SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40243 / July 22, 1998 Admin. Proc. File No. 3-9259 : In the Matter of the Application of : : DANIEL C. MONTANO : 245 Duranzo Aisle : Irvine, CA 92606 : : 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 Violations of Rules of Fair Practice Misleading Advertisements Improper and Unwarranted Forecasts and Recommendations Registered general securities principal made exaggerated and unwarranted statements and projections during television broadcast. Held, association's findings of violation are sustained in part and set aside in part and the matter remanded for reconsideration of sanctions. APPEARANCES: Daniel C. Montano, pro se. Alden S. Adkins and Jeffrey S. Davis, for NASD Regulation,Inc. Appeal filed:February 25, 1997 Last brief received: June 27, 1997 I. Daniel C. Montano, a registered general securities principal and president of Montano Securities Corporation ("MSC") [/] at the time of the events at issue in this proceeding, appeals from NASD disciplinary action. At issue are statements Montano made in recommending the short sale of a security during an appearance on a television broadcast. The NASD found that Montano violated former Article III, Sections 1 and 35 of the NASD Rules of Fair Practice ("NASD Rules") [/] by (1) failing to provide a sound basis for evaluating the facts underlying his recommendation; (2) referring improperly to the results of previous specific recommendations without disclosing certain information required by the NASD Rules; (3) making exaggerated and unwarranted claims and using unwarranted superlatives; (4) making improper comparisons by referring to previous specific recommendations and implying comparable future results for his current recommendation; and (5) making specific predictions and projections concerning future investment results. The NASD censured Montano, fined him $10,000, assessed costs, and required him to requalify as a general securities principal. We base our findings on an independent review of the record. [/] II. These proceedings resulted from an appearance by Montano on an October 18, 1993 television program entitled "The Undervalued Securities Report" that aired on a local business channel. Montano purchased three advertisements from the television station and thereby received editorial control of the program. The program was divided into three segments. Montano began by reminding viewers of three earlier "primary recommendations" that he had made to purchase what he characterized as "undervalued" securities. He stated that each of these "undervalued" securities had appreciated between 40 percent and 65 percent since his recommendation. Montano contrasted these previous recommendations to purchase "undervalued" securities with the recommendation that he intended to make in the current program, with respect to an "overvalued" stock. Montano then asserted generally that selling a stock "short" was a way to make a profitable investment in an overpriced stock that was likely to decline in value. Before he identified that stock, Montano claimed that "over the next 60 days to 6 months, you stand a chance of making between 40 and 50% on your money." Montano then made his only reference to the risks inherent in this strategy: "You have risks when you short a stock. You make money when a stock goes down. You lose money when a stock goes up." Montano's comments concerning risk were separated from his actual recommendation by a commercial break. After the commercial break, Montano recommended that his viewers sell short the stock of U.S. Drug Testing, Inc. ("USDT"). At the time of the broadcast, USDT was a development-stage company, designing technology to detect drug abuse. USDT's parent company owned 70 percent of its outstanding shares. Montano stated that he believed that USDT's stock was "grossly overvalued" and "so overvalued as to be nonrealistic." According to Montano, USDT's market capitalization at the time of $26 million was "nonrealistic" because USDT had no revenue, no sales, and according to its own prospectus, no products. Looking towards the future, Montano predicted: This company, I believe, if they are able to develop a product, and I'll give them that, . . . in the next 2 or 3 years, their sales may be $5 million in 3 years' time. And if it is $5 million, I think the company may be worth $2 1/2 million. Now you divide that by 5 million shares. That's 50 cents a share. Now who out there is going to buy a stock for 5 1/4 that's worth 50 cents a share? I don't believe that when the investors wake up, that they're going to hang on to this stock and I believe the stock is going to collapse. Montano then discussed what he described as the "mathematics" of short-selling USDT's stock. He computed the return to be received from selling short, through a margin account, 2000 shares of USDT stock at $5-1/4 per share. Because the investor would have to deposit at least 50 percent of the value of the underlying stock, Montano calculated that if USDT stock fell two "points" per share the investor could gain $4,000 on the "$10,000 you'd have at risk." Montano further asserted that investors who purchased USDT's stock in its initial public offering would "panic[] out of this stock" once they realized that there was "no company and no product that [was] going to support this kind of valuation." In his view, the catalyst for this sell-off would be USDT's quarterly report to be filed with this Commission two weeks after the broadcast. Montano concluded by reiterating that "[t]his thing is overvalued by 10 times what I think its worth," and "I wouldn't be shocked to see it at $2 in 60 days." Montano stated that USDT stock was "[t]he best sell I've seen this year. It's so overpriced, it's ridiculous . . . . Watch it. Make some money with us." The NASD found that Montano violated former Article III, Sections 1 and 35(d)(1)(A) and (d)(2)(B), (C), (M), and (N) of the NASD Rules. III. A. Former Article III, Section 35(d)(1)(A) of the NASD Rules requires that advertisements provide a sound basis to evaluate the recommendations made. The rule further provides that no material fact may be omitted if the omission would cause the advertising to be misleading in light of the context of the material presented. Former Article III, Section 35(d)(1)(C) applies the NASD's standards for advertisements to members and associates of members "[w]hen sponsoring or participating in a seminar, forum, radio or television interview, or when otherwise engaged in public appearances or speaking activities which may not constitute advertisements. . . ." The issue here is whether Montano provided viewers with a "sound basis for evaluating" his recommendation. Thus, we must consider whether Montano furnished sufficient information about both the security that was the subject of his recommendation -- USDT shares -- and the type of transaction that he suggested -- use of a short-sell trading strategy -- for viewers to determine the merits of his recommendations. With respect to USDT, the NASD claims that Montano did not provide viewers with all of the information necessary to evaluate the company. We disagree. Montano stated that he thought USDT was "overvalued" and made references to USDT's lack of revenues, sales, and a product line. In addition, he referred to the company's recent incorporation and described it as a "start-up." He also compared the price to then-current earnings and questioned why a company with "no sales and no product" should have a "valuation of $25 million." The NASD concluded that Montano should have disclosed certain additional information relating to USDT's status as a development-stage company that would have explained the lack of revenues. In addition, the NASD concluded that Montano should have explained that USDT engaged primarily in research and development, and that the company held certain patent sub- licenses and had applied for and received Food and Drug Administration marketing approval for certain aspects of its licensed material. We do not believe that these omissions caused Montano's statements to be misleading, in light of the context of the material presented. Montano made it clear that USDT was a new company that was attempting to develop a product. Indeed, Montano's projections for the company's future revenue assumed that USDT would be successful in bringing a product to market within two to three years. The NASD also suggested that Montano should have expounded upon USDT's relationship with its parent company. It is unclear from the record what information about this relationship the NASD believed was important and why any such omission was misleading. We wish to make clear that, in coming to this conclusion, we are not agreeing with Montano's argument that providing more information about USDT would in itself have been "fraudulent." Nothing we have said should be interpreted as suggesting that additional disclosure may not be required under other circumstances. We find only that Montano made adequate disclosure of USDT's attempts to develop a product and conclude that, in the context of the company's described status at the time, the omitted information did not render the communication misleading. We agree with the NASD, however, that Montano violated former Article III, Sections 35(d)(1)(A) and (d)(2)(M) of the NASD Rules in his discussion of the appropriateness and risks of short- selling. These NASD Rules provide that "an essential test" of whether a communication is misleading is whether the communication presents a balanced treatment of the risks and potential benefits of the recommendation. [/] Former Article III, Section 35(d)(2)(M) further requires proper disclosure of the material differences between investments that are being compared (in this case, Montano's prior recommendations to buy certain securities and the recommendation to short-sell USDT stock). The advertiser must explain "investment objectives, sales and management fees, liquidity, safety, . . . fluctuation of principal and/or return, tax features, and any other factors necessary to make such comparisons fair and not misleading." [/] We conclude that Montano did not accurately and sufficiently discuss the mechanism of short-selling or the risks associated with implementing this strategy using USDT stock. [/] To consummate a short sale, an investor sells a security that is borrowed (often from a firm that holds it in street name as security for a margin account) and replaces it later with a security bought on the open market. The short seller anticipates that the market price of the security will fall between the time of sale of the borrowed security and the date of purchase of the replacement security. [/] Montano began with a discussion of his strategy for holding securities for the long-term, whose success, he asserted, was evidenced by his three prior recommendations. The juxtaposition of this discussion with Montano's explanation of short-selling implied that the risks associated with the two strategies are similar. This impression was enhanced by Montano's reference to the risks involved in selling short: that one makes money when the stock price decreases and loses money when the stock price increases. An unsophisticated investor might interpret these observations as simply the converse of the risks associated with buying securities. In fact, the risks associated with short- selling can be significantly different. For example, an investor's potential loss in a security purchased in a long position is limited to the aggregate purchase price of the security. Although the risks of selling short vary depending on the strategy employed, the investor's potential loss in some circumstances is infinite, as the investor can be required to purchase the security to close out the short position at the then-current trading price of the stock. Moreover, a commercial break separated Montano's limited references to risk from his recommendation to sell USDT's stock short, thereby dissipating the impact of his already deficient risk description. Montano claims that he had a sound basis in fact for his recommendation to sell USDT stock short. Accepting Montano's assertion arguendo, it is not relevant to the charge here. The NASD did not charge Montano with violating former Article III, Section 35(d)(2)(B)(i), which requires a member to have a reasonable basis for the recommendation. Rather, it alleged that Montano had failed to provide viewers with a "sound basis for evaluating" that recommendation. B. Former Article III, Section 35(d)(2)(B) prohibits "[r]eference to the results of a previous specific recommendation . . . if the intent or the effect is to show the success of a past recommendation" unless the member discloses the date and nature of each recommendation, the price at the time of the recommendation, the price at which the recommendation was to be acted upon, and the general market conditions during the period at issue. [/] The NASD found that Montano improperly cited the results of his three previous recommendations with the intent and effect of showing the success of these prior selections, but without fully complying with the disclosure requirements. As the NASD determined, Montano failed to discuss the general market conditions that existed at the time that he had made his previous recommendations. C. Former Article III, Section 35(d)(2)(C) requires that "communications with the public must not contain promises of specific results, exaggerated or unwarranted claims or unwarranted superlatives, opinions for which there is no reasonable basis, or forecasts of future events which are unwarranted, or which are not clearly labeled as forecasts." The NASD found that Montano violated this section because his television broadcast promised specific results, made exaggerated claims, and used unwarranted superlatives. We agree. Montano's statements that "over the next 60 days to 6 months you stand a chance of making between 40 and 50% on your money" and "I think you're looking at, in 60 days to 6 months, this being a 2 to 3 dollar stock," are promises of specific results that violate this section of the NASD Rules. The fact that Montano couched these statements with "you stand a chance" and "I think" did not alleviate the impression that he promised specific results. [/] The overall effect of these statements was to imply that any investor could expect these returns. [/] This impression was exacerbated by Montano's use of phrases such as "so overvalued," "tremendous opportunity," "investor shock," and "so over-priced, it's ridiculous," that were designed to elicit strong emotion in the viewing public and "whet the appetite of the unsophisticated," and by his heated, emphatic delivery of these opinions. [/] While Montano may have strongly believed that USDT stock was overpriced and subject to an imminent price correction, the impression generated by his broadcast was that his predictions were certain to come true. [/] An unsophisticated investor might not be aware that other factors related to a company or the market as a whole could cause that company's stock price to increase even if negative news about it became public. D. Former Article III, Section 35(d)(2)(N) states that "[i]nvestment results cannot be predicted or projected." [/] We agree with the NASD that Montano violated this section. In addition to the price and investment return predictions previously discussed, Montano also made specific dollar projections based on his short-sell strategy: If you were to short 2000 shares of [USDT] stock at 5 1/4, you're shorting $10,500 in money. If you have a margin account and you can short this stock, you put up half that, which is roughly $5,250. In 60 days, if my prediction is correct and this stock is selling for 3 1/4 or lower, and I think the lower is the real number, you would make a 2 point profit on 2000 shares or $4,000 on the $10,000 you'd have at risk. So, in plain words, you could still make 40% if this stock only drops to 3 1/4. . . . This company is so overvalued, it's ridiculous. Montano attempts to characterize this projection as a mere hypothetical illustration of a short-sell trading strategy. Pursuant to former Article III, Section 35(d)(2)(N), "[h]ypothetical illustrations of mathematical principles are not considered projections of performance; e.g., illustrations designed to show the effects of dollar cost averaging, tax-free compounding, or the mechanics of variable annuity contracts or variable life policies." Montano's use of USDT's then-current stock price, coupled with his forecast of the stock's future performance, however, makes it clear that Montano was making a prediction in a manner prohibited by the NASD Rules. * * * * * Montano raises several points in his defense. He claims that many of his predictions about USDT were eventually borne out by subsequent developments. The representations made in the broadcast, however, must be judged against information available at the time and cannot be justified by subsequent events. In this regard, Montano seeks to introduce two new exhibits: a Schedule 13E3 filed on behalf of USDT and information about an individual who, allegedly, has been indicted for conduct related to USDT that violated federal securities laws. We exclude both exhibits pursuant to Commission Rule of Practice 452. A party seeking leave to introduce evidence pursuant to Rule 452 must show with particularity that such additional evidence is material and that there were reasonable grounds for the party's failure to adduce such evidence previously. Montano has failed to show good cause for not introducing the evidence prior to this appeal. In any event, this evidence deals with events that had not occurred at the time of the broadcast. We understand Montano to assert that these subsequent events were the result of events that Montano knew of at the time of his broadcast. The fact remains that Montano could not have known in 1993 how those events would evolve. The proffered evidence, moreover, is not material to many of the allegations here, including Montano's references to prior recommendations, his exaggerated and inappropriate presentation of both the prior recommendations and his recommendation concerning USDT, and his improper projections. We conclude that these subsequent developments are not material to our review. Montano also claims that he knew in advance of the broadcast that it was impossible to borrow shares of USDT and sell the stock short. During testimony Montano was asked why, if he wanted to publicize his concern about USDT, Montano would recommend a strategy that could not be implemented rather than simply advising viewers to not buy USDT stock. Montano responded that he had previously been sued for making negative statements about another company and so decided to couch his concerns in terms of a trading strategy. Be that as it may, a violation of the NASD Rules depends on the content of the advertisement or broadcast and does not hinge on whether any viewer could have acted on the information, or even whether any viewer actually saw the material. [/] Montano's belief that he was performing a public service by publicizing his concerns about USDT does not excuse the manner in which he presented his concerns. We also note that, by recommending a strategy that could not be implemented, Montano may have omitted a material fact from his recommendation that goes to the sound basis of the recommendation. Accordingly, we find that Montano violated Article III, Sections 1 and 35 of the NASD Rules of Fair Practice. [/] IV. In determining what sanction is in the public interest, the NASD properly considered a number of factors, including some outside the "four corners" of the broadcast itself. These factors included the absence of demonstrable harm or injury to the investing public from Montano's misconduct, Montano's apparent belief that USDT was overvalued, and his attempts to verify the information conveyed. [/] In addition, there was only one broadcast at issue, and Montano did not receive any earnings from the program. We agree with the NASD that, "[m]ore importantly, perhaps, . . . Montano's broadcast was not intentionally misleading." These mitigating factors, however, must be balanced against the importance of promoting balanced and fair advertising. We also note that Montano has been disciplined for previous misconduct by this Commission and two state regulators. [/] This Commission sanctioned Montano, pursuant to a consent order without his admitting or denying liability, for materially false and misleading statements disseminated in promotional materials prepared in connection with a private placement. Montano served as chairman of the board and chief executive officer of the company. [/] Because we have modified in part the NASD's findings, we remand this matter for reconsideration of sanctions. With respect to the NASD's determination that Montano should requalify as a general securities principal, we note that this sanction is not listed in the NASD Guidelines as an appropriate sanction for these violations. In fact, the NASD Guidelines do not recommend requalification for misleading advertisements even when the individual acted intentionally or recklessly. We recognize that the NASD Guidelines are neither exclusive nor mandatory, and that different sanctions may be appropriate in different situations. Accordingly, the NASD should explain why requalification is appropriate if, on remand, the NASD determines to impose this sanction. We do not intend to suggest any view as to the appropriateness of a particular outcome. An appropriate order will issue. [/] By the Commission (Chairman LEVITT and Commissioners JOHNSON and HUNT); Commissioners CAREY and UNGER not participating. Jonathan G. Katz Secretary **FOOTNOTES** [/]:/MSC was a member firm of the NASD from December 1984 through February 1995. The District Business Conduct Committee censured MSC, and MSC did not appeal. See January 23, 1997 Order. [/]:/These provisions have been recodified as Conduct Rules 2110 and 2210, respectively. [/]:/In addition to transcripts, exhibits, and pleadings, we reviewed a videotape of Montano's television broadcast in the record. [/]:/Article III, Section 35(d)(1)(D) (describing relevant factors in judging whether a communication or particular element of a communication is "misleading"). [/]:/Compare G.J. Mitchell, Jr., Co., 40 S.E.C. 409, 413 (1960) (advertisement did not properly explain material differences between securities being offered and other securities used in comparison). [/]:/See Sheen Financial Resources, Inc., Securities Exchange Act Rel. No. 35477 (March 13, 1995) 58 SEC Docket 2791, 2798 (advertisement must discuss risks associated with specific investment recommended); Jay Michael Fertman, 51 S.E.C. 943, 950 (1994) (advertisement must contain balanced disclosure or risks and rewards of touted investment); compare Jesse Rosenblum, 47 S.E.C. 1065, 1069 (1984) (positive aspects of hiring respondent emphasized to such degree that they"completely overshadowed" pro forma disclaimers). [/]:/Randolph K. Pace, 51 S.E.C. 361, 365, n. 19 (1993). [/]:/These requirements are contained in former Article III, Section 35(d)(2)(B)(iii). [/]:/Compare Sheen Financial Resources, Inc., 58 SEC Docket at 2795 n. 11, 2799(statements in advertisement that "investors can double their income and that one may earn up to 15 percent a year and reduce taxes by $8,250" are promises of future performance) (emphasis added). [/]:/Id. [/]:/Marketline, Inc. v. S.E.C., 384 F.2d 264, 266 (2d Cir. 1967), cert. denied, 390 U.S. 947 (1968) (applying Investment Advisors Act of 1940). [/]:/Compare Id. (investment advisor's advertisements may be judged based on their impact on the population segment at which they were aimed). [/]:/In its opinion and briefs to this Commission, the NASD incorrectly identifies this section as former Article III, Section 35(d)(1)(N). The complaint, however, charges Montano with violating Section 35(d)(2)(N). Our review of the record indicates that the parties understood what subsection and what alleged conduct was at issue. We therefore conclude that Montano was properly on notice of the correct subsection. [/]:/See Robert A. Grunburg, Exchange Act Rel. No. 36182 (September 1, 1995), 60 SEC Docket 430 (finding violation of the NASD Rules even though no connection between the advertisements and any sales). [/]:/See Steven B. Theys, 51 S.E.C. 473, 480 (1993) ("the NASD may properly find . . . violations of these, or any other sections of the [NASD] Rules, to be inconsistent with just and equitable principles of trade, in contravention of Article III, Section 1 thereof."). [/]:/Many of these factors are enumerated by the NASD in the "Principal Considerations in Determining Sanctions" of the NASD Sanction Guidelines for advertising violations (1993) ("NASD Guidelines"). [/]:/Montano does not contest the NASD's findings that he has been sanctioned by the Massachusetts Securities Division in 1993 and the Missouri Secretary of State in 1996, in addition to his stipulated settlement with this Commission in August 1992. See Gold Properties Restoration Co., Inc., 50 S.E.C. 1236 (1992). [/]:/Id. [/]:/All of the arguments advanced by the parties have been considered. They are rejected or sustained to the extent they are inconsistent or in accordance with the views expressed herein. UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40243 / July 22, 1998 Admin. Proc. File No. 3-9259 : In the Matter of the Application of : : DANIEL C. MONTANO : 245 Duranzo Aisle : Irvine, CA 92606 : : For Review of Disciplinary Action Taken by the : NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.: : ORDER REMANDING PROCEEDINGS TO REGISTERED SECURITIES ASSOCIATION On the basis of the Commission's opinion issued this day, it is ORDERED that the findings of violation by the National Association of Securities Dealers, Inc. against Daniel C. Montano are sustained in part and set aside in part as set forth in the Commission's opinion, the sanctions are vacated, and the matter is remanded to the association for consideration of sanctions consistent with the Commission's opinion. By the Commission. Jonathan G. Katz Secretary