SECURITIES AND EXCHANGE COMMISSION
In the Matter of
DAVID E. LYNCH
OPINION OF THE COMMISSION
Grounds for Remedial Action
Failure to Disclose Excessive Markups
Charging Non-Bona Fide Prices of Securities
Aiding and Abetting Net Capital and Recordkeeping Violations
Respondent, an associated person and trader at a broker-dealer, engaged in a scheme to "park" securities with other dealers. He effected transactions at non-bona fide prices and charged undisclosed, excessive markups to the firm's customers. As a result of this scheme, the broker-dealer failed to maintain accurate books and records and incurred numerous net-capital deficiencies. Held, it is in the public interest that respondent be ordered to cease and desist from committing or causing any violations or future violations of Section 17(a) of the Securities Act of 1933, Sections 10(b), 15(c), and 17(a) of the Securities Exchange Act of 1934 and Exchange Act Rules 10b-5, 15c3-1, 17a-3, 17a-5, and 17a-11; be barred from association with any broker or dealer; and pay a third-tier civil money penalty in the amount of $100,000.
Teresa J. Verges, for the Division of Enforcement.
No appearance on appeal for David E. Lynch.
Appeal filed: December 5, 2001
Last brief received: January 22, 2002
The Division of Enforcement appeals the amount of the civil money penalty imposed by an administrative law judge on David E. Lynch, an associated person of First Montauk Securities ("First Montauk"), a registered broker-dealer. The law judge ordered Lynch to cease and desist from committing or causing any violations or future violations of Section 17(a) of the Securities Act of 1933,1 Sections 10(b),2 15(c),3 and 17(a)4 of the Securities Exchange Act of 1934 and Exchange Act Rules 10b-5,5 15c3-1,6 17a-3,7 17a-5,8 and 17a-11;9barred him from association with any broker or dealer; and ordered that he pay a second-tier civil money penalty in theamount of $50,000. We base our findings on an independent review of the record.
Lynch appeared and answered the order instituting this proceeding ("OIP"). At an April 23, 1998 prehearing conference, however, Lynch's counsel announced that Lynch would not attend or defend at the forthcoming hearing but would instead accept a default. At the hearing held on April 28-30, 1998, the Division presented a prima facie case against Lynch, introducing into evidence Lynch's investigative testimony, as well as other exhibits.10 Under Rule of Practice 155(a),11 the Commission may determine the proceeding against a defaulting party upon consideration of the record, which includes but is not limited to the OIP.12
Lynch was a trader associated with First Montauk in its Houston branch office. Lynch and another individual opened the Houston office to sell to institutional clients fixed-income products, primarily mortgage-backed securities known as collateralized mortgage obligations ("CMOs"). First Montauk granted the Houston branch office the authority to execute riskless principal transactions.13
First Montauk did not allow the Houston branch office to hold positions in securities unless the branch office received approval from the firm's president. The president rarely granted such permission. In order to circumvent First Montauk's restrictions on the branch office's holding security positions, Lynch engaged in a "parking" scheme14 that enabled the office to purchase bonds and secretly hold them "off the books," while still maintaining control of the securities.
From October 1992 through March 1994, the Houston branch office parked government agency securities on at least fifteen occasions. The Houston office would sell CMOs to a dealer. That dealer sold the CMOs to a second dealer for a small profit. The Houston branch office would repurchase from the second dealer, again at a small profit for the second dealer.
Each time Lynch executed a parking transaction, he reported the trades to First Montauk's principal in the main office. As a result of Lynch's actions, one or more of the order tickets written by the main office principal inaccurately depicted each of the parking transactions as two separate trades, preventing detection of Lynch's scheme.
On at least seven occasions, Lynch and others used the parking scheme to manipulate the prices of certain government agency securities and to charge undisclosed fraudulent markups to First Montauk customers. Lynch and others purchased bonds and sold them at a markup to a dealer. That dealer then marked up the securities another 1/32 or 2/32 and sold them to a second dealer. The second dealer marked up the securities another 2/32, and sold the securities back to First Montauk's Houston branchoffice. Lynch and others then marked up the securities an additional 4% to 5% and sold them to First Montauk's customers. First Montauk's customers paid undisclosed markups of between 8% and 20.6%. The markups in excess of 5% amounted to approximately $1.85 million. Lynch received compensation totalling $485,558 as a result of these markups.
Lynch dictated the prices on at least some of the parking transactions. The contra-dealers acquiesced in the price set by Lynch, resulting in fictitious, non-bona fide transactions that did not indicate or reflect the actual market value of those securities.
As a result of Lynch's scheme, First Montauk maintained inaccurate books and records that did not reflect the liabilities arising from Lynch's and others' commitments to repurchase the securities involved. The records contained incorrect valuations of the firm's positions.
Lynch knew that First Montauk did not have the net capital to hold the Houston branch office's positions in these securities. Properly recording these transactions on First Montauk's books and records would have adversely affected First Montauk's computation of net capital and, in some instances, resulted in undisclosed net capital deficiencies.15 Theparking scheme also caused First Montauk to file inaccurate Financial and Operational Combined Uniform Single ("FOCUS") Reports with the NASD as required by Exchange Act Rule 17a-5. The scheme caused First Montauk to fail to disclose to the Commission that the firm was in net capital violation on numerous occasions.
In March 1998, Lynch was convicted by a Florida court of two counts of engaging in a pattern of racketeering and one count of fraud. The criminal complaint charged that Lynch had committed fraud by arranging to sell and then repurchase CMOs at pre-arranged prices and then reselling the CMOs by means of untrue statements or omissions of material fact and at prices that were excessive and not determined by the market.
Lynch engaged in a scheme over an eighteen-month period that resulted in transactions being effected at non-bona fide prices. He charged First Montauk's customers undisclosed, excessive markups of over $1.85 million.16 He received more than $485,000 from these excessive markups. Lynch deceived both his employer and the marketplace by causing First Montauk's books and records to show incorrect valuations of the firm's liabilities and inaccurate net capital computations, resulting in the firm's failure to disclose net capital deficiencies. As we have previously recognized, "[p]arking stock to conceal a firm's true net capital position is serious misconduct."17 Lynch's conduct caused First Montauk to file inaccurate reports with the NASD, thereby giving regulators a false picture of the firm's net worth, and also misled First Montauk into not disclosing to the Commission its violations of the net capital requirements. He was criminally convicted as a result of certain of this conduct.
We find that Lynch willfully violated Securities Act Section 17(a), Exchange Act Section 10(b), and Rule 10b-5 thereunder. We further find that Lynch willfully aided and abetted violations of Exchange Act Sections 15(c) and 17(a) and Exchange Act Rules 15c3-1, 17a-3, 17a-5 and 17a-11.
Neither party appealed the sanctions imposed by the law judge, except for the amount of the civil penalty. Given the scope of the conduct engaged in by Lynch and the degree of his scienter, we find that it is in the public interest to bar Lynch from associating with any broker or dealer18 and to order him to cease and desist from committing or causing any violations or future violations of the above provisions.
Exchange Act Section 21B authorizes the Commission to impose a civil money penalty in any proceeding instituted pursuant to Exchange Act Section 15(b) when such penalty is inthe public interest.19 Once a public interest determination is made, Section 21B(b) establishes a three-tier system for assessing the amount of the penalty to be imposed.20 The first tier provides for a maximum of $5,000 for an individual for each act or omission.21 The second tier provides for a maximum of $50,000 for an individual for each act or omission if the conduct involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement.22 The third tier provides for a maximum of $100,000 for an individual foreach act or omission 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.23
As set forth in Section III above, we find that Lynch's conduct in parking and pricing the CMOs involved fraud, deceit, manipulation, and a deliberate or reckless disregard of the net capital and recordkeeping requirements.24 The law judge imposed a second-tier penalty, but refused the Division's request for a third-tier penalty, stating only that she "[did] not find such a sanction to be warranted in this case and instead" determined that it was "in the public interest that Lynch be ordered to pay the maximum second-tier civil money penalty of $50,000."
We find that Lynch's misconduct both caused substantial losses to First Montauk's customers and resulted in substantial pecuniary gain to himself. Lynch's prices defrauded First Montauk's customers of at least $1.85 million. Lynch received over $485,000, a substantial pecuniary gain as a result of his misconduct. We therefore find that it is in the public interest to impose on Lynch a third-tier civil penalty of $100,000.25
An appropriate order will issue.26
By the Commission (Chairman PITT and Commissioners GLASSMAN and GOLDSCHMID); Commissioners ATKINS and CAMPOS not participating.
Jonathan G. Katz
Admin. Proc. File No. 3-9440
In the Matter of
DAVID E. LYNCH
ORDER IMPOSING REMEDIAL SANCTIONS
On the basis of the Commission's opinion issued this day, it is
ORDERED that David E. Lynch cease and desist from committing or causing any violations or future violations of Section 17(a) of the Securities Act of 1933, Sections 10(b), 15(c), and 17(a) of the Securities Exchange Act of 1934, and Exchange Act Rules 10b-5, 15c3-1, 17a-3, 17a-5, and 17a-11; and it is further
ORDERED that David E. Lynch be, and he hereby is, barred from association with any broker or dealer; and it is further
ORDERED that David E. Lynch pay a civil money penalty in the amount of $100,000.
Payment of the civil penalty shall be made within 21 days of the issuance of this order. The civil penalty shall be (a) made by United States postal money order, certified check, bank cashier's check, or bank money order; (b) made payable to the Securities and Exchange Commission; (c) mailed or delivered by hand to the Comptroller, 6432 General Green Way, Alexandria, VA 22312; and (d) submitted under cover letter that identifies the particular respondent in these proceedings, as well as the Commission's administrative proceeding file number. A copy of this cover letter and money order or check shall be sent to Teresa J. Verges, Southeast Regional Office, Securities and Exchange Commission, 1401 Brickell Avenue, Suite 200, Miami, Florida 33131.
By the Commission.
Jonathan G. Katz
1 Section 17(a) of the Securities Act makes it unlawful for any person to:
"(1) to employ any device, scheme, or artifice to defraud, or
(2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or
(3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser. use or employ, in connection with the purchase or sale of any security.
15 U.S.C. § 77q(a).
2 Section 10(b) of the Exchange Act makes it unlawful for any person to "use or employ, in connection with the purchase or sale of any security . . ., any manipulative or deceptive device or contrivance in contravention of" the Commission's rules. 15 U.S.C. § 78j(b).
3 Among other things, Exchange Act Section 15(c) makes it illegal for a broker or dealer to effect any transactions ina security in contravention of the Commission's rules with respect to financial responsibility. 15 U.S.C. § 78o(c).
4 Exchange Act Section 17(a) requires every registered broker or dealer to keep certain records and file certain reports. 15 U.S.C. § 78q(a).
5 Rule 10b-5 makes it unlawful for any person to "employ any device, scheme, or artifice to defraud" or to "engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security." 17 C.F.R. § 240.10b-5.
6 Exchange Act Rule 15c3-1 specifies the net capital requirements for brokers and dealers. 17 C.F.R. § 240.15c3-1.
7 Exchange Act Rule 17a-3 requires brokers and dealers to create and maintain certain records, including brokerage orders and memoranda of the firm's trading activity. 17 C.F.R. § 240.17a-3.
8 As relevant here, Securities Exchange Act Rule 17a-5 requires every broker-dealer that neither clears transactions nor carries customer accounts to file FOCUS Reports with the National Association of Securities Dealers ("NASD") within specified time periods. 17 C.F.R. § 240.17a-5.
9 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. 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. Further, the broker or dealer must transmit a report to the Commission within 48 hours of the notice stating what it has done or is doing to correct the situation. 17 C.F.R. § 240.17a-11(b) and (d).
10 Notice of the Division's proposed exhibits was provided to Lynch on April 10, 1998.
11 17 C.F.R. § 201.155(a).
12 Under Rule 155(a), the allegations of the OIP may be deemed to be true.
Rule 155(a) does not limit the fact-finder in a default proceeding to only the specific allegations contained in the OIP. Rule 155(a) states that "the Commission or the hearing officer may determine the proceeding against [the defaulting] party upon consideration of the record, including the order instituting proceedings, the allegations of which may be deemed to be true . . . ." Thus, if additional evidence is adduced in a proceeding against a respondent, the decisionmaker properly should consider that evidence in the determination of the proceeding.
13 A riskless principal transaction occurs when a dealer receives from its customer an order to purchase (or sell) asecurity and purchases (or sells) that security to another person in a transaction that is proximate in time and designed to offset the customer's order. Strategic Resource Management, Inc., 52 S.E.C. 542, 544 n.8 (1995).
14 In a parking scheme, a person "sells" securities to a purchaser subject to an agreement or understanding that the seller will repurchase the securities at a later time at a price that leaves the economic risk with the seller. A parking scheme often involves an attempt to reduce the apparent amount of securities owned by the seller. Yoshikawa v. SEC, 192 F.3d 1209, 1212 (9th Cir. 1999); Securities Investor Protection Corp. v. Vigman, 74 F.3d 932, 933 n.3 (9th Cir. 1996).
15 First Montauk calculated its net capital position on a settlement date basis at the end of each month.
The following table summarizes First Montauk's undisclosed net capital deficiencies as a result of Lynch's parking scheme:
Net Capital Per
|April 1993||$ 533,000||$ (77,735)|
|May 1993||$ 818,000||$ 627,250|
|June 1993||$ 874,000||$ 431,646|
|July 1993||$ 677,000||$ 416,430|
|August 1993||$ 791,000||$ (49,484)|
|September 1993||$ 758,000||$ 465,873|
|October 1993||$ 627,000||$ (65,730)|
|November 1993||$ 538,000||$ (1,249,532)|
|December 1993||$ 557,000||$ (69,834)|
|January 1994||$ 634,000||$ 11,269|
|February 1994||$ 1,075,000||$ 477,160|
|March 1994||$ 1,035,000||$ 348,270|
16 The Division charged that the amount of the excessive markups was more than $1.85 million. Because Lynch defaulted, he has not contested the Division's calculation.
17 Mayer A. Amsel, 52 S.E.C. 761, 768 (1996).
18 See, e.g., Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd, 450 U.S. 91 (1981).
19 15 U.S.C. § 78u-2. Exchange Act Section 21B(c) directs the Commission to consider the following factors in considering whether a penalty is in the public interest:
(1) whether the act or omission for which such penalty is assessed involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement;
(2) the harm to other persons resulting either directly or indirectly from such act or omission;
(3) the extent to which any person was unjustly enriched, taking into account any restitution made to persons injured by such behavior;
(4) whether such person previously has been found by the Commission, another appropriate regulatory agency, or a self-regulatory organization to have violated the Federal securities laws, State securities laws, or the rules of a self-regulatory organization, has been enjoined by a court of competent jurisdiction from violations of such laws or rules, or has been convicted by a court of competent jurisdiction of violations of such laws or of any felony or misdemeanor described in 15 U.S.C. § 78o(b)(4)(B);
(5) the need to deter such person and other persons from committing such acts or omissions; and
(6) such other matters as justice may require.
15 U.S.C. § 78u-2(c).
20 15 U.S.C. § 78u-2(b).
21 15 U.S.C. § 78u-2(b)(1).
22 15 U.S.C. § 78u-2(b)(2).
23 15 U.S.C. § 78u-2(b)(3).
24 See text accompanying n.17 supra.
25 Even if we did not consider Lynch's gains on these transactions, a third-tier penalty is warranted since Section 21B(b)(3)(B) permits a third-tier penalty if Lynch's conduct resulted in a substantial loss to other persons. The substantial loss to others is established by the allegation in the OIP of excessive markups, which we deem to be true under Rule of Practice 155(a).
26 We have considered all of the contentions advanced by the Division. We have rejected or sustained them to the extent that they are inconsistent or in accord with the views expressed in this opinion.