The Registered Representative Engaged in Efforts to Increase Creative Host's Stock Price
6. In September 1999, the Registered Representative formulated a written plan to inflate Creative Host's stock price. The plan called for the Registered Representative to restrict the supply of Creative Host stock by (1) having an investor buy up to 9.9% of Creative Host's shares "quietly;" (2) directing an investor to purchase 80,000 shares in a pending sale of a 140,000-share block; and (3) causing his clients to buy 200,000 shares. To artificially increase demand for stock, the plan called for the Registered Representative to (1) hire an analyst to write a research report; and (2) pay an Internet site to tout the stock with a buy recommendation. The written plan stated that it presented an opportunity for "stock appreciation," and a "rare opportunity to move a market."2
7. Beginning in November 1999, the Registered Representative executed his written plan, having one of his clients buy over 22% of Creative Host's outstanding shares and his other clients acquire large amounts of Creative Host stock. The Registered Representative used aggressive sales tactics to cause his clients to buy over 200,000 additional shares of Creative Host, namely high-pressure sales tactics, unauthorized trading, and falsely stating that Creative Host had a "virtual monopoly" on airport concessions. Indeed, from December 31, 1999 to at least June 2000, Kirkpatrick's client accounts held between 70% and 90% of the company's free trading shares, and the Registered Representative was responsible for a substantial portion of the firm's trading in the stock. In addition, he targeted his and his clients' purchases of Creative Host stock to broker-dealers he identified through monthly securities position listing reports prepared by the Depository Trust Company ("DTC").3 In addition to reducing the float, he took several further steps to restrict the supply of the security as part of the scheme to affect the price of Creative Host's stock artificially, including, but not limited to refusing to execute sell orders when instructed to do so and persuading his clients, by misrepresenting the costs and risks, to use margin in order to increase sales.
8. In furtherance of his scheme, the Registered Representative also carried out the steps of the written plan designed to create artificial demand for the security.
a. First, he created this demand through the use of false and misleading touts on the Internet. In May 2000, when Creative Host's stock price had increased to the $15-$17 range, the Registered Representative hired Internet stock touters who, without reasonable basis, projected in documents they posted on the Internet that Creative Host's share price would rise to $30 near term and to $60-$70 mid-term. There was no reasonable basis for the projections because there had been no change in Creative Host's business, and in fact, Creative Host continued to operate at a net loss. During the week following commencement of touting by the Internet touters, Creative Host's stock price increased 30.7%.
b. Second, in order to affect the price of Creative Host stock the Registered Representative also circumvented Kirkpatrick's internal market making policies. To avoid risk, Kirkpatrick had an internal policy to end each day "flat" so that it would have no position in the stocks in which it made a market. Because Kirkpatrick typically had little or no inventory, Kirkpatrick's order desk had to execute the orders placed at the end of the day by purchasing or selling stock on the open market rather than from its own inventory. The Registered Representative was aware of Kirkpatrick's policy, and he exploited it to raise Creative Host's stock price towards the end of the day by placing buy orders on a delayed basis.
c. Third, the Registered Representative generated artificial demand for Creative Host stock by exploiting Kirkpatrick's market making activities through the numerous buy orders he placed. The Registered Representative's large volume of buy orders at successively higher prices — in conjunction with his delayed orders and Kirkpatrick's policy of ending each day flat — facilitated Kirkpatrick's price leadership by placing additional pressure on Kirkpatrick's order desk to enter numerous bid quotes for the security at successively higher prices in order to obtain stock to fill the Registered Representative's orders. Indeed, Kirkpatrick was the exclusive high bidder twice as often as the nearest of the other 30 market makers. Moreover, Kirkpatrick rarely decreased Creative Host's ask price.
d. Finally, the Registered Representative also engaged in prearranged trading to create the appearance of active demand for Creative Host stock.4 The Registered Representative spoke to traders at other brokerage firms about Creative Host and negotiated trades that he then gave to Kirkpatrick's order desk for execution along with instructions to contact the specific trader with whom the Registered Representative had negotiated. Even though Kirkpatrick instructed the Registered Representative previously to cease contacting other market makers, the Registered Representative continued to prearrange trades until at least the first week of May 2000.
9. Kirkpatrick made inquiries beginning in December 1999 concerning the Registered Representative's trading concentration in Creative Host stock. In mid-May 2000, Kirkpatrick began imposing restrictions on trading in Creative Host stock due to concerns that the Registered Representative's activities might be affecting the market price of Creative Host stock. On May 29, 2000, Kirkpatrick decided to cease making a market in the stock due to various concerns, including Kirkpatrick's concentrated position and the possibility that the Registered Representative's trading activities may have affected Creative Host's share price. On June 16, 2000, in light of additional information concerning the activities of the Registered Representative uncovered during an internal investigation, Kirkpatrick further restricted the Registered Representative's ability to solicit orders in Creative Host. The combination of these restrictions plus the lack of significant legitimate support for Creative Host and the high percentage of shares held in margin accounts resulted in numerous margin calls from Kirkpatrick to the Registered Representative's customers. Kirkpatrick then began to sell the customers' shares in Creative Host and other stocks in order to satisfy unanswered margin calls. From mid-June until early August 2000, Creative Host's share price dropped from $29 to $4.12 per share.
10. The Registered Representative's activities discussed above violated Section 17(a) of the Securities Act of 1933 ("Securities Act") and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. |
