SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40639 / November 4, 1998 Admin. Proc. File No. 3-9519 _________________________________________________ : In the Matter of the Application of : : WILLIAM H. GERHAUSER, Sr. : : and : : WILLIAM C. GERHAUSER, Jr. : : For Review of 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 Failure to Comply with Net Capital, Recordkeeping, and Reporting Requirements President and registered financial and operations principal of introducing broker-dealer member firm of registered securities association failed to reduce firm's net capital by the known deficit in margin accounts and thereby, violated net capital, recordkeeping and reporting requirements. Held, association's findings of violations and the sanctions it imposed are sustained. APPEARANCES: Daniel J. Dugan, of Spector Gadon & Rosen, P.C., for William H. Gerhauser, Sr. and William C. Gerhauser, Jr. Alden S. Adkins, Susan L. Beesley and Deborah F. McIlroy, for NASD Regulation, Inc. Appeal filed: December 23, 1997 Last brief received: March 20, 1998 I. William H. Gerhauser, Sr. and William C. Gerhauser, Jr. (collectively, "Applicants" or the "Gerhausers"), [1] registered principals of Rothschild Global Investments, Inc. ("RGI" or the "Firm"), a former member firm of the National Association of Securities Dealers, Inc. ("NASD"), appeal from NASD disciplinary action. [2] The NASD found that the Gerhausers, along with Robert K. Savage, were liable under former Article III, Section 1 of the NASD Rules of Fair Practice ("NASD Rules") for failing to reduce the Firm's net capital by the known amount of negative equity in certain customers' margin accounts, thereby operating a securities business in violation of our net capital rule, Rule 15c3-1(a) under the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. 78. [3] The NASD further found that, as a consequence, Gerhauser, Sr. and Savage were liable under Article III, Section 1 of the NASD Rules for preparing materially inaccurate Financial and Operational Combined Uniform Single ("FOCUS") Reports, as required by Exchange Act Rule 17a-5; that Gerhauser, Sr. and Savage were liable under Article III, Sections 1 and 21(a) of the NASD Rules [4] for preparing materially inaccurate general ledgers, net capital computations, and trial balances, in violation of Exchange Act Rule 17a-3; and that Gerhauser, Sr. and Savage were liable under Article III, Section 1 of the NASD Rules for failing to report telegraphically the Firm's net capital deficiency from February 1994 through June 26, 1995, as required by Exchange Act Rule 17a-11. The NASD censured Applicants, fined them $15,000 jointly and severally, required Gerhauser, Sr. to requalify as a financial and operations principal ("FINOP"), and required Gerhauser, Jr. to requalify as a general securities principal. [5] We base our findings on an independent review of the record. II. RGI was a registered broker-dealer firm which began operations as the List Capital Corporation in 1985. [6] Gerhauser, Sr. was the principal shareholder, Chairman, Chief Executive Officer, and Chief Financial Officer of RGI until February, 1996; he also held the position of FINOP from January 1991 until July 1994. Gerhauser, Jr. began working at RGI in January 1991. He was registered as an options principal, general securities principal, municipal securities principal, and municipal securities representative at the Firm until July 1995, and served as the Firm's President from approximately April 1994 until July 1995. Savage began his employment at RGI in May 1994 and was registered as its FINOP from July 29, 1994 until July 1995. RGI, an introducing firm, cleared its business on a fully disclosed basis with Soci‚t‚ G‚n‚rale Securities Corp. ("SGSC"). In late 1993 and early 1994, several customers of RGI whose accounts were carried by SGSC purchased stock of Spectrum Information Technologies, Inc. ("Spectrum") on margin. In January 1994, the price of Spectrum stock began to fall dramatically. By the end of February 1994, several customers began to carry negative equity balances in their margin accounts. The margin account for one customer, Alan Attar, had the largest deficit, amounting to a negative equity balance of $259,936 by the end of February 1994. During the first several months of 1994, representatives from RGI and SGSC corresponded on numerous occasions and made various proposals concerning how to handle the customer debit balances, including provisions regarding selling out the margin accounts. In a March 17, 1994 letter agreement ("March 1994 Agreement") between RGI and SGSC (signed by Gerhauser, Jr.) "relative to the collaterization of the unsecured debit balances," RGI agreed, inter alia, to deposit $200,000 with SGSC, and acknowledged that SGSC would "exercis[e] its rights to begin selling out the securities positions" for those accounts. The March 1994 Agreement also stated that the parties would "continue to perform all of their respective obligations and duties as outlined" in the Clearing Agreement. Furthermore, the March 1994 Agreement provided that SGSC would defer selling out the Attar margin account for one day (until March 18, 1994) to provide Attar the opportunity to pay the balance that he owed. Attar failed to pay the balance in his margin account as requested by SGSC. Therefore, in April 1994, SGSC sold out the remaining positions in Attar's account. By that time, the price of Spectrum stock had decreased to such an extent that, even after the proceeds from that sale were applied to the debit balance, the equity balance in Attar's account was negative $580,495. Interest on the account continued to accrue through October 1994, when the account balance was capped by SGSC at negative $601,417. The parties supplemented the March 1994 Agreement with a June 14, 1994 letter agreement ("June 1994 Agreement"), which, inter alia, clarified that the $200,000 payment from RGI to SGSC in March 1994 was to "constitute a reserve against all outstanding unsecured debits in connection with any of the Introduced Accounts." Gerhauser, Sr. and Gerhauser, Jr. both testified that an officer at SGSC agreed verbally that SGSC would take the charge for the outstanding customer debits against SGSC's net capital position in exchange for RGI's "good faith deposit" of $200,000. Gerhauser, Sr. added that SGSC verbally agreed that this payment relieved RGI's responsibility to charge these debits against its net capital. SGSC did, in fact, take a charge against its net capital for these debits, although the amount of the deduction and the timing of the charge are unclear. Applicants also testified that third parties, including outside counsel and accountants, advised them that RGI's payment to SGSC would allow RGI to remain in business. Gerhauser, Jr. testified, however, that he was aware that there was an ongoing dispute between RGI and SGSC concerning the extent to which RGI was responsible for the debit balances. Gerhauser, Jr. also testified that he understood that, when the debit balances first arose in February 1994, "we were faced with two options, either to go out of business due to a net capital deficiency . . . or . . . put up additional funds with [SGSC]." Robert Savage became aware of the deficits in the margin accounts in approximately July 1994 (around the time when he became the FINOP at RGI) and brought them to the attention of Gerhauser, Jr. Savage testified that Gerhauser, Jr. told him that RGI and SGSC had reached an "agreement" earlier in 1994. According to the agreement, SGSC took the charge for the debit balances against its own net capital because RGI had provided additional capital to SGSC. Savage testified further that Gerhauser, Jr. advised him that this agreement "took care of" RGI's responsibility for the account deficits. RGI never deducted the deficits in the margin accounts from its net capital. RGI also filed FOCUS Reports and prepared the Firm's books and records reflecting a net capital amount that was not reduced by the margin account debits. The Firm failed to provide telegraphic notice of a net capital deficiency until required to do so by NASD staff in June 1995. III. A. Our net capital rule, which was "designed to assure financial responsibility of brokers and dealers," is "one of the most important weapons in the Commission's arsenal to protect investors." [7] The net capital requirements are designed to "operate as an early warning system" of potential financial difficulties at a firm. [8] The rule's requirements are intended "to ensure that broker-dealers have sufficient liquid capital to protect the assets of customers and to meet their responsibilities to other broker-dealers." [9] These requirements "involve fundamental safeguards imposed for the protection of the investing public on those who wish to engage in the securities business." [10] Applicants do not dispute that, if RGI was required to take the customer debits in the introduced accounts as a deduction in its net capital calculations, then the Firm did not maintain sufficient minimum net capital from February 1994 through June 1995. [11] We find that the Firm was so required by the terms of its Clearing Agreement with SGSC. In particular, paragraph 4(c) of the Clearing Agreement provided that: [RGI] shall be responsible for assuring that each Introduced Account (i) deposits by settlement date sufficient and adequate initial margin in connection with any margin transaction; and (ii) promptly deposits sufficient and adequate maintenance margin upon SGSC's request and in the event of a failure of an Introduced Account to do any of the foregoing [RGI] agree[s] to pay [SGSC] promptly the full amount of any loss or expense incurred by [SGSC] as a result thereof. The parties were required by NASD rules to submit any amendments to the Clearing Agreement to the NASD for review and approval. [12] The Clearing Agreement thus created a liability for RGI, as the introducing firm, to pay SGSC when a customer failed to deposit sufficient margin upon SGSC's request. This liability should have been deducted from the Firm's net capital. [13] Applicants, however, contend that RGI did not violate Rule 15c3-1 because RGI provided a $200,000 deposit to SGSC in March 1994 in consideration of which SGSC assumed sole responsibility for the negative balances in the margin accounts. They contend that this deposit, together with the March 1994 and June 1994 Agreements, other correspondence, and a "verbal agreement" with SGSC in early 1994, essentially amended the Clearing Agreement. Finally, they argue that SGSC was responsible for the debits because it had full responsibility for the margin accounts and ineffectively liquidated the accounts. We find that there was no effective amendment to the Clearing Agreement negating RGI's obligation to deduct its liability to SGSC in its net capital calculations. Neither the March 1994 Agreement nor the June 1994 Agreement, nor any other agreements, were submitted for approval to the NASD as required by NASD rules. Approval by a self-regulatory organization of amendments to clearing agreements is important precisely because, among other things, the approval process ensures that any amendments effectively clarify net capital obligations. Without such regulatory approval, we are constrained to construe the Clearing Agreement and RGI's net capital obligations pursuant to the Clearing Agreement as it was originally submitted and approved by the NASD. [14] We also reject the contention that SGSC solely was responsible for the debits under paragraphs 4(a) and (b) of the Clearing Agreement. [15] Although these provisions permitted SGSC to take measures to limit losses in the event of deficiencies in Introduced Accounts, they did not require that SGSC take such measures. In any event, paragraph 4(c) placed ultimate liability on RGI when its customers failed to provide sufficient margin upon request. [16] Applicants also argue that they are not liable because the NASD found no net capital violation when it conducted an audit of the firm in 1994; the NASD counters that no such audit was conducted. The record does not support a conclusion that the NASD conducted an audit in 1994. However, even had there been an NASD audit that found no violations, we have held that "a broker-dealer cannot shift its responsibility for compliance with applicable requirements to the NASD or to us. A regulatory authority's failure to take early action neither operates as an estoppel against later action nor cures a violation." [17] We conclude that RGI was required to deduct the margin account deficits in calculating its net capital, but failed to do so. Deducting the deficits from RGI's net capital results in net capital deficiencies for the Firm from February 1994 through June 1995. [18] B. Gerhauser, Sr. was the FINOP of RGI through June 1994. Pursuant to NASD rules, the duties of a FINOP include the "supervision and/or performance of the member's responsibilities under all financial responsibility rules promulgated pursuant to the provisions of the [Exchange] Act" as well as the "responsibility for the accuracy of financial reports submitted" to the NASD and this Commission. [19] Therefore, we conclude that Gerhauser, Sr. was liable under Article III, Section 1 for the month-end dates from February 1994 through June 1994, the period during which there was a net capital deficiency and he was the Firm's FINOP. With respect to Gerhauser, Jr., the NASD found him liable for the net capital deficiencies during only the period in which he was President of RGI and Savage was FINOP, on the basis that Gerhauser, Jr. misled Savage concerning the Firm's net capital obligations. Gerhauser, Jr. argues that he did not violate Article III, Section 1 because he had no responsibilities for net capital compliance as President of the Firm. We have long maintained, however, that "[t]he president of a corporate broker- dealer is responsible for compliance with all of the requirements imposed on his firm unless and until he reasonably delegates particular functions to another person in that firm, and neither knows nor has reason to know that such person's performance is deficient." [20] It is unclear from the record whether a delegation of financial compliance responsibilities from the President to another RGI employee was in effect in February 1994. [21] Because the NASD did not hold Gerhauser, Jr. liable until Savage became FINOP, we do not need to resolve this issue. It is clear that, even if there had been an effective delegation, soon after Savage became FINOP, he sought and received advice from Gerhauser, Jr. concerning net capital calculations. Gerhauser, Jr. told Savage that the customer debits had been "taken care of" because SGSC had agreed to take the charge against its net capital in exchange for the $200,000 deposit from RGI. Once Gerhauser, Jr. intervened in determining the firm's net capital, he incurred responsibility for the result. In these circumstances, we find that Gerhauser, Jr. was liable under Article III, Section 1 based on the Firm's net capital deficiencies for the month-end dates July 1994 through June 26, 1995. C. Applicants further contend that, even if RGI violated the net capital rule, they are not liable because they acted in the good faith belief that the Firm complied with its net capital requirements. They do not dispute that the lack of intent or scienter is not a defense to a violation of Rule 15c3-1. However, they argue that they are not being charged with a violation of Rule 15c3-1, but with an infraction of Article III, Section 1 of the NASD Rules of Fair Practice, which is an ethical standard requiring a showing of bad faith. Applicants testified that they believed in good faith that SGSC's agreement to take the charge for the customer debits in exchange for the $200,000 payment from RGI obviated the need for RGI to deduct the deficit. Based on this understanding, Gerhauser, Jr. testified that he "had no idea that [RGI was] violating any NASD rules." Applicants also testified that they relied upon legal advice and accountants' reports that they were in net capital compliance. We agree with Applicants that Article III, Section 1 reflects a broad ethical standard of conduct. [22] Here, Applicants are charged under NASD Article III, Section 1 based upon infractions of various rules under the Exchange Act. We have consistently maintained that a violation of another SEC or NASD rule or regulation constitutes a violation of the requirement to adhere to "just and equitable principles of trade" embodied in the NASD Rules of Fair Practice and does not require a finding of intent or scienter. [23] This is particularly true with respect to violations of the net capital rule. [24] Moreover, even if good faith were relevant as a defense here, we do not believe that Applicants acted with good faith. Notwithstanding Gerhauser Jr.'s professed ignorance of any rule violations, when asked specifically if he thought that the March 1994 Agreement excused RGI from taking a charge to its net capital, he admitted that he did not. Further, the record makes clear that both Applicants should have known that the dispute between RGI and SGSC concerning the extent to which RGI was responsible for the customer debits was not resolved by any of the agreements reached. Yet Applicants neglected to account for these debits in the Firm's books and records and never sought a recommendation from NASD staff as to which party should account for the deficits. We have previously held that "[o]fficers of securities firms bear a heavy responsibility in ensuring that the firm complies with all applicable rules and regulations . . . [including] the net capital requirements." [25] Applicants' misconduct resulted in misleading this Commission and the NASD about the true state of RGI's finances and constituted a violation of the NASD's "just and equitable principles of trade." [26] We find, therefore, that, if it were required, Applicants did not possess the requisite "good faith" to avoid liability under Article III, Section 1. IV. Section 17(a) of the Exchange Act and the rules promulgated thereunder required RGI to reflect its correct net capital position in its books and records and in its filings with this Commission and the NASD. Accordingly, RGI was required to maintain books and records that accurately represented its net capital. [27] RGI was also required, at the end of each month and quarter, to file FOCUS Reports with the NASD setting forth the Firm's net capital position. [28] RGI was further obligated to provide telegraphic notice of a net capital deficiency on the date that the deficiency occurred. [29] We found above that RGI maintained insufficient net capital on the month-end dates from February 1994 through June 26, 1995 because it did not deduct the debit balances as liabilities. The Firm's books and records, and FOCUS Reports based on the information in the books and records, reported the Firm's net capital without the required deduction. The Firm did not notify this Commission of any net capital deficiency until the NASD told it to do so. It follows, therefore, that the Firm and its FINOP are liable for filing inaccurate FOCUS Reports, for preparing inaccurate books and records which did not reflect such a deduction, and for failing to provide the required telegraphic notice of a net capital violation during this period. Specifically, we find that Gerhauser, Sr. is liable under Article III, Section 1 for causing the Firm to file materially inaccurate FOCUS Reports Part I for February 1994 through June 1994, and by filing materially inaccurate FOCUS Reports Part IIA on March 31, 1994 and June 30, 1994, as required by Exchange Act Rule 17a-5. We find that Gerhauser, Sr. is liable under Article III, Sections 1 and 21(a) for preparing materially inaccurate general ledgers, trial balances and net capital computations for RGI, in violation of Exchange Act Rule 17a-3, from February through June 1994. [30] Finally, we conclude that Gerhauser, Sr. is liable under Article III, Section 1 for failing to provide telegraphic notice of RGI's net capital deficiency from February through June 1994, as required by Exchange Act Rule 17a-11. V. Applicants argue that there were procedural irregularities in the hearings below. Their principal contention is that the hearings were biased because NASD staff "worked hand in glove with" SGSC in prosecuting this case, which allowed SGSC "to gain an advantage over RGI in subsequent arbitration or litigation." Applicants argue that NASD staff submitted, and the DBCC admitted, an exhibit consisting of a "one-sided" chronology prepared by SGSC personnel which was unauthenticated, consisted of hearsay and was not the subject of cross-examination. They also suggest that a telephone call by the NASD staff attorney to an SGSC attorney and the SGSC compliance officer, Kenneth Lampert, immediately after the DBCC hearing further evinced an improper association between the NASD and SGSC. Finally, Applicants assert that the NBCC decision improperly analyzed issues that are essential to the ongoing arbitration proceeding between the parties. Applicants urge that the NBCC decision should be reversed, or vacated and remanded for a new, impartial hearing. We are unpersuaded that there were procedural irregularities below that prejudiced Applicants. First, Gerhauser, Sr. failed to object to the admission of the disputed chronology at the DBCC hearing. Moreover, hearsay evidence is admissible in administrative proceedings. [31] Gerhauser, Sr. also successfully objected to the testimony of Lampert, the author of the chronology, and therefore gave up his right to cross-examine Lampert on that exhibit. Finally, we base our ruling on an independent review of the record and find that admission of this exhibit -- even if improper -- amounted to harmless error. [32] With respect to the disputed telephone call, there is nothing in the record to contradict the representation of the NASD attorney that he placed the phone call innocently to notify Lampert (who had been listed as a prosecution witness) that he would not be needed to testify after adjournment of the hearing. [33] We also find no impropriety in the choice of issues analyzed by the NBCC in reaching its conclusion. As noted in our analysis of Applicants' net capital compliance, an examination of the Clearing Agreement between RGI and SGSC is necessary to determine which party was liable for the net capital deduction. In any event, we have conducted a de novo review of the record and find ample support for the NASD's findings of violation. [34] VI. Applicants contend that, even if they are liable for violating the NASD Rules, the sanctions imposed on them were excessive, because they attempted to comply with the net capital rule in good faith. They also assert that no customers were injured by their conduct and that other cases have imposed lesser fines for more egregious conduct. Section 19(e) of the Exchange Act governs our review of the sanctions imposed by the NASD. [35] The proper sanction depends on the unique facts and circumstances of this case and cannot be determined precisely by comparison with the facts in other cases. [36] We do not find the sanctions imposed here to be excessive or oppressive. The monetary sanctions fall within the range recommended by the NASD Sanctions Guidelines for net capital violations. [37] We recognize that Applicants have no disciplinary history in the securities industry and that there is no evidence in the record that customers were harmed by the net capital deficiency. However, we found that Applicants did not act in good faith and that the Firm was in net capital deficiency over a period of seventeen months. The long period of continuing violation is an aggravating factor in assessing sanctions under the NASD Guidelines. Moreover, it is immaterial whether any customers were injured by the net capital violation. [38] We have previously emphasized that "[n]et capital violations are serious violations. The net capital rule is designed to ensure that the broker-dealer will have sufficient liquid assets to satisfy its indebtedness, particularly the claims of customers. By engaging in business when the firm was not in compliance with net capital requirements, the firm and [its FINOP] subjected the firm's customers to undue risks." [39] We conclude that the sanctions appropriately reflect both mitigating and aggravating factors of Applicants' liability and we therefore sustain them. [40] An appropriate order will issue. [41] By the Commission (Chairman LEVITT and Commissioners JOHNSON, HUNT, and CAREY); Commissioner UNGER not participating. Jonathan G. Katz Secretary **FOOTNOTES** [1]: William H. Gerhauser, Sr. ("Gerhauser, Sr.") is the father of William C. Gerhauser, Jr. ("Gerhauser, Jr."). [2]: RGI was also named in the Complaint by the NASD. The Firm, however, did not answer the Complaint and subsequently was censured, fined, and expelled from the NASD pursuant to a decision by the NASD District Business Conduct Committee ("DBCC"), which was not appealed. The Firm's membership with the NASD had been revoked on February 2, 1996 for failure to file Financial and Operational Combined Uniform Single ("FOCUS") Reports. [3]: Article III, Section 1 of the NASD Rules required that members "observe high standards of commercial honor and just and equitable principles of trade." This provision has been recodified as Conduct Rule 2110, NASD Manual (CCH), p. 4111. [4]: Article III, Section 21(a) required that "[e]ach member shall keep and preserve books, accounts, records, memoranda, and correspondence in conformity with all applicable laws, rules, regulations and statements of policy promulgated thereunder and with the Rules of this Association." This provision has been recodified as NASD Conduct Rule 3110(a), NASD Manual (CCH), p. 4892. [5]: The NASD also assessed costs, jointly and severally, onApplicants. The NASD imposed no sanctions against Savage. The DBCC had censured Savage, imposed a $10,000 fine, and required him to requalify as a FINOP. On appeal, the NASD's National Business Conduct Committee ("NBCC") eliminated these sanctions against Savage. Our findings here with respect to Savage are made solely for the purposes of this proceeding, to which he is not a party. [6]: The Firm changed its name to "Rothschild Global Investments, Inc." in December, 1990. [7]: Livada Securities Co., 45 S.E.C. 598, 600 (1974) (citing Blaise D'Antoni & Associates, Inc. v. SEC, 289 F.2d 276, 277 (5th Cir. 1961), cert. denied, 368 U.S. 899 (1961)). [8]: William J. Blalock, Securities Exchange Act Rel. No. 35002 (Nov. 23, 1994), 58 SEC Docket 155, 166 n.30, aff'd, 96 F.3d 1457 (11th Cir. 1996)(Table). [9]: Lowell H. Listrom, 50 S.E.C. 883, 886 (1992), aff'd, 975 F.2d 866 (8th Cir. 1992)(Table). [10]: Id. at 888. [11]: The NASD found (and Applicants do not contest) that RGI had a minimum net capital requirement of $75,000 from February through June 1994, and a minimum requirement of $100,000 from July 1994 through June 1995. [11]: NASD Conduct Rule 3230, NASD Manual (CCH), p. 4922. [12]: In making this finding, we agree with the NASD that the terms of the Clearing Agreement control RGI's net capital responsibilities with respect to deficiencies in customer accounts. The NASD, however, additionally relied on an interpretation of Rule 15c3-1 published in the 1994 NASD Guide to Rule Interpretations, providing that deficits in unsecured and partly secured introduced accounts should be deducted by both the carrying and introducing broker-dealers when the clearing agreement states that such deficits are the liability of the introducing broker-dealer. See NASD Guide to Rule Interpretations 8 (1994) ("NASD Guide"). The record is unclear concerning when the NASD Guide became available to Applicants, but we note that a similar interpretation was available as early as 1988 from the NYSE. See NYSE Interpretation Handbook (No. 88-14, August, 1988). We expect firms to avail themselves of all relevant authorities, even if the source is an exchange of which they are not a member. However, this issue is not dispositive here, since Applicants' liability is clear from the Clearing Agreement, even without citation to the rule interpretation. [13]: In reaching our conclusion, we emphasize that our holding is limited to the narrow issue of RGI's responsibility to regulatory authorities in calculating its net capital. RGI and SGSC apparently are involved in an ongoing dispute concerning whether any written or verbal agreements modified their respective obligations to each other. Whether they effectively reached a private agreement regarding who would bear the losses generated by the customer account deficiencies is a separate question from their regulatory responsibilities. [14]: Paragraphs 4(a) and 4(b) of the Clearing Agreement permitted SGSC to, inter alia, extend credit and sell out securities in the margin accounts. [15]: Applicants suggest that paragraph 7 of the Clearing Agreement assigns liability for the account deficits to SGSC. Paragraph 7 refers to the liability for the "acts or omissions" of the parties. It is unclear precisely to which "acts or omissions" Applicants are referring. However, Applicants' argument appears to be based, at least in part, on their interpretation of SGSC's obligations pursuant to the March and June 1994 Agreements, which we have found did not effectively amend the Clearing Agreement. [16]: Variable Investment Corporation, 46 S.E.C. 1352, 1354 n.6 (1978). See also Richard R. Perkins, 51 S.E.C. 380, 384 n.20 (1993); W.N. Whelan & Co., Inc., 50 S.E.C. 282, 287 (1990); Don D. Anderson & Co., Inc., 43 S.E.C. 989, 991 (1968), aff'd, 423 F.2d 813 (10th Cir. 1970). Applicants further assert that RGI did not violate the net capital rule because it was never notified by SGSC in writing of the customer debits for which RGI was responsible. Applicants contend that such written notification is a prerequisite for imposing liability on the introducing firm under the rule interpretation in the 1994 NASD Guide. It is undisputed, however, that Applicants had actual notice of the negative equity balances in their customers' margin accounts. [17]: The NASD charged RGI and its principals with violating the net capital rule from February 1994 through June 26, 1995. However, the NASD submitted evidence that RGI was conducting a securities business only on the month- end dates during that period. [18]: NASD Membership and Registration Rule 1022(b), NASD Manual (CCH), p. 3173. See also George L. Freeland, 51 S.E.C. 389, 392 (1993) (FINOP responsible for firm's "compliance with applicable financial reporting and net capital requirements"). [19]: Sheldon v. SEC, 45 F.3d 1515, 1517 (11th Cir. 1995); Thomas F. White, 51 S.E.C. 1194, 1197 (1994); James M. Brown, 50 S.E.C. 1322, 1325 (1992), aff'd, 21 F.3d 1124 (11th Cir. 1994)(Table); Swartwood, Hesse, Inc., 50 S.E.C. 1301, 1308 (1992). [20]: Applicants cite the December 8, 1993 minutes of RGI's Board of Directors (and accompanying materials) to support their argument that Gerhauser, Jr. had limited responsibilities with respect to compliance matters. The minutes do not specify the respective responsibilities of the President, the FINOP, or other financial officer, and do not list who held these positions with the Firm at that time. [21]: See, e.g., Mayer A. Amsel, Securities Exchange Act Rel. No. 37092 (April 10, 1996), 61 SEC Docket 2119, 2125; Robert E. Kauffman, 51 S.E.C. 838, 839 n.5 (1993), aff'd, 40 F.3d 1240 (Table); Benjamin Werner & Co., 44 S.E.C. 622, 624 n.9 (1971). [22]: See, e.g., Erdos v. SEC, 742 F.2d 507, 508 (9th Cir. 1984) (violation of Article III, Section 1 for making unsuitable recommendations to customer "does not require that the dealer act with scienter"); Clinton Hugh Holland Jr., Securities Exchange Act Rel. No. 36621 (December 21, 1995), 60 SEC Docket 2935, 2941 n.20, aff'd, 105 F.3d 665 (9th Cir. 1997)(Table) (recognizing that violations of other NASD Rules constitute a violation of the ethical standards of Article III, Section 1, and finding such a violation even where the applicant acted in good faith). [23]: See, e.g., Litwin Securities, Inc., Securities Exchange Act Rel. No. 38673 (May 27, 1997), 64 SEC Docket 1772, 1779 (intent to violate net capital rules is irrelevant because NASD member firms and their FINOPs are charged with knowing the applicable regulations); First Heritage Investment Co., 51 S.E.C. 953, 957 n.15 (1994) (rejecting claim that Rule 15c3-1 has an implicit scienter requirement); Hutchison Financial Corp., 51 S.E.C. 398, 403-04 (1993) (finding violation of Article III, Section 1 for "inadvertent" net capital violation even though no showing that firm officer intended a net capital deficiency or to mislead regulators); W.N. Whelan & Co., 50 S.E.C. 282, 287 (1990) (proof of intent to violate is unnecessary to establish net capital violations because such violations "were clearly incompatible with the observance of 'just and equitable principles of trade'"). [24]: Hutchison Financial Corp., 51 S.E.C. at 403-04. [25]: We also find that Applicants have not satisfied their burden of showing that they are not liable because they relied upon the advice of counsel. The "advice of counsel" defense requires that the applicant (1) make a complete disclosure to the attorney of the intended action, (2) request the attorney's advice of the legality of the intended action, (3) receive counsel's advice that the conduct would be legal, and (4) rely in good faith on that advice. See John Thomas Gabriel, 51 S.E.C. 1285, 1292 (1994), aff'd, 60 F.3d 812 (2d Cir. 1995)(Table). See also Richard J. Lanigan, Exchange Act Rel. No. 36028 (July 27, 1995), 59 SEC Docket 2693, 2696 n.9. The record does not indicate that these standards were met. To the contrary, Gerhauser, Jr. testified that "[t]he question specifically would we meet net capital requirements [if RGI made its payment to SGSC] I don't think was brought up" in meetings with RGI's attorneys. [26]: See 17 C.F.R. 240.17a-3; NASD Rule Article III, Section 21(a). See also Hutchison Financial Corp., 51 S.E.C. at 399 n.6. [27]: See 17 C.F.R. 240.17a-5. [28]: See 17 C.F.R. 240.17a-11. See also W.N. Whelan & Co., 50 S.E.C. at 286; Whiteside and Co., Inc., 49 S.E.C. 963, 965 (1988). [29]: To the extent that Gerhauser, Sr. claims that Article III, Section 21(a) incorporated a bad faith requirement, we reject this argument for the same reasons as we did for Article III, Section 1, above. [31]: See, e.g., Carlton W. Fleming, Jr., Securities Exchange Act. Rel. No. 36215 (September 11, 1995), 60 SEC Docket 595, 598; Michael A. Niebuhr, Securities Exchange Act. Rel. No. 36620 (Dec. 21, 1995), 60 SEC Docket 2923, 2932. [32]: See U.S. Associates, Inc., 51 S.E.C. 805, 812 (1993) (noting that finding of harmless error may overcome procedural objections). [33]: We note that the NASD attorney, although conceding no improprieties in the prosecution, admitted that he "certainly cooperated closely with [SGSC]." [34]: See Thomas C. Kocherhans, Securities Exchange Act Rel. No. 36556 (Dec. 6, 1995), 60 SEC Docket 2589, 2596 n.27 (allegations of procedural abuse by NASD countered by Commission's de novo review of proceedings). Gerhauser, Sr. also suggested below that he was prejudiced in his defense because he received the NASD exhibits only one day before the hearing. The record indicates that the NASD sent the records to Gerhauser, Sr. at his service address in Great Britain, but that he did not receive them. The NASD immediately sent another set of exhibits to him as soon as it became aware that he was in Florida. In any event, Gerhauser, Sr. refused the suggestion to postpone the hearing until he had an opportunity to further review the NASD's exhibits. Cf. Brooklyn Capital & Securities Trading, Inc., Securities Exchange Act Rel. No. 38454 (March 31, 1997), 64 SEC Docket 584, 595 n.34 (Commission not required to consider objections that were not raised at a time when the matter complained of could have been remedied). [35]: In particular, Exchange Act Section 19(e)(2), 15 U.S.C. 78s(e)(2), provides that the Commission "may cancel, reduce, or require the remission" of a sanction imposed by a self-regulatory organization where it finds the sanction to be "excessive or oppressive." [36]: See Butz v. Glover Livestock Commission Corp., 411 U.S. 182, 187 (1973); Hiller v. SEC, 429 F.2d 856, 858-59 (2d Cir. 1970); Martin J. Cunnane, Jr., Securities Exchange Act Rel. No. 39242 (October 15, 1997), 65 SEC Docket 2217, 2220. [37]: See NASD Sanction Guidelines 30 (Net Capital Violations) (1993) ("Guidelines"). Moreover, the Guidelines provide for a suspension of the FINOP for net capital violations in appropriate circumstances, a sanction which was not imposed here. [38]: See Blaise D'Antoni & Assoc., 289 F.2d at 277 ("By limiting the ratio of a broker's indebtedness to his capital, the [net capital] rule operates to assure confidence and safety to the investing public. The question is not whether actual injuries or losses were suffered by anyone"). [39]: Wallace G. Conley, 51 S.E.C. 300, 303 (1993). [40]: We note an additional matter not at issue in this proceeding. The NBCC sustained the findings of liability against Robert Savage, RGI's FINOP from July 1994 through July 1995, but vacated the sanctions imposed on him by the DBCC due to what it termed "extremely mitigating circumstances," i.e., because he had been misinformed by Gerhauser, Jr. concerning the status of negotiations with SGSC. Notwithstanding what he was told by Gerhauser, Jr., Savage should have independently reviewed the Clearing Agreement and the various correspondences between RGI and SGSC to determine whether there was an effective amendment to the Clearing Account and whether RGI was liable for the margin account deficits. We have held previously that a FINOP is liable for net capital, recordkeeping and reporting violations and may face sanctions even where the firm's president instructed the FINOP not to book a liability in calculating the firm's net capital. See Conley, 51 S.E.C. at 302-04; Freeland, 51 S.E.C. at 392. We recognize that Savage is not a party to this appeal and that, therefore, the NBCC's findings are final as to him. However, the record does not disclose any clear distinction between Savage's circumstances and our prior precedent imposing sanctions on a firm's FINOP. [41]: We have considered all of the arguments advanced by the parties. We reject or accept them to the extent that they are inconsistent or in accord with the views expressed in this opinion. UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40639 / November 4, 1998 Admin. Proc. File No. 3-9519 _________________________________________________ : In the Matter of the Application of : : WILLIAM H. GERHAUSER, Sr. : : and : : WILLIAM C. GERHAUSER, Jr. : : : For Review of 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, imposition of sanctions, and assessment of costs by the National Association of Securities Dealers, Inc. against William H. Gerhauser, Sr. and William C. Gerhauser, Jr., be, and they hereby are, sustained. By the Commission. Jonathan G. Katz Secretary