SECURITIES AND EXCHANGE COMMISSION
In the Matter of the Application of
PAUL JOSEPH BENZ
For Review of Action Taken by
Former president and general securities principal of a former member firm of registered securities association was responsible for firm's failure to comply with net capital requirements. Held, the findings of violation and the sanctions imposed are sustained.
H. Thomas Fehn, of Fields, Fehn & Sherwin, for Paul Joseph Benz.
Marc Menchel, Alan B. Lawhead, and Gary J. Dernelle, for NASD.
Appeal filed: June 15, 2004
Last brief received: September 8, 2004
Paul Joseph Benz, formerly a general securities principal and the president of Beacon Trading, LLC ("Beacon" or "the Firm"), formerly an NASD firm, seeks review of NASD disciplinary action. NASD found that Benz violated NASD Rule 21101 by permitting Beacon to conduct a securities business when it did not meet its net capital requirement under Securities Exchange Act of 1934 Rule 15c3-1.2 As a result, NASD imposed on Benz a $5,000 fine, a thirty-day suspension from acting as a general securities principal, and a requirement that he requalify as a principal before serving in that capacity again.3 We base our findings on an independent review of the record.4
In June 1998, Benz and his brother, Christopher Benz,5 1394 formed Beacon, an introducing broker-dealer6 with a $5,000 net capital requirement. Beacon's customers included traditional retail clients and approximately 200 day traders. During the relevant time period, Benz served as president and his brother served as the Financial and Operations Principal of the Firm.
Beacon cleared its securities trades on a fully disclosed basis through its clearing broker,7 Computer Clearing Services ("CCS"). The clearing agreement between Beacon and CCS, dated October 30, 1998 (the "Clearing Agreement"), provided in relevant part that Beacon agreed to indemnify and hold CCS harmless in the event "any customer of [Beacon] fail[ed] to make payment for securities purchased."8
On October 10, 2000, Beacon established a margin account with CCS on behalf of its customer, Dan Rubin, doing business as Rubin Investment Group. Rubin indicated on the account forms that he completed that he was a self-employed investment banker with an annual income of $300,000 and a liquid net worth of $2 million.
The net capital violation at issue stems from Beacon's failure to recognize an approximate $5 million liability arising from Rubin's failure to pay CCS for securities he purchased through this margin account. Rubin made this securities purchase, an unsolicited order to purchase 999,000 shares of GlobalNet, Inc. ("GlobalNet") stock at $5.015 per share, at the end of the trading day on October 31, 2000. Because the trade occurred late in the trading day on October 31, CCS did not book the trade until November 1.
On November 2, 2000, CCS employees Steve Wooster and Brad Kaiser contacted Christopher Benz regarding their concern about Rubin's ability to pay for the GlobalNet trade given his stated income and net worth. Kaiser, associated with CCS as a general securities principal, testified before the hearing panel that Christopher Benz told him during the call that he knew Rubin personally, that Rubin's net worth was greater than what he disclosed on his account forms, and that Rubin had the ability to pay for the trade. Later that same day, CCS placed a second call to Beacon in which both Benz and Christopher Benz participated. During this call, Benz told CCS employees to use their discretion in deciding whether to accept or cancel the Rubin trade. CCS did not cancel the Rubin trade, and the trade settled on November 6, 2000. Kaiser testified that he relied on Christopher Benz's statements as well as information he received from Rubin's accountant in deciding that CCS should accept the trade.
CCS contacted Rubin and his accountant directly on several occasions to discuss payment for the GlobalNet trade. Benz was not involved in any of these discussions. On November 2 and November 8, 2000, Rubin wired to CCS two payments, each in the amount of $200,000, towards the GlobalNet purchase. Rubin failed to pay for the remainder of the purchase, leaving a debit balance of $4.6 million in his account.9
On December 19, 2000, NASD staff examiners contacted Benz by telephone to inform him that Beacon no longer met its minimum net capital requirement of $5,000 because of the unsecured debit balance in the Rubin account, and, as a result, Beacon was prohibited from conducting a securities business. Although Benz disagreed with NASD's determination that the Rubin account deficit should be considered in calculating Beacon's net capital, Benz nevertheless sought to halt Beacon's securities business after receiving the NASD call. He and other Beacon employees attempted to contact all of Beacon's traditional retail and day-trading customers by telephone, email, and facsimile to advise them that they should not effect any transactions except to liquidate positions in their accounts. Beacon's attempt to halt the business of its day-trading customers was difficult since these traders effected transactions directly through CCS using CCS' proprietary software on their home computers. Thus, despite Beacon's efforts to halt securities trading, three day traders effected a total of nineteen trades after NASD's December 19 notification.
Exchange Act Rule 15c3-1, the net capital rule, sets forth the net capital requirements for brokers and dealers. Exchange Act Section 15(c)(3) prohibits broker-dealers from effecting any securities transactions in contravention of the Commission's rules establishing, among other things, financial responsibility requirements, including the net capital rule.10 The purpose of the net capital rule is to ensure that a broker-dealer has sufficient liquidity to protect the assets of its customers and to be able to cover its indebtedness to other broker-dealers.11
Benz does not dispute that he did not include the Rubin account deficit in calculating Beacon's requisite net capital. Nor does he dispute that, had the deficit been included, the Firm would have sustained a net capital violation. Thus, whether Beacon had a net capital deficiency hinges on whether the Rubin account deficit should have been treated as Beacon's liability for purposes of its net capital computation.
Benz contends that Beacon was not required to consider the Rubin account deficit in calculating its net capital requirement. Instead, Benz contends that Beacon's liability to CCS for Rubin's failure to pay for the GlobalNet stock was abrogated when CCS, without Beacon's knowledge or consent, negotiated and allegedly agreed to payment terms with Rubin. Benz reasons that, as a result of CCS' unilateral actions, Rubin ceased to be a customer of Beacon and became exclusively a customer of CCS; Beacon was no longer responsible for indemnifying CCS for Rubin's failure to pay.
We reject Benz's contention and find that Beacon, under the express terms of its Clearing Agreement with CCS, was required to treat the Rubin account deficit as a liability in determining its net capital. The Clearing Agreement provided that Beacon would indemnify CCS for any Beacon customer's failure to pay for securities purchased, such as the Rubin purchase of GlobalNet stock. The discussions between CCS and Rubin did not alter this indemnification obligation. Any change in Beacon's liability to CCS for the Rubin trade required, pursuant to NASD Conduct Rule 3230(e), a written amendment to the Clearing Agreement be made and submitted to NASD for review and approval.12 As we have explained previously, NASD approval of amendments "to clearing agreements is important precisely because, among other things, the approval process ensures that any amendments effectively clarify net capital obligations."13 Here, no such amendment was submitted to NASD. Thus, we conclude that Beacon was required to deduct the Rubin account deficit in calculating the Firm's net capital. The effect of that deduction caused the Firm to have insufficient net capital.
Because Beacon customers effected securities transactions while the Firm had a net capital deficiency, the Firm operated a securities business in violation of Exchange Act Rule 15c3-1 and therefore engaged in conduct inconsistent with Conduct Rule 2110. Benz, as president of Beacon, was responsible for the Firm's violation. Benz had actual knowledge of the Firm's net capital insufficiency as a result of NASD's notification and was responsible for ensuring that the Firm complied with all regulatory requirements.14 We recognize, as did NASD, that Benz made a good faith effort to halt the trading of the Firm's customers, but violations of the net capital rule do not require a finding of scienter.15
We may reduce or cancel sanctions imposed by NASD if we find, having due regard for the public interest and the protection of investors, that the sanctions are excessive or oppressive or impose an unnecessary burden on competition.16 We do not make such a finding on this record.
The NASD Sanction Guidelines with respect to net capital violations provide for a fine of $1,000 to $50,000 and a suspension of up to 30 days or a lengthier suspension or bar in egregious cases.17 The Sanction Guidelines further provide that the principal consideration in determining sanctions is, among other factors, whether the firm continued in business while knowing of deficiencies or voluntarily ceased conducting business because of the deficiencies.18 NASD concluded that Benz acted in good faith to cease his securities business .and imposed sanctions near the low end of the Guidelines, a $5,000 fine and a 30-day suspension in a principal capacity. NASD further determined it was appropriate to require Benz to requalify as a principal in order to impress upon him the importance of complying with the net capital rule and of the obligations that a principal has for the Firm's compliance with NASD rules. We do not find these sanctions either excessive or oppressive.
An appropriate order will issue.19
By the Commission (Chairman DONALDSON and Commissioners CAMPOS and ATKINS); Commissioners GLASSMAN and GOLDSCHMID not participating.
Jonathan G. Katz
In the Matter of the Application of
PAUL JOSEPH BENZ
For Review of Action Taken by
On the basis of the Commission's opinion issued this day, it is
ORDERED that the disciplinary action taken by NASD against Paul Joseph Benz be, and NASD's assessment of costs, be, and they hereby are, sustained.
By the Commission.
Jonathan G. Katz
Conduct Rule 2110 requires the observance of high standards of commercial honor and just and equitable principles of trade. The Commission has found that a violation of the securities laws, including the net capital rule, is a violation of Conduct Rule 2110. See Gerhauser, 53 S.E.C. at 942-43.
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