SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 39296 / November 4, 1997 Admin. Proc. file No. 3-9067 _______________________________________________________ : In the Matter of the Application of : : EXCEL FINANCIAL, INC. : 185 South State Street : Suite 850 : Salt Lake City, Utah : : and : : GARY R. BEYNON : 2838 East 4215 South : Salt Lake City, Utah : : and : : ROBERT L. SPERRY : 2842 E. Brookburn Road : Salt Lake City, Utah : : 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 Violation of Rules of Fair Practice Sale of Unregistered Securities Misleading Advertisements Member firm of registered securities association and firm's president and vice president accepted funds from nonaccredited investors in an escrow account before the distribution of required information. They thereby sold unregistered securities in violation of the Securities Act. Applicants solicited investors using a misleading advertisement. Held, association's findings of violations and sanctions it imposed are sustained. APPEARANCES: James G. Swensen, Jr., for applicants. Alden S. Adkins and Susan L. Beesley, for NASD Regulation, Inc. Appeal Filed: August 28, 1996 Last brief filed: December 30, 1996 I. Excel Financial, Inc. ("Excel" or the "Firm"), a member of the National Association of Securities Dealers, Inc. ("NASD"), Gary R. Beynon, then vice president of the Firm, and Robert L. Sperry, then a half-owner and president of the Firm (collectively, "Applicants"), <(1)> appeal from NASD disciplinary action. The NASD found that, during the period September 11, 1993, to October 20, 1993, Applicants sold unregistered securities to investors in violation of Section 5 of the Securities Act of 1933 ("Securities Act"), and thereby violated Article III, Section 1 of the Rules of Fair Practice ("NASD Rules"). <(2)> The NASD also found that Applicants had prepared and distributed misleading sales literature (a summary of the offering) in violation of Article III, Sections 1 and 35 of the NASD Rules. <(3)> The NASD censured Applicants and imposed a joint and several fine of $10,000. The NASD also ordered Applicants jointly and severally to disgorge $9,348, subject to adjustment. <(4)> For a period of 270 days, Excel was ordered to pre-file its advertising and sales literature with the NASD's Advertising Department and obtain a "no <(1)> Currently, Beynon is the Firm's owner and president, and Sperry is a registered representative. <(2)> The NASD has renumbered its Rules of Fair Practice; no substantive changes were made to the particular rules at issue here. Section 1 of the NASD Rules [new Rule 2110] requires the observance of "high standards of commercial honor and just and equitable principles of trade." <(3)> Article III, Section 35 of the NASD Rules [new Rule 2210] sets forth the general advertising standards for sales literature applicable for all member communications with customers or the public. <(4)> Because the NASD could not determine from the record if certain investors had made their investment after receipt of the private placement memorandum for this offering, the NASD permitted a reduction in the disgorgement amount for any payments made by nonaccredited investors after October 20, 1993, the date of the private placement memorandum. ======END OF PAGE 2====== objection" response prior to its use. <(5)> Our findings are based on an independent review of the record. II. Excel was the selling agent for an offering that sought to raise funds in connection with the purchase of an office building. <(6)> The building had been constructed in 1982 with the proceeds of a tax-exempt industrial revenue bond ("Bond"), which had been issued by Salt Lake City and purchased by Aetna Casualty and Surety Co. The owner of the building defaulted on payments due Aetna under the Bond. Aetna acquired the building. In early 1993, Aetna entered into negotiations to sell both the building and the Bond. On October 19, 1993, an agreement was reached among Aetna, Zions First National Bank, Inc. ("Zions"), an entity called 185 South State, Inc. ("185"), 185 Bond Participation LC (the "Company"), and 185 Bond Investors LC ("Investors"). <(7)> Under the agreement, 185 would purchase the building from Aetna and assume the payment obligations under the Bond. Zions would purchase the Bond from Aetna. Company and Investors would each acquire a "Certificate of Participation" in the Bond of approximately $2,000,000 and $1,500,000 respectively. Company planned to finance the acquisition of its Certificate of Participation by issuing and selling participation interests. Beginning on September 11, 1993, before the details of the offering were finalized, Applicants sent at least 57 of their customers a two-page information summary describing the anticipated offering and related transactions. The summary stated that Company was negotiating to acquire an interest in "a tax-exempt industrial revenue bond." The summary reported that "Company's proposed acquisition of the participation in the Bond is expected to yield approximately 10.45% per annum on a tax-exempt basis," although the term of the Bond could be extended for up to six months "at a taxable rate of 13.5% per annum." The participation interest would be "subordinate to an approximately $3,525,000 senior interest in the Bond." The summary noted that the terms of the Company's acquisition had not been finalized. The summary did not mention certain other risks of the investment or that the investment was speculative and could involve a high degree of risk. For example, 185 had no other assets; the tax status of the transactions was uncertain; and the property had not been generating sufficient income to service its then-existing debt. <(5)> The NASD also assessed costs against Applicants in the amount of $1,633.90. <(6)> Excel is an introducing broker-dealer with four registered representatives, each with between 40 and 50 clients. <(7)> Company and Investors were formed specifically to participate in the transactions contemplated under the agreement. ======END OF PAGE 3====== The summary invited customers to deposit funds into a bank escrow account. The summary included instructions, forms, and an "Escrow Agreement" to forward funds to an escrow agent. The Escrow Agreement provided that depositors retained the right to withdraw escrowed funds until the closing. It further specified that the funds would not be released to the Company unless a completed and signed subscription agreement was delivered to the escrow agent by October 31, 1993. If the depositor did not execute and deliver a subscription agreement by that date, the funds would be returned to the depositor. The subscription agreement form was included with Company's private placement memorandum. The private placement memorandum, dated October 20, 1993, provided greater disclosure regarding the final terms and the risks associated with the purchase of the office building and the Bond. Excel would receive a commission of 3.8% of the selling price. Beynon and Sperry would be managers of Company. Excel would also receive a 19% equity interest in 185. Zions, which intended to purchase the Bond, would require Sperry and Beynon to provide personal guarantees in connection with the transactions. The purchasers of the participation interests would receive an undivided interest in the Company's Certificate of Participation. Purchasers would have no interest in the Company or the building and only an indirect or derivative interest in the Bond. <(8)> The first $1,067,000 of the offering would be offered on an "all-or-none" basis, with the remaining $1,067,000 on a "best efforts" basis. Many customers deposited funds with the escrow agent before October 20, 1993. These customers had received the summary and the escrow agreement, but not the private placement memorandum. Approximately $1.8 million was deposited with the escrow agent prior to the issuance of the private placement memorandum. The deposits made prior to October 20, 1993 accounted for approximately 90% of the total proceeds raised in the offering. After the customers received the private placement memorandum, only two of the customers withdrew funds previously deposited in the escrow account. Applicants submitted executed subscription agreements to the escrow agent on October 29, 1993. On November 3, 1993, the transactions closed, and the escrowed funds were disbursed. Applicants filed a Form D with us on November 12, 1993, claiming an exemption from registration under Regulation D and Section 4(6) of the Securities Act. <(9)> The Form D reported that 43 accredited <(8)> The private placement memorandum also set forth certain risk factors relating to the speculative nature of the investment; the possibility of adverse tax determinations; the fluctuation of real estate values; and the limited liquidity of restricted securities. <(9)> 17 C.F.R. 230.501, et seq. The Form D was filed under Rules 505, 506, and Section 4(6) of the Securities Act. Section 4(6) exempts from Section 5 certain transactions with accredited investors. ======END OF PAGE 4====== investors <(10)> purchased $1,860,000 of the offering and that 13 nonaccredited investors purchased $246,000. The NASD determined that, when the customers deposited funds in the escrow account prior to the release of the private placement memorandum, the "psychological reality" was that "sales" of securities occurred. The NASD recognized that Rule 505 of Regulation D could exempt the sales to the 43 accredited investors from the Securities Act registration requirements. <(11)> Under Rule 502(b)(2)(i)(A), however, Company was required to provide the nonaccredited investors with the same kind of information that would appear in a registration statement. The NASD found that the summary, which was the only written information available to these customers before October 20, 1993, did not provide the information contemplated by Rule 502(b). The NASD thus concluded that the sales to the nonaccredited investors did not qualify for exemption under Rule 505 and violated Section 5 of the Securities Act. The NASD also found that the summary failed adequately to disclose the risks of the offering, contained misleading statements and omitted material facts about the offering, and projected a rate of return without disclosure of the related uncertainties. The NASD concluded that Applicants, in preparing and distributing the summary, violated Article III, Sections 1 and 35 of the NASD Rules. III. The securities at issue here were unregistered. Thus, their sale was in violation of Section 5 unless an exemption <(10)> The term "accredited investor" is defined in Rule 501(a) of Regulation D. 17 C.F.R. 230.501(a). See also Section 2(15)(ii) of the Securities Act authorizing the Commission further to prescribe qualifications of an accredited investor by rules and regulations. <(11)> Rule 505 provides an exemption from registration where: the total offering price is at or below $5 million; there are 35 or fewer nonaccredited investors; and, with respect to any nonaccredited investors, the disclosure requirements of Rule 502(b) are met. The NASD noted that Applicants did not attempt to establish that the sales were exempt pursuant to any other exemption from registration. Rather, Applicants argued that no "sales" occurred prior to October 20, 1993, the date of the private placement memorandum, and that, after that date, all of the transactions met the requirements of Regulation D. ======END OF PAGE 5====== was available. Applicants assert that they complied with Rule 505. <(12)> There is no allegation that the private placement memorandum provided inadequate disclosure with respect to the offering. The summary, however, did not provide adequate disclosure about the terms and risks of the transactions. Thus, with respect to the non-accredited investors, <(13)> whether Applicants complied with Rule 505's information requirements depends on when the "sale" of these securities occurred. <(14)> Applicants assert that their solicitation of customers before the customers received the private placement memorandum and the customers' deposit of funds made payable to the escrow agent into the escrow account did not constitute a "sale" of a security in violation of Section 5 of the Securities Act. Applicants assert that "sales" did not occur until after October 20, 1993 (after customers had received the private placement memorandum), when they completed and returned the subscription agreement. Applicants also claim that, prior to October 20, 1993, no security existed because there was no agreement with respect to either the terms of the transactions or the participation interests. They argue that the terms of the escrow agreement -- automatic return of funds to the customer if the escrow agent did not receive a signed subscription agreement or other further instruction from the customer on or before a fixed date -- delayed the sale until after October 20 (at which time the customer had adequate information). In their view, the Escrow Agreement ensured that depositors retained control over their funds until they took subsequent action. This Commission has indicated that the solicitation and acceptance of funds in anticipation of a securities offering raise concerns that a sale of a security has occurred for purposes of the Securities Act. <(15)> <(12)> Persons claiming exemption must identify and establish it. SEC v. Ralston Purina Co., 346 U.S. 119, 126 (1953). See also New Allied Development Corp., Securities Exchange Act Rel. No. 37990 (Nov. 26, 1996), 63 SEC Docket 807, 809 n.25 and cases cited therein. <(13)> Regulation D does not specify the type of information that must be disclosed to accredited investors. Rule 502(b)(1). <(14)> In this regard, Applicants note that our Interpretive Release on Regulation D recognized that the delivery of required disclosure could occur in two or more installments. Securities Act Rel. No. 6455 (Mar. 3, 1983), 27 SEC Docket 561 (Questions 40, 41). <(15)> We have addressed situations where securities in a public offering were sold before a registration statement became effective (see, e.g., First Heritage Investment Co., 51 S.E.C. 953 (1994); Van Alstyne, Noel (continued...) ======END OF PAGE 6====== In addition, in a series of Securities Act releases, we have stated that, if funds are received in the course of an offering, a "sale" has occurred for purposes of Section 5 of the Securities Act. We have stated, with respect to public offerings, that a broker-dealer may not receive payment for a security during the "waiting period" between the filing date of a registration statement and its effective date. <(16)> We also have explained that it is a violation of Section 5 for a broker-dealer to insist on any form of prepayment, by way of deposit or otherwise, while a security is in registration. <(17)> In that connection, we explained that, even if the funds were separately escrowed, the "significance of independent investment decision making would inevitably be diminished." <(18)> As noted, Applicants argue that the escrowed funds would be returned to the customer if the customer did not tender an executed subscription agreement and thus there could be no "sale" until that occurred. We have directly rejected this argument. [I]ndications of interest may be taken, but . . . the acceptance of purchase price payments, deposits, or purchase commitments violates Section 5 . . . whether or not the payment or deposit is placed in escrow, whether or not it is refundable at the option <(15)>(...continued) & Co., 22 S.E.C. 176 (1946)); where money was collected but a registration never became effective (see, e.g., Daniel J. Breslin, 44 S.E.C. 596 (1971); Financial Equity Corp., 41 S.E.C. 997 (1964)); and where no registration statement was filed and the qualifications for an exemption were not met (see, e.g., V.F. Minton Securities, Inc., 51 S.E.C. 346 (1993), aff'd, 18 F.3d 937 (5th Cir. 1994) (Table); New Allied Development Corp., Securities Exchange Act Release No. 37990 (Nov. 26, 1996), 63 SEC Docket 807. <(16)> See Offers and Sales of Securities By Underwriters and Dealers, Securities Act Rel. No. 4697 (May 28, 1964). <(17)> Securities Act Rel. No. 5071 (June 29, 1970). Cf. Whiteside & Co., 46 S.E.C. 452 (1976), aff'd, 557 F.2d 1118 (5th Cir. 1977) (re Rule 15c3-3 special reserve accounts, when customers tendered checks, they parted with their money and petitioners' acceptance of those prepayments created liabilities to those customers). <(18)> Securities Act Rel. No. 5071. The Release emphasized that the independent affirmative investment commitment that must be made by each purchaser would be "thwarted by arrangements under which monies are deposited . . . in advance of effectiveness" placing a burden on the purchaser to secure a return of his or her funds. ======END OF PAGE 7====== of the prospective purchaser, whether or not such refund may be obtained upon request, [and] whether or not a refund will be made in the absence of notification . . . . <(19)> While the releases referred to above deal specifically with registered offerings, their interpretation of "sale" for pur-poses of Section 5 is applicable to any offering. Where an investor parts with funds, a sale has occurred for Section 5 purposes. <(20)> By depositing the funds, the investor is essentially committed to the investment decision and the transaction has occurred. We draw no distinction for this purpose on the basis of whether the security at issue is registered or exempt from registration. For all these reasons, we agree with the NASD. The deposit by the 13 nonaccredited customers of funds into the escrow account in anticipation of the transaction constituted a "sale" for Section 5 purposes, and that sale was not exempt under Regulation D. Applicants thereby violated Article III, Section 1 of the NASD Rules. IV. The NASD also held that the summary violated the standards of Article III, Section 35 of the NASD Rules for sales literature <(21)> and <(19)> See Advertising and Sales Practices in Connection with Offers and Sales of Securities Involving Condominium Units and Other Units in Real Estate Developments, Securities Act Release No. 5382 (April 9, 1973). <(20)> Applicants assert that our analysis in First Heritage Investment Company, 51 S.E.C. 953, 958 (1994), applies only to public offerings. In First Heritage, the customers were permitted to withdraw funds from their accounts at the clearing broker-dealer until the purchase of securities in a registered offering was confirmed. We concluded that by requesting and receiving a check for the purchase before the effectiveness of the registration statement of an anticipated security, a "sale" occurred. We quoted Securities Act Rel. No. 5071, supra n.17, explaining that the Securities Act contemplated an independent affirmative commitment to purchase by the investor after receipt of required material information, a purpose thwarted by the premature deposit of funds, even if those funds are separately escrowed. We believe that this analysis applies equally in a registered offering or a private placement. <(21)> Article III, Section 35(a)(2) of the NASD Rules defines "sales literature" very broadly as "any written (continued...) ======END OF PAGE 8====== that the Firm violated Article III, Section 1 of the Rules by distributing the summary. The NASD found that the summary set forth selling points attractive to investors (the tax-exempt nature of the investment and "expected yields"). The summary did not, however, explain the offering's contingent and speculative nature, including the possibility of an adverse tax ruling, the lack of liquidity in the securities, and the potential fluctuations of real estate values. <(22)> The NASD concluded that the summary's affirmative representations were misleading, as they were not balanced with a presentation of the risks. <(23)> The NASD also found that the summary contained misleading statements about the offering, especially its tax-exempt nature, and the derivative nature of the interests investors would receive. The summary omitted to disclose material facts (for example, that the building was not generating sufficient income to service the Bond and that Sperry and Beynon had a potential conflict of interest because they would receive <(21)>(...continued) communication distributed or generally made available to customers or the public." Article III, Section 35(d)(1) sets forth the general standards applicable to communications with the public. <(22)> The summary was captioned with a statement that it was not "an offer to sell or solicitation of an offer to purchase any interest of participation. Offers and sales will be made only pursuant to the delivery of a private placement memorandum." The NASD found, however, that the summary's solicitation of a signature and request for funds indicated an offering, despite the caption. The NASD also concluded that the cautionary heading violated Article III, Section 35(d)(2)(G)'s prohibition against the use of "hedge clauses" or caveats that conflict with the purpose or object of the communication -- the selling points. Applicants contend that use of the "hedge clause" was proper because it simply referred to the fact that a private placement memorandum was forthcoming and that an investment decision should not be made until then. In its brief to the Commission, the NASD characterized this violation as "relatively minor." We do not view this violation as necessary to support the sanctions. <(23)> Article III, Section 35(d)(1)(B) prohibits "[e]xaggerated, unwarranted or misleading statements or claims" and cautions members to bear in mind the investment risks. ======END OF PAGE 9====== a 19% equity interest in 185), <(24)> and failed to disclose the uncertainties with respect to representations concerning the projected rate of return. Applicants do not dispute that the summary standing alone was not adequate disclosure on which to consummate a sale. They argue that the summary should be viewed in conjunction with the private placement memorandum, and that the combined disclosure should be evaluated by the factors set forth in Article III, Section 35. <(25)> They argue that the summary was accurate at the time it was prepared, and that the missing information identified by the NASD was not known until the transaction was finalized. We agree with the NASD that use of the summary violated Article III, Sections 1 and 35. By soliciting funds and the deposit of funds in an escrow, the document constituted an offer to sell rather than a preliminary description intended to elicit only indications of interest. Thus, the overall context of the summary was to promote an investment. The summary, however, did not contain a balanced statement of the benefits of the investment and its risks. The fact that some of the intended audience were accredited investors did not excuse its failure to provide disclosure that was not misleading. V. Applicants challenge the NASD's sanctions generally, contending that no sales occurred until after October 20. They further claim that, since there were no sales prior to that <(24)> Article III, Section 35(d)(1)(A) provides in part that "[n]o material fact or qualification may be omitted if the omission, in light of the context to the material presented, would cause the advertising or sales literature to be misleading." <(25)> Article III, Section 35(d)(1)(D) sets forth factors by which to judge sales literature. One factor is the overall context of the communication. The NASD has stated, "An essential test in this regard is the balance of treatment of risks and potential benefits." A second consideration in Article III, Section 35(d)(1)(D) is the audience for the communication. The NASD notes that different levels of explanation or detail may be necessary depending on the audience to which a communication is directed. Under this section, the NASD also considers the overall clarity of the communication. ======END OF PAGE 10====== date, no commissions were earned that are subject to disgorgement. <(26)> As discussed above, we have rejected that argument. Applicants also challenge the fine. The NASD imposed a $10,000 fine for both the registration and advertising violations. The NASD accepted Applicants' assertion that they had not committed the registration violation in bad faith, noting that they appeared to have acted upon the advice of their attorney. Although it imposed the $10,000 fine for the two violations, the NASD stated that it viewed the advertising violation with "great seriousness" and concluded that the fine would have been justified by the advertising violation standing alone. This view appears to have been based on the NASD's finding that, in March 1993, NASD staff counseled Applicants about various sales literature problems discovered in the preceding year's compliance examination. The NASD viewed this compliance conference as evidencing "prior or similar" sales literature misconduct, which could be considered an aggravating factor. The National Business Conduct Committee concluded, based on the District Business Conduct Committee ("District Committee") hearing transcript, that the District Committee had determined to admit evidence of the compliance conference for the limited purpose of determining sanctions. The record, however, does not reflect that the staff's views in that conference resulted in any charges or actions, or that Applicants agreed with those views. The record further reflects that Applicants did not acquiesce in the District Committee's ruling and asked that they be permitted to respond to the use of information concerning the compliance conference if sanctions became an issue. Applicants were not given that opportunity. We thus do not believe that the compliance conference constituted aggravating evidence of "prior similar misconduct" under the Sanction Guidelines. We nonetheless conclude that the fine here is neither excessive nor oppressive. We view both the registration and advertising violations sustained here as serious. The fine was imposed for both violations and is <(26)> The National Business Conduct Committee ("National Committee") reversed the District Business Conduct Committee's ("District Committee's") finding that sales to the 43 accredited investors also were in violation of Section 5. The National Committee reduced the resulting disgorgement amount from $72,427 to $9,348, reflecting the commissions Applicants earned on the sales to the 13 nonaccredited investors. The disgorgement amount equaled 3.8% commissions on the $246,000 in sales of the participation interests to nonaccredited investors. The National Committee further eliminated, as unwarranted, the District Committee's 90-day suspension of the Firm from the use of any advertising and sales literature. ======END OF PAGE 11====== well within the amounts suggested in the NASD Sanction Guidelines for either violation standing alone. <(27)> Applicants further contend that the NASD requirement that for 270 days they pre-file all advertising and sales literature with the NASD's Advertising Department and obtain a "no objection" response is overly broad. The provision of Article III, Section 35(c)(4)(A) of the NASD Rules provides that this sanction can be imposed if the member deviated from the standards of that rule and there is reasonable likelihood that it will do so again. Under the circumstances presented here, we do not view this requirement as excessive or oppressive. An appropriate order will issue. <(28)> By the Commission (Chairman LEVITT, Commissioners, JOHNSON AND HUNT.) Jonathan G. Katz Secretary <(27)> The NASD Sanction Guidelines (1993) specify, for an inadvertent sales literature violation, a $2,500 to $10,000 monetary sanction, but $10,000 to $25,000 for intentional or recklessly misleading literature. The Guidelines also permit suspending a firm's right to issue any sales literature or requiring the firm to obtain a NASD staff "no objection" letter to any proposed sales literature. The Guidelines suggest a $2,500 to $50,000 fine, plus the amount of any commissions, for sales of unregistered securities. A bar or suspension may be appropriate for knowing or reckless conduct. <(28)> All of the arguments advanced by the parties have been considered. They are rejected or sustained to the extent that they are inconsistent or in accord with the views expressed in this opinion. ======END OF PAGE 12====== UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. 39296 / November 4, 1997 Admin. Proc. File No. 3-9067 _______________________________________________________ : In the Matter of the Application of : : EXCEL FINANCIAL, INC. : 185 South State Street : Suite 850 : Salt Lake City, Utah : : and : : GARY R. BEYNON : 2838 East 4215 South : Salt Lake City, Utah : : and : : ROBERT L. SPERRY : 2842 E. Brookburn Road : Salt Lake City, Utah : : For Review of Disciplinary Action Taken by the : : NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. : _______________________________________________________: ORDER SUSTAINING DISCIPLINARY ACTION TAKEN BY REGISTERED SECURITIES ASSOCIATION On the basis of the Commission's opinion issued this day, it is ORDERED that the findings of violation made and sanctions imposed by the National Association of Securities Dealers, Inc. against Excel Financial, Inc., Gary R. Beynon, and Robert L. Sperry, and the Association's assessment of costs, be, and they hereby are, sustained. By the Commission. Jonathan G. Katz Secretary