SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40000 / May 18, 1998 Admin. Proc. File No. 3-9339 ____________________________________________________ : In the Matter of the Application of : : JOHN P. GOLDSWORTHY : 1820 Hickory Avenue, Apt. B : Harahan, LA 70123 : : 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 Alleged Violation of Rules of Fair Practice Failure to Inform Employer of Private Securities Transactions Former general securities representative associated with member firm of registered securities association allegedly engaged in private securities transactions without prior written notification to member. Held, association's findings of violation and the sanctions it imposed are vacated and this matter is remanded. APPEARANCES: John P. Goldsworthy, pro se. Alden S. Adkins and Norman Sue, Jr., for NASD Regulation, Inc. Appeal filed: June 20, 1997 Last brief received: October 31, 1997 ======END OF PAGE 1====== I. John P. Goldsworthy, formerly a registered general securities representative associated with U.S. Securities Clearing Corporation ("USSCC" or the "Firm"), a member of the National Association of Securities Dealers, Inc. ("NASD"), appeals from NASD disciplinary action. The NASD found that, during the period from April through December 1993, Goldsworthy engaged in private securities transactions without providing prior written notice to USSCC, in violation of Article III, Sections 1 and 40 of the NASD Rules of Fair Practice ("NASD Rules"). <(1)> The NASD censured Goldsworthy, barred him from association with any NASD member in any capacity, fined him $50,000, assessed costs, and ordered restitution to Smith Barney Shearson, Inc. ("Smith Barney") in the amount of $499,744. To the extent that we make findings in this opinion, we base them on an independent review of the record. II. In 1993, a registered representative at Smith Barney Shearson, Inc. ("Smith Barney") sold demand notes issued by SCF, Inc. ("SCF") to ten of his customers for a total of $499,744. Goldsworthy, the president of SCF, signed each of the eighteen demand notes at issue and served as the signatory for an account that SCF maintained at Smith Barney. All but one of the notes is included in the record, and an NASD investigator testified that the terms of all of the notes were substantially identical. The most significant terms of the notes were as follows: (1) the noteholders were to be paid ten percent interest per year until the notes were repaid in full; (2) if written demand for repayment of a note was made by a noteholder, SCF would pay the aggregate outstanding principal and all accrued and unpaid interest within sixty days of demand; and (3) <(1)>/ The NASD recently revised and renumbered its Rules of Practice. Section 1 of the Rules [new Rule 2110] requires the observance of "high standards of commercial honor and just and equitable principles of trade." Section 40 [new Rule 3040] provides, among other things, that, prior to participating in any securities transaction outside the regular course or scope of his or her employment, a person associated with a member firm must give that firm prior written notification. In addition, if the firm is notified that the associated person may receive selling compensation, it is required to issue written approval or disapproval. The complaint in this matter charged Goldsworthy with violations of Sections 1 and 40 as a result of engaging "in private securities transactions without prior written notice to and approval from his employer . . . ." While there can be circumstances in which conduct that is not securities- related violates Section 1, this case was pled and tried as a case involving private securities transactions. ======END OF PAGE 2====== SCF could prepay the note in whole or in part without premium or penalty. Each note stated on its face that the proceeds would be used to fund certain start-up costs in connection with the formation of an investment advisory firm and a mutual fund and that "[u]nder no circumstances shall this promissory note be deemed to grant to lender any option to purchase shares of any mutual fund, it being understood that the form of repayment thereof shall be at the option of Borrower." Goldsworthy admitted before the NASD's District Business Conduct Committee that the transactions at issue involved considerable risks for the noteholders. Goldsworthy acknowledged that, given SCF's financial situation, if one or more of the noteholders demanded repayment prior to the time the mutual fund was operational and the investment adviser was earning fees, "the entire situation would collapse." This risk was not disclosed to the noteholders. When several of the noteholders demanded repayment, neither SCF nor Goldsworthy tendered repayment. <(1)> Goldsworthy subsequently was indicted by Louisiana criminal authorities for his role in SCF's default, pled guilty to attempted theft and to the sale of unregistered securities, and was sentenced in late 1995 to six months incarceration, which was suspended, and two years inactive probation, and was fined $10,000. III. Article III, Section 40 prohibits an associated person of a member firm from participating "in any manner" in a private transaction in securities without prior written notice to that person's employer. As we have stated previously, "the reach of Section 40 is very broad. It covers an associated person who not only makes a sale but who participates `in any manner' in the transaction." <(1)> Goldsworthy contests the application of this rule to his conduct here. Goldsworthy contends, among other things, that he did not violate Article III, Section 40 because the promissory notes at issue were not securities. In Reves v. Ernst & Young, 494 U.S. 56 (1990), the Supreme Court considered the issue of when a note is a security within the meaning of Section 3(a)(10) of the Securities Exchange Act of 1934. The Supreme Court adopted the "family resemblance" test for determining when a note is a security. <(1)> Under that test, a note is presumed to be a security unless (1) an examination of the note, based on four factors <(1)>/ Smith Barney, however, paid approximately $500,000, plus interest, to its customers that had signed the SCF demand notes. <(1)>/ Ronald J. Gogul and Christopher E. Peta, Securities Exchange Act Release No. 35824 (June 8, 1995), 59 SEC Docket 1444. <(1)>/ 494 U.S. at 64-65, 67. ======END OF PAGE 3====== described by the Court, reveals that the note bears a strong resemblance to certain types of notes recognized as being outside the investment market regulated under the securities laws <(1)> or (2) based upon the same four factors, the note should be added to the list. The four factors are: (1) the motivations that would prompt a reasonable borrower and lender to enter into the transaction; (2) the plan of distributing the notes; (3) the reasonable expectations of the investing public regarding whether the instruments were securities; and (4) the presence of any alternative scheme of regulation or other factor that significantly reduces the risk of the instrument so as to make regulation under the securities laws unnecessary. <(1)> The NASD recognized in its opinion in this matter that the SCF demand notes must be analyzed in accordance with Reves, and found that, "[u]nder the four prongs of the family resemblance test, the notes should not be added to the class of exempt notes." The NASD found that "purchasers bought the[ ] [notes] in order to earn a return based on a rate of interest; the notes were sold to members of the general public; and many customers thought they were purchasing a security -- shares in a mutual fund." However, the record before us includes little factual support for these findings; the "motivations" and "expectations" of the noteholders, and the "plan of distribution" of these notes are not clearly developed in this record. Because the Smith Barney registered representative who sold the notes committed suicide prior to the NASD hearing, his testimony could not be adduced. An unsigned letter from the Smith Barney representative that discusses the note sales was placed in the record with the explanation that the NASD received the letter from the representative's counsel shortly after the representative's death. This letter, which was dated after the representative's death, is not corroborated by other reliable, probative evidence in the record. An NASD investigator testified that, based on his conversations with noteholders, some of the noteholders thought that they were buying securities sponsored by Smith Barney when they purchased the SCF notes, and that some of these same noteholders believed that they were buying shares of a mutual fund. However, none of the noteholders testified in this matter, and no affidavits from noteholders were introduced. Although it appears from an exhibit in the record that the NASD had access <(1)>/ Id. at 65. The Supreme Court believed that the following notes are not securities: the note delivered in consumer financing; the note secured by a mortgage on a home; the short-term note secured by a lien on a small business or some of its assets; the note evidencing a character loan to a bank customer; a short-term note secured by an assignment of accounts receivable; the note that simply formalizes an open-account debt incurred in the ordinary course of business; and the note evidencing a loan by a commercial bank for current operations. <(1)>/ 494 U.S. at 66-67. ======END OF PAGE 4====== both to customer questionnaires compiled by the State of Louisiana Securities Department in connection with Goldsworthy's prosecution and to documentation of customer complaints, no noteholder complaint letters, questionnaires, account statements, or other relevant customer records were introduced. Moreover, the brief opposing Goldsworthy's appeal to us neither cites Reves nor analyzes whether the notes at issue are securities under Reves. Under these circumstances we presently are unable to discharge our review function. We have determined, consistent with Section 19(e)(1) of the Securities Exchange Act of 1934, that it is appropriate to remand this matter to the NASD to marshal evidence concerning the circumstances surrounding the sale of the notes from which the reasonable motivations and expectations of the noteholders, as well as the plan of distribution, may be discerned, to analyze that evidence, and to apply Reves to determine if the notes at issue are securities. An appropriate order will issue. By the Commission (Chairman LEVITT and Commissioners JOHNSON, HUNT, and UNGER); Commissioner CAREY not participating. Jonathan G. Katz Secretary ======END OF PAGE 5====== UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. Admin. Proc. File No. 3-9339 ____________________________________________________ : In the Matter of the Application of : : JOHN P. GOLDSWORTHY : 1820 Hickory Avenue, Apt. B : Harahan, LA 70123 : : For Review of Disciplinary Action Taken by the : : NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. : ____________________________________________________: ORDER VACATING DISCIPLINARY ACTION AND REMANDING THIS MATTER TO REGISTERED SECURITIES ASSOCIATION On the basis of the Commission's opinion issued this day, it is ORDERED that the disciplinary action taken by the National Association of Securities Dealers, Inc. against John P. Goldsworthy, be, and it hereby is, vacated and this matter is remanded for proceedings consistent with that opinion. By the Commission. Jonathan G. Katz Secretary ======END OF PAGE 6======