SECURITIES FRAUD
A. SEC ADMINISTRATIVE ACTIONS:
1. In re Michael Flanagan, Ronald Kindschi, and Spectrum Administration, Inc., SEC Initial Decision Release No. 160, January 31, 2000).
If a registered representative sells mutual fund shares, in amounts close to but less than a breakpoint at which a lower sales load becomes applicable, to a customer known to have available for investment total amounts which exceed the breakpoint, the representative must disclose to the customer prior to the transaction the savings in sales charges obtainable through increasing the amount of the purchase. A representative who fails to do so violates the antifraud provisions of the securities laws. Russell L. Irish, 42 S.E.C. 735, 741-42 (1965), aff'd, 367 F.2d 637 (9th Cir. 1966); Shearson, Hammill & Co., 42 S.E.C. 811, 849-51 (1965); Robert J. Check, 49 S.E.C. 1004, 1005-06 (1988).
2. In re Zion Capital Management, LLC & Ricky Lang, SEC Initial Decision No. 220 (January 29, 2003).
i) A company's scienter may be imputed from that of the individuals controlling it. See SEC v. Blinder, Robinson & Co., 542 F. Supp. 468, 476 n.3 (D. Colo. 1982) (citing SEC v. Manor Nursing Ctrs., Inc., 458 F.2d 1082, 1096-97 nn.16-18 (2d Cir. 1972)). As an associated person of Zion, Lang's conduct and scienter are also attributed to the firm.
ii) A finding of willfulness does not require an intent to violate, but merely an intent to do the act which constitutes a violation. See Wonsover v. SEC, 205 F.3d 408, 413-15 (D.C. Cir. 2000); see also Steadman v. SEC, 603 F.2d 1126, 1135 (5th Cir. 1979); Arthur Lipper Corp. v. SEC, 547 F.2d 171, 180 (2d Cir. 1976); Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965).
iii) Reliance by investors is not a necessary element of the violation in Commission proceedings to enforce the antifraud provisions. See Martin Herer Engelman, 52 SEC 271, 283 n.43 (1995) (citing SEC v. Rana Research, Inc., 8 F.3d 1358, 1363-64 (9th Cir. 1993); SEC v. Blavin, 760 F.2d 706, 711 (6th Cir. 1985); SEC v. North Am. Research & Dev. Corp., 424 F.2d 63, 84 (2d Cir. 1970)); Richard C. Spangler, Inc., 46 SEC 238, 244 (1976) (citing Hanly v. SEC, 415 F.2d 589, 596 (2d Cir. 1969). Nor is proof that injury resulted from the fraudulent practice a necessary element of the violation. See SEC v. Capital Gains Research Bureau, 375 U.S. at 195 (holding that enforcement action against a practice that operates as a fraud or deceit on a client does not require proof of intent to injure and actual injury to the client.)
iv) Recklessness can satisfy the scienter requirement. See David Disner, 52 S.E.C. 1217, 1222 & n.20 (1997); see also Steadman, 967 F.2d at 641-42; Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990).
v) A person cannot escape aiding and abetting liability by claiming he was ignorant of the securities laws. See Sharon M. Graham, 53 S.E.C. 1072, 1084 n.33 (1998), aff'd, 222 F.3d 994 (D.C. Cir. 2000). The knowledge or awareness requirement can be satisfied by recklessness when the alleged aider and abettor is a fiduciary or active participant. See Ross v. Bolton, 904 F.2d 819, 824 (2d Cir. 1990).
B. NASD REGULATORY MATERIAL:
3. NASD Dep�t of Enforcement v. John Fiero & Fiero Brothers, Inc., Complaint No. CAF980002 (October 28, 2002).
"[I]nvestors and prospective investors ... are ... entitled to assume that the prices that they pay and receive are determined by the unimpeded interaction of real supply and real demand so that those prices are the collective marketplace judgments that they purport to be." Edward J. Mawod & Co., 46 S.E.C. 865, 871-72 (1977), aff'd, 591 F.2d 588 (10th Cir. 1979). Frauds, like the fraud perpetrated by the Fiero Respondents, that mislead the general public as to the market value for a security affect the integrity of the securities markets as a whole and violate Rule 10b-5. See U.S. v. Russo, 74 F.3d 1383, 1390 (2d Cir. 1996) (the purpose of Section 10(b) and Rule 10b-5 is to prevent fraud, whether it is a standard type of fraud or a novel type that presents a "unique form of deception").
4. NASD Dep�t of Enforcement v. Robert J. Rosato & Michael Albino, NASD
Disciplinary
Proceeding No. CAF970002 (February 17, 1999).
i) "Generally,
predictions of specific and substantial increases in the price of a
speculative security within a relatively short period of time are fraudulent
within
the meaning of Section 10(b) and Rule 10b-5. See, e.g., In re Donald A. Roche,
Exchange Act Release No. 38742, 64 S.E.C. Docket 2042, 1997 SEC LEXIS
1283, at * 6 (June 17, 1997).36 Such statements are considered per se
fraudulent because, in a free market, it is impossible to predict with any
measure of confidence the timing and amount by which a speculative security will
increase in
price. Thus, when a respondent makes such a price prediction in connection
with
the purchase or sale of a speculative security, no further proof of scienter is
required. Predictions of specific and substantial increases in the price of
non-
speculative securities that are made without a reasonable basis are likewise
fraudulent. Donald A. Roche, 1997 SEC LEXIS 1283, at * 6.37 Irrespective of
whether the prediction is made with respect to a speculative or non-speculative
security, materiality is presumed: it is obvious that any prediction of a
substantial
increase in the price of a security would affect a reasonable investor's
decision to
buy, hold, or sell a security."
ii) Nor is it relevant to a finding of fraud that Rosato expressed the price prediction as a range rather than a precise amount.
iii) A �representation that an investment will recoup losses from previous investments is a price or profit prediction,� SEC v. Hasho, 784 F. Supp. at 1109, and therefore fraudulent.
iv) Far from innocent hyperbole, Rosato�s representation about Stratton�s purported track record in recovering losses was designed to � and did � enhance the perceived reliability of Rosato�s price prediction concerning Dollar Time stock and fraudulently induced RD to purchase Dollar Time shares as a means to recover losses from his IDM
Environmental securities holdings.41
Based on the foregoing, the Hearing Panel concludes that Rosato violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and NASD Conduct Rule 2120 by making a baseless and improper price prediction and an improper promise to recover losses to RD, as alleged in the Complaint.
5. NASD Dep�t of Enforcement v. Howard R. Perles, Complaint No.
CAF980005
(August 16, 2000).
The Supreme Court's approach to interpreting the scope of liability under Section 10(b) stands in contrast to our approach to interpreting the NASD's antifraud rule. We find that Conduct Rule 2120 should be interpreted flexibly, with a view towards eliminating fraud and manipulation. The NASD adopted its antifraud rule against the backdrop of the Exchange Act, which requires the SEC to determine that a self-regulatory organization has rules that are "designed to prevent fraudulent and manipulative acts and practices." Exchange Act '15A(b)(6). The NASD's By-Laws identify preventing "fraudulent and manipulative acts and practices" as one of the reasons that the NASD Board of Governors is authorized to adopt Conduct Rules. NASD By-Laws, Art. XI, Sec. 1. Because preventing fraud and manipulation is central to the NASD's purpose, we pay particular attention to the general NASD rule regarding rule interpretation. It states: "The Rules shall be interpreted in such a manner as will aid in effectuating the purposes and business of the Association . . . ." Rule 113. Following this interpretative framework, we conclude that prohibiting the aiding and abetting of a manipulation effectuates the NASD's purpose of preventing manipulation. See In re Lile & Co., 42 S.E.C. 664, 670 n.12 (1965) ("In some respects the NASD's powers are broader than the Commission's authority, since it is thus authorized to act with respect to some unethical practices which may not be within the reach of the provisions of the securities acts which deal with fraud upon investors."); cf. In re Daniel Joseph Alderman, 52 S.E.C. 366, 369 (1995), aff'd, 104 F.3d 285 (9th Cir. 1997) (finding that an NASD Conduct Rule set "forth a standard intended to encompass a wide variety of conduct that may operate as an injustice to investors or other participants in the marketplace.")
6. NASD Dep�t of Enforcement v. Premier Capital Management, Bryan James O'Leary & Ryan Mark Reynolds, Disciplinary Proceeding No. CAF990018 (September 13, 2000).
i) A respondent acts with scienter when the fraudulent circumstances "were so obvious
... that he must have been aware of them.
ii) Conduct Rule 2120 and SEC Rule 10b-5 are designed "to ensure that sales representatives fulfill their obligation to their customers to be accurate when making statements about securities." District Bus. Conduct Comm. No. 9 v. Euripides, No.C9B950014, 1997 NASD Discip. LEXIS 45, at *16-17 (NBCC, July 28, 1997). A registered representative "has a duty to make an adequate independent investigation" to ensure that his representations have a reasonable basis. In re Frank W. Leonesio, Exchange Act Rel. No. 23524, 1986 SEC LEXIS 1009, at *11 (1986).
That duty is not satisfied by a representative's reliance on sources affiliated with the issuer. Such action "affords no basis for leniency. [Regulators] must protect the public not only from professionals in the business who practice deliberate deception, but also from those whose credulity and failure to investigate inflict equal harm on investors and undermine public confidence in the securities market to the same extent." In re Nassar & Co., 47 S.E.C. 20, 26 (1978). Acting solely on the basis of "euphoric representations" made by those associated with the issuer reflects the scienter necessary for fraud.
iii) Reynolds cannot escape liability merely because he did not personally make misleading statements. As the court said in SEC v. First Jersey Securities, Inc., 101 F.3d 1450, 1471 (2d Cir. 1996), cert. denied, 522 U.S. 812 (l997), "[p]rimary liability may be imposed 'not only on persons who made fraudulent misrepresentations, but also on those who had knowledge of the fraud and assisted in its perpetration.
7. NASD Dep�t of Enforcement v. Robert Tretiak, Complaint Nos. C02990042 and C02980085 (January 23, 2001)
i) The materiality of information relating to financial condition, solvency and profitability is not subject to serious challenge." SEC v. Stephen Murphy, 626 F.2d 633, 653 (9th Cir. 1980).
ii) Material facts include not only information disclosing the earnings and distributions of a company but also those facts which affect the probable future of the company and those which may affect the desire of investors to buy, sell, or hold the company's securities." Texas Gulf Sulphur at 849. In sum, wefind that the misrepresentations and omissions at issue were material.
8. NASD Dep�t of Enforcement v. Monroe Parker Securities, Alan Scott Lipsky, Bryan J. Herman, Ralph Joseph Angeline, & Richard Steven Levitov, Disciplinary Proceeding No. CAF970011 (June 18, 1999).
The Supreme Court has defined scienter as a "mental state embracing intent to deceive, manipulate or defraud." 65 Scienter encompasses knowing or intentional misconduct, or recklessness. 66 And proof of scienter where securities manipulation is involved need not be established through direct evidence. Scienter is satisfactorily proven when it has been shown through circumstantial evidence that the respondents pursued a course of conduct that constituted market manipulation.
9. NASD Dep�t of Enforcement v. Josephthal & Co., Inc., Dan Purjes & Paul H. Fitzgerald, Disciplinary Proceeding No. C3A990071 (May 15, 2001).
Brokers owe a fundamental duty of fair dealing to their customers. See, e.g., District Bus. Conduct Comm. Dist. No. 9 v. Goodman, No. C9B960013, 1999 NASD Discip. LEXIS 34, *33-34 (N.A.C. Nov. 9, 1999). Embedded in this duty is the requirement that when making a recommendation, the broker must disclose facts bearing on the risks associated with the recommended security that he knows and that are reasonably ascertainable. Hanly v. SEC, 415 F.2d 589, 597 (2d Cir. 1969). Conversely, �[w]here the [broker] lacks essential information about a security, he should disclose this as well as the risks which arise from his lack of information.� Id. This duty of fair disclosure applies to the broker�s commissions and other compensation where the non-disclosure may be material to the customer�s decision to purchase the security the broker has recommended.
The failure to disclose such commissions deprives the customer of the knowledge that his registered representative might be recommending a security based upon the registered representative�s own financial interest rather than the investment value of the recommended security. Misrepresenting or omitting to disclose a broker�s financial or economic incentive in connection with a stock recommendation constitutes a violation of the antifraud provisions.
Brokers are not excused from the duty to disclose such commissions and compensation by the fact that there is not a specific rule requiring the disclosure of non-excessive sales credits. Cf. SEC v. Feminella, 947 F. Supp. 722, 731 (S.D.N.Y. 1996) (failure to disclose sales credit added to markup violated the antifraud provisions of the federal securities laws). Indeed, �the SEC has established through its enforcement actions the principle that charging undisclosed excessive commissions constitutes fraud.� See Ettinger v. Merrill
Lynch, Pierce, Fenner & Smith, 835 F.2d 1031, 1033 (3d Cir. 1987).
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