Pinchas had misappropriated funds from her accounts and that the hearing panel did not want to "face this subject at the hearing." The complaint in this matter did not charge misappropriation from Schimel's account. That determination by the NASD is not reviewable in this proceeding. Nor do we understand Pinchas' argument that he is somehow prejudiced by the NASD's failure to make such an allegation.
-- Pinchas provided two explanations for the transfer. Pinchas told NASD staff in an April 1992 on-the-record interviewthat Wang had agreed to pay him $6,000 in return for helping Wang and her family fill out immigration applications and tutoring them in American history in preparation for their U.S. citizenship examinations. At his hearing, Pinchas subsequently disavowed this first version and testified that Wang, Rabayev, and William Cotsifas, a mutual acquaintance, secretly agreed to transfer $6,000 from Wang's account to Rabayev's account so Wang could invest in options.
-- There is no evidence that Pinchas ever received any of the money. Evidence does support the District Committee's conclusion that the $6,000 quite likely went to pay off a shortage in Rabayev's account. Two days prior to the transfer, Pinchas made ten options trades in Rabayev's account that resulted in a $6,000 shortage. This was eliminated by the $6,000 transfer from Wang's account.
-- Litwin Securities, Inc. and Harold A. Litwin, Securities Exchange Act Rel. No. 38673 (May 27, 1997), 64 SEC Docket 1772, 1777 n.13.
-- Because Pinchas was not charged with misusing the $6,000, we are also unable to support the District Committee's finding that Pinchas misused the funds for some other purpose, such as paying off Rabayev's account deficit.
-- Hecht v. Harris, Upham & Co., 430 F.2d 1202, 1208 (9th Cir. 1970).
-- For example, Wang's on-the-record interview, which was conducted in writing, required a Chinese interpreter. Pinchas' and Schimel's interviews required American Sign Language interpreters.
-- Pinchas notes that during this period Cotsifas, who could have supported Pinchas' second explanation of the $6,000 transfer, died before he could testify. Even assuming that the content of Cotsifas' testimony would have been favorable to Pinchas, Pinchas is still unable to demonstrate prejudice from the delay. Cotsifas' testimony was relevant only to the allegation that Pinchas misappropriated funds from Wang's account. We have determined to dismiss that allegation.
-- At the time of the filing of the complaint against Pinchas, NASD Rule 8120 provided that any person feeling aggrieved by an act of an NASD member or associated person that he or she believed to be in violation of those rules could file a written complaint with the NASD that would be handled in accordance with the NASD Code of Procedure. Rule 8120 was eliminated in 1997 when the Commission approved new rules governing the NASD disciplinary process. See Exchange ActRel. No. 38908 (August 7, 1997), 62 Fed. Reg. 43,385, 43,401 (1997).
-- On appeal, Pinchas also argues that the hearing panel ignored the fact that Schimel tried to bribe him because she felt guilty for receiving a arbitration settlement from Prudential. We find this contention to be unsupported by any reliable evidence in the record.
-- We find it curious that Pinchas chose not to reveal the identity of the objectionable panel members. Pinchas appeared before the panel through a 15-day hearing, during which the panel started almost each hearing day by introducing themselves.
-- See First Colorado Financial Services Company, Inc., Securities Exchange Act Rel. No. 40436 (September 14, 1998), 68 SEC Docket 24, 32-33 (rejecting claims against NASD Regulation staff of bias, improper conduct, and selective enforcement as vague and unsupported by the record); Frank J. Custable, Jr., 51 S.E.C. 643, 650 (1993) (rejecting general and unspecific allegations of bias of NASD Regulation staff and contention alleged bias of NASD Regulation staff tainted impartiality of the District Committee or NAC); see also New Allied Development Corporation, 52 S.E.C. 1119, 1128 n.23 (1996).
-- See NASD Sanction Guidelines (1993). A finding of excessive trading carries a potential monetary sanction of "any commission, concessions, or profits to the respondent and firm plus $5,000 to $50,000" and a potential suspension of up to 60 days. If a respondent commits more serious misconduct during the excessive trading, such as attempting to lull the investor, or being untruthful about the transactions, the respondent may face a longer suspension or a bar.
A finding of unsuitable recommendations carries a potential monetary sanction of "the amount of any commissions, concessions, or profits to the respondent and firm, plus $5,000 to $25,000 and a potential suspension for 10 to 30 business days."
-- We have considered all of the contentions of the parties. We reject or sustain them to the extent they are inconsistent or in accord with the views expressed in this opinion.