Chris Block was banned for life from the securities industry:
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NASD REGULATION, INC.
OFFICE OF HEARING OFFICERS
DEPARTMENT OF ENFORCEMENT,
Complainant,
v.
CHRISTOPHER M. BLOCK
(CRD #2073057),
Houston, TX
and
Houston, TX
and
JEFFREY S. BURKE
(CRD #2007369),
Houston, TX
and
Houston, TX
and
JENNIFER L. GONZALEZ1
(CRD #2461482),
Respondents.
Disciplinary Proceeding No. C05990026
HEARING PANEL DECISION AS TO RESPONDENTS BLOCK AND
BURKE
Hearing Officer - JN
September 5, 2000
Digest
The Complaint contains six causes. The First Cause alleges Respondent
Block’s involvement in improper bookkeeping for Block Trading, Inc., in violation of
SEC Rules 17a-3 and 17a-4, and NASD Rules 2110 and 3110. The Second Cause
charges Respondents Block and Burke with net capital violations by the firm, in
violation of SEC Rule 15c3-1, and NASD Rule 2110. The Third Cause alleges that
Block failed to provide notification that the firm’s net capital was below the required
minimum, in violation of SEC Rule 15c3-1, and NASD Rule 2110. The Fourth Cause
charges Block with filing various inaccurate FOCUS reports, in violation of Rule
2110. The Fifth Cause charges Block with fraud in providing false and misleading
financial information to investors, in violation of Rules 2110 and 2120. The Sixth
Cause charges supervisory violations by Block and Burke, in violation of Rules 2110
and 3010.
The Hearing Panel found that Respondents Block and Burke were liable as
charged in Causes One through Five of the Complaint. As sanctions for Block, the
Panel imposed a total of $50,000 in fines and a bar from associating with a member in
any principal or supervisory capacity. As sanctions for Burke, the Panel imposed a
total of $15,000 in fines, a 30-day suspension from associating with any member in a
principal or supervisory capacity, and a requirement that he re-qualify as a General
Securities Principal.
A respondent who is liable as a primary violator cannot also be liable for
supervisory failures involving that same misconduct. The Panel thus found that Block,
already liable for the First through Fifth Causes, cannot also be responsible for those
same violations as a supervisor. Had he not been charged as a primary violator in
those Causes, the Panel would find, alternatively, that he did violate his supervisory
responsibilities with regard to the conduct alleged therein. For such supervisory
violations, the Panel would have imposed a fine of $10,000 and a bar from
associating with any member in a principal or supervisory capacity.
Burke was not charged in the First, Third and Fourth Causes, and as to those
allegations, the Panel found him liable for supervisory failures. As a sanction for these
supervisory violations, the Panel fined Burke $5,000 and required that he re-qualify
for his Series 24 license. Had he not been charged as a primary violator in the Second
Cause, the Panel would find, alternatively, that he was responsible for supervisory
failures as to the conduct there alleged. In this event, no additional sanction for that
supervisory violation was necessary because Burke was sanctioned for supervisory
violations as to the First, Third and Fourth Causes.
Respondents were also jointly and severally assessed $7,339.80 as costs,
including $6,589.80 for transcripts and an administrative fee of $750.
Appearances
Ralph J. Veth, Esq. and Mark P. Dauer, Esq., New Orleans, LA and Rory C.
Flynn, Esq., Washington, DC, for the Department of Enforcement.
G. Scott Williams, Esq., Houston, TX, for Respondent Block.
Andrew R. Harvin, Esq., Houston, TX, for Respondent Burke.
DECISION
I. Introduction
Respondent Block was the Chief Executive Officer, Chairman, and sole
director of Block Trading, Inc., a Houston daytrading firm which ceased operations in
September of 1998, due to a net capital deficiency. Respondent Burke was
President of the firm.
Although an outside auditor did not discover net capital violations until
September of 1998, the firm had operated with net capital below the required
minimum since October of 1997. During that time, its monthly deficiencies, hidden
from the SEC and NASD, ranged from $192,099 to $1,720,468 (Joint Exhibit 1).
During this period of net capital violations, Block and Burke, co-founders of the
firm, who shared joint supervisory responsibility for its operations, fell into serious
disagreement. Their deteriorating relationship culminated in Block running the
company on a day-to-day basis, while Burke operated a branch office trading floor in
another location. While Block relied on Gonzalez, a non-accountant, he nevertheless
involved himself in the firm’s bookkeeping, including some of the techniques which
concealed the net capital violations. An accountant employed by the firm (Mr. S)
questioned some of the entries and discussed with Burke his suspicions that the firm
was in violation. In June of 1998, Burke conferred with Mr. C, the firm’s outside
auditor, who, in September of 1998, found that Block Trading was operating without
the required minimum net capital. The firm then ceased operations.
The principal issues at the hearing involved the extent to which Block and Burke
are culpable for these net capital deficiencies. A Hearing Panel, composed of an
NASD Hearing Officer and a current and a former member of District Committee
Number 6, conducted hearings in Houston, Texas on April 24, 25, and 26, 2000.
After the parties filed briefs, the Panel heard closing statements and arguments on
June 16, 2000.
II. Discussion
A.) Block’s liability for financial violations
The First through Fourth Causes of the Complaint charged Block with making
improper entries on the firm’s books, operating under net capital deficits, failing to
report such deficits, and filing false FOCUS reports. Each of these allegations charged
a different version of the same underlying misconduct - the firm’s net capital violations.
Enforcement’s evidence was essentially the same for all of these counts, and Block
defended each with the claim that his knowledge of and involvement in the firm’s net
capital situation were not sufficient to establish liability. For purposes of clarity and of
avoiding repetition, the Panel here discusses the four Counts on a combined basis.2
1.) Block’s activities
Block argues that he was neither involved in nor aware of the accounting
misconduct which concealed the net capital violations; that the books were solely the
responsibility of Gonzalez, the FINOP, to whom he delegated such duties; and that
he, therefore, should not be held liable for the deficiencies in the books and records,
the net capital violations, or the failure to report them (Brief, pp. 1-9). The Panel
disagrees and concludes that Block - the CEO, Chairman and sole director of the
company which bore his name - had close involvement in the net capital violations.
One of the firm’s techniques for evading net capital deficits on its books was to
treat certain of its liabilities as those of an affiliated management company (Jt. Ex. 1;
Tr. 62-63). Block knew about this bookkeeping device; indeed, two of the firm’s
employees questioned him about the practice. The firm’s former compliance officer
(Katz) stated that he told Block that such liabilities had to be booked to the firm, not
to another entity (CB-33, par. 10). Mr. S, an accountant employed by the firm,
testified that he told Block “I will book the entries into [the management affiliate] if
you can provide me a letter that stated the arms-length reach between the two
companies, or if you would call Jeff Mr. C [the outside auditor] and get his approval
to book these entries” and that Block refused to make such a call (Tr. 688). Block
himself agreed that Mr. S told him “he thought it was illegal” to book the firm’s
liabilities this way and that he wanted Mr. S to do so anyway because he believed it
was permissible (Tr. 562-563).
Gonzalez, the FINOP, testified before investigators that she, together with
Block, Burke, and another employee, “decided to use the management company and
make those entries” (Tr. 314). She testified at the hearing that booking some of the
firm’s payables to an affiliate was “probably Chris’ idea” (Tr. 430). Minutes of the
firm’s October 1997 executive committee meeting, referring to Gonzalez’ questions
about net capital problems, state that Block “proposed the solution of running it
through” the management affiliate (CX-21, p. 8774).
A staff supervisor with training and background in analyzing net capital
explained “netting,” an improper bookkeeping technique which the firm used to
understate liabilities. Using this device, the firm would eliminate one of its true liabilities
by “netting” it against a “nonallowable asset” (i.e.- an unsecured receivable due to the
firm) (Tr. 53-55). After the reporting period ended, the firm would reverse these
entries (Id.). As to this device, Gonzalez testified that Block “was aware of the netting
procedure because he and I had discussed that at length” and that he “told me to do
it,” though she did not believe that he knew it was improper (Tr. 315, 356, 430).
Block’s involvement with the firm’s accounting practices was also shown by
Mr. C, the outside auditor. When asked who was “in charge of supervising the
accounting department at the firm,” he answered: “Well, I always thought Chris. I
mean, yeah, Chris did,” explaining that Block was his contact at the firm, and that “if I
had accounting issues that [Gonzalez] didn’t want to answer or were very specific
questions, they were always referred to Chris” (Tr. 168).
The record also demonstrates that Block knew of the firm’s net capital
deficiencies. Gonzalez explained that she, Block and Burke “knew that there was a
number every month that we were adjusting or working with every month,” a number
which “was just whatever we were having to either put off into management
companies, or net as far as payables were concerned, to be in capital compliance”
(Tr. 314, 315). She testified repeatedly that Block knew “the number” (Tr. 321,
426). Her testimony was corroborated by Mogonye, an employee of the firm and
friend of Block, who testified that sometime prior to the summer of 1998, he heard
Gonzalez tell Block that the firm needed $600,000 or $700,000 to bring itself into net
capital compliance (Tr. 447). The firm had such a deficit in February of 1998, when it
was $600,445 below the required minimum (Jt. Ex. 1).
Block’s professed belief in the innocence of “netting” and booking the firm’s payables
to a subsidiary is not persuasive. It is true that Block was not an accountant, but Mr.
S, who was a CPA, told him that the latter was illegal. Moreover, Katz had warned
him about this practice. In any event, Block’s opinion as to the legitimacy of two of
the evasive techniques was immaterial. Rules 2110 and 3110, the bases for the
Complaint’s First, Second, Third, and Fourth Causes, require no showing of specific
intent.3 Block knew of the firm’s net capital deficit and used these and other devices
to hide it. The firm’s books and records were defective, the net capital violations
occurred, the required reports were not made, and the FOCUS reports were
inaccurate - no matter what he thought about the means used.
The testimony of Mr. S, the employee-accountant, also shows Block’s overall
awareness of the net capital deficits. He described a meeting with Gonzalez, Block,
and others involving “how to get out of the net capital, and how much money we
needed, and how they [Gonzalez and Block] could align the financials to make it look
like a profitable company” (Tr. 680). During that meeting, “Chris [Block] asked Jeni
[Gonzalez] if you defraud or you fraudulently turn in focus reports to the NASD once
or twice, is it bad that you do it a third time, and Jeni referred to, yes, it is, and he
said, well, you’re just going to have to keep doing it until we can come up with a way
to get out of the net cap violation” (Tr. 682).
Block’s argument that he had no involvement in the filing of FOCUS reports
(Brief, p. 9) ignores Mr. S’s’ testimony and is contrary to other evidence in any event.
His reported remark about filing “fraudulent” FOCUS reports is corroborated by the
reports themselves. For quarters ending December 31, 1997, March 31, 1998, and
June 30, 1998, the firm’s reports incorporated the accounting irregularities and failed
to disclose net capital deficiencies (Jt. Ex. 1, Schedule A and par. 9; CX-26, pp.
9176-9205).
Each FOCUS report was transmitted to the NASD under a PIN number assigned to
Block (Tr. 112). The keypunch operator for the reports relied wholly on financial data
given him by Gonzalez, who was Block’s appointee and with whom Block discussed
accounting matters. Block effectively signed the FOCUS reports themselves. The first
page of each bears his name as the “Principal Submitting Form Electronically” and as
the “person to contact in regard to this report” (CX-26, pp. 9176, 9186, 9196). A
boxed notice on each of those pages states: “[t]he registrant/broker or dealer
submitting this Form and its attachments and the person(s) by whom it is executed
represent hereby that all information contained therein is true, correct and complete”
(Id.).
2.) Block’s delegation to Gonzalez
Gonzalez, who held a Series 27 license, was the firm’s Limited Principal-Financial and
Operations (FINOP). Under Rule 1022(b)(2), her duties included “final approval and
responsibility for the accuracy of financial reports” and “final preparation of such
reports.” Block, who lacked a FINOP license, argues that he delegated “final”
responsibility for the books and records to Gonzalez and thus could not be liable
under the First through Fourth Causes of the Complaint, citing In re Everest
Securities, Inc., Exchange Act Rel. No. 37600, 1996 SEC LEXIS 2272 at *17-*18
(August 26, 1996).4
As stated in Everest Securities, “[t]he president of a brokerage firm is responsible for
the firm’s compliance … unless or until he or she reasonably delegated a particular
function to another person in the firm, and neither knows nor has reason to know that
such person is not properly performing his duties” (Id.). That Gonzalez was a licensed
FINOP is not dispositive of the reasonableness of the delegation. See In re Kirk A.
Knapp, Exchange Act Rel. No. 31556, 1992 SEC LEXIS 2971, at * 26 (December
3, 1992), where Knapp, the firm’s chief shareholder and executive, “claim[ed] he is
not responsible … because he was not licensed as a financial principal, and
necessarily relied on [the firm’s] FINOP.” The SEC concluded that Knapp was
responsible for net capital and other financial violations, notwithstanding the
delegation, stating, “[w]e agree with the NASD that Knapp’s reliance on [the
FINOP] who he knew had almost no experience, would have been, at best,
misplaced.”5
Block’s reliance on Gonzalez was similarly misplaced. She had an undergraduate
degree in history, with a minor in Spanish, and three hours of accounting during some
post-graduate work (Tr. 288-290). As Block admitted, he knew that Gonzalez did
not possess a degree in accounting and she had no previous accounting experience,
“other than balancing her checkbook” (Tr. 485). She passed her Series 7 while
working as a “[g]opher, secretary” and was employed by Block Trading to write
tickets and enter trades on a computer (Tr. 288-289). After two months she became
“bookkeeper/accountant/controller, sort of all at once” (Id., at 289).
When a panelist asked her “[o]n what basis do you feel you are qualified to become
the controller …?”, she replied: “I do not think I was qualified. I was grossly
underqualified, and when I’m not somewhat ashamed, I’m amused by the amount of
things that we sort of all figured out as we went. Accounting happened to be my given
area, and I figured it out somewhat” (Tr. 420). Mr. C, the outside auditor, described
Gonzalez as “kind of learning as she went” and stated that “early on” in the firm’s
operations, he told Block that “due to the, size of the organization and the complexity,
... a degreed accountant would be appropriate for his firm” (Tr. 139, 140)6. Mr. C
explained Block’s delegation to Gonzalez in these terms: “[a]ccounting enlists a sense
of trust, and I think he trusted Jeni [Gonzalez], and sometimes people put people in
positions of trust over skill. They may not have the skills but, they have the trust part”
(Tr. 181-182).
Block’s installation of this admittedly “grossly underqualified” non-accountant as
FINOP of a multimillion dollar firm, in disregard of the outside auditor’s advice, was
unreasonable and cannot be the predicate for a “delegation” defense.
Second, Block was not the pure delegator he claims to be. The record shows his
close involvement with the firm’s accounting and related net capital problems. Block
instructed Gonzalez to net certain receivables and payables; he had conversations with
Gonzalez and Mr. S, the in-house accountant, about booking the firm’s liabilities to an
affiliated management company (“probably Chris’ idea”); he knew the monthly
“number” necessary to bring the firm into net capital compliance; he was the person to
whom Gonzalez referred the outside auditor’s questions; and his name appeared on
the FOCUS reports as the person making the submission and the person to contact,
recitals which made him the guarantor of their accuracy.
Finally, as shown infra in the discussion of supervisory failures, there were several
“red flags” which should have alerted Block to the underlying net capital deficiencies
He ignored these signs, allowing (and even encouraging) the violations. His failure to
act appropriately in response to the situation at the firm should be considered as “part
of the equation” in determining that Block was a primary actor in Causes One through
Four.7
The argument that Block was so distant or remote from the firm’s books as to be
somehow insulated from liability for their entries and net capital consequences is not
supported by this record. The Panel finds that the evidence directly links Block to the
improper accounting, to the net capital violations, to the failure to report them, and to
the inaccurate FOCUS reports. He is thus liable under the First, Second, Third, and
Fourth Causes.
B.) Burke’s liability for the net capital violations
The Complaint’s Second cause charged Burke with allowing the firm to operate under
net capital deficits from October of 1997 to September of 1998.
Burke was the President of Block Trading, with a salary equal to Block’s (Tr. 757).
The firm’s compliance manual provided that he and Block “share in the ultimate
supervision of the firm” (CB-21, p. 2). He was present at the firm’s Executive
Committee meeting in October of 1997, where Gonzalez warned about likely net
capital problems at the end of the month and Block suggested “running” certain
liabilities through an affiliated company (Tr. 293-294, 305-306). Gonzalez testified
that Burke had discussed some of the on-going improper accounting techniques and
that he was among those who knew “the number” (Tr. 298, 314).
During sometime in May or June of 1998, Mr. S, the firm’s in-house accountant, told
Burke of his concerns about net capital violations and gave him materials showing net
capital violations from November of 1997 (Tr. 675-676, 678, 695, 697, 708; CX-
16, p. 7263). Burke’s handwritten note, reflecting what Mr. S told him, said
“$564,000 in net capital violation and have been in net cap violation since October of
last year” (Tr. 779; CX-16, p. 7283).
On the basis of Mr. S’’ materials, Burke went to Dallas to confer with Mr. C, the
outside auditor, telling him in a June 2, 1998 meeting that he “had concerns about the
[firm’s] accounting” (Tr. 141, 165-167). Burke believed that the firm might be in
violation and raised net capital questions with the executive committee at a June 15,
1998 meeting, but did not pursue the matter further because he had no “conclusive
evidence” and because Mr. C had told him to be cautious - advice which Mr. C
corroborated (Tr. 170, 742-743, 746).
In January of 1998, Burke first attempted to sell his ownership share of the firm (JB-
3; Tr. 384-386). In a later agreement, executed after the June 15, 1998 meeting
(where Burke raised questions about the firm’s net capital), Block agreed to buy
Burke’s shares for $1 million (Tr. 594, 733-744).8 These two Respondents were the
firm’s principal stockholders and shared an obvious economic interest in keeping the
firm going; although the million dollar sale fell through, Burke acknowledged that the
firm’s continued operation was important to the value of his stock (Tr. 767).
Burke challenges Gonzalez’ credibility, suggesting that her testimony was a product of
her promise to cooperate with Enforcement (Tr. 940-941, 953-954). The Panel finds
nothing in this contention which justifies exonerating Burke. First, her testimony was
not critical to his liability. Burke’s presence at the October 1997 meeting, where net
capital was discussed, is shown by the minutes of that meeting, as well as by his own
admission (CX-21, pp. 8770, 8774; Tr. 769). Even if he did not know the “number”
earlier (as Gonzalez testified), he nevertheless suspected net capital problems as early
as April of 1998, when he called Mr. S to his office to discuss them (Tr. 673, 675).
Burke’s counsel had ample opportunity to explore any relationship between
Gonzalez’ “cooperation” with Enforcement and her testimony during cross-
examination, but chose not to do so. Her testimony reflected understandable memory
lapses, considering the passage of time since the events. Her overall caution was
consistent with a reluctance to admit that her performance as FINOP, of which she
was already “ashamed” (Tr. 420), was even worse. Finally, many aspects of her
testimony were corroborated. The Panel saw and heard Gonzalez and concludes, on
balance, that her testimony was truthful.
The totality of the evidence shows that Burke knew of the net capital violations, but
never took his concerns beyond the company and its auditor. This inaction came
during the time when he decided to sell his interest in the firm and was consistent with
a desire to avoid action which might depress the selling price. The Panel concludes
that though Burke did not cause or direct the particular accounting irregularities, he
nevertheless knowingly acquiesced in them and thus may be held liable for the net
capital violations.
The Panel recognizes that Burke’s involvement differed from Block’s; his conduct
involved omissions rather than commissions. That distinction, while relevant to the
questions of sanctions, does not create a defense. In the Panel’s view, the evidence
sufficiently links Burke to the net capital violations. Respondent Burke notes
Enforcement’s statement that “[t]he Department of Enforcement does not contend
that Burke was an active participant in the manipulation of the firm’s records” (Brief,
p. 14) and asks the Panel to find that he was not such a participant. The Panel agrees
that Burke was not an active participant in the manipulation of the records of Block
Trading Inc., a factor which will be considered in determining an appropriate sanction. |
