Other
Municipal Bond Participants:
The Financial Advisor
May 12, 2017
Report under Section 21(a) of the Exchange Act
SEC, Staff Report on Transactions in the Marine Protein Corporation Industrial Development Revenue Bonds , Exchange Act Release No. 15719 (April 11, 1979).
See "Obligated Persons" section.
Injunctive Proceedings
Securities and Exchange Commission v. John Gardner Black, Devon Capital Management, Inc., and Financial Management Sciences, Inc., Civ. Action No. 97-2257 (W.D. Pa.) Litigation Release No. 15511 (September 26, 1997) (complaint).
The Securities and Exchange Commission ("Commission") announced that, on September 26, 1997, the Honorable William L. Standish of the U.S. District Court for the Western District of Pennsylvania issued a temporary restraining order against John Gardner Black ("Black"), Devon Capital Management, Inc. ("Devon"), and Financial Management Sciences, Inc. ("FMS"). Among other things, the Order freezes the defendants' assets and appoints as Trustee over those assets Dick Thornburgh, formerly Attorney General of the United States, United States Attorney for the Western District of Pennsylvania and Governor of Pennsylvania.
The complaint alleges an on-going fraudulent scheme perpetrated by Black through Devon, a Pennsylvania-based registered investment adviser, and FMS, an affiliate of Devon's. Both Devon and FMS are wholly owned and controlled by Black. The complaint alleges that the scheme has resulted in the loss of millions of dollars of municipal bond proceeds invested by school districts throughout western and central Pennsylvania.
Devon manages approximately $345 million in assets for approximately 100 investment advisory clients, the vast majority of which are local school districts seeking to invest the proceeds of municipal bond offerings. Devon has invested approximately $233 million of these funds, on behalf of 75 local school districts, in a form of investment called a Collateralized Investment Agreement ("CIA"). In promotional materials, Devon represented to these school districts that the CIA is an investment which pays a specified rate of return over a fixed period and which is fully protected by a pool of securities equaling the amount of the school districts' total principal investment. The complaint alleges that, in fact, the school districts that have invested in the CIA program have suffered a combined loss of their principal investment of approximately $71 million.
The complaint alleges that, in an effort to conceal this loss of principal from the school districts that have invested in the CIA program, Devon and Black have misrepresented to them the value of the assets held as collateral, overstating the actual value of those assets by approximately $71 million. The complaint further alleges that Black has continued to accept new clients for investment into the CIA program without disclosing to these new clients that, as a result of the shortfall in the funds already under management, any funds that new clients invest into the CIA program are immediately diluted. The complaint alleges that Devon must continue to attract new funds for investment in the program in order to fulfill its entire obligations to current advisory clients in the CIA program.
Finally, the complaint alleges that Black, Devon and FMS have benefited financially from this fraudulent scheme. Specifically, from January 1996 through August 1997, at least $2 million of school district funds were used to pay for the defendants' personal and business expenses.
The complaint alleges that Devon, FMS and Black violated the antifraud provisions of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint further alleges that Devon, aided and abetted by Black, violated the antifraud and custody provisions in Sections 206(1), (2) and (4) of the Investment Advisers Act of 1940 and Rule 206(4)-2(a) thereunder.
Securities and Exchange Commission v. John Gardner Black, Devon Capital Management, Inc., and Financial Management Sciences, Inc., Litigation Release No. 15591 (December 15, 1997) (settled final orders).
The Securities and Exchange Commission ("Commission") announced that, on December 12, 1997, the Honorable Donetta Ambrose of the U.S. District Court for the Western District of Pennsylvania signed an order of permanent injunction ("Order") against defendants John Gardner Black ("Black"), Devon Capital Management, Inc. ("Devon"), and Financial Management Sciences, Inc. ("FMS"). The Order enjoins the defendants from future violations of the anti-fraud provisions of the federal securities laws while reserving the issues of the dollar amounts of disgorgement and civil penalties to be paid by them. The Order provides for a forty-five day period of discovery relating to the issues of disgorgement and civil penalties. At the conclusion of the discovery period, if the parties are unable to agree on the amounts of disgorgement and penalties to be paid, the parties will request that Judge Ambrose hold an evidentiary hearing and make rulings on these remaining issues.
Defendants Black, Devon and FMS consented to the Order without admitting or denying the allegations in the Commission's Complaint. The Commission filed this action as an emergency matter on September 26, 1997. On the same date, the Court granted the Commission's requested relief, including a temporary restraining order, freeze of assets and an order appointing the Honorable Richard Thornburgh, formerly Attorney General of the United States, United States Attorney for Western Pennsylvania and Governor of Pennsylvania, as Trustee.
The Order of permanent injunction maintains the freeze of the defendants' assets until such time as the issues of payment of disgorgement and civil penalties are resolved. Previously, on October 30, 1997, the Court denied defendant Black's request to release $625,000 of the frozen assets to pay legal fees, in part because he had failed to demonstrate that he did not have access to other funds. At the same time the Court denied in substantial part defendant Black's request to release approximately $127,000 of the frozen funds to pay living expenses, allowing him only $25,000 for this purpose.
The Commission's Complaint alleged that Black, acting through Devon, a Pennsylvania-based registered investment adviser, and FMS, an affiliate of Devon's engaged in a fraudulent scheme in connection with the solicitation and management of Devon's investment advisory clients' funds. The Complaint alleged that the scheme resulted in the loss of millions of dollars of municipal bond proceeds invested by school districts and other local government units throughout Western and Central Pennsylvania.
At the time the Complaint was filed, Devon managed approximately $345 million in assets for approximately 100 investment advisory clients, the vast majority of which were local school districts seeking to invest the proceeds of municipal bond offerings. The Complaint alleged that Devon had invested approximately $233 million of these funds, on behalf of 75 local school districts, in a form of investment called a Collateralized Investment Agreement ("CIA"). In promotional materials, Devon represented to these school districts that the CIA was an investment which paid a specified rate of return over a fixed period and which was fully protected by a pool of securities equaling the amount of the school districts' total principal investment. The Complaint alleged that, in fact, the school districts that had invested in the CIA program have suffered a combined loss of their principal investment of approximately $71 million. Finally, the Complaint alleged that Black, Devon and FMS benefited financially from this fraudulent scheme.
The Complaint alleged that Devon, FMS and Black violated the antifraud provisions of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The Complaint further alleges that Devon, aided and abetted by Black, violated the antifraud and custody provisions in Section 206(1), (2) and (4) of the Investment Advisers Act of 1940 and Rule 206(4)-2(a) thereunder.
Securities and Exchange Commission v. Mark S. Ferber, Civ. Action No. 96-12653 (EFH) (D. Mass.), Litigation Release No. 15193 (December 19, 1996) (settled final order).
On December 19, 1996, the Securities and Exchange Commission filed a Complaint in the U.S. District Court for the District of Massachusetts against Mark S. Ferber ("Ferber"), a former partner of Lazard Freres & Co. ("Lazard"). In its Complaint, the Commission alleged that Ferber failed to adequately disclose a contract with Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") to three of Lazard's financial advisory clients that were serviced by Ferber and that selected Merrill Lynch to provide underwriting, interest rate swap or other financial services. Simultaneously with the filing of the Complaint, Ferber consented, without admitting or denying the allegations in the Complaint, to a permanent injunction enjoining him from future violations of the antifraud provisions and rule G-17 of the Municipal Securities Rulemaking Board, which requires fair dealing in the municipal securities markets. Ferber also agreed to pay disgorgement of $553,000, which represents his portion of the financial advisory fees that he received, plus prejudgment interest of $97,000, for a total of $650,000.
The Complaint alleged that Ferber, on behalf of Lazard, negotiated a lucrative contract with Merrill Lynch, which provided that Lazard and Merrill Lynch would jointly market interest rate swaps and that Lazard would be a consultant to Merrill Lynch. Pursuant to the contract, between September 1990 and November 1992, Merrill Lynch paid Lazard nearly $5.8 million, which resulted in a substantial financial benefit to Ferber.
The Complaint further alleged that the contract with Merrill Lynch was a material fact that should have been disclosed to Lazard's financial advisory clients that were serviced by Ferber and were considering the selection of Merrill Lynch as a provider of financial services – the Massachusetts Water Resources Authority ("MWRA"), the District of Columbia ("the District") and the United States Postal Service ("USPS"). The contract created at least a potential conflict of interest for Ferber in that it gave rise to a significant risk that Ferber would not provide impartial advice to the financial advisory clients that were considering the selection of Merrill Lynch as a provider of financial services. Thus, the contract created the potential for Ferber to abuse his influence over the financial advisory clients.
The Complaint further alleged that Ferber knowingly or recklessly failed to adequately disclose the contract to the MWRA, the District and the USPS, all of which selected Merrill Lynch to provide underwriting, interest rate swap or other financial services in connection with municipal securities offerings and/or the purchase and sale of securities. As a result, Ferber defrauded these financial advisory clients and the purchasers of their municipal securities in violation of Sections 10(b) and 15B(c)(1) of the Securities Exchange Act of 1934, Rule 10b-5 thereunder and rule G-17 of the Municipal Securities Rulemaking Board.
The Commission investigation that led to this action was conducted in close mutual cooperation with the Offices of the United States Attorney for the District of Massachusetts and the Attorney General of the Commonwealth of Massachusetts.
Securities and Exchange Commission v. Nicholas A. Rudi, Joseph C. Salema, Public Capital Advisors, Inc., George L. Tuttle Jr. and Alexander S. Williams, Civ. Action No. 95 Civ. 182 (S.D.N.Y.), Litigation Release No. 14421 (February 23, 1995) (settled final order against Salema).
The Commission announced today that defendants Nicholas A. Rudi ("Rudi") and his financial advisory firm, Public Capital Advisors, Inc. (formerly known as Consolidated Financial Management, Inc.) ("CFM") have agreed to settle this action without admitting or denying the Commission's allegations that Rudi and CFM committed securities fraud by soliciting and receiving more than $200,000 in kickbacks from First Fidelity Securities Group ("FFSG") in connection with a Camden County Municipal Utilities Authority's February 1990 offering of approximately $237,500,000 of debt securities ("Offering"). Under the terms of the settlement, which has been submitted to the Court for approval, Rudi and CFM would each be enjoined from committing securities fraud and Rudi would be ordered to pay $86,331.40, representing disgorgement of $49,131.63 and prejudgment interest of $37,199.77.
Also named in the Complaint were George L. Tuttle, Jr. ("Tuttle") and Alexander S. Williams ("Williams"), both formerly associated with FFSG, which was a registered municipal securities dealer and a division of First Fidelity Bank, N.A. at the time of the transactions and events alleged in the Complaint. The Complaint alleges that, between February and April 1990, Tuttle and Williams caused FFSG to pay CFM the kickbacks, which were shared by Rudi and his then partner Joseph C. Salema ("Salema"). Salema also allegedly solicited and received from Robert J. Jablonski ("Jablonski") an additional $90,000 as a kickback from the finder's fee that FFSG paid to Jablonski relating to the Offering. Tuttle and Williams caused FFSG to pay the kickbacks to CFM through Jablonski's firm and disguised these payments and other related payments on FFSG's municipal securities dealer books and records.
Each of the defendants is alleged to have violated Section 17(a) of the Securities Act of 1933 ("Securities Act"), and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5. In addition, Tuttle and Williams are alleged to have violated Section 15B(c)(1) of the Exchange Act, which prohibits effecting transactions in municipal securities in contravention of any rule of the Municipal Securities Rulemaking Board ("MSRB"), and MSRB rules G-8 (books and records), G-17 (fair dealing) and G-20 (gifts and gratuities).
Simultaneously with the filing of the Complaint, Salema consented, without admitting or denying the allegations, to the entry of a final judgment permanently enjoining him from violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5. Salema also paid $324,764.55, representing disgorgement of the money he received as a result of the conduct alleged in the Complaint and prejudgment interest. At the same time, Tuttle and Williams, without admitting or denying the allegations of the Complaint, each consented to the entry of a final judgment permanently enjoining them from violating Section 17(a) of the Securities Act, Sections 10(b) and 15B(c)(1) of the Exchange Act and Rule 10b-5, and MSRB rules G-8, G-17, and G-20. Tuttle and Williams have disgorged $18,171.48 and $4,684.14, respectively, representing the money each received as a result of the conduct alleged in the Complaint.
The disgorgement and prejudgment interest to be paid by Rudi will be held by the Court for the benefit of persons who submit valid claims arising under the federal securities laws by reason of the conduct alleged against defendants in the Complaint. Such claims must be filed within one year after the Court approves the settlement.
This past June, Rudi was acquitted in a criminal action of all charges based on the same conduct. For more information, see Litigation Release No. 14421 (Feb. 23, 1995).
Securities and Exchange Commission v. Nicholas A. Rudi, Joseph C. Salema, Public Capital Advisors, Inc., George L. Tuttle Jr. and Alexander S. Williams, Litigation Release No. 15218 (January 17, 1997) (settled final orders against Rudi and Public Capital Advisors).
The Commission announced today that, on January 15, 1997, the United States District Court for the Southern District of New York entered the Final Judgments on consent against defendants Nicholas A. Rudi ("Rudi") and his financial advisory firm, Public Capital Advisors, Inc. (formerly known as Consolidated Financial Management, Inc.). As previously announced, the disgorgement and prejudgment interest to be paid by Rudi will be held by the Court for the benefit of persons who submit valid claims arising under the federal securities laws by reason of the conduct alleged against Rudi in the Complaint. Such claims must be filed by January 16, 1998. For more information, see Litigation Release Nos. 15202 (Dec. 30, 1996) and 14421 (Feb. 23, 1995).
SEC v. The Senex Corporation, et al., Civ. Action No. 74-53 (E.D. Ky.), Litigation Release No. 6451 (July 24, 1974) (complaint); Litigation Release No. 6769 (March 5, 1975) (settled final order); Litigation Release No. 8651 (January 23, 1979) (settled final order); 399 F. Supp. 497 (E.D. Ky. 1975).
See "Obligated Persons" section.
Commission Orders – Settled Administrative Proceedings
In re Lazard Freres & Co. LLC, Securities Act Release No. 7671, Exchange Act Release No. 41318, A.P. File No. 3-9880 (April 21, 1999).
I. The Commission deems it appropriate and in the public interest that public administrative proceedings be, and they hereby are, instituted pursuant to Section 8A of the Securities Act of 1933 (Securities Act) and Sections 15(b)(4), 15B(c)(2) and 21C of the Securities Exchange Act of 1934 (Exchange Act) against Lazard Frères & Co. LLC (Lazard). In anticipation of the institution of these proceedings, Lazard has submitted an offer of settlement, which the Commission has determined to accept. Solely for the purpose
of these proceedings and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, Lazard, without admitting or denying the findings contained herein, except that it admits to the jurisdiction of the Commission over it and over the subject matter of these proceedings, consents to the entry of the findings, the institution of the cease-and-desist order, and the imposition of the remedial sanctions set forth below.
II. Based on the foregoing, the Commission finds as follows:
A. Respondent
Lazard Frères & Co. LLC is an investment banking firm with its principal place of business in New York City. It is the successor to Lazard Frères & Co., a New York limited partnership. At all relevant times, both Lazard and its predecessor were registered with the Commission as broker-dealers and municipal securities dealers pursuant to Sections 15(b) and 15B(a)(2) of the Exchange Act.
B. Summary
This is a municipal finance case involving the breach of Lazard's fiduciary duty to its financial advisory client, the Passaic Valley Sewerage Commissioners ("Passaic Valley"). The breach of duty involved Lazard's failure to make necessary disclosures in an advance refunding transaction in which it served as financial advisor and also sold Treasury securities to Passaic Valley as principal. This case also involves Lazard's sale of Treasury securities to Passaic Valley at excessive, undisclosed markups.
C. Background: Advance Refundings
When interest rates fall, state and local governments often seek to reduce their borrowing costs by paying off outstanding bonds through the issuance of new bonds paying lower interest rates. When the old bonds cannot be paid off until a future call date, the municipality can still obtain a benefit from lower interest rates through an advance refunding. An advance refunding can lock in current interest rates and ensure that the municipality will realize debt service savings over the life of the new bonds.
In an advance refunding, the municipality issues new "refunding" bonds and immediately invests the proceeds in a portfolio of U.S. Treasury or agency securities structured to pay the principal and interest obligations on the old bonds until the call date and then to pay off the outstanding principal and any call premium. The portfolio of government securities is normally placed in a defeasance escrow to guarantee repayment of the old bonds.
Defeasance escrow portfolios are subject to Internal Revenue Code provisions and Treasury regulations that prohibit the issuer of tax-exempt refunding bonds from earning tax arbitrage (that is, a profit from the rate differential between the taxable and tax-exempt markets). 1 I.R.C. § 148; Treas. Reg. §§1.148-0 et seq. The regulations provide that the issuer cannot receive a yield on the securities held in escrow that exceeds the yield it pays on the refunding bonds. In addition, to prevent an issuer from diverting tax arbitrage to the seller of the escrow securities by paying artificially high prices, the regulations provide, in effect, that the price paid by refunding bond issuers for escrow securities purchased in the secondary market (known as "open market securities") cannot exceed the fair market value or market price of the securities as defined in those regulations. 2
When the yield on the investments in the escrow, if purchased at fair market value, would be below the yield on the refunding bonds, the transaction is said to be in "negative arbitrage." Overcharging by dealers for open market escrow securities in a negative arbitrage transaction takes money away from the municipality by reducing, dollar for dollar, the present value savings the municipality obtains through the advance refunding, but it does not involve any diversion of tax arbitrage. 3
D. Lazard Failed to Make Required Disclosures to Passaic Valley
In mid-1992, Lazard proposed to Passaic Valley that it undertake an advance refunding to achieve debt service savings, with Lazard as its financial advisor. Passaic Valley accepted Lazard's proposal. Under the parties' written agreement, Lazard was to perform financial advisory services in connection with Passaic Valley's refunding. In exchange for those services Lazard was to receive a fee of one dollar for every one thousand dollars of principal amount of bonds issued by Passaic Valley. The agreement listed certain services that Lazard would perform "as requested by [Passaic Valley]," including the providing of government securities to fund the escrow for the refunded bonds.
As is often the case in municipal bond transactions, the sale date and closing date of Passaic Valley's $191,535,000 refunding bond offering were several weeks apart. Both the bonds and the escrow securities were priced on the sale date, November 19, 1992, but not delivered until the closing date nearly a month later. The refunding portion of the issue required Passaic Valley to purchase a portfolio of Treasury securities costing nearly $140 million. Lazard sold the Treasury securities to Passaic Valley as principal from Lazard's own account. Lazard priced the Treasury securities without any discussion with Passaic Valley.
Passaic Valley's personnel had no prior experience with refundings or purchasing Treasury notes or bonds. They relied on Lazard to provide financial expertise and to represent Passaic Valley's economic interests in the refunding. Lazard explained little about the escrow securities transaction to Passaic Valley personnel. There is no evidence that Passaic Valley was aware that Lazard would make a profit on the securities. 4 Nor is there evidence that anyone at Passaic Valley was aware until several weeks after the sale date that Lazard would sell the securities to Passaic Valley from Lazard's own account. On or about December 7, 1992, bond counsel sent Passaic Valley a copy of a draft escrow deposit agreement that noted, among other things, that the escrow securities were being purchased from Lazard. Also, on December 10, 1992, Lazard provided Passaic Valley with a memorandum stating that the Treasury securities would be purchased from Lazard. On the refunding's closing date, December 17, 1992, Lazard provided a letter stating that it had sold the escrow securities to Passaic Valley and that "the prices at which [Lazard] sold the Escrow securities were equal to the fair market value of such Escrow Securities obtained in an arm's length transaction." In turn, Passaic Valley certified that it had acquired the escrow securities "at arm's length, fair market value prices based on representations made by Lazard Frères & Co. as set forth in [Lazard's December 17 letter]." Lazard subsequently collected $191,535 in financial advisory fees from Passaic Valley under the financial advisory agreement.
E. Lazard Sold Treasury Securities to Passaic Valley at Excessive, Undisclosed Markups
Lazard received an additional $685,000 from the markups charged on, and carry received from, the sale of the escrow securities to Passaic Valley. 5 Lazard did not disclose this profit to Passaic Valley. Because the Passaic Valley refunding was a negative arbitrage transaction, all profit made by Lazard on the escrow securities reduced dollar-for-dollar Passaic Valley's debt service savings on the refunding. Under the Treasury regulations, Passaic Valley could have purchased escrow investments for approximately $727,000 less than the prices charged by Lazard and still complied with the yield restrictions. Therefore, Passaic Valley could have retained the benefit of purchasing the securities at lower prices.
Lazard's markup and carry on the transaction was approximately one half of one percent of the prevailing interdealer market prices of the Treasury securities sold to Passaic Valley. At the time, other dealers generally charged materially lower markups on escrow securities when the prices were determined through competition or bona fide arm's length negotiation. Under the facts and circumstances, Lazard's prices were above fair market value as defined by federal tax laws.
III. Section 17(a) of the Securities Act prohibits materially false or misleading statements, or material omissions when there is a duty to speak, in the offer or sale of any security. Section 17(a)(1) requires a showing of scienter; however, Sections 17(a)(2) and 17(a)(3) do not require such a showing. Aaron v. SEC, 446 U.S. 680, 697 (1980). Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit materially false or misleading statements, or material omissions when there is a duty to speak, made with scienter, in connection with the purchase or sale of any security. Both knowing and reckless conduct satisfy the scienter element. See, e.g., Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990). A duty to speak arises, and material omissions become fraudulent, when a person or entity has information that another is entitled to know because of a fiduciary or similar relationship of trust and confidence. See Affiliated Ute Citizens v. United States, 406 U.S. 128, 153-55 (1972); Chiarella v. United States, 445 U.S. 222, 228 (1980); In re Arleen W. Hughes, 27 S.E.C. 629 (1948), aff'd sub nom. Hughes v. SEC, 174 F.2d 969 (D.C. Cir. 1949).
A. Material Omissions in Connection with the Sale of Securities to Passaic Valley
Generally, a municipality's financial advisor owes fiduciary obligations to it in connection with bond financings by the municipality. 6 In addition, under New Jersey state law, a fiduciary relationship arises when one person is under a duty to give advice for the benefit of another on matters within the scope of their relationship and the advisor occupies a dominant position over the other. 7 Passaic Valley had no expertise or experience in advance refundings or purchasing Treasury bonds and notes. Instead, Passaic Valley relied on Lazard, as its financial advisor, to serve its interests in all aspects of the refunding, including the purchase of escrow securities. Therefore, based on the facts and circumstances, Lazard had a fiduciary or similar relationship of trust and confidence with Passaic Valley.
Courts have imposed on a fiduciary affirmative duties of utmost good faith, and full and fair disclosure of all material facts, as well as an affirmative obligation to employ reasonable care to avoid misleading its client. SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963). A broker-dealer that seeks to sell securities from its own account, as principal, to a client to whom it owes fiduciary duties must follow well-established standards. Under both common law and federal securities law, the broker-dealer can only deal with its fiduciary client as a principal by making full disclosure(before entering into the transaction(of the nature and extent of any adverse interest that the broker-dealer may have with the client. See In re Arleen W. Hughes, 27 S.E.C. at 635-36; Restatement (Second) of Agency § 390 (1958). This standard requires disclosure of more than the fact that the broker-dealer will act as principal in the transaction. See, e.g., In re R.H. Johnson & Co., 36 S.E.C. 467 (1955), aff'd, 231 F.2d 523 (D.C. Cir. 1956); Norris & Hirshberg, Inc. v. SEC, 177 F.2d 228, 233 (D.C. Cir. 1949) (holding that a broker-dealer that sent a fiduciary client confirmations stating that it acted as principal in certain transactions nevertheless violated the anti-fraud provisions by failing to disclose its capacity as principal rather than agent at the time of the transaction). A broker-dealer subject to fiduciary obligations must disclose all material facts, including any current market price at which the customer could effect the transaction that is better than the price that the dealer intends to provide to the customer. See, e.g., Off Board Trading Restrictions, Exchange Act Rel. No. 13662, text accompanying notes 113-116 (June 23, 1977).
Lazard violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder when it failed to obtain Passaic Valley's fully informed consent before engaging in the escrow securities transaction as principal. Lazard failed to disclose "in a manner that its client would be sure to understand"(1) that it would sell the escrow securities to Passaic Valley from Lazard's own account, and (2) the nature and extent of its actual and apparent conflicts of interest. Under the circumstances, Lazard had, at a minimum, an obligation to investigate whether another seller would have provided the securities to Passaic Valley at better prices, and to disclose to Passaic Valley the results of that investigation.
B. Material Misrepresentations and Omissions in the Sale of Securities to Passaic Valley
As to the pricing of the escrow securities sold to Passaic Valley, Lazard violated Sections 17(a)(2) and 17(a)(3) of the Securities Act by effecting that transaction at prices not reasonably related to the current wholesale market prices for the securities under the particular facts and circumstances, including the pertinent tax regulations, and by representing to Passaic Valley that Lazard had sold the securities at fair market value. See, e.g., Grandon v. Merrill Lynch & Co., 147 F.3d 184, 192 (2d Cir. 1998) (under
the shingle theory, a broker-dealer has a duty to disclose excessive markups); In re Lehman Bros. Inc., 62 SEC Dkt. at 2330-31; In re Duker & Duker, 6 S.E.C. 386, 389 (1939). Lazard's markup and carry on the transaction was approximately one half of one percent of the prevailing interdealer market prices of the Treasury securities sold to Passaic Valley. Based on all the relevant facts and circumstances, Lazard knew
or should have known that the prices it charged were not reasonably related to the prevailing wholesale market prices of the securities. The excessive markups operated as a fraud or deceit because unbeknownst to Passaic Valley the excessive markups reduced the savings available to Passaic Valley from the refunding.
IV. On the basis of this Order and Lazard's offer of settlement, the Commission finds that Lazard willfully violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5.
V. Accordingly, IT IS ORDERED, pursuant to Section 8A of the Securities Act and Sections 15(b)(4), 15B(c)(2), and 21C of the Exchange Act, that:
A. Lazard is censured;
B. Lazard shall cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder;
C. Within ten days of the entry of the Order, Lazard shall, by a postal or bank money order, certified check or bank cashier's check, pay disgorgement of $272,759 and prejudgment interest of $174,615 to the Passaic Valley Sewerage Commissioners in connection with a refunding that settled on December 17, 1992;
D. Within ten days of the entry of the Order, Lazard shall comply with its undertaking to make the following payments related to other sales of escrow securities: $305,421 to the City of Pittsburgh in connection with the advance refunding that settled on April 1, 1993; $1,355,719 to the Municipality of Seattle in connection with the advance refundings that settled on August 27, 1992, March 23, 1993, July 1, 1993, and September 8, 1993; $1,221,995 to the City of Indianapolis Public Improvement Bond Bank in connection with the advance refunding that settled on December 3, 1992; and $218,240 to the City of Indianapolis in connection with the advance refunding that settled on March 11, 1993;
E. Lazard shall comply with its undertaking to pay $7,451,251 to the United States Treasury under an agreement simultaneously entered into among Lazard, the Internal Revenue Service and the United States Attorney for the Southern District of New York; and
F. Copies of payments made to the municipalities and the United States Treasury as described in sub-paragraphs C, D and E above and any cover letters accompanying them shall be sent by Lazard to Lawrence A. West, Branch Chief, Division of Enforcement, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0806.
By the Commission.
In re Leifer Capital, Inc., Jeffrey Leifer, and David Leifer, Securities Act Release No. 7630, A.P. File No. 3-9810 (January 14, 1999).
I. The Securities and Exchange Commission ("Commission") deems it appropriate that a public cease-and-desist proceeding be and hereby is instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") against Leifer Capital, Inc. ("Leifer Capital"), Jeffrey Leifer, and David Leifer (collectively, the Leifers").
II. In anticipation of the institution of this proceeding, the Leifers have submitted Offers of Settlement, which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, and without admitting or denying the findings contained herein, except that the Leifers admit the jurisdiction of the Commission over them and over the subject matter of this proceeding, the Leifers, by their Offers of Settlement, consent to the entry of this Order Instituting a Public Cease-And-Desist Proceeding Pursuant to Section 8A of the Securities Act of 1933, Making Findings, and Imposing Cease-and-Desist Order ("Order") and to the entry of the findings and the cease-and-desist order set forth below.
Accordingly, IT IS HEREBY ORDERED that a proceeding pursuant to Section 8A of the Securities Act be, and hereby is, instituted.
III. On the basis of this Order and the Offers of Settlement submitted by the Leifers, the Commission finds that: 8
A. Respondents
1. Leifer Capital, Inc. ("Leifer Capital") is a California corporation and was the issuers' Financial and Marketing Specialist ("marketing specialist") for seven note offerings (the "Note Offerings") related to the County of Orange ("Orange County" or the "County") Investment Pools (the "Pools") that raised a total of $1.125 billion. Leifer Capital, among other things, participated in preparing the official statements (the "Official Statements") for the Note Offerings.
2. Jeffrey Leifer, since 1989, has been the sole owner and President of Leifer Capital. Jeffrey Leifer, with his brother David Leifer, represented Leifer Capital in the Note Offerings.
3. David Leifer is Jeffrey Leifer's brother and, since 1993, has been employed by Leifer Capital as a Vice-President. David Leifer also represented Leifer Capital in the Note Offerings.
B. FACTS
1. Introduction
Leifer Capital was the issuers' marketing specialist for the Note Offerings. The Official Statements for the Note Offerings, which the Leifers participated in drafting, omitted material facts about the Pools' investment strategy, the risks of that strategy, and the Pools' investment losses. Accurate and complete disclosure about the Pools was material to investors because these matters affected the issuers' ability to repay the Notes, as the funds pledged to repay the Notes were invested in the Pools and three of the offerings were conducted for the purpose of reinvesting the offering proceeds for profit. In addition, in two other Note Offerings, the Pools guaranteed repayment of the Notes.
2. The Orange County Investment Pools
The Pools operated as an investment fund managed by the Orange County Treasurer-Tax Collector (the "Treasurer"), in which the County and various local governments or districts (the "Participants") deposited public funds. As of December 6, 1994, the Pools held approximately $7.6 billion in Participant deposits, which the County had leveraged to an investment portfolio with a book value of over $20.6 billion.
a. The Pools' Investment Strategy
From at least April 1992 until December 1994, the Treasurer's investment strategy for the Pools involved: (1) using a high degree of leverage by obtaining funds through reverse repurchase agreements on a short-term basis (less than 180 days); and (2) investing the Participants' deposits and funds obtained through reverse repurchase agreements in debt securities (issued by the United States Treasury, United States government sponsored enterprises, and highly-rated banks and corporations) with a maturity of two to five years, many of which were derivative securities. The Pools' investment return was to result principally from the interest received on the securities in the Pools. Leverage enabled the Pools to purchase more securities with the anticipation of increasing interest income. This strategy was profitable as long as the Pools were able to maintain a positive spread between the long-term interest rate received on the securities and the short-term interest rate paid on the funds obtained through reverse repurchase agreements.
b. The Pools' Portfolio
During 1993 and 1994, the Treasurer, using reverse repurchase agreements, leveraged the Participants' deposits to amounts ranging from 158% to over 292%. As of the end of June 1994, the Pools held $19.8 billion in securities, with approximately $7.2 billion in Participant deposits and about $12.6 billion in reverse repurchase agreements, resulting in leverage of about 274%.
During 1993 and 1994, the amount of derivatives in the Pools' portfolio ranged from 27.6% to 42.2% of the portfolio. As of the end of June 1994, 38.2% of the Pools' securities were derivatives. Most of the Pools' derivative securities were inverse floaters, which paid interest rates inversely related to the prevailing interest rate. From January 1993 through November 1994, 24.89% to 39.84% of the Pools' portfolio consisted of inverse floaters. As of the end of June 1994, 35% of the Pools' portfolio was invested in inverse floaters. From January 1993 through November 1994, only 1.84% to 5.59% of the Pools' portfolio consisted of securities that paid interest rates directly related to the prevailing interest rate (variable rate securities) or securities that paid interest rates that rose at certain stated intervals to certain stated rates (step-up securities). As of the end of June 1994, about 3.17% of the Pools' portfolio was invested in variable and step-up securities.
c. The Pools' Sensitivity To Interest Rate Changes And The Rise In Interest Rates During 1994
The composition of the Pools' portfolio made it sensitive to interest rate changes. As interest rates rose, the market value of the Pools' securities fell, and the interest received on the Pools' inverse floaters also declined. Thus, the Treasurer's investment strategy was profitable so long as interest rates, including the cost of obtaining funds through reverse repurchase agreements, remained low, the market value of the Pools' securities did not decline, and the Pools had the ability to hold securities to maturity.
From April 1992 through 1993, U.S. interest rates remained low and relatively stable. Due to the low interest rates and the Pools' investment strategy, the Pools earned a relatively high yield of approximately 8%. Beginning in February 1994, interest rates began to rise. This rise in interest rates resulted in: (1) an increase in the cost of obtaining funds under reverse repurchase agreements; (2) a decrease in the interest income on inverse floaters; (3) a decrease in the market value of the Pools' debt securities; (4) collateral calls and reductions in amounts obtained under reverse repurchase agreements; and (5) a decrease in the Pools' yield.
d. Orange County's Bankruptcy
By early December 1994, the Pools had an unrealized decline in market value of about $1.5 billion. Shortly thereafter, on December 6, 1994, Orange County filed Chapter 9 bankruptcy petitions on behalf of itself and the Pools (the petition filed on behalf of the Pools was later dismissed). Between early December 1994 and January 20, 1995, the Pools' securities portfolio was liquidated, incurring a loss of almost $1.7 billion on the Participants' deposits of $7.6 billion, a 22.3% loss.
3. The Note Offerings
In July and August 1994, Leifer Capital, through Jeffrey Leifer and David Leifer, was the marketing specialist to Orange County, the Orange County Flood Control District (the "Flood Control District"), and the Placentia-Yorba Linda Unified School District ("Placentia USD") in connection with and for purposes of their seven offerings of municipal securities that raised a total of $1.125 billion. 9
a. The Taxable Note Offerings
Orange County, the Flood Control District, and Placentia USD raised $750 million through three offerings of taxable notes (the "Taxable Note Offerings") in 1994. The issuers conducted these offerings for the purpose of generating an anticipated profit by reinvesting the proceeds (together with funds equal to the estimated interest on the notes) in the Pools to earn an investment return that would be higher than the rate of interest payable to the Taxable Note investors. The issuers pledged these invested funds to secure repayment of the Taxable Notes, and, if the pledged funds were insufficient to pay principal and interest, the issuers would satisfy any deficiency with other moneys lawfully available to repay the notes in the respective issuer's general fund attributable to the fiscal year in which the notes were issued.
The County issued $600 million in notes (the "$600 Million Taxable Notes") on July 8, 1994, described in an Official Statement dated July 1, 1994. These notes earned a variable interest rate reset monthly at the one-month London Interbank Offered Rate ("LIBOR") not to exceed 12% per annum. The $600 Million Taxable Notes were originally due on July 10, 1995. On June 27, 1995, the County and the noteholders entered into Rollover Agreements under which the maturity of the notes was extended from July 10, 1995, to June 30, 1996, and the interest rate paid on the notes was increased. On June 12, 1996, as part of its emergence from bankruptcy, the County repaid the notes with a portion of the proceeds from another County municipal securities offering.
On August 2, 1994, the Flood Control District issued $100 million in notes (the "$100 Million Taxable Notes") described in an Official Statement dated July 27, 1994. These notes earned a variable interest rate reset monthly at the one-month LIBOR plus .03% not to exceed 12% per annum. The notes matured, and were repaid, on August 1, 1995.
On August 25, 1994, Placentia USD issued $50 million in notes (the "$50 Million Taxable Notes") described in an Official Statement dated August 19, 1994. The notes matured, and were repaid, on August 24, 1995.
b. The TRAN Offerings
In 1994, the County conducted two tax and revenue anticipation note ("TRAN") offerings (the "TRAN Offerings") to raise a total of $200 million to fund its expected cash flow deficits, as it received revenue infrequently throughout the fiscal year but had constant working capital expenses. The Official Statements for these offerings represented that: the County would pledge certain anticipated revenues to pay the notes' principal and interest; the revenue, when received, would be placed into a repayment account; the funds in the repayment account would be invested; and if the County lacked sufficient funds in the repayment account to repay the notes, the County would satisfy any deficiency from other moneys received or accrued during the fiscal year in which the notes were issued and lawfully available for repayment of the notes.
The County issued $169 million in TRANs (the "$169 Million TRANs") on July 5, 1994, described in an Official Statement dated June 27, 1994, and $31 million in tax-exempt TRANs (the "$31 Million TRANs") on August 11, 1994, described in an Official Statement dated August 5, 1994. The $169 Million TRANs and $31 Million TRANs were originally due on July 19, 1995 and August 10, 1995, respectively. On June 27, 1995, the County and the noteholders entered into Rollover Agreements under which the maturity of the TRANs was extended to June 30, 1996. On June 12, 1996, as part of its emergence from bankruptcy, the County repaid the TRANs with a portion of the proceeds from another County municipal securities offering.
c. The Teeter Note Offerings
In 1994, Orange County conducted two offerings of Teeter Notes (the "Teeter Note Offerings"). The purpose of these offerings was to fund the County's Teeter Plan, an alternate method of property tax distribution whereby the County pays local taxing entities (such as school districts) their share of property taxes upon levy rather than actual collection and the County retains all property taxes, and the penalties and interest thereon, upon collection.
The first Teeter Note Offering was conducted on July 20, 1994, for $111 million (the "$111 Million Teeter Notes"). These notes were described in an Official Statement dated July 13, 1994. These notes earned a variable interest rate reset monthly at one-month LIBOR not to exceed 12% per annum. The second Teeter Note Offering was conducted on August 18, 1994, for $64 million (the "$64 Million Teeter Notes"). These notes were described in an Official Statement dated August 12, 1994. These notes earned a variable interest rate reset monthly at 70% of one-month LIBOR not to exceed 12% per annum. The $111 Million and $64 Million Teeter Notes matured, and were repaid, in part with proceeds from a June 30, 1995 Teeter bond offering.
The Official Statements for the Teeter Note Offerings represented that the County planned to deposit certain delinquent tax payments, penalties, and interest collections in accounts pledged to repay the Teeter Notes and to then invest those funds in the Pools. The Official Statements for the Teeter Note Offerings represented that the County anticipated that the funds in the repayment account would not be sufficient to pay the principal and interest on the Teeter Notes at maturity and that the County estimated that, at maturity of the Teeter Notes, approximately $70 million would be available in the repayment account to pay the principal and interest on the $175 million in Teeter Notes. The Official Statements further represented that this anticipated deficiency in the repayment account would be satisfied from moneys received under Standby Note Purchase Agreements, which agreements obligated the Treasurer (as "fund manager" of the Pools) to purchase the Teeter Notes, and from other moneys lawfully available to the County for repayment from revenues received or attributable to the fiscal year in which the notes were issued.
4. The Leifers' Role In The Note Offerings
Leifer Capital was the issuers' marketing specialist for the Note Offerings. In this capacity, the Leifers assisted the issuers in negotiating the interest rate on the Notes and the underwriters' fees or discounts. Leifer Capital, through Jeffrey Leifer and David Leifer, also participated with other participants in the Note Offerings in the preparation of the Official Statements for all of the Note Offerings and communicated with the other participants to ensure that the transactions remained on schedule. 10
5. The Omissions
a. The Pools' Investment Strategy
The disclosure in the Official Statements for the Note Offerings regarding the Pools' investment strategy was misleading because it failed to disclose material information, including: (1) the Pools' investment strategy was predicated upon the assumption that prevailing interest rates would remain at relatively low levels; (2) the Pools' use of leverage through reverse repurchase agreements was constant, high, and a major part of the Pools' investment strategy; and (3) the Pools had a substantial investment in derivative securities, particularly inverse floaters.
b. The Risks Of The Pools' Investment Strategy
The disclosure in the Official Statements regarding the risks of the Pools' investment strategy was misleading because it omitted material information about the Pools' sensitivity to rises in interest rates. Specifically, the Official Statements failed to disclose that because of the Pools' high degree of leverage and substantial investment in inverse floaters, rising interest rates would have a negative effect on the Pools, including: (1) the Pools' cost of obtaining funds under reverse repurchase agreements would increase; (2) the Pools' interest income on the inverse floaters would decrease; (3) the Pools' securities would decline in market value; (4) as the value of the securities fell, the Pools would be subject to collateral calls and reductions in amounts obtained under reverse repurchase agreements; (5) the Pools' earnings would decrease; (6) the Pools would suffer losses of principal at certain interest rate levels; and (7) if the Pools' began to suffer lower earnings or losses of principal, certain Participants could withdraw their invested funds, leaving the County and other Participants such as the Flood Control District who were required to deposit their funds with the Treasurer to absorb any losses.
c. The Pools' Investment Results
The disclosure in the Official Statements regarding the Pools' historic investment results was misleading because it omitted material information regarding the Pools' investment results during the first half of 1994 when interest rates were rising. Specifically, the Official Statements omitted to disclose that as a result of rising interest rates in 1994, the market value of the Pools' securities was declining, the Pools were subject to collateral calls and reductions in amounts obtained under reverse repurchase agreements, and the Pools' costs of obtaining funds under reverse repurchase agreements were increasing.
6. The Leifers' Knowledge Of Or Access To Information About The Pools And Their Participation In The Drafting Of The Disclosure
While assisting in the preparation of the Official Statements, the Leifers received, had access to, or could have sought to discover information concerning the Pools' investment strategy, the risks of that strategy, and the Pools' recent investment results. The Leifers, however, did not adequately assure that this information about the Pools was disclosed in the Official Statements.
a. March 1994 Meetings
In late March 1994, Jeffrey Leifer, David Leifer and others participating in preparing the Official Statements for the Note Offerings met with the rating agencies and two potential institutional investors in New York City to discuss the upcoming Note Offerings. During the meetings, the rating agencies and the potential investors questioned a County official about the Pools and the effect the recent rise in interest rates had had on the Pools. The official responded that the Pools used leverage through reverse repurchase agreements and invested in derivative securities, including inverse floaters. The official also stated that the County would continue to pursue a "buy and hold" investment strategy and that the Pools had liquidity to meet its needs.
b. The Media Coverage Of the Pools
From January 31 through June 30, 1994, articles appeared in the media regarding the Pools. The articles reported that the Treasurer admitted that: he used reverse repurchase agreements to leverage the Pools' $7.5 billion in deposits to $19.5 billion in investments; 20% of the $19.5 billion portfolio was invested in derivative securities; his strategy was to borrow short-term and invest in medium-term securities; the value of the Pools' portfolio had "been hit by rising interest rates"; and as a result of rising interest rates and the declining market value of the Pools' securities, the County had recently experienced up to $300 million in collateral calls under reverse repurchase agreements. These articles also reported that the County's portfolio had suffered a decline in market value of "an estimated $1.2 billion" and that many believed that the investment strategy was too risky for public funds and exposed the Pools to very large losses. Press coverage also noted that the rating agencies that reviewed and rated the Note Offerings did not have any major concerns about the Pools' financial condition and investment strategy. Jeffrey Leifer and David Leifer read at least one of the articles discussed above, and Jeffrey Leifer was aware of other articles published about the Pools.
c. The Adoption Of, And Changes To, The Disclosure In A Prior Offering
As a result of the media coverage and the rating agency's questions regarding the Pools and in an effort to improve the issuers' disclosure regarding the Pools, David Leifer obtained and reviewed a copy of the Official Statement for a 1993 taxable note offering conducted by another local government located in Southern California (the "Prior Offering"). The Official Statement for the Prior Offering contained disclosure regarding the issuer's investment pool (the "Prior Pool"). The Leifers circulated the relevant portions of the Prior Offering to others participating in drafting and reviewing the Official Statements and recommended that it be used in the Note Offerings as a template for disclosure regarding the Pools.
On June 17, 1994, the County, after discussion with David Leifer and with other professionals participating in drafting the Official Statements, including disclosure counsel and bond counsel, determined to revise the disclosure about the Pools to be similar to the Prior Pool disclosure. Indeed, much of the disclosure in the Official Statements for the Note Offerings was copied directly from the Official Statement for the Prior Offering. The County, however, in consultation with David Leifer and with others who participated in drafting the Official Statements, including disclosure counsel and bond counsel, made some critical changes to the disclosure in the Prior Offering for use in the Note Offerings. The changes to the disclosure principally related to the Pools' reverse repurchase position and derivative holdings. The Leifers were aware of these changes and did not object to them.
First, with respect to reverse repurchase agreements, both offerings stated that "[f]rom time to time" the pools engaged in reverse repurchase transactions. The Prior Offering, however, disclosed that the Prior Pool had engaged in no reverse repurchase agreements as of the end of the prior quarter and that the maximum amount of the Prior Pool's portfolio that could be pledged under reverse repurchase agreements was 25%. In contrast, the Note Offerings only disclosed that "a significant portion" of the Pools' securities were pledged under reverse repurchase agreements but did not disclose that the Pools were leveraged by about 274% and that the Pools' investment strategy was based on such leverage. Second, with respect to derivative investments, the Prior Offering specifically disclosed the dollar amount of derivative securities held by the pool and the structure of the derivatives. In contrast, the Note Offering only disclosed the Pools' investment in fixed and floating rate securities but did not specifically disclose the Pools' dollar investment in inverse floaters.
C. LEGAL DISCUSSION
1. The Leifers Violated Sections 17(a)(2) And (3) Of The Securities Act In The Offer And Sale Of The Notes
Sections 17(a)(2) and (3) of the Securities Act make it unlawful for any person, through the means or instruments of interstate commerce or the mails, in the offer or sale of any security:
(2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or (3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.
Scienter is not required to prove violations of Sections 17(a)(2) or (3) of the Securities Act. Aaron v. SEC, 446 U.S. 680, 697 (1980). Violations of these sections may be established by showing negligence. SEC v. Hughes Capital Corp., 124 F.3d 449, 453-54 (3d Cir. 1997); SEC v. Steadman, 967 F.2d 636, 643 n.5 (D.C. Cir. 1992). Accordingly, the Leifers, through negligent conduct, violated Sections 17(a)(2) and (3) of the Securities Act in the offer and sale of the Notes.
a. The Omissions Were Material
Information about the Pools' investment strategy, the risks of that strategy, and the Pools' declining investment results was material to the Note investors. Information is material if there is a substantial likelihood that a reasonable investor in making an investment decision would consider it as having significantly altered the total mix of information made available. See Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).
Accurate and complete disclosure about the Pools was material to investors because it affected the sources of repayment for the Notes. In particular, in all of the Note Offerings, the funds pledged to repay the securities were invested in the Pools, and, in the two of Teeter Note Offerings, the Pools guaranteed repayment of the securities.
b. The Leifers Should Have Known That The Official Statements Were Materially Misleading
The Leifers, as the marketing specialist to the issuers of the Note Offerings, participated in drafting the disclosure in the Official Statements that omitted material information about the Pools. The Leifers also knew, had access to information from which they could have known, or reasonably should have known material information about the Pools. From participating in drafting the Official Statements, the Leifers reasonably should have known that the Official Statements omitted to disclose material information that they knew or reasonably should have known about the Pools.
2. Conclusion
Accordingly, based on the foregoing, the Commission finds that the Leifers violated Sections 17(a)(2) and (3) of the Securities Act.
IV. The Leifers have submitted Offers of Settlement in which, without admitting or denying the findings herein, they consent to the Commission's entry of this Order, which: (1) makes findings, as set forth above; and (2) orders the Leifers to cease and desist from committing or causing any violations and any future violations of Sections 17(a)(2) and (3) of the Securities Act. As set forth in the Offers of Settlement, the Leifers undertake to continue to cooperate with Commission staff in preparing for and presenting any civil litigation or administrative proceedings against others concerning the transaction that is the subject of this Order.
V. In view of the foregoing, the Commission deems it appropriate to accept the Offers of Settlement submitted by the Leifers. Accordingly, IT IS HEREBY ORDERED that, pursuant to Section 8A of the Securities Act, Leifer Capital, Jeffrey Leifer, and David Leifer shall, effective immediately, cease and desist from committing or causing any violation and any future violation of Sections 17(a)(2) and (3) of the Securities Act.
In re O'Brien Partners, Inc., Securities Act Release No. 7594, Investment Advisers Act Release No. 1772, A.P. File No. 3-9761 (October 27, 1998).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be, and they hereby are, instituted pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940 ("Advisers Act), and Section 8A of the Securities Act of 1933 ("Securities Act") against O'Brien Partners, Inc. ("O'Brien Partners" or the "Respondent").
II. In anticipation of the institution of these administrative proceedings, the Respondent has submitted an Offer of Settlement for the purpose of disposing of the issues raised in these proceedings. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, the Respondent, without admitting or denying the findings set forth herein, except that it admits to the jurisdiction of the Commission over it and over the subject matter of these proceedings, consents to the entry of the findings and to the issuance of this Order Instituting Proceedings ("Order").
III. On the basis of this Order and the Respondent's Offer of Settlement, the Commission finds the following:
A. RESPONDENT
O'Brien Partners, whose offices are located in New York and Los Angeles, was incorporated in November 1987, and was registered with the Commission as an investment adviser during all relevant periods. O'Brien Partners served as an investment adviser, as well as a financial advisor11 to state and local government agencies on a variety of matters, including bond transactions and refundings, and the investment of bond proceeds. O'Brien Partners withdrew its registration with the Commission in March 1996.
B. OTHER RELEVANT ENTITIES AND PERSON
OBP Municipals Corporation ("OBPM"), an affiliate of and under common control with O'Brien Partners, was registered with the Commission as a broker-dealer during all relevant periods, and received nine of the ten third-party payments that are discussed below. OBPM withdrew its registration with the Commission on March 10, 1997, and the company was dissolved on July 15, 1997.
Pacific Matrix Financial Group, Inc. ("Pacific Matrix") acted as a finder of investments for bond proceeds, including guaranteed investment contracts ("GICs") and other complex investment vehicles during all relevant periods. A Pacific Matrix vice president, Christopher Winters ("Winters"), left Pacific Matrix in late 1992, along with a colleague, to form Feld Winters Financial Inc. ("Feld Winters"), which also acted as a finder of investments for bond proceeds. In instances in which it successfully brokered agreements that were used for the investment of bond proceeds, Pacific Matrix and Feld Winters generally received a commission equal to the maximum allowable commission calculated in accordance with the five basis point formula set forth in the applicable tax regulations. In 1991, Pacific Matrix, through Winters, began an arrangement that led to its sharing with O'Brien Partners approximately 50 percent of the commissions that Pacific Matrix received for brokering investment agreements used by O'Brien Partners' clients to invest bond proceeds. Winters and O'Brien Partners continued this practice when Winters left Pacific Matrix to form Feld Winters.
C. FACTS
1. Summary
This case concerns O'Brien Partners' failure adequately to disclose to its municipal advisory clients that it had arranged to obtain a portion of the commissions paid to the broker involved in the placement of interim investments of the proceeds of O'Brien Partners' clients' bond offerings. O'Brien Partners, directly or through OBPM, received approximately $450,000 in ten third-party payments in connection with investments by four municipal bond issuers from August 1991 through November 1993. Although there is no evidence that the payments directly affected the cost of those investments to O'Brien Partners' clients, the payments created at least a potential conflict of interest for O'Brien Partners in discharging its duty to provide impartial advice to its clients concerning the choice of the fee-sharing broker to handle investments for the issuers' bond proceeds. O'Brien Partners thus breached its fiduciary duty to its clients to disclose all actual or potential conflicts of interest by not adequately disclosing fees it shared in handling investments for the issuer's bond proceeds. After considering legal advice that it solicited in late 1991, O'Brien Partners decided that disclosure should be made, and took certain steps to implement that decision, but those steps were not effective. In addition, amendments and annual supplements to O'Brien Partners' Form ADV filed with the Commission failed to disclose O'Brien Partners' receipt of such payments as additional compensation. Additionally, O'Brien Partners failed to provide either a copy of Part II of its Form ADV or a document containing the information required in Part II to its advisory clients, as required by the Advisers Act.
2. Background
In its role as financial advisor to municipalities, O'Brien Partners offers a range of services, the precise scope of which varies from engagement to engagement depending on the bond offering and client. O'Brien Partners typically assists in preparing the preliminary official statement, and may assist the issuer in selecting and/or negotiating with the underwriter. O'Brien Partners also, among other things, advises the issuer on the optimum time to issue bonds to minimize interest costs; attends the signing of the bond purchase agreement; and assists in the preparation of the Official Statement and the formal signing and delivery of the bonds.
During the period relevant to this Order, O'Brien Partners also advised clients in their investments of bond proceeds in securities, consistent with the limitations thereon as generally described in the bond issue indenture or bond resolution. 12In such instances, O'Brien Partners identified appropriate investment vehicles, solicited potential investment providers, prepared and disseminated bid forms, and collected and evaluated the bids. At times, O'Brien Partners used Winters as a broker to assist in various aspects of the process.
3. O'Brien Partners Begins Receiving A Split Of Brokerage Commissions Without Notice to its Client
In August 1991, O'Brien Partners accepted its first payment from Pacific Matrix in connection with a reinvestment transaction. The payment occurred in a transaction involving the Wisconsin Public Power Inc. System ("Wisconsin"), for whom O'Brien Partners served as financial advisor for bond offerings in 1990 and 1991 and subsequent investments of bond proceeds used for reserve funds. 13 The 1990 bond issue of approximately $113 million was Wisconsin's first bond offering ever, and Wisconsin looked to O'Brien Partners for special guidance concerning the offering and investment of proceeds in securities, including repurchase agreements, consistent with the limitations in the bond offering documents or bond resolution. As part of the transaction, O'Brien Partners used Pacific Matrix to broker the investment agreement for the approximately $9.4 million held in the debt service reserve fund. Pacific Matrix and O'Brien Partners entered into an arrangement whereby Pacific Matrix would pay 50 percent of its resulting commission to O'Brien Partners. At O'Brien Partners' recommendation, Wisconsin entered into a repurchase agreement with the winning bidder, Mitsui Taiyo Kobe Global Capital Inc. ("MTK"). MTK paid a $68,000 commission to Pacific Matrix, which wrote a check dated August 22, 1991 made payable to O'Brien Partners in the amount of $34,000. 14
The O'Brien Partners employee responsible for the Wisconsin offerings asked John O'Brien, the President of O'Brien Partners, whether he should notify Wisconsin of the Pacific Matrix payment. The O'Brien Partners employee stated that John O'Brien replied that he believed that notice wasn't necessary because the client was getting the best price available after receiving at least three bids and the fee was being paid not by the client but by the third-party provider. Accordingly, O'Brien Partners did not disclose that payment to Wisconsin. O'Brien Partners' invoice to Pacific Matrix incorrectly described the services for which payment was sought (i.e., a share of the commissions that Pacific Matrix was receiving from MTK) as "Professional Services" related to "Tax Exempt Market Information Pertaining to Municipal Issues Debt Service Reserve Fund Investments."
O'Brien Partners also advised Wisconsin with respect to its July 1991 bond offering of approximately $42 million and the subsequent investment of bond proceeds for the reserve fund. As with the previous transaction, Wisconsin relied on O'Brien Partners' expertise with respect to the investment of proceeds in securities, including repurchase agreements. At O'Brien Partners' request, Pacific Matrix brokered a repurchase agreement to invest moneys from the debt service reserve fund. Pacific Matrix and O'Brien Partners again agreed to share the commission. The winning bidder paid a commission of $48,733.52 to Pacific Matrix, which, in turn, paid $24,366 to OBPM. 15O'Brien Partners followed the same process as in the first Wisconsin transaction and, for the same reasons, did not notify the client of Pacific Matrix's payment to OBPM.
While OBPM's invoice to Pacific Matrix described the $24,366 due as a "referral fee for investments services," other than a handwritten entry by an O'Brien Partners bookkeeper it did not identify the issuer, bond offering, investment provider, or any other information. 16
4. O'Brien Partners Reevaluates Its Notice Obligation But Fails to Adopt Procedures Adequate to Ensure Successful Notice to Clients
By late 1991, when it became apparent that additional opportunities to share brokerage commissions would become available, O'Brien Partners began to analyze further whether it needed to notify its clients of its receipt of third-party commissions. O'Brien Partners sought legal advice on the issue of client notification in late 1991. Counsel opined in an advice memorandum dated November 18, 1991 that while it did not believe that legal authority specifically mandated disclosure, "[n]onetheless, published disclosure guidelines, the spirit and intent of securities disclosure laws, and a related statutory provision suggest that such disclosure to the Issuer and the Seller should be made." 17
Shortly thereafter, John O'Brien decided that O'Brien Partners would notify its clients of its opportunity to receive third-party payments and seek permission to do so, but did not implement an effective notification procedure. John O'Brien orally informed O'Brien Partners employees that such notice should be given, but O'Brien Partners did not provide written direction to its employees or instructions as to the precise form and substance of such disclosure. At relevant times, O'Brien Partners' policy also did not contemplate any written disclosure. Nor did it require that the notice be given to a particular decision-making body within each issuer, such as a board or committee. Rather, the procedures adopted by O'Brien Partners called for the employee who handled the transaction at issue to inform the official at the client handling the transaction that O'Brien Partners had the opportunity to receive a third-party payment stemming from the investment of bond proceeds. John O'Brien said that he would confirm with that employee that notice had been given; if not, John O'Brien would notify the client himself. The policy of O'Brien Partners was to inform clients that the total payment in which it would share would equal up to five basis points of the investment. They did not inform the clients of the dollar amount that it had received, unless asked. 18
The disclosure procedures adopted by O'Brien Partners at that time were not adequate to inform its clients of the facts creating a potential conflict of interest. The disclosure failure is evident from the disparate statements of O'Brien Partners and its clients. Although John O'Brien and other O'Brien Partners' officers and employees stated that from the time its disclosure procedures began, in late 1991 or early 1992, each client was informed of each third-party payment to be made to O'Brien Partners or OBPM, no O'Brien Partners clients discussed herein recalled receiving any such notice, or knew of any third-party payment. 19
a. Calleguas Municipal Water District
O'Brien Partners served as financial advisor to Calleguas Municipal Water District ("Calleguas") in its 1991 offering of approximately $62 million and investments of bond proceeds held in the construction and debt service reserve funds. 20 The offering was Calleguas' first since the 1970s, and the issuer relied on O'Brien Partners' advice concerning the offering and the investments of proceeds in securities, including repurchase agreements, consistent with the limitations in the bond offering documents or bond resolution. O'Brien Partners used Pacific Matrix to broker the two above-mentioned investments, and they again agreed to share the commissions. The two winning bidders paid commissions to Pacific Matrix in the amount of $50,000 and $33,000, and it, in turn, paid OBPM $25,000 and $16,500, respectively.
John O'Brien stated that, at the outset of the engagement, he had a general conversation with the Calleguas Board Chairman in which he discussed reinvestment of proceeds and that OBPM could receive a brokerage fee on reinvestments. Also, an O'Brien Partners' officer stated that she explained the process of investing proceeds to Calleguas' Controller, informing the Controller how the bidding worked, that the winning bidder generally paid a brokerage commission, and that O'Brien Partners might receive a split of that commission. The officer also stated that Calleguas' bond counsel participated in this conversation, and that, after its conclusion, the Controller stated that she had the authority to and did approve O'Brien Partners' request to receive brokerage fees of up to five basis points. While bond counsel recalled a general conversation about the investment process, including the payment of fees, bond counsel and the Controller stated that they could not recall any discussion that O'Brien Partners and OBPM would be sharing in such payments.
O'Brien Partners also advised Calleguas in its August 1993 bond offering of approximately $57 million and the investment of certain bond proceeds in GICs. At O'Brien Partners' request, Feld Winters brokered an investment agreement for approximately $3.2 million held in the reserve fund. The winning bidder paid a commission of $19,540 to Feld Winters, which, in turn, paid 60 percent of that total, or $11,724, to OBPM. 21 Although an O'Brien Partners employee who worked on the transaction recalled that this payment was disclosed during a Calleguas Board meeting, Calleguas' Controller, bond counsel, and outside counsel, who attended the meeting, said they did not recall such a discussion and were not aware of the payment.
b. Southern California Public Power Authority
Pursuant to a January 1989 contract, O'Brien Partners served as financial advisor to the Southern California Public Power Authority ("SCPPA") for various bond offerings, including two 1993 transactions discussed below. SCPPA relied on O'Brien Partners' advice with respect to, among other things, the timing and pricing of the offering, and the investment of bond proceeds in securities, including repurchase agreements and GICs.
O'Brien Partners advised SCPPA in connection with two bond offerings in March 1993 and July 1993 for a combined $520 million. At O'Brien Partners' request, Feld Winters brokered the repurchase agreement used to invest the reserve funds in each offering. The winning bidders paid commissions of $72,000 and $200,000 to Feld Winters, which, in turn, paid $36,000 and $125,000 to OBPM.
The O'Brien Partners point person on the transactions said that he spoke with a SCPPA representative several times about sharing brokerage fees, and received permission from that representative for O'Brien Partners to receive such fees. That representative stated that no such conversations occurred, and he and other high-level SCPPA officials who were involved in the offerings stated that they were not aware of, and did not consent to, these payments.
c. City of Anaheim, California
Pursuant to an April 1989 contract, O'Brien Partners served as financial advisor to the City of Anaheim, California ("Anaheim"), for four bond offerings in the summer of 1993. 22 In each transaction, Anaheim relied on O'Brien Partners' advice on various matters, including the investment of certain bond proceeds in repurchase agreements. At O'Brien Partners' request, Feld Winters conducted the bidding process and brokered three agreements used to invest certain proceeds resulting from the above-mentioned Anaheim offerings. OBPM received three payments from Feld Winters totaling approximately $180,000 in connection with these investments. 23
John O'Brien and another O'Brien Partners employee asserted that they discussed the payments with an Anaheim official prior to the offerings, saying they disclosed that O'Brien Partners might be able to share in a brokerage commission of up to five basis points. Although O'Brien Partners representatives claim that the Anaheim official consented to O'Brien Partners' receipt of the third-party fees, the Anaheim official said no such discussions occurred, that he was not aware of and did not consent to O'Brien Partners' receipt of any such payments.
Further, sometime in 1994 (several months after the Feld Winters payments), Anaheim's City Treasurer stated that she learned for the first time that investment providers occasionally pay commissions in connection with the investment of bond proceeds, and that payments that exceed the maximum allowable commission calculated in accordance with the five basis point formula set forth in the applicable tax regulations could affect the tax-exempt status of the bonds. 24 She then asked O'Brien Partners for a written record of any such payments. The point person on the transactions created a multi-page document entitled "Summary of Investments" ("Summary"), which referenced all bids submitted for each investment vehicle discussed above, who solicited each bid, and the total payments made by the winning bidder. A copy of the Summary was provided to Anaheim.
The Summary accurately identified the total dollar amounts paid by two of the winning bidders, (Transamerica Life ($39,922) and Societe Generale ($217,000)), but did not identify the payees, and did not disclose that O'Brien Partners or OBPM had received any part of the payments. 25 The Summary incorrectly stated that O'Brien Partners solicited all bids for the forward supply contract and that no payments were made by the winning bidder, but Feld Winters ultimately assisted in securing the winning bidder, Merrill Lynch, and Merrill Lynch paid a $61,000 commission to Feld Winters, which paid $25,250 to OBPM.
5. O'Brien Partners Fails to Report Its Third-Party Fees in Amended Forms ADV, and Fails to Provide Such Information to Its Clients
None of the amendments to O'Brien Partners' Form ADV filed from 1991-93 disclosed the third-party payments discussed herein. Furthermore, an amendment to O'Brien Partners' Form ADV filed with the Commission on February 18, 1992 incorrectly indicated, in a section entitled "Additional Compensation," that neither O'Brien Partners nor any related person had any written or oral arrangements under which it received cash or "some economic benefit," including "commissions," from a "non-client in connection with giving advice to clients." Moreover, O'Brien Partners failed to provide either a copy of Part II of its Form ADV or a document containing at least the information required in Part II to its municipal advisory clients, as required by Rule 204-3 under the Advisers Act.
D. LEGAL DISCUSSION
1. O'Brien Partners Provided Investment Advice to its Municipal Clients
O'Brien Partners acted as an investment adviser to Wisconsin, Calleguas, SCPPA, and Anaheim for purposes of the Advisers Act because it rendered advice to those clients concerning their investment of bond proceeds in securities, including repurchase agreements and GICs, and was compensated for that advice. See Section 202(a)(11) of the Advisers Act; 26 see also Applicability of the Investment Advisers Act to Financial Planners, Pension Consultants, and Other Persons Who Provide Investment Advisory Services as a Component of Other Financial Services, Release No. IA-1092, 39 SEC Docket 653 (October 8, 1987) (hereinafter "Advisers Act Release No. 1092"). O'Brien Partners' relationship with these issuers generally envisioned that O'Brien Partners would advise them as to how they should invest their bond proceeds, including whether to invest them in securities, whenever such advice might be requested. O'Brien Partners' contracts with Wisconsin and Calleguas specifically provided that O'Brien Partners would provide "expert advice" on a variety of matters, including the "reinvestment of the bond proceeds." SCPPA and Anaheim also entered into each bond transaction relying on O'Brien Partners' advice concerning how to invest their proceeds. Although municipal issuers have somewhat limited options with respect to how they can invest bond proceeds, 27 a sufficient number of alternatives existed in each transaction at issue so as to support the issuers' need for investment advice. O'Brien Partners selected the GIC broker used in each transaction and advised the issuers on the possible alternatives with respect to how to invest their proceeds. By overseeing the competitive bidding process for locating appropriate investment vehicles for the bond proceeds, reviewing the bid forms, and assuring that the investments met the client's guidelines and were within the parameters of the bond offering, O'Brien Partners advised its clients regarding the investment of their bond proceeds in non-government securities and the type of securities in which to invest. Based on O'Brien Partners' advice, each municipality at issue invested the relevant bond proceeds in government securities or in separate investment agreements, including GICs, forward supply contracts, and repurchase agreements. All of the GICs, forward supply contracts and repurchase agreements discussed herein were securities for purposes of the federal securities laws. Other recent enforcement proceedings have been based on similar transactions. See e.g., SEC v. Stifel, Nicolaus and Company, Inc., Lit. Rel. No. 14587 (August 3, 1995) (complaint alleged undisclosed payments stemming from issuer's investment of bond proceeds in GICs and forward purchase agreements); In the Matter of Pacific Matrix Financial Group, Inc., Administrative Proceeding File No. 3-9539 (January 30, 1998).
Finally, O'Brien Partners was compensated for rendering advice concerning its clients' investments in securities. This compensation was received in a variety of ways. As discussed above, O'Brien Partners' contracts with its clients in some cases explicitly provided that investment advice was among the services to be provided in exchange for the contractual payments. In one instance, O'Brien Partners separately invoiced its client for its advice concerning the reinvestment of proceeds. In addition, O'Brien Partners was compensated for this advice through its receipt of third-party payments. Compensation for advisory services rendered can be demonstrated by showing the adviser received compensation "from some source for his services;" it is not necessary to show the compensation was paid directly by the person receiving the investment advisory services. See Advisers Act Release No. 1092, 39 SEC Docket at 662.
O'Brien Partners' arrangement with its clients is distinguishable from the arrangement described in The Knight Group, 1991 SEC No-Act. LEXIS 1303 (Nov. 13, 1991). In that no-action letter, the staff of the Division of Investment Management said that it would not recommend enforcement action against a financial advisor to issuers of municipal securities if, without registering as an investment adviser, the financial advisor assisted clients in structuring new bond issues and occasionally made recommendations of temporarily idle proceeds pending their project use. The staff's response noted in particular that The Knight Group would not be compensated for making such recommendations.
2. O'Brien Partners Violated Section 206(2) of the Advisers Act
Section 206(2) makes it unlawful for an investment adviser to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or potential client and codifies the fiduciary duty of investment advisers to act for the benefit of their clients, requiring advisers to exercise the "utmost good faith in dealing with clients, to disclose all material facts, and to employ reasonable care to avoid misleading clients." SEC v. Moran, 922 F. Supp. 867, 895-96 (S.D. N.Y. 1996); see also SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963). An investment adviser's failure to disclose an actual or potential conflict of interest violates Section 206(2). Capital Gains, 375 U.S. 180; In the Matter of Patrick Clements d/b/a/ Patrick Clements & Assoc., 42 S.E.C. 373 (1964). Proof of scienter is not required to establish a violation of Section 206(2). See Capital Gains, 375 U.S. at 195.
As an investment adviser, O'Brien Partners owed a fiduciary duty to its clients, Wisconsin, Calleguas, SCPPA and Anaheim, to disclose all material facts, including all instances in which "the adviser is in a situation involving a conflict, or potential conflict, of interest with a client. The type of disclosure required by an investment adviser who has a potential conflict of interest with a client will depend upon all the facts and circumstances. As a general matter, an adviser must disclose to clients all material facts regarding the potential conflict of interest so that the client can make an informed decision as to whether to enter into or continue an advisory relationship with the adviser or whether to take some action to protect himself against the specific conflict of interest involved." Advisers Act Release No. 1092, 39 SEC Docket at 667-68. See also Capital Gains, 375 U.S. at 191-92 (Congress's intent in enacting the Advisers Act was "to eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser -- consciously or unconsciously -- to render advice which was not disinterested").
O'Brien Partners breached its fiduciary duty to Wisconsin, Calleguas, SCPPA, and Anaheim by failing adequately to disclose that, while providing advisory services to these issuers, O'Brien Partners also was receiving payments from third parties that brokered agreements used by these issuers to invest their bond proceeds. These third-party payments were material because they gave rise to a risk that O'Brien Partners would not provide impartial advice to its financial advisory clients with respect to the use of Pacific Matrix and Feld Winters as investment brokers, and how the issuers should invest their bond proceeds. 28"An investor seeking the advice of a registered investment adviser must . . . be permitted to evaluate such overlapping motivations, through appropriate disclosure, in deciding whether an adviser is serving two masters or only one, `especially . . . if one of the masters happens to be economic self-interest.' " Capital Gains, 375 U.S. at 196 (citations omitted). The payments also cast doubt on the integrity of the offering process. O'Brien Partners' clients lacked material information they needed to consider in deciding whether to proceed with the offerings, the manner in which to invest the bond proceeds, and whether to heed O'Brien Partners' advice. See Wilson v. Great American Industries, Inc., 855 F.2d 987, 993-94 (2d Cir. 1988) (where a person with a duty to investors makes a decision or recommendation on a matter important to investors, but fails to disclose that he has a potential conflict that might have influenced his decision, the existence of the conflict of interest is material and should be disclosed); Steadman v. SEC, 603 F.2d 1126, 1130 (5th Cir. 1979). 29
In view of the materiality of these payments and the actual or potential conflict they created, O'Brien Partners was obligated, but failed, to adopt procedures that would insure effective notice was given to its clients. By failing adequately to advise its clients of its receipt of these payments, O'Brien Partners violated Section 206(2) of the Advisers Act.
3. O'Brien Partners Violated Sections 17(a)(2) and (3) of the Securities Act
Sections 17(a)(2) and (3) of the Securities Act prohibit misrepresentations or omissions of material facts in the offer or sale of any security. Scienter is not required to prove violations of Sections 17(a)(2) or (3). Aaron v. SEC, 446 U.S. 680, 697 (1980). Instead, violations of these sections may be established by showing negligent conduct. SEC v. Hughes Capital Corp., 124 F.3d 449, 453-54 (3d Cir. 1997). For purposes of the Securities Act, a duty to disclose material information may be premised upon a fiduciary relationship, or the existence of a similar relationship of trust and confidence, which results in the party charged with the disclosure obligation being aware that the other party is relying on the relationship in making his or her investment decisions. See Chiarella v. United States, 445 U.S. 222, 228 (1980); United States v. Chestman, 947 F.2d 551, 568 (2d Cir. 1991), cert. denied, 112 S. Ct. 1759 (1992); Zweig v. Hearst Corp., 594 F.2d 1261, 1268 (9th Cir. 1979). A fiduciary relationship can exist between financial advisor and client when the relationship is marked by dependency and influence. Chestman, 947 F.2d at 568-69. Further, as mentioned earlier, an investment adviser also owes a fiduciary duty to its clients. Capital Gains, 375 U.S. at 194.
O'Brien Partners owed a fiduciary duty to its clients, both as a financial advisor and as an investment adviser. 30As a result, it was obligated to disclose the material facts concerning its arrangement to share commissions paid to the brokers on its clients' transactions. See Hughes v. SEC, 174 F.2d 969 (D.C. Cir. 1949) (petitioner acted in dual capacity of investment adviser and broker, owed a fiduciary duty to her clients, and violated Section 17(a) by failing to make full disclosure concerning certain securities transactions). O'Brien Partners' failure to make full disclosure of those facts violated Sections 17(a)(2) and (3) of the Securities Act.
4. O'Brien Partners Violated The Reporting, Disclosure and Recordkeeping Provisions of the Advisers Act
Section 207 of the Advisers Act makes it unlawful for any person "willfully to make any untrue statements of a material fact," or "willfully to omit to state ... or report any material fact," in any "report" filed with the Commission. The term "report" includes amendments to Form ADV and Forms ADV-S. 31 Rule 204-3 under the Advisers Act requires investment advisers to furnish to each advisory client either a copy of Part II of the adviser's Form ADV or a document containing at least the information required therein. Under Rule 204-2(a)(5) under the Advisers Act, investment advisers must maintain "true, accurate and current" records forming the basis of entries in any ledger and "all bills or statements . . . relating to the business of the investment adviser."
None of O'Brien Partners' amendments to Form ADV filed between 1991 and 1993 disclosed its receipt of the additional compensation generated by its fee-sharing arrangements with Pacific Matrix and Feld Winters. Furthermore, the amendment to Form ADV filed on February 19, 1992, incorrectly indicated that O'Brien Partners received no economic benefit (defined as including commissions) from a non-client in connection with giving advice to clients. In addition, O'Brien Partners' Forms ADV-S filed between 1991 and 1993 incorrectly certified that no amendment needed to be filed to correct any information contained in the Form ADV. Accordingly, O'Brien Partners violated Section 207 of the Advisers Act, which makes it unlawful for "any person willfully to make any untrue statements of a material fact," or "willfully to omit to . . . report any material fact" in an amended Form ADV or other report filed with the Commission.
In addition, O'Brien Partners failed to provide the information set forth in Part II of its Form ADV, and amendments thereto, to Wisconsin, Calleguas, SCPPA, or Anaheim or other municipal issuers, as required by the Advisers Act. Accordingly, O'Brien Partners violated Section 204 of the Advisers Act and Rule 204-3 thereunder.
Finally, O'Brien Partners generated and submitted to Pacific Matrix an incorrect invoice in 1991 concerning the $34,000 paid in connection with Wisconsin's investment of bond proceeds. Accordingly, O'Brien Partners failed to make and keep true and accurate books and records as required under Section 204 of the Advisers Act and Rule 204-2(a)(5) thereunder.
IV. FINDINGS
On the basis of this Order and the Offer of Settlement submitted by the Respondent, the Commission finds that O'Brien Partners willfully violated Sections 17(a)(2) and (3) of the Securities Act, and Sections 204, 206(2) and Section 207 of the Advisers Act and Rules 204-2 and 204-3 thereunder. 32
V. In view of the foregoing, the Commission has determined it is in the public interest to accept the Respondent's Offer of Settlement. Accordingly, IT IS HEREBY ORDERED, effective immediately, that O'Brien Partners:
A. be, and hereby is, censured;
B. shall cease and desist from committing or causing any violation and any future violation of Sections 17(a)(2) and (3) of the Securities Act, and Sections 204, 206(2) and Section 207 of the Advisers Act and Rules 204-2 and 204-3 thereunder; and
C. shall pay a civil penalty in the amount of $250,000 to the United States Treasury, which shall be paid pursuant to the following schedule: $100,000 shall be paid within ten (10) days of the date of this Order; $75,000 shall be paid within three (3) months of the date of this order; and $75,000 shall be paid within six (6) months of the date of this Order. Such payments shall be: (1) made by United States postal money order, certified check, bank cashier's check or bank money order; (2) made payable to the Securities and Exchange Commission; (3) delivered to the Comptroller, Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop 0-3, Washington D.C. 20549; and (4) submitted under cover letter which identifies O'Brien Partners as a Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Erich T. Schwartz, Assistant Director, Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop 7-6, Washington, D.C. 20549.
In re John Gardner Black and Devon Capital Management, Inc., Investment Advisers Act Release No. 1720, A.P. File No. 3-9599 (May 4, 1998).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be instituted pursuant to Sections 203(e) and 203(f) of the Investment Advisers Act of 1940 ("Advisers Act") against Devon Capital Management, Inc. ("Devon") and John Gardner Black ("Black").
In anticipation of the institution of these proceedings, Devon and Black have submitted Offers of Settlement ("Offers") which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the findings contained herein, except for those set forth below in Section II, paragraphs A. and B., which are admitted, Devon and Black, by their respective Offers, consent to the entry of the findings and imposition of the sanctions contained in this Order Instituting Public Proceedings, Making Findings and Imposing Remedial Sanctions ("Order").
Accordingly, IT IS ORDERED that proceedings, pursuant to Sections 203(e) and 203(f) of the Advisers Act, against Devon and Black be, and hereby are, instituted.
II. On the basis of this Order and the Offers submitted by Devon and Black, the Commission finds that:
A. Devon Capital Management, Inc. has been registered with the Commission as an investment adviser from December 15, 1989 until the present. As of September 1997, Devon managed approximately $345 million in assets for approximately 100 investment advisory clients, the vast majority of which were local school districts seeking to invest the proceeds of municipal bond offerings.
B. John Gardner Black was, at all times relevant to this proceeding, the president, portfolio manager, and sole shareholder of Devon.
C. On December 12, 1997, an Order of Permanent Injunction was entered against Black and Devon by the United States District Court for the Western District of Pennsylvania, in Securities and Exchange Commission v. John Gardner Black, et al., 97-CV-2257, pursuant to their consent. The Order of Permanent Injunction, inter alia, enjoined Black and Devon from future violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. In addition, Devon was enjoined from future violations of Sections 206(1), 206(2) and 206(4) of the Advisers Act and Rule 206(4)-2 thereunder, and Black was enjoined from aiding and abetting violations of these same provisions.
D. The Commission's Complaint alleged that Black, acting through Devon and a corporate affiliate of Devon's, made misrepresentations and omissions of material fact in connection with the solicitation and management of Devon's investment advisory clients' funds, resulting in the loss of millions of dollars of municipal bond proceeds invested by school districts and other local government units throughout Western and Central Pennsylvania. The Complaint alleged that Black and Devon benefited financially from their actions.
III. On the basis of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offers submitted by Devon and Black and to impose the sanctions specified therein.
Accordingly, IT IS HEREBY ORDERED THAT:
A. The registration of Devon Capital Management, Inc. with the Commission as an investment adviser is revoked.
B. John Gardner Black is barred from association with any broker, dealer, municipal securities dealer, investment adviser or investment company.
In re Freeman B. Irby III, Exchange Act Release No. 39362, A.P. File No. 3-9490 (November 26, 1997).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest to institute this administrative proceeding pursuant to Sections 15(b)(6) and 21C of the Securities Exchange Act of 1934 ("Exchange Act"), against Freeman B. Irby III ("Irby" or "Respondent") to determine whether Respondent willfully aided and abetted and was a cause of violations of Section 17(a) of the Securities Act of 1933 ("Securities Act") and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
II. In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. 33; Solely for the purpose of these proceedings, and any other proceeding brought by or on behalf of the Commission or to which the Commission is a party, and without admitting or denying the findings contained herein, except as to the Commission's finding of jurisdiction over him and the subject matter, which are admitted, Respondent consents to the entry of this Order Instituting A Proceeding, Making Findings and Imposing Remedial Sanctions, a Cease and Desist Order and a Penalty (the "Order").
III. On the basis of this Order and Respondent's Offer, the Commission finds34 that:
A. From March 1992 until July 24, 1996, Respondent was associated with Stephens Inc. ("Stephens"), a broker-dealer and municipal securities dealer registered with the Commission pursuant to Sections 15 and 15B(a) of the Exchange Act.
B. On June 3, 1992, the Board of Commissioners of Fulton County, Georgia, selected Stephens and another firm (the "Co-Financial Advisor") to serve as financial advisors to the county for a two-year term commencing July 1, 1992. 35
C. As part of its work as one of the financial advisors to Fulton County, Stephens assisted with the selection of underwriters for an offering by Fulton County of $163.375 million in Water & Sewerage Revenue Bonds, Refunding Series 1992 ("Fulton Water & Sewer Refunding"), which closed on November 19, 1992. Respondent and his immediate supervisor (the "Supervisor") were principally responsible for drafting the request for underwriting proposals, and evaluating the responses to that request.
D. By late July 1992, the Supervisor had agreed, in exchange for a promise of remuneration, to help Lazard Freres obtain the position of senior managing underwriter (the most lucrative position) for the Fulton Water & Sewer Refunding. By mid-August 1992, the Supervisor had informed Respondent that he (the Supervisor) wanted Lazard Freres to be selected as lead underwriter on the Fulton Water & Sewer Refunding. The Supervisor did not tell Respondent or the Co-Financial Advisor that he (the Supervisor) expected to be paid by Lazard Freres.
E. During the period August 31 – September 2, 1992, at the Supervisor's instruction, Respondent took steps that affected the process of evaluating and ranking the responses to the request for underwriting proposals so that Lazard Freres was given the highest score and recommended
to the Fulton County Commission to serve as senior managing underwriter. At a meeting of the Fulton County Commission on September 2, 1992, the County's financial advisors and its Finance Director submitted a joint recommendation to the Fulton County Commission that Lazard Freres be named lead underwriter for the Fulton Water & Sewer Refunding. The County Commission adopted that recommendation on September 16, 1992. On November 19, 1992, the Fulton Water & Sewer Refunding issue closed.
F. By agreeing to assist Lazard Freres with its effort to be named senior managing underwriter for the Fulton Water & Sewer Refunding in exchange for undisclosed remuneration, and by taking undisclosed steps, described above, to assist Lazard Freres with that effort, the Supervisor violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
G. As a result of the conduct described above, Respondent willfully aided and abetted and was a cause of the Supervisor's violation of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
IV. Based on the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer submitted by Respondent and impose the sanctions that are consented to in that Offer. Accordingly, IT IS HEREBY ORDERED that:
A. Pursuant to Section 15(b)(6) of the Exchange Act [15 U.S.C. § 7 o(b)(6)], Respondent be, and hereby is, censured;
B. Pursuant to Section 21C of the Exchange Act [15 U.S.C. § 7 8u-3], Respondent cease and desist from being a cause of any violation, and from being a cause of any future violation, of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; and C. Pursuant to Section 21B(a) of the Exchange Act [15 U.S.C. § 7 8u-2(a)], Respondent shall within 21 days of the entry of this Order, pay a civil penalty of $5,000 to the United States Treasury. Such payment shall be (a) made by United States postal money order, certified check, bank cashier's check or bank money order; (b) made payable to the Securities and Exchange Commission; (c) hand-delivered or delivered by certified mail (return receipt requested) to the Comptroller, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C., 20549; and (d) submitted under cover letter that identifies the Respondent in these proceedings, and the file number of the proceedings. A copy of such cover letter and check shall be sent to J. Lee Buck, II, Senior Counsel, Division of Enforcement, Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop 7-5, Washington, D.C., 20549.
In re Ferber, Exchange Act Release No. 38102, A.P. File No. 3-9211 (December 31, 1996).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that a public administrative proceeding be instituted pursuant to Sections 15(b), 15B and 19(h) of the Securities Exchange Act of 1934 ("Exchange Act") against Mark S. Ferber ("Ferber").
II. In anticipation of the institution of these proceedings, Ferber has submitted an Offer of Settlement ("Offer") that the Commission has determined to accept. Solely for the purpose of this proceeding, and any other proceeding brought by or on behalf of the Commission, or to which the Commission is a party, and prior to a hearing pursuant to the Commission's Rules of Practice, 17 C.F.R. _201.100 et seq., and without admitting or denying the findings contained herein, except as to the jurisdiction of the Commission over him and over the subject matter of this proceeding and the entry of the conviction and injunction as set forth in paragraphs III.B.1. and III.C.5., which are admitted, Ferber consents to the issuance of this Order Pursuant to Sections 15(b), 15B and 19(h) of the Exchange Act, Instituting Proceedings, Making Findings and Imposing Remedial Sanctions (the "Order") and to the imposition of the remedial sanctions set forth below.
III. FINDINGS
On the basis of this Order and the Offer, the Commission finds that:
A. Respondent
Ferber, a resident of Concord, Massachusetts, was at all times relevant hereto an investment banker with Lazard Freres & Co., a broker-dealer and municipal securities dealer with a principal place of business in New York, New York ("Lazard"). Ferber joined Lazard in April 1988 as Senior Vice President, and was promoted to General Partner in January 1990. Ferber established and managed Lazard's Municipal Department branch office in Boston, Massachusetts until he resigned in January 1993.
B. Criminal Conviction
1. Following his conviction on mail and wire fraud charges, on December 19, 1996, Ferber was sentenced to a prison term of 33 months, and was ordered to pay a criminal fine of $1,000,000. United States of America v. Mark S. Ferber, Criminal No. 95-10338-WGY (D. Mass).
2. The indictment alleged that Ferber violated his fiduciary duties to his public financial advisory clients. The indictment further alleged that Ferber intentionally failed to adequately disclose to those clients material facts concerning a financial relationship that he entered into on behalf of Lazard with Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch"), and thereby deprived his financial advisory clients of the ability to assess his advice concerning Merrill Lynch.
C. Injunction for Securities Laws Violations
1. On December 19, 1996 the Commission filed a Complaint against Ferber in the United States District Court for the District of Massachusetts, SEC v. Mark S. Ferber, Civil Action No. 96-12653 (EFH) (D. Mass). 36
2. The Complaint alleged that Ferber was responsible for performing and/or overseeing all financial advisory services provided to the Massachusetts Water Resources Authority ("MWRA"), the District of Columbia ("the District") and the United States Postal Service ("USPS"). The Complaint alleged that Ferber, on behalf of Lazard, negotiated a lucrative contract with Merrill Lynch, which provided that Lazard and Merrill Lynch would jointly market interest rate swaps and that Lazard would be a consultant to Merrill Lynch. The Complaint alleged that Ferber and others under his direct supervision primarily provided Lazard's services under the contract. Pursuant to the contract, between September 1990 and November 1992, Merrill Lynch paid Lazard nearly $5.8 million, which resulted in a substantial financial benefit to Ferber.
3. The Complaint further alleged that the contract with Merrill Lynch was a material fact that should have been disclosed to Lazard's financial advisory clients that were serviced by Ferber and were considering the selection of Merrill Lynch as a provider of financial services. The Complaint alleged that the contract created at least a potential conflict of interest for Ferber in that it gave rise to a significant risk that Ferber would not provide impartial advice to the financial advisory clients that were considering the selection of Merrill Lynch as a provider of financial services. Thus, the Complaint alleged that the contract created the potential for Ferber to abuse his influence over the financial advisory clients.
4. The Complaint further alleged that Ferber knowingly or recklessly failed to adequately disclose the contract to the MWRA, the District and the USPS, all of which selected Merrill Lynch to provide underwriting, interest rate swap or other financial services in connection with municipal securities offerings and/or the purchase and sale of securities. As a result, the Complaint alleged that Ferber defrauded these financial advisory clients and the purchasers of their municipal securities.
5. On December 19, 1996, without admitting or denying the Commission's allegations, Ferber consented to the entry of a final judgment of permanent injunction. On December 27, 1996, the District Court (i) permanently enjoined Ferber from future violations of Sections 10(b) and 15B(c)(1) of the Exchange Act, Rule 10b-5 thereunder and rule G-17 of the Municipal Securities Rulemaking Board, and (ii) ordered Ferber to pay disgorgement of $553,000, plus prejudgment interest of $97,000, for a total of $650,000.
IV. Based on the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions specified in Ferber's Offer of Settlement.
Accordingly, IT IS HEREBY ORDERED that Ferber be, and hereby is, barred from association with any broker, dealer, municipal securities dealer, investment adviser or investment company.
In re Peacock, Hislop, Staley & Given, Inc. and Larry S. Given, Securities Act Release No. 7353, Exchange Act Release No. 37777, A.P. File No. 3-9139 (October 2, 1996).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest to institute public cease-and-desist and administrative proceedings pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Sections 15(b)(4), 15(b)6) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Peacock, Hislop, Staley & Given, Inc. ("PHS&G") and Larry S. Given ("Given") (collectively "the Respondents").
Accordingly, IT IS HEREBY ORDERED that said proceedings be, and hereby are, instituted.
II. In anticipation of the institution of these proceedings, Respondents have submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceeding brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings contained herein, except as to the jurisdiction of the Commission over them and over the subject matter of these proceedings, Respondents consent to the entry of this Order Instituting Cease-and-Desist and Public Administrative Proceedings Pursuant to Section 8A of the Securities Act and Sections 15(b)(4), 15(b)(6) and 21C of the Exchange Act, Making Findings, and Imposing a Cease-and-Desist Order and Remedial Sanctions ("Order"), and to the entry of the findings and the imposition of the cease-and-desist order and sanctions set forth below.
III. On the basis of this Order and the Respondents' Offer, the Commission finds that: 37
A. THE RESPONDENTS
1. PHS&G, headquartered in Phoenix, Arizona (File No. 8-38994), has been a registered broker-dealer since May 1989. During 1993, PHS&G served as financial adviser to Maricopa County, Arizona ("Maricopa County" or "the County") in connection with two general obligation bond offerings ("the 1993 G.O. Bond Offerings"). As financial adviser, PHS&G had access to the County's financial information including interim financial statements and budget projections.
2. Given, a registered representative, at all relevant times was and currently is a principal of PHS&G. During 1993, Given was President of PHS&G and was primarily responsible for providing financial advisory services to the County in connection with the 1993 G.O. Bond Offerings.
B. FACTS
1. Between July 26, 1993 and August 10, 1993, Maricopa County offered and sold $25.575 million worth of ten year general obligation project bonds ("Project Bonds") and $22.25 million worth of four year general obligation refunding bonds ("Refunding Bonds") (collectively referred to as the "1993 G.O. Bond Offerings"). PHS&G and Given served as financial adviser to the County in connection with the 1993 G.O. Bond Offerings and, pursuant to an agreement, prepared offering statements which were to contain complete financial and other data. The Preliminary and Final Official Statements (hereinafter, the "Official Statements"), the primary disclosure documents for the 1993 G.O. Bond Offerings, were reviewed by the County, PHS&G, Given and others for accuracy and completeness.
2. The Official Statements for each offering contained financial statements for the year ended June 30, 1992. However, the County's financial condition at the time of the 1993 G.O. Bond Offerings had materially worsened since June 30, 1992, in that the County's operating cash flow had materially declined. Specifically, during fiscal year 1992-93, the County developed a deficit in its General Fund and had nearly doubled the deficit in its Medical Center Enterprise Fund, from $16.9 million to $31.8 million. The Official Statements, which included 1992 financial statements, failed to disclose these changes. Given was aware of the County's cash flow problems and of Moody's Investor Service's downgrade of the County's preexisting G.O. Bond rating due to the cash flow situation. In addition, the Official Statements failed to disclose that the current liabilities of the Medical Center Enterprise Fund on June 30, 1993, exceeded its current assets by approximately 40% more than on June 30, 1992.
3. Furthermore, the Official Statements for the 1993 G.O. Bond Offerings failed to disclose that the County's cash flow position had materially declined since the close of the prior fiscal year. Such information, which was available to PHS&G and Given, was included in contemporaneous documents relating to a tax anticipation note offering by the County.
4. In addition, the Project Bonds' Official Statements represented that bond proceeds would be used to finance specific County projects. However, at a July 26, 1993, meeting of the County's Board of Supervisors, Given learned that proceeds from the sale of Project Bonds would be made available for other purposes, not disclosed to investors. In fact, Project Bond proceeds were used temporarily to finance the County's cash flow deficit through July 1994. Despite knowing of the County's plan to make Project Bond proceeds available for other purposes, PHS&G, through Given, did not revise or supplement or cause the County to revise or supplement the Final Official Statement for the Project Bond Offering to reflect this plan. Consequently, persons and entities who received the Official Statements for the Project Bond Offering, including investors in the offering, were unaware of the County's plan to make investor funds available for other purposes not disclosed in the Official Statements.
5. These facts were material since: 1) the County's changed financial condition, as reflected by the development of a General Fund deficit and the doubling of the Medical Center Enterprise Fund deficit would have been important for an investor to consider in deciding whether or not to purchase the County's G.O. Bonds; and 2) use of Project Bond proceeds to alleviate the County's cash flow deficit was an undisclosed use of investor funds, which an investor may have considered important in deciding whether or not to purchase the Bonds.
6. As the County's financial adviser, PHS&G and Given were reckless in that they, in, and in connection with, the offer, purchase and sale of the 1993 G.O. Bond Offerings, by use of the means and instruments of transportation and communication in interstate commerce and the means and instrumentalities of interstate commerce, and the mails, failed to cause the County to include in the Official Statements for the G.O. Bonds interim financial information indicating that the County's operating cash flow position had materially declined and information regarding the interim use of Project Bond proceeds. Therefore, Respondents caused and willfully aided and abetted the County's violation of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder in connection with the offer and sale of the 1993 G.O. Bonds.
IV. Based on the foregoing, the Commission deems it appropriate to accept the Offer of the Respondents.
Accordingly, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act that PHS&G and Given cease and desist from committing or causing any violation and any future violation of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
IT IS FURTHER ORDERED, pursuant to Section 21B of the Exchange Act that PHS&G and Given shall, within 60 days of the entry of this Order, pay a civil money penalty in the respective amounts of $50,000 (PHS&G) and $25,000 (Given) to the United States Treasury. Such payment shall be: (A) made by United States postal money order, certified check, bank cashier's check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered to the Comptroller, Securities and Exchange Commission, 450 5th Street, N.W., Washington, D.C. 20549; and (D) submitted under cover letter that identifies PHS&G and Given as Respondents in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Sandra J. Harris, Pacific Regional Office, Securities and Exchange Commission, 5670 Wilshire Boulevard, 11th Floor, Los Angeles, CA 90036.
In re Lazard Freres & Co., LLC, and Merrill Lynch, Pierce, Fenner & Smith Incorporated, Exchange Act Release No. 36419, A.P. File No. 3-8872 (October 26, 1995).
See " The Underwriter" section.
Footnotes
-[1]-: These provisions and regulations are designed to prevent abuse of the benefit the federal government affords municipalities by not taxing interest paid on municipal bonds. See Joint Comm. on Taxation, 91st
Cong., 2d Sess., General Explanation of the Tax Reform Act of 1969, at 185-86 (Comm. Print 1970).
-[2]-: During the relevant period, Treasury regulations provided several definitions of fair market value and market price for purposes of valuing open market government securities for advance refundings. For example, a regulation generally applicable to advance refunding transactions that settled on or before June 30, 1993 defined market price as "the mean of the bid and offered prices on an established market" on the day of pricing; if, however, the price paid by the issuer was higher than the mean of the bid and offered prices, then the higher price could be treated as the market price of the security if the issuer acquired it in an "arm's length transaction without regard to any amount paid to reduce the yield . . . ." Treas. Reg. § 1.103-13(c)(1)(iii)(B) (1979). Generally, after June 30, 1993, fair market value was defined as "the price at which a willing buyer would purchase the [security] from a willing seller in a bona fide, arm's length transaction." Treas. Reg. § 1.148-5(d)(6)(i) (1993).
-[3]-: In contrast, in a "positive arbitrage" situation "when the yield on open market securities purchased at fair market value would exceed the yield on the refunding bonds" overcharging by dealers for open market escrow securities diverts tax arbitrage to the dealers at the expense of the U.S. Treasury. This diversion, known colloquially as "yield burning," is illegal. If yield burning occurs, the IRS can declare interest paid on the refunding bonds taxable. See Harbor Bancorp & Subsidiaries v. Keith, 115 F.3d 722 (9th Cir. 1997), cert. denied, 118 S. Ct. 1035 (1998). There are several lawful methods to limit the yield of the defeasance escrow in a positive arbitrage situation. One method is to purchase from the Bureau of Public Debt at the Department of the Treasury below-market-interest Treasury securities "known as State and Local Government Series securities (SLGS)" customized to match the yield limitation. Alternatively, the municipality can purchase open market securities of shorter durations (and lower yields) than those required to satisfy the escrow requirements; when these securities mature, the cash proceeds are invested for the remaining period of the escrow in non-interest-bearing SLGS. When either of these methods is used, the Treasury obtains a benefit by issuing debt at interest rates lower than those prevailing in the taxable market.
-[4]-: Bond counsel to Passaic Valley for the refunding knew by the sale date that Lazard would act as principal and make a profit on the sale of the escrow securities. However, bond counsel had no expertise in the pricing of escrow securities, and its representation of Passaic Valley did not extend to such financial matters as whether Passaic Valley was obtaining the best available prices. Bond counsel's services were limited to drafting documents and rendering certain opinions related to the validity and tax-exempt status of the refunding bonds.
-[5]-: Profit on open market escrow securities generally has two components: markup and carry. Markup is the difference between the price the dealer charges the issuer and the prevailing wholesale market price. In re Lehman Bros. Inc., Exchange Act Release No. 37673 (Sept. 12, 1996), 62 SEC Dkt. 2324, 2330. Carry is the difference between (a) the interest and accretion produced by the escrow securities between the sale date and closing date and (b) the cost of financing those securities during that period. See Board of Governors of the Federal Reserve System, Trading Activities Manual, Part 2 at 2-8 (March 1994).
-[6]-: See, e.g., Order Approving Proposed Rule Change of MSRB Relating to Activities of Financial Advisors, Exchange Act Release No. 30258 (Jan. 16, 1992) ("The MSRB . . . believes that the existence of the conflict of interest [faced by a dealer acting as both financial advisor and placement agent on the same issue] is contrary to the fiduciary obligations of municipal securities professionals acting as financial advisors to issuers . . . ."); Notice by MSRB of Proposed Rule G-23, 42 Fed. Reg. 49856, 49859 (Sept. 28, 1977) ("As a financial advisor, the municipal securities professional acts in a fiduciary capacity as agent for the governmental unit . . . ."); cf. In re O'Brien Partners, Inc., Securities Act Release No. 7594 (October 27, 1998) (violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act for failure to make full disclosure in breach of fiduciary duty owed as municipal financial advisor). The term financial advisor is not defined in the federal securities laws. However, Rule G-23(b) of the Rules of the Municipal Securities Rulemaking Board provides that "a financial advisory relationship shall be deemed to exist when a broker, dealer, or municipal securities dealer renders or enters into an agreement to render financial advisory or consultant services to or on behalf of an issuer with respect to a new issue or issues of municipal securities, including advice with respect to the structure, timing, terms and other similar matters concerning such issue or issues, for a fee or other compensation or in expectation of such compensation for the rendering of such services."
-[7]-: F.G. v. MacDonell, 150 N.J. 550, 696 A.2d 697 (1997) (citing In re Stroming's Will, 12 N.J. Super. 217, 224, 79 A.2d 492, 495 (App. Div.), certif. denied, 8 N.J. 319 (1951) (stating essentials of confidential relationship "are a reposed confidence and the dominant and controlling position of the beneficiary of the transaction"), and Blake v. Brennan, 1 N.J. Super. 446, 453, 61 A.2d 916 (Ch. Div. 1948) (describing "the test [as] whether the relations between the parties were of such a character of trust and confidence as to render it reasonably certain that the one party occupied a dominant position over the other and that consequently they did not deal on terms and conditions of equality").
-[8]-: The findings herein are made pursuant to the Leifers' Offers of Settlement and are not binding on any other person or entity named as a respondent in this or any other proceeding.
-[9]-: Orange County, the Flood Control District, and related parties previously settled enforcement proceedings relating to the Note Offerings. See SEC v. Citron, Civil Action No. SA CV 96-0074 (C.D. Cal. Jan. 24, 1996); In re County of Orange, California, Securities Act Rel. No. 7260 (Jan. 24, 1996).
-[10]-: Other participants in the Note Offerings were County officials, bond counsel (retained by the County), the underwriter, and disclosure counsel (retained by the Leifers). The Leifers were not financial advisers to the Treasurer or to the Pools in connection with the Pools' investment strategy or investments or with the County's decision to issue Taxable Notes.
-[11]-: The term financial advisor is not defined in the federal securities laws. Rule G-23(b) of the Rules of the Municipal Securities Rulemaking Board provides that "a financial advisory relationship shall be deemed to exist when a broker, dealer, or municipal securities dealer renders or enters into an agreement to render financial advisory or consultant services to or on behalf of an issuer with respect to a new issue or issues of municipal securities, including advice with respect to the structure, timing, terms and other similar matters concerning such issue or issues, for a fee or other compensation or in expectation of such compensation for the rendering of such services."
-[12]-: A municipal bond offering ordinarily creates several investment requirements for the issuer. For example, if the bond issue is undertaken to advance refund all or part of the issuer's outstanding debt, the issuer will be required to purchase and place in escrow securities sufficient to "defease," or pay when due, the principal and interest on the refunded debt. Frequently, the security for a municipal bond issue includes a debt service reserve fund providing a cushion of one year's debt service against cash flow problems during the life of the issue. This fund, too, is invested. If the purpose of the offering is to finance a construction or other project, issuers may use instruments such as a GIC to invest the proceeds until needed. Generally, with respect to municipal securities offerings, a GIC is an agreement to deposit money with a financial institution. The terms of the GIC, including the interest rate, withdrawal limitations, termination and collateralization are specifically negotiated and tailored to address the specific needs of the issuer. A GIC allows the issuer to invest the bond proceeds at a specified rate or rates until needed and earn a return in excess of most short-term investments. Municipal issuers also often need to invest other moneys associated with a bond offering, including reserve funds, which are set aside as additional security for bondholders in the event of default.
Beginning in the mid-1980s, firms known as investment or GIC brokers arose to assist issuers in locating investment vehicles to meet these investment requirements. These brokers typically solicit providers of GICs, forward supply contracts, and other investments needed by municipal entities. Given their expertise and industry contacts, such brokers often can find investment alternatives for an issuer that the issuer's underwriter or financial advisor cannot secure. Such brokers generally are compensated by the entity selected to provide the investment vehicle to the issuer. Fee percentages typically were equal to the maximum allowable commission calculated in accordance with the five basis point formula set forth in the applicable tax regulations.
-[13]-: n April 1990, O'Brien Partners entered into a financial advisory contract with Wisconsin that provided that O'Brien Partners would advise the issuer about the upcoming 1990 bond issue and the reasonableness of future bond issuances, and provide "expert advice" with respect to various matters, including the "reinvestment of the bond proceeds." In exchange for such services, Wisconsin agreed to pay O'Brien Partners a quarterly retainer and an additional transaction fee, depending on the size and complexity of the bond offerings.
-[14]-: O'Brien Partners sent an invoice dated August 21, 1991 to Wisconsin in the amount of $34,125 for "professional services associated with the Repurchase Agreement with Mitsui Taiyo Kobe Global Capital Inc." Thus, O'Brien Partners was paid twice -- once by Wisconsin, and once by Pacific Matrix -- for the same services. O'Brien had previously been paid separately by Wisconsin for services provided in connection with the underlying bond offering.
-[15]-: This and all subsequent third-party payments discussed herein were made through OBPM, as opposed to directly to O'Brien Partners.
-[16]-: With respect to each subsequent payment discussed herein, the OBPM invoice submitted to Pacific Matrix or Feld Winters for payment similarly described the amount due as concerning simply a "Referral Fee for Investments Services." The invoices uniformly failed to include a single identifying aspect of the transaction, such as the issuer, bond offering, or investment vehicle. O'Brien Partners' copies of the invoices included a handwritten note by an O'Brien Partners clerk that identified the issuer. This absence of detail contrasts with invoices that O'Brien Partners routinely sends its clients, which generally identify the bond issue by name and dollar amount and, when relevant, the investment provider.
-[17]-: In the memorandum, O'Brien Partner's counsel stated that, notwithstanding that O'Brien Partners was registered as an investment adviser, counsel generally had taken the position that O'Brien Partners was not an investment adviser to municipal issuers because it was not providing advice with respect to investments in securities. The memorandum further stated, however, that if O'Brien Partners were deemed to be providing such advice, it would be required to comply with various provisions of the Advisers Act, including provisions requiring disclosure in O'Brien Partners' Form ADV of OBPM's receipt of third-party commissions.
-[18]-: Although it received counsel's opinion in November 1991 concerning the need to give notice to its clients, O'Brien Partners did not immediately implement its disclosure policy. For example, O'Brien Partners did not give notice to Wisconsin concerning the payment to OBPM in May 1992. (See supra at Section III.C.3.).
-[19]-: In certain transactions the procedures employed did place O'Brien Partners' municipal clients on notice that the firm proposed to receive such fees from third-party providers. Those transactions are not charged in this Order.
-[20]-: In December 1990, O'Brien Partners entered into a financial advisory contract with Calleguas that provided that it would provide "expert advice" concerning, among other things, the "reinvestment of the bond proceeds."
-[21]-: The 50-50 fee-sharing arrangement between Winters and O'Brien Partners was adjusted to 60-40 in O'Brien Partners' favor in certain transactions, and was adjusted to less than 50 percent in one other.
-[22]-: The transactions were: (1) a June 1993 offering of $71.3 million; (2) a June 1993 offering of $60.7 million; (3) a June 1993 offering of $13.545 million; and (4) a July 1993 offering of $62.810 million.
-[23]-: First, Feld Winters brokered repurchase agreements used to invest moneys held in the reserve funds from the $71.3 million and $62.810 million offerings. The winning bidder for both investments, Transamerica Life Insurance Co., paid a combined commission of $39,922 to Feld Winters which, in turn, paid $23,995.64 to OBPM. Second, Feld Winters brokered two repurchase agreements used to invest moneys held in the reserve funds from the $60.7 million and $13.545 million offerings. The winning bidder for both repurchase agreements, Societe Generale, paid Feld Winters a commission of $217,179 and Feld Winters, in turn, paid OBPM a total of $130,307.53. Finally, Feld Winters brokered a forward supply contract in connection with the $71.3 million, $60.7 million, and $13.545 million offerings. Merrill Lynch, the winning bidder, paid a combined commission of $61,000 to Feld Winters which, in turn, paid OBPM a total of $25,250.
-[24]-: It does not appear that any of the commissions discussed herein threatened the tax exempt status of the underlying municipal securities.
-[25]-: The amounts were listed under a heading entitled "Administrative Cost," which the Summary said "includes cost paid by the provider for the brokerage or selling commissions, legal and accounting fees, investment advisory fees, recording keeping, safekeeping, custody and similar cost." While identifying the payors, it did not identify the payees.
-[26]-: Section 202(a)(11) of the Advisers Act, in relevant part, defines an investment adviser as "any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities . . ."
-[27]-: State law and the governing documents in each bond offering set the parameters with respect to how proceeds can be reinvested, and often limit such investments to certificates of deposit, Treasury securities, government agency securities, and other similar investments.
-[28]-: Because the third-party payments were significant, they created great risk of influencing the advice O'Brien Partners gave to its clients. The third-party payments ranged from 15 percent to more than 100 percent of the financial advisory fee received by O'Brien Partners directly from its client in the particular transactions.
-[29]-: Moreover, since even potential conflicts of interest are material and must be disclosed, O'Brien Partners was required to disclose its receipt of third-party payments, even if it had concluded that the payments did not influence the manner in which it advised its clients.
-[30]-: In addition to its duties under the Advisers Act, relevant state law also imposed a fiduciary duty on O'Brien Partners. Under Wisconsin law, a fiduciary relationship exists when there is an inequality, dependence, weakness of business intelligence, "or other conditions giving to one an advantage over the other." Production Credit Ass'n of Lancaster v. Croft, 143 Wis. 2d 746, 754-55, 423 N.W. 2d 544, 547 (App. 1988). Similarly, under California law, a fiduciary relationship is created where a person " `reposes trust and confidence in another and the person in whom such confidence is reposed obtains control over the other person's affairs.' " Recorded Picture Co. v. Nelson Entertainment, Inc., 61 Cal. Rptr. 2d 742, 754 (Ct. App. 2 Dist. 1997) (citation omitted). O'Brien Partners' relationship with Wisconsin, Calleguas, SCPPA and Anaheim was characterized by the superiority of position and entrusting of power that Wisconsin and California courts have deemed sufficient to find a fiduciary relationship. The issuers relied on O'Brien Partners' expertise and advice concerning, among other things, the optimum investments in which to place certain bond proceeds. As a fiduciary, O'Brien Partners owed its clients a duty of loyalty and assumed an obligation to notify these entities of all information relevant to the affairs entrusted to it.
-[31]-: See Rule 204-1(d). Pursuant to Rule 204-1(c) under the Advisers Act, Forms ADV-S were required to be filed annually until December 27, 1996, and obligated advisers to certify that no amendment to Form ADV needed to be filed to correct any information contained therein. This requirement was in effect at all relevant times. Subsequent to the time period at issue in this case, the requirement to file Form ADV-S was stayed pending other rulemaking. See Advisers Act Release No. 1602 (Dec. 20, 1996).
-[32]-: In applying the term "willful" in Commission administrative proceedings instituted pursuant to Sections 15(b), 15B, 15C, 17A, 19(h) and 21B of the Securities Exchange Act, Section 9 of the Investment Company Act, and Section 203 of the Investment Advisers Act, the Commission evaluates on a case-by-case basis whether the respondent knew or reasonably should have known under the particular facts and circumstances that his conduct was improper. In this case, as in all Commission administrative proceedings charging a willful violation under these statutory provisions, the Commission applies this standard to persons -- specifically, securities industry professionals -- who are directly subject to Commission jurisdiction and who have a responsibility to understand their duties to the investing public and to comply with the applicable rules and regulations which govern their behavior.
-[33]-: In determining to accept the Offer, the Commission considered the cooperation Respondent afforded the Commission staff.
-[34]-: The findings herein are made pursuant to Respondent's Offer and are not binding on any other person or entity in this or any other proceeding.
-[35]-: Rule G-23(b) of the MSRB provides, in relevant part, that: "a financial advisory relationship shall be deemed to exist when a broker, dealer, or municipal securities dealer renders or enters into an agreement to render financial advisory or consultant services to or on behalf of an issuer with respect to a new issue or issues of municipal securities, including advice with respect to the structure, timing, terms and other similar matters concerning such issue or issues, for a fee or other compensation or in expectation of such compensation for the rendering of such services."
In determining to accept the Offer, the Commission considered the cooperation Respondent afforded the Commission staff.
-[36]-: See Litigation Release No. 15193 (December 19, 1996).
-[37]-: The findings herein are made pursuant to Respondents' Offer of Settlement and are not binding on any other person or entity named as a respondent in this or any other proceeding.