SECURITIES AND EXCHANGE COMMISSION
In the Matter of
RUSSO SECURITIES, INC.
OPINION OF THE COMMISSION
BROKER-DEALER AND CEASE-AND-DESIST PROCEEDINGS
Grounds for Remedial Action
Failure to Comply with Net Capital, Reporting, Recordkeeping, and Notice Requirements
Aiding and Abetting Net Capital, Reporting, Recordkeeping, and Notice Violations
Registered broker-dealer willfully violated Commission's net capital rule and related reporting, recordkeeping, and notice requirements, and firm's chief financial officer willfully aided and abetted, and caused, these violations. Held, it is in the public interest to impose on firm a monetary penalty of $75,000; to suspend chief financial officer for one year from association with a broker-dealer or a member of a national securities exchange or of a registered securities association; to impose on chief financial officer a monetary penalty of $25,000; and to impose on firm and chief financial officer a cease and desist order.
Charles B. Manuel, Jr. and James C. Jones, for Russo Securities, Inc. and Kimberly Kent.
Lisa Rosenthal, Andrew J. Geist, Barry W. Rashkover, and John J. O'Donnell, for the Division of Enforcement.
Appeal filed: April 29, 1999
Last brief received: January 12, 2001
Oral argument held: December 13, 2000
Russo Securities, Inc. ("RSI"), a registered broker-dealer, and Kimberly Kent, RSI's chief financial officer and registered financial and operations principal ("FINOP"), appeal from an administrative law judge's decision. 1 The law judge found that, on four separate dates between December 1995 and March 1996, RSI failed to comply with the Commission's net capital rule, 2 keep accurate books and records, 3 and notify the Commission of its net capital and books and records deficiencies. 4 The law judge also found that Kent aided and abetted, and was a cause of, RSI's violations. 5 The law judge imposed on RSI a $100,000 civil money penalty; suspended Kent for a year from association with a broker-dealer or a member of a national securities exchange or of a registered securities association; imposed on her a $25,000 civil money penalty; and ordered that both RSI and Kent cease and desist from future similar violations. We base our findings on an independent review of the record, except with respect to those findings not challenged on appeal.
RSI is a member of the National Association of Securities Dealers, Inc. ("NASD") and the New York Stock Exchange, Inc. ("NYSE"). RSI, as an introducing broker, had to maintain net capital of at least $100,000. 6 This proceeding arose when RSI included in its net capital stock due to the firm under three investment banking agreements. There are no allegations with respect to any other items relating to the firm's net capital calculations.
A. RSI's Net Capital Computation for December 29, 1995
For the month ended December 31, 1995, RSI reported to the Commission on its Financial and Operational Combined Uniform Single ("FOCUS") report that the firm had net capital of $302,857, including two million shares of American Diversified Group, Inc. ("ADGI") common stock. 7 RSI valued the ADGI stock at $460,000, or 45% of the total allowable assets it calculated under the net capital rule. Without the two million shares of ADGI stock, RSI would have had a negative net capital of $39,621.
RSI included the ADGI stock as an allowable asset based on a contract with ADGI entered into on December 14, 1995, and subsequently amended on December 28, 1995. Under the contract, RSI agreed to provide investment banking and consulting services to ADGI in exchange for ADGI common stock. 8
As of December 29, 1995, however, when RSI included the ADGI stock in its net capital, it had not been issued or authorized for issuance to RSI by ADGI's board of directors. In fact, ADGI never issued any stock to RSI. Nor had the stock been registered with the Commission. Although Karlton Zamost, an RSI consultant and longtime Russo associate, testified that he saw an ADGI board resolution authorizing the issuance of the ADGI stock to RSI, RSI failed to produce any such resolution. Zamost's testimony, moreover, was contradicted by ADGI president Jerrold Hinton's affidavit. In the affidavit, Hinton stated that the contract between ADGI and RSI was canceled in January 1996, and that ADGI's board of directors neverauthorized any stock for issuance to RSI. In light of Zamost's longtime relationship with the Russo family, the lack of evidence corroborating his testimony, and the persuasive evidence contradicting his contentions, notably the Hinton affidavit, the law judge found that Zamost's testimony on the subject of stock authorization was not credible. 9 We find no reason to disturb that finding. 10
B. RSI's Net Capital Computations for January 31, 1996 and February 29, 1996
For the months ended January 31, 1996, and February 29, 1996, RSI's FOCUS reports stated that RSI maintained net capital of $279,338 and $275,766, respectively. On these dates, RSI included as an allowable asset on its books and records the value of two million shares of BestSellers Group, Inc. common stock. The firm valued the stock at $400,000 on January 31, 1996, and at $380,000 on February 29, 1996. The BestSellers stock represented 42% of RSI's total allowable assets on January 31, 1996, and 38% on February 29, 1996. Without the two million BestSellers shares, RSI had a negative net capital of $23,651 on January 31, 1996, and a positive net capital of only $21,818 on February 29, 1996.
RSI included the BestSellers stock as an allowable asset based on a January 17, 1996 investment banking agreement with BestSellers entitling RSI, upon execution of the agreement, to receive two million shares of BestSellers stock in exchange for consulting work. However, as of January 31, 1996, and February 29, 1996, when RSI included the BestSellers stock in its net capital, the stock had not been issued or authorized for issuance to RSI by BestSellers' board of directors. BestSellers' board did not authorize the issuance of the stock to RSI until March 25, 1996. 11 BestSellers did not issue the shares until April 2, 1996. 12
C. RSI's Net Capital Computation for March 22, 1996
As of March 22, 1996, RSI's FOCUS report stated that the firm maintained net capital of $308,000. 13 RSI included in its net capital 671,000 BestSellers shares, valued at $120,798, and 525,000 shares of Semicon Tools, Inc., valued at $357,000. Without the BestSellers and Semicon stock, RSI had a negative net capital of $19,333 on March 22, 1996.
RSI included the BestSellers stock as an allowable asset based on its January 17, 1996, investment banking agreement with BestSellers although RSI still had not received the stock that was to have been issued upon execution of that agreement. RSI included the Semicon stock as an allowable asset based on a March 6, 1996, investment banking agreement entitling RSI to receive options, exercisable until September 30, 1996, to purchase six million shares of Semicon common stock in exchange for RSI's consulting services. The Semicon agreement, like the ADGI agreement, required registration of the stock. 14
As of March 22, 1996, when RSI included the BestSellers and Semicon stock in its net capital, the stock had not been issued or authorized for issuance to RSI by either issuer's board of directors. In addition, the Semicon stock had not been registered with the Commission. As described previously, BestSellers stock was not authorized until March 25, 1996, and not issued to RSI until April 2,1996. Similarly, Semicon's board did not authorize issuance to RSI of either the options to purchase its shares or the stock underlying the options until March 29, 1996. 15 Semicon did not register the stock with the Commission until April 3, 1996. That same day, RSI exercised the Semicon options. 16 RSI did not receive the 525,000 Semicon shares until April 11, 1996.
* * *
RSI cites no other assets that would permit it to be in net capital compliance on December 29, 1995, January 31, 1996, February 29, 1996, and March 22, 1996. RSI effected customer transactions in securities on those dates.
D. Kent's Role in RSI's Net Capital Computations
During the relevant period, Kent prepared RSI's books and records, performed RSI's net capital calculations, and prepared and signed RSI's FOCUS reports, which included as an asset the stock covered by the three consulting agreements. Neither RSI nor Kent notified the Commission that RSI had less than $100,000 in net capital as of the four dates at issue, or that RSI's books and records, including its FOCUS reports, were inaccurate.
The Division alleges that RSI willfully violated the net capital rule and related regulations on the relevant dates, and that Kent willfully aided and abetted, and was the cause of, RSI's violations.
A. RSI's Net Capital Violations
The net capital rule prohibits broker-dealers from engaging in securities transactions in contravention of prescribed minimum net capital requirements. Its purpose is to assure that a broker-dealer has sufficient liquid capital to protect customers' assets and to meet its responsibilities to other broker dealers. 17
1. The Disputed Stock Was Not Readily Convertible Into Cash
The net capital rule provides, in part, that assets that are not liquid or "readily convertible into cash," including certain unsecured receivables, must be deducted from a broker-dealer's total capital to compute its "net capital" or liquid net worth. 18 A firmclaiming that a particular asset is "readily convertible into cash" bears the burden of establishing that claim. 19
The stock due to RSI under its investment banking agreements was not "readily convertible into cash" because RSI could not even receive the stock until it had been authorized and issued to RSI by each issuer's board of directors. Neither of these actions had occurred as of the dates that RSI included the stock in its net capital. Under applicable state corporate law, 20 issuance of stock by a corporation must be duly authorized by its board of directors, 21 and may not be delegated by the board to an officer or employee. 22 Thus, in the absence of board resolutions authorizing and issuing the disputed stock to RSI as of the relevant dates, RSI could not properly have included the stock in its net capital. 23
2. The Disputed Stock Had No "Ready Market"
The net capital rule separately provides that securities for which there is no "ready market," or which may not be sold because of "statutory, regulatory or contractual arrangements," must be deducted from a broker-dealer's net capital. 24 The term "ready market" means "a recognized established securities market" in which there exist "independent bona fide offers to buy and sell . . . . " 25
On the dates of RSI's net capital computations, the stock in question was neither issued nor authorized for issuance to RSI. Until the stock was authorized and issued, there could be no "ready market" for the stock. 26 In addition, RSI's agreements with ADGI and Semicon required the shares of those issuers to be registered with the Commission in order to be resold. Because those shares were not registered as of the dates that RSI included them in its net capital, they were "nonmarketable" securities, and therefore should have been deducted from RSI's net capital.
3. RSI's Expert Testimony That The Disputed Stock May Serve As Collateral For Margin Purposes Did Not Establish That It Was An Allowable Asset
RSI argues that the stock was properly included in its net capital based on expert testimony that RSI's clearing firm would treat stock to be received under an investment banking agreement as a "long" asset and extend margin credit against it. Whether a clearing firm is willing to extend margin credit against a long position, however, has no bearing on whether such stock is "readily convertible into cash" as required by the net capital rule. 27 RSI's expert admitted, moreover, that he would not extend credit based on an investment banking agreement for yet-to-be issued stock if the stock had not been authorized for issuance by the issuer's board of directors. The expert also admitted that, for net capital purposes, he would first require an opinion of counsel that "the position can be readily converted into cash." 28
4. The Disputed Stock Was Not "When Issued" Stock
RSI argues that the disputed stock was "when issued" stock, and therefore could be included in net capital. 29 The term "when issued," according to the NYSE Glossary, "indicates a conditional transaction in a security authorized for issuance but not as yet actually issued." 30 Thus, stock that has not yet been issued by acorporation, but has been authorized for issuance by the corporation's board of directors, is considered "when issued" stock. Here, by contrast, the stock due to RSI under its investment banking agreements had not been authorized for issuance to RSI on the dates that RSI counted the stock in its net capital. Therefore, the stock was not "when issued" stock. 31
5. Respondents Cannot Shift Responsibility For Compliance To Regulators
Respondents argue that, because RSI filed reports with the NYSE reflecting the inclusion of the stock in its net capital, and because the NYSE did not challenge those net capital computations, the NYSE approved of RSI's treatment of the stock for net capital purposes. We find that RSI's reports erroneously indicated RSI was to receive the stock within thirty days, and therefore were misleading. Even ifthe reports had accurately represented the stock's status, Respondents cannot shift their responsibility for compliance with net capital requirements to the NYSE or to us. 32
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We find that RSI willfully violated Exchange Act Section 15(c)(3) and Exchange Act Rule 15c3-1.
B. RSI's Recordkeeping, Reporting, And Notification
Exchange Act Section 17(a)(1) provides that brokers and dealers shall make, keep, furnish, and disseminate records and reports prescribed by Commission rule "as necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Exchange Act." 33 The requirement that a firm maintain records and file reports encompasses the requirement that these records and reports be true and correct. 34
Exchange Act Rule 17a-3 requires broker-dealers to make and keep current records of their net capital computations. 35 Under Exchange Act Rule 17a-5, certain broker-dealers, including RSI, must file with the Commission monthly FOCUS reports containing a net capital computation. 36
Furthermore, Exchange Act Rule 17a-11 provides that every broker or dealer whose net capital falls below the required minimum must give notice of such deficiency that same day to the Commission. 37 The rule also provides that a broker or dealer that fails to make or keep current the books and records required by Rule 17a-3 must give notice to the Commission of this fact on the same day. 38 The broker or dealer must transmit a report to the Commission within48 hours of the notice stating what it has done or is doing to correct the situation. 39
RSI's balance sheets and general ledgers for the periods ending on December 31, 1995, January 31, 1996, and February 29, 1996, inaccurately characterized as long positions in inventory the value of the ADGI and BestSellers stock, in violation of Exchange Act Rule 17a-3. RSI's trial balances for the same periods inaccurately included the value of this stock as long positions in inventory, also in violation of Rule 17a-3. RSI created and filed inaccurate FOCUS reports for these periods, in violation of Rule 17a-5. RSI also created an inaccurate record of its net capital computation for March 22, 1996, in violation of Rule 17a-3. By making and keeping these inaccurate records, RSI willfully violated Exchange Act Section 17(a)(1) and Exchange Act Rules 17a-3 and 17a-5.
RSI failed to notify the Commission that it had net capital deficiencies on December 19, 1995, January 31, 1996, February 29, 1996, and March 22, 1996. RSI failed to notify the Commission that its books and records were inaccurate, and failed to file with the Commission reports stating what it was doing to remedy the violation. RSI thus willfully violated Exchange Act Section 17(a)(1) and Exchange Act Rule 17a-11.
C. Kent's Secondary Violations
The elements required for finding Kent liable for aiding and abetting are: (1) a securities law violation by RSI; (2) Kent's substantial assistance in the conduct constituting the violation; and (3) Kent's providing that assistance with the requisite scienter. 40 Kent's conduct satisfies all three elements.
As shown above, RSI violated the net capital and related rule requirements. As FINOP, Kent was intimately involved in RSI's net capital computations and the preparation of RSI's books and records. Kent substantially assisted RSI's securities law violations. Kent computed the firm's net capital on the dates in question and included the value of the disputed stock in those computations. Kent also reflected the inaccurate net capital in RSI's books and records, and did not notify the Commission of RSI's violations, as required. Kent prepared and signed RSI's FOCUS reports, certifying that all of the information contained in the reports was "true, correct, and complete."
Kent knew of the wrongful nature of her conduct. Kent knew that the disputed stock represented about 40% of RSI's reported allowable assets on the dates of the net capital computations. On several occasions, Kent knew or recklessly disregarded the fact that, if RSI were unable to include the stock in its net capital, it would fall below the $100,000 minimum required net capital and be unable to conduct business. Kent also knew that on the dates at issue the stock was not in the firm's account. Nevertheless, Kent made no effort to determine whether the stock had been authorized or registered. Nor did Kent ask the Commission or NYSE staff about the propriety of including the disputed stock in the firm's net capital even though she knew the NYSE could offer RSI guidance and had done so in the past with respect to other net capital matters.
The misleading representations that Kent made to Commission staff and the NYSE constitute additional evidence that she knew that including the disputed stock in RSI's net capital was improper. When Commission staff asked about the location of the ADGI and BestSellers stock, Kent claimed that the stock was "in transit." However, during the hearing before the law judge, Kent admitted that, when she said the stock was "in transit," she meant only that RSI had a contractual claim for the stock. 41 At no point during the relevant period did Kent ask either ADGI or BestSellers to issue the stock that was supposedly "in transit." Similarly, in reports filed with the NYSE, RSI represented that it would receive the ADGI and BestSellers stock within thirty days. Kent conceded, however, that RSI did not receive the stock within that time.
We conclude that Kent willfully aided and abetted, and was a "cause" of, RSI's violations of Exchange Act Sections 15(c)(3) and 17(a)(1) and Exchange Act Rules 15c3-1, 17a-3, 17a-5, and 17a-11. 42
On appeal, Respondents raise additional arguments against being disciplined.
A. Due Process
Respondents contend that they were denied due process because the net capital rule's provision for disallowing assets that are not "readily convertible into cash" is vague and ambiguous and failed to place them on notice that inclusion of the disputed stock in RSI's net capital would violate the rule. This argument has been previously considered and rejected. In Don B. Anderson & Co. v. SEC, 43 the petitioners argued that the net capital rule's "readily convertible into cash" provision was "too uncertain to afford a proper guideline," and therefore its application to them would be a denial of due process. 44 The court disagreed and found that the liquidity requirement for compliance with the net capital rule was "well-established." The court held that "[t]here is nothing uncertain about this rule. All that is required is that there be a ready market for the liquidation of the assets." 45
B. Selective Enforcement
Respondents also contend that the Division of Enforcement is "persecut[ing] and victimiz[ing]" RSI and its employees, and that this proceeding is the product of a "vendetta" against them. The United States Supreme Court has stated that "the conscious exercise of some selectivity in enforcement is not in itself a federal constitutional violation." 46 At a minimum, a party seeking to assert such a claim must show that he was singled out for enforcement while others who were similarly situated were not, and that his prosecution was motivated by arbitrary or unjust considerations such as race, religion, or the desire to prevent the exercise of a constitutionally protected right. 47 No such showing has been made.
After briefing was concluded in this matter, Respondents filed motions to adduce additional evidence, for issuance of subpoenas, and to re-open and supplement the record. Rule of Practice 452 requires a party who seeks to adduce additional evidence to "show with particularity that such additional evidence is material and that there were reasonable grounds for failure to adduce such evidence previously." 48
A. Respondents seek to depose Alfred Padovano, whose firm was RSI's outside accountant and auditor during 1995 and 1996. While Padovano was scheduled to testify at the hearing below, Respondents claim that they were unable to call Padovano because the staff "sequestered" Padovano from Respondents and their counsel.
According to affidavits submitted by Respondents, Padovano came to the Commission's offices on April 27, 1998, the first day of the hearing. Although the affidavits suggest that both Respondents and the staff were unaware of Padovano's precise whereabouts within the Commission's offices, nothing in those affidavits suggests that the Commission's staff took any action to prevent Respondents from having access to Padovano. The affidavits also do not allege that Commission staff prevented any communication between Padovano and Respondents' counsel after Padovano left the Commission's offices atlunchtime on April 27. Nor do they explain why Padovano could not have testified later in the hearing, which continued through April 30, 1998.
Moreover, from the record, it appears that Respondents determined not to call Padovano below. At the conclusion of the first day of the hearing on April 27, 1998, Respondents' counsel stated that, because he had been unable to locate Padovano, he would contact Padovano by the end of that day and determine "whether we will be introducing any such evidence" with respect to a claimed accounting adjustment. At the opening of the second day of the hearing, Division counsel announced that she rested, subject to calling a witness to rebut any testimony with respect to the alleged accounting adjustment. Respondents' counsel announced that "we have withdrawn any claim with respect to" the adjustment issue. There is no further mention in the record of Respondents' desire to call Padovano as a witness or Padovano's availability.
Before us, Respondents state, "Our subsequent withdrawal of our claim with respect to the balance sheet adjustments was based solely upon the total failure of the Enforcement Division's case. Little did we imagine that nine months later the law judge would issue an initial decision that simply parrotted [sic] the Division's contentions and bypassed the failure of their evidence and legal position." Respondents' hearing strategy does not warrant reopening the record in this proceeding. As we have previously stated, "Public policy considerations favor the expeditious disposition of litigation, and a respondent cannot be permitted to gamble on one course of action and, upon an unfavorable decision, to try another course of action." 49
B. As discussed above, during the proceeding, the Division introduced an affidavit of Jerrold Hinton, president of ADGI, asserting that ADGI never authorized the issuance of stock to RSI. 50 Respondents now seek to probe Hinton's assertions by deposing Hinton and obtaining subpoenas for documents from ADGI's attorney and transfer agent. Respondents state that they "expect" that notes of a meeting between ADGI and RSI's investment banking consultant, Karlton Zamost, are in ADGI's records.
Respondents have challenged Hinton's affidavit on a variety of grounds both before the law judge and on appeal to us. They were free to obtain the testimony of Hinton, ADGI's counsel, and/or ADGI's transfer agent during the hearing before the law judge but did not do so. Respondents called Zamost, who testified about his meetings with ADGI. 51 Moreover, they tendered evidence with respect to American Diversified Medical Corporation's issuance of stock to Russo in 1993. 52 It was Respondents' "obligation 'to marshall all the evidence in [their] defense.'" 53 Respondents have failed to demonstrate either that their proposed deposition and document subpoenas would produce material evidence or that there was some reasonable basis for their failure to obtain this evidence before the hearing and adduce it before the law judge. We do not believe that they should be permitted at this late date to search for evidence that they "expect" to find.
C. Respondents seek to introduce an unspecified motion that they represent was filed in January 2000 in an unrelated proceeding, SEC v. Cassano, 99 Civ. 3822 (S.D.N.Y). They assert that this filing "will set forth a pattern of gross misconduct" by the Division with respect to RSI. Respondents have not demonstrated the materiality of the Cassano filing to the instant matter. We have already considered and rejected Respondents' arguments alleging that this proceeding constitutes a "vendetta" and selective prosecution.
D. After oral argument, Respondents offered three documents to demonstrate that the BestSellers Board authorized issuance of stock to RSI in December 1995. One of the documents, a December 1995 letter from Patrick Russo to Hinton, was previously admitted. The remaining two documents are a letter dated May 12, 1997, and an affidavit dated December 1, 2000, both signed by Irving Rill, who states that, before and during 1996, he was BestSellers' majority shareholder.
Respondents do not explain why Rill's submissions were not tendered at the hearing. Moreover, his submissions are not material. In his affidavit, Rill states, "I can say for certain that the Board resolved the distribution of the company's stock to Russo" and thatBestSellers' president was charged with obtaining a corporate resolution. He states that he does not have a copy of the resolution. The record demonstrates that the BestSellers' board did not sign that resolution until March 25, 1996, and the stock was issued thereafter.
Under Exchange Act Section 15(b)(4)(D), the Commission may censure, place limitations on, suspend, or revoke the registration of any broker-dealer that has willfully violated the federal securities laws or regulations, when such sanction is in the public interest. 54 Exchange Act Section 15(b)(6) authorizes the Commission to censure, place limitations on, suspend, or bar a person associated with a broker-dealer, when such sanction is in the public interest and, for example, the person has willfully aided and abetted a violation of the federal securities laws or regulations. 55
Exchange Act Section 21B authorizes the Commission to impose a money penalty in any proceeding instituted pursuant to Exchange Act Section 15(b) when such penalty is in the public interest. 56 Exchange Act Section 21C authorizes the Commission to issue a cease-and-desist order when a person has violated, or has been a cause of the violation of, the federal securities laws or regulations. 57
Respondents challenge the sanctions imposed as "malicious," "destructive," and "unprecedented." 58 Respondents also contend that no customers were harmed by their conduct, and that other cases have imposed lesser sanctions for similar conduct.
The proper sanctions to be imposed in this case depend on its particular facts and circumstances, and cannot be determined by comparison with the action taken in other cases. 59 The relationship of remedy to policy is "peculiarly a matter for administrative competence." 60 Under the circumstances presented, we find that Respondents' conduct evinces a deliberate or reckless disregard of the net capital rule and related requirements.
In December 1993, the NYSE found, among other things, that RSI maintained inadequate net capital and filed inaccurate reports, including FOCUS reports. The NYSE censured and fined RSI and ordered RSI to employ a FINOP. 61 RSI employed Kent as its FINOP.
Kent took the position at RSI with the knowledge that RSI previously had engaged in these violations. 62 Given her knowledge, Kent should have been particularly careful in her oversight of RSI's compliance with the net capital rule. Instead, on four separate occasions between December 1995 and March 1996, RSI violated, and Kent aided and abetted RSI's violations of, the net capital and related rule provisions. She did not verify the existence of assets that she reported to the NYSE and to us as a substantial portion of RSI's assets and without which RSI was in net capital violation. She ignored, among other things, the facts that the ADGI stock was never issued and that the BestSellers stock, which was to have been issued upon execution of the January 1996 agreement, had not issued two months after that agreement had been signed. Kent also misled regulators when they questioned her about these securities, representing to the NYSE staff that RSI would receive the securities within 30 days and telling our staff that the stock was "in transit." She thus gave the false impression that RSI was in net capital compliance.
The net capital rule's requirements are essential to protect investors. 63 RSI's inclusion of unauthorized, unissued, and unregistered stock in its net capital placed customers at great risk.64 Whether any customers were harmed by this conduct is immaterial. 65 Without the stock, RSI failed to satisfy its minimum $100,000 net capital requirement. On three of the four dates in question, RSI had a negative net capital, 66 and RSI previously engaged in similar violations. Respondents have provided no assurances against future violations. Nor have they recognized the wrongfulness of their conduct. 67
For the foregoing reasons, we believe that it is in the public interest to suspend Kent for a year. We further order RSI and Kent to cease and desist from future violations of the net capital rule and related recordkeeping, reporting, and notice requirements. In light of our finding that Respondents' conduct involved a deliberate or reckless disregard of a regulatory requirement, we impose on RSI a $75,000 civil money penalty and on Kent a $25,000 civil money penalty.
An appropriate order will issue. 68
By the Commission (Acting Chairman UNGER and Commissioners HUNT and CAREY).
Jonathan G. Katz
UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 44186 / April 17, 2001
Admin. Proc. File No. 3-9484
In the Matter of
RUSSO SECURITIES, INC.
ORDER IMPOSING SANCTIONS
On the basis of the Commission's opinion issued this day, it is
ORDERED that Kimberly Kent be, and she hereby is, suspended for one year from association with a broker-dealer or a member of a national securities exchange or of a registered securities association, effective at the opening of business ten business days from the date of this order; and it is further
ORDERED that Russo Securities, Inc. and Kimberly Kent cease and desist from committing or causing any violations or future violations of Sections 15(c)(3) and 17(a)(1) of the Securities Exchange Act of 1934 and Exchange Act Rules 15c3-1, 17a-3, 17a-5, and 17a-11; and it is further
ORDERED that Russo Securities, Inc. pay a civil money penalty of $75,000 and Kimberly Kent pay a civil money penalty of $25,000.
The payment of the civil money penalties shall be: (i) made by United States postal money order, certified check, bank cashier's check, or bank money order; (ii) made payable to the Securities and Exchange Commission; (iii) delivered by hand or courier to the Comptroller, Securities and Exchange Commission, 450 5th Street, N.W., Washington, D.C. 20549 within thirty days of the date of this order; and (iv) submitted under cover letter which identifies the respondents and the file number of this proceeding. A copy of this cover letter and check shall be sent to John J. O'Donnell, Counsel for the Division of Enforcement, Securities and Exchange Commission, Northeast Regional Office, 7 World Trade Center, New York, New York 10048.
By the Commission.
Jonathan G. Katz
1 Russo Securities, Inc., Patrick Russo, and Kimberly Kent, Initial Decision No. 136, 69 SEC Docket 803 (Mar. 2, 1999).
Patrick Russo, who was RSI's president and chief executive officer and a respondent in these proceedings, died during the pendency of this appeal. By order dated October 4, 2000, the proceedings were discontinued as to Russo.
2 17 C.F.R. §240.15c3-1.
3 See 17 C.F.R. §240.17a-3.
4 See 17 C.F.R. §240.17a-11.
5 The law judge found Patrick Russo liable for aiding and abetting RSI's violations. The law judge barred Russo from association with a broker-dealer or a member of a national securities exchange or of a registered securities association with the right to reapply after two years; imposed on Russo a civil money penalty of $25,000; and ordered Russo to cease and desist from future similar violations. In view of the October 4 Order discontinuing proceedings as to Russo, the Commission will not impose any sanctions against him.
6 RSI's minimum net capital was $100,000 because the firm was a "broker . . . that effect[ed] more than ten transactions in any one calendar year for its own investment account." 17 C.F.R. §240.15c3-1(a)(2)(iii)(B).
7 Because December 31, 1995, was a Sunday, RSI's FOCUS report for the period ended December 31, 1995 reflected its position as of the close of business on Friday, December 29, 1995.
8 The ADGI contract also required ADGI to register the stock with the Commission.
9 RSI argues that Zamost's testimony was corroborated by a board resolution of an entity called American Diversified Medical Corporation. The resolution, dated December 27, 1993, purported to authorize the issuance of 1.2 million shares of stock to RSI and "First Equity Capital Corporation." The law judge found that the resolution predated the ADGI agreement by two years, was not a resolution of ADGI's board, and authorized issuance of a lesser number of shares than were included in RSI's net capital. The law judge excluded the resolution from the record, and RSI has not challenged that ruling. Pursuant to Rule of Practice 460, we have not considered this evidence on appeal. See 17 C.F.R. §201.460(c).
10 Credibility determinations by the fact finder are entitled to considerable weight, and can be overcome only where the record contains "substantial evidence" for doing so. Anthony Tricarico, 51 S.E.C. 457, 460 (1993). The asserted infirmities in Hinton's affidavit provide no basis for disregarding the law judge's credibility determination. Although RSI has asked us for leave to adduce additional evidence to rebut Hinton's affidavit, RSI has not demonstrated reasonable grounds for its failure to produce such evidence previously, as required by Rule of Practice 452. 17 C.F.R. §201.452.
11 The law judge did not credit Zamost's testimony that the BestSellers stock was properly authorized at a meeting in 1995. The law judge found that RSI offered no corroborating evidence of such a meeting, and produced no resolution or other documentary evidence authorizing the issuance of the disputed BestSellers stock.
12 The BestSellers stock was issued to RSI under the exemption from registration provided in Section 504 of Regulation D of the Securities Act of 1933, 17 C.F.R. §230.504.
13 The Commission's staff conducted an examination of RSI in March 1996 before RSI's FOCUS report for the period ending March 31, 1996, was due. The staff asked Patrick Russo and Kent to calculate RSI's net capital as of March 22, 1996.
14 Both the Semicon and ADGI agreements required the stock to be registered pursuant to Form S-8 so as to be freely tradeable.
15 The law judge found that a Semicon board resolution approving issuance of the options and underlying stock to RSI on March 29, 1996, undermined Zamost's testimony that the Semicon board authorized the options and stock on March 6, 1996.
16 Ferdinand Russo, RSI's vice president and Patrick Russo's brother, testified that on March 20, 1996, RSI exercised its options to purchase the 525,000 Semicon shares. The record shows, however, that RSI did not exercise the Semicon options until April 3, 1996, and did not own the underlying stock until April 11, 1996.
Ferdinand Russo claimed that, on March 20, 1996, he drafted an options exercise form and Kent sent the request via facsimile transmission to RSI's clearing firm, Murphey, Marseilles, Smith & Nammack ("MMSN"). John Derrico, MMSN's president and an RSI consultant, testified that the original fax was received, but that his office took no action on the request. Derrico further testified that, before MMSN processed an options request, it required a copy of the relevant consulting agreement and an opinion letter from the issuer's counsel stating that the underlying stock was able to be freely traded. MMSN received Semicon's opinion of counsel letter on April 3, 1996. That same day, MMSN, acting on RSI's behalf, wired to Semicon the funds to purchase the 525,000 Semicon shares.
17 FundCLEAR, Inc., 51 S.E.C. 1316, 1319 (1994).
18 17 C.F.R. §240.15c3-1(c)(2)(iv). "[I]t makes no difference that the securities may have substantial intrinsic value if they cannot be converted readily into cash." Lowell H. Listrom, 50 S.E.C. 883, 886 n.4 (1992), aff'd, 975 F.2d 866 (8th Cir. 1992) (Table), citing Walter Capital Corporation, 50 S.E.C. 176, 178 (1989) ("[S]ecurities [in a firm's inventory] must be valued at the prices they will command in an immediate sale into the inter-dealer market, not on the amount a brokerage firm might obtain for them if it had time to dispose of its inventory by selling it gradually to retail customers.").
19 FundCLEAR, Inc., 51 S.E.C. at 1319.
20 BestSellers is a Delaware corporation. ADGI and Semicon are Nevada corporations. In the absence of Nevada statutory or case law on point, we may refer to Delaware case law. Hilton Hotels Corp. v. ITT Corp., 978 F. Supp. 1342, 1346 (D. Nev. 1997).
21 The Brandner Corp. v. Stelnick, 1996 Del. Ch. LEXIS 20, at *23 (Del. Ch. Feb. 22, 1996); see also Nev. Rev. Stat. §78.211 (before board of directors authorizes issuance of shares, it must determine the adequacy of the consideration received for the shares).
RSI argues that, at the time the Semicon agreement was executed, Semicon's president, who signed the agreement, was also Semicon's sole director. Thus, according to RSI, Semicon's president had the authority both to enter into the agreement and to authorize the issuance of the stock and options to RSI. However, Semicon's bylaws required that the Semicon board have at least three directors in order to act. Semicon did not elect two new directors until March 29, 1996. Consequently, there were not enough directors to approve such action.
22 See Field v. Carlisle Corp., 68 A.2d 817, 820 (Del. Ch. 1949) (directors of a Delaware corporation may not delegate their statutory duty to determine the value of property acquired as consideration for the issuance of stock).
23 We reject RSI's argument that board authorization on those dates was unnecessary because the boards of each issuer subsequently executed and then ratified the contracts. Neither execution nor ratification of the contracts establishes thatthe stock due to RSI was duly authorized and issued to RSI at the relevant times.
We also reject RSI's argument that it should be given the benefit of hindsight. Although RSI eventually received the BestSellers and Semicon stock, the ADGI stock was never issued to RSI. In any event, the liquidity of an asset is determined as of the date of the net capital computation, and not at a subsequent point in time. See Don D. Anderson & Co., 43 S.E.C. 989, 991 (1968) (rejecting "self-serving ex-post-facto" statement as proof that an asset was convertible into cash on the date of the net capital computation), aff'd, 423 F.2d 813 (10th Cir. 1970); Melvin Y. Zucker, 46 S.E.C. 731, 732 (1976) (same).
24 17 C.F.R. §240.15c3-1(c)(2)(vii).
25 17 C.F.R. §240.15c3-1(c)(11).
26 For the same reason, there could be no market for RSI's interests in the contracts themselves. RSI suggests, without citation to any authority, that "the ready market test on its face applies to the market for the underlying stock, which is not in question in this case." Even if there were a "ready market" for outstanding shares of the three issuers -- a matter we do not decide -- it does not follow that a "ready market" existed for the shares due to RSI.
27 Cf. Melvin Y. Zucker, 46 S.E.C. at 732 ("a bank's willingness to lend money on an illiquid security does not transform that security into a readily convertible asset for net capital purposes.").
28 RSI also contends, based on the NASD Guide to Rule Interpretations, that physical possession of securities is not required in determining value for net capital purposes. This contention, however, has no relevance here because the disputed stock was neither issued nor authorized for issuance when it was included in RSI's net capital.
29 The net capital rule permits broker-dealers to include in net capital "open contractual commitments," less applicable "haircuts" (i.e., deductions) attributable to the value of each long and short position "contemplated by any open contractual commitment," plus any unrealized profit from the commitment. 17 C.F.R. §240.15c3-1(c)(2)(viii). The term "contractual commitment" includes "when issued, when distributed and delayed delivery contracts." 17 C.F.R. §240.15c3-1(c)(4).
30 NYSE Glossary, at p.30 (1987). Although RSI argues that the NYSE Glossary is not legal authority, it has not offered a contrary definition of the term. Based on our expertise as theagency charged with overseeing the securities markets, we believe that the NYSE Glossary's definition of "when issued" stock is a proper one. See also Barron's Dictionary of Finance and Investment Terms 653 (4th ed. 1995) (referring to the term "when issued" stock as a short form of "when, as, and if issued"; and stating that the term "refers to a transaction made conditionally because a security, although authorized, has not yet been issued").
31 RSI cites to various provisions of the net capital rule and to an NYSE rule to argue that securities "expected to be issued and/or received in the future" are properly included in net capital. None of the cited provisions, however, supports RSI's treatment of the disputed stock as good capital. For example, the net capital rule allows broker-dealers to include in net capital "failed to receive" securities. See 17 C.F.R. §240.15c3-1(c)(2)(iv)(E) (providing 30-day window for "failed to receive" securities). A "fail to receive" occurs when a buying broker-dealer has not taken delivery from the selling broker-dealer as of the settlement date. Net Capital Requirements for Brokers and Dealers, Exchange Act Rel. No. 18737 (May 13, 1982), 25 SEC Docket 468, 477 n.38. The disputed stock is not analogous to a "fail" because, as of the date RSI included it in net capital, the stock had not been authorized, issued, or even registered with the Commission.
NYSE Rule 440B, on which RSI also relies, is equally unhelpful. NYSE Rule 440B concerns short sales. The definition of "ownership" contained in the rule interpretation is for determining who is a short or long seller under NYSE Rule 440B. It has no bearing on the determination of what is an allowable asset for net capital purposes.
32 Don B. Anderson & Co., 43 S.E.C. at 991.
33 15 U.S.C. §78q(a).
34 FundCLEAR, Inc., 51 S.E.C. at 1318 n.7.
35 17 C.F.R. §240.17a-3.
36 17 C.F.R. §240.17a-5(a).
37 17 C.F.R. §240.17a-11(b).
38 17 C.F.R. §240.17a-11(d).
40 See Graham v. SEC, 222 F.3d 994, 1000 (D.C. Cir. 2000); Donald T. Sheldon, 51 S.E.C. 59, 66 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995).
41 The Commission and staff have considered the meaning of the term "in transit" in various contexts, and have construed the term to mean property which has been transmitted and the receipt of which is imminent. For interpretations of the physical possession requirement under Exchange Act Rule 15c3-3, the customer protection rule, see NASD Manual, at 8213 (1999) (Commission staff interpretation providing that property "in transit" is deemed to be under the broker-dealer's physical control if it is in fact received within five days). For interpretations of bank deposits in transit, see Vincent Musso, 48 S.E.C. 1, 3 (1984) ("a deposit in transit normally reflects a bank deposit that has been made but has not yet appeared on the company's most recent bank statement"), and NASD Guide to Rule Interpretations (1996), at 11 (reporting a Commission staff interpretation that a "broker-dealer that, as part of its normal business practice, promptly mails deposits to its bank may include such deposits in transit as allowable assets in its computation of net capital."). In this case, these securities were hardly "in transit" -- not only had they not been mailed to RSI, they were not issued or even authorized for issuance to RSI.
42 See 15 U.S.C. §78u-3. Our finding that Kent willfully aided and abetted RSI's violations necessarily makes her a "cause" of those violations. Richard D. Chema, Exchange Act Rel. No. 40719 (Nov. 30, 1998), 68 SEC Docket 2017, 2027; see Dominick & Dominick, Inc., 50 S.E.C. 571, 578 & n.11 (1991).
43 423 F.2d 813 (10th Cir. 1970).
44 Id. at 816.
45 Id. Relying primarily on Upton v. SEC, 75 F.3d 92 (2d Cir. 1996), Respondents contend that disallowance of the stock in RSI's net capital represents a substantial change in Commission enforcement policy that was not reasonably communicated to the public, and that the Commission should have engaged in rule-making before bringing this proceeding. Respondents have not shown any change in Commission net capital requirements of which they had no notice. Nor have they pointed to any authority requiring the Commission to specify in the net capital rule every conceivable asset that a broker-dealer may not treat as allowable.
46 Oyler v. Boles, 368 U.S. 448, 456 (1962).
47 Michael Markowski, 51 S.E.C. 553, 559 n.23 (1993), aff'd, 34 F.3d 99 (2d Cir. 1994); Kim G. Girdner, 50 S.E.C. 221, 226-27 (1990).
48 17 C.F.R. §201.452.
49 David T. Fleischman, 43 S.E.C. 518, 522 (1967), quoted with approval in Sidney C. Eng, Exchange Act Rel. No. 40297 (Aug. 3, 1998), 67 SEC Docket 2175, 2185.
50 See text accompanying n.9 supra.
52 See n.9 supra.
53 Laurie Jones Canady, Exchange Act Rel. No. 41713 (Aug. 6, 1999) (motion for reconsideration), 70 SEC Docket 905, 909, quoting Ronald Earl Smits, 50 S.E.C. 1020, 1024 (1992).
54 15 U.S.C. §78o(b)(4)(D). In determining the public interest, we consider the egregiousness of Respondents' conduct, the isolated or recurrent nature of the infractions, the degree of scienter involved, the sincerity of Respondents' assurances against future violations, Respondents' recognition of the wrongful nature of their conduct, and the likelihood that Respondents' occupations will present opportunities for future violations. Donald T. Sheldon, 51 S.E.C. at 86.
55 15 U.S.C. §78o(b)(6). Exchange Act Section 19(h) authorizes the Commission to suspend or expel from membership any member of a national securities exchange or registered securities association, and to suspend or bar any person from association with any such member. 15 U.S.C. §78s(h).
56 15 U.S.C. §78u-2. Section 21B provides that, in determining the public interest, we may consider whether the violation involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement; the harm to others resulting from the violation; the extent of the violator's unjust enrichment; the violator's disciplinary history, and the need for deterrence. Id.
Section 21B also specifies a three-tier system for assessing the amount of the penalty: (1) the first tier provides for a maximum of $5,000 for an individual and $50,000 for a firm; (2) the second tier provides for a maximum of $50,000 for anindividual and $250,000 for a firm if the conduct involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement; and (3) the third tier provides for a maximum of $100,000 for an individual and $500,000 for a firm if the conduct (a) involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement, and (b) resulted in, or created a significant risk of, substantial loss to others or resulted in substantial pecuniary gain to the violator. Id.
57 15 U.S.C. §78u-3.
58 To the extent that RSI claims the money penalty is designed to put RSI out of business, Respondents have not produced any evidence to support that claim, nor have they otherwise indicated, as provided in Exchange Act Section 21B, 15 U.S.C. §78u-2, a financial inability to pay the money penalties. Rule of Practice 410(c) provides that any demonstration of inability to pay should have been filed with Respondents' initial brief. 17 C.F.R. §201.410(c). Respondents have failed to do so.
To the extent, moreover, that RSI claims the sanctions are too severe in comparison to those imposed on larger firms, RSI has produced no evidence of disparate treatment between small and large broker-dealers. See Dillon Securities, Inc., 51 S.E.C. 142, 151 (1992).
59 Butz v. Glover Livestock Co., 411 U.S. 182, 187 (1973).
60 Id. at 185, quoting American Power Co. v. SEC, 329 U.S. 90, 112 (1946).
61 Thereafter, in September 1994, the State of Massachusetts sanctioned RSI for making factual misrepresentations in an application for broker-dealer registration. Each of these sanctions resulted from settlements in which RSI neither admitted nor denied liability. In reviewing an individual's disciplinary history, we routinely consider orders in both settled and litigated proceedings. La Jolla Capital Corp., Exchange Act Rel. No. 41755 (Aug. 18, 1999), 70 SEC Docket 1101, 1113 n.31.
62 Compare John A. Chepak, Exchange Act Rel. No. 42356 (Jan. 24, 2000), 71 SEC Docket 1429 (upholding NASD disciplinary action finding compliance director who assumed position with knowledge of firm's prior misconduct should have exercised special vigilance in his oversight).
63 See Blaise D'Antoni & Assocs. v. SEC, 289 F.2d 276, 277 (5th Cir.) ("The net capital rule is one of the most important weapons in the Commission's arsenal to protect investors. By limiting the ratio of a broker's indebtedness to his capital, the rule operates to assure confidence and safety to the investing public."), cert. denied, 368 U.S. 899 (1961).
64 See William H. Gerhauser, Exchange Act Rel. No. 40639 (Nov. 4, 1998), 68 SEC Docket 1289, 1304 ("[b]y engaging in business when the firm was not in compliance with net capital requirements, the firm and [its FINOP] subjected the firm's customers to undue risks").
65 Blaise D'Antoni & Assocs., 289 F.2d at 277.
66 Contrary to Respondents' suggestion, a culpable intent is not required in order to find that a wrongdoer acted willfully. Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000); see SEC v. Great Lakes Equities Co., 1990 U.S. Dist. LEXIS 19819, at *55, Fed. Sec. L. Rep. para. 95,685 (E.D. Mich. 1990).
67 On April 28, 1998, the second day of the hearing before the law judge in this matter, the NYSE notified RSI that it deemed RSI to be in net capital deficiency. Less than four months later, on August 4, 1998, the NYSE again notified RSI that it had a net capital deficiency. The NYSE instructed RSI to stop doing customer and firm business until its capital deficiency was resolved, and requested that RSI seek Commission approval to liquidate its firm positions.
Contrary to Respondents' contention, the law judge did not make any finding that RSI violated the net capital rule in 1998, nor do we. Rather, the law judge merely restated the substance of two letters admitted into evidence and dated April 29 and August 4, 1998, respectively. The letters, which were written on RSI letterhead and signed by Kent, notified the Commission, pursuant to Exchange Act Rule 17a-11, that the NYSE had found RSI to be in net capital deficiency.
68 We have considered all of the parties' contentions. We have rejected or sustained these contentions to the extent that they are inconsistent or in accord with the views we express in this opinion.
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