David Lavigne
"Schneider’s office supervision chart lists Rouse as Bates’s direct supervisor from November 2000 through May 2001. (Div. Ex. 23.) The chart does not distinguish between Bates’s retail and other activities, as it does with other members of the branch office. (Div. Ex. 23.) For example, supervision of David Lavigne was divided between O’Rourke and Bates, depending on whether Lavigne’s research or retail activities were involved.23 (Div. Ex. 23.)"
Subsequent Events
Schneider permitted Muth to resign in May 2001. (Muth Answer at 2; Tr. 186, 293.) Bates ceased being the branch office manager in May 2001, following receipt of a letter from David Lavigne, which represented that the branch office no longer had sufficient revenue to pay Bates, due to Muth’s departure. (Tr. 472-73; Div. Ex. 2178.) Schneider ceased doing business as a broker or dealer in late 2002. (Tr. 847.)
sec.gov
INITIAL DECISION RELEASE NO. 262
ADMINISTRATIVE PROCEEDING
FILE NO. 3-11346
UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
--------------------------------------------------------------------------------
In the Matter of
Steven E. Muth, Richard J. Rouse, and Bruce J. Bates
--------------------------------------------------------------------------------
:
:
:
:
INITIAL DECISION
October 8, 2004
APPEARANCES:
Steven E. Muth, pro se
Richard J. Rouse, pro se
Robert M. Fusfeld and Julie K. Lutz for the Division of Enforcement, Securities and Exchange Commission
BEFORE:
Brenda P. Murray, Administrative Law Judge.
INTRODUCTION
The Securities and Exchange Commission (Commission) initiated these proceedings on November 26, 2003, pursuant to Section 8A of the Securities Act of 1933 (Securities Act), and Sections 15(b) and 21C of the Securities Exchange Act of 1934 (Exchange Act).1 The Order Instituting Proceedings (OIP) alleges that Respondent Steven E. Muth (Muth), while a registered representative with Schneider Securities, Inc. (Schneider), engaged in fraudulent sales practices and misrepresented material facts to Schneider customers from December 2000 through April 2001. As a result, the OIP alleges that Muth willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
The OIP alleges that Respondent Richard J. Rouse (Rouse), the former Executive Vice President and a Director of Schneider, failed reasonably to supervise Muth with a view to preventing Muth’s violations of the antifraud provisions of the federal securities laws by failing to develop a system to monitor whether Muth’s supervisors, including himself, were adequately carrying out their responsibilities. The OIP further alleges that Rouse failed reasonably to supervise Muth by failing to follow the firm’s procedures regarding heightened supervision and failed to respond to red flags relating to Muth’s misconduct. As a result, the OIP alleges that Rouse failed reasonably to supervise Muth with a view to preventing Muth’s violations, within the meaning of Section 15(b)(4)(E) of the Exchange Act.
I held a four-day public hearing from June 1-4, 2004, in Denver, Colorado, during which fourteen witnesses testified, including Muth, Rouse, and seven of Muth’s customers. I admitted exhibits from the Division of Enforcement (Division), Muth, and Rouse into evidence. On July 27, 2004, I admitted an additional exhibit from Rouse into evidence. On August 24, 2004, I admitted two additional exhibits from the Division into evidence.2
PROCEDURAL ISSUES
On September 10, 2004, the Division filed a Motion to Strike (Motion) exhibits that Muth included with his Post-Hearing Brief. Muth filed his opposition to the Division’s Motion on September 27, 2004. The Commission favors a liberal standard of admissibility. See City of Anaheim, 71 SEC Docket 191, 193-94 & nn.4-8 (Nov. 16, 1999). This standard, however, is not limitless. See 17 C.F.R. § 201.320.
Most of the exhibits accompanying Muth’s Post-Hearing Brief are not relevant to the allegations stated in the OIP. The remainder were already admitted during the hearing. Moreover, none of this material is new and Muth had the opportunity to offer exhibits at the hearing. Accordingly, I GRANT the Division’s Motion and ORDER the exhibits included with Muth’s Post-Hearing Brief stricken from the record.
FINDINGS OF FACT AND CONCLUSIONS OF LAW
The findings and conclusions herein are based on the entire record and my observation of the witnesses’ demeanor. I applied preponderance of the evidence as the standard of proof for the Division’s case. See Steadman v. SEC, 450 U.S. 91, 102 (1981). I have considered and rejected all arguments and proposed findings and conclusions that are inconsistent with this Initial Decision.
Background
Steven E. Muth
Muth is a 44-year-old resident of Aurora, Colorado.3 (Tr. 17.) He attended college but did not graduate. (Tr. 18.) He was employed continuously as a registered representative from 1983 until 2001, and has received Series 7, 24, 63, and 65 securities licenses. (Tr. 18-27.)
In 1991, the National Association of Securities Dealers (NASD) censured Muth, fined him $2,500, suspended him from association with any NASD member for ten business days, and suspended him from association with any NASD member in any principal or ownership capacity for one year. (Tr. 31-33; Div. Ex. 48.) The conduct underlying the NASD action occurred while Muth was associated with an office of supervisory jurisdiction at a broker or dealer in which he had an ownership interest. (Tr. 33.) He maintains that he did nothing wrong in connection with the NASD matter and consented to the order only because he did not have enough money to fight it. (Tr. 33, 205-06.) Muth filed for bankruptcy in 1991. (Tr. 20-21.)
Muth was named as a defendant in a case filed by the Commission in the United States District Court for the Southern District of California, in which he was charged with manipulating the market price of Creative Host Services, Inc. (Creative Host), stock from November 1999 until June 2000. (Tr. 28-31.) On August 9, 2004, the district court entered a final judgment by consent against Muth, permanently enjoining him from future violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. 17 C.F.R. § 201.323 (official notice).4 Subsequently, Muth consented to the entry of a sanction barring him from association with any broker or dealer. See Exchange Act Release No. 50223 (Aug. 20, 2004) (official notice).
Richard J. Rouse
Rouse is a 46-year-old college graduate who is currently employed as a branch office manager at a broker or dealer. (Tr. 250.) He has worked in the securities industry since 1981, primarily as a compliance officer, and holds Series 4, 7, 24, 27, and 63 securities licenses. (Tr. 250-52.) Rouse has known Muth since 1990, when they both worked at Cobra Securities. (Tr. 260.) Rouse has previously testified as an expert on investment suitability. (Tr. 254-55.)
Rouse joined Schneider in April 1995 as the director of compliance and subsequently became a regional sales manager.5 (Tr. 253-55.) He also was a member of Schneider’s board of directors. (Tr. 848-49.) In his capacity as regional sales manager, Rouse was responsible for supervising half of Schneider’s branch offices and branch office managers. (Tr. 255-56, 848-49.) Rouse’s annual salary during 2000 and 2001 was between $80,000 and $100,000. (Tr. 872-74.)
In 1993, the Commission censured Rouse in a disciplinary proceeding. (Tr. 256-57; Div. Ex. 49.) Also in 1993, the State of Florida sanctioned Rouse and fined him $1,000 in connection with alleged violations of that state’s penny stock rules. (Tr. 258; Div. Ex. 42.) In 2000, the NASD fined Rouse $1,500 based on the deficiency of Schneider’s written policies in the areas of excessive trading and use of discretion. (Tr. 258-59; Div. Ex. 42.)
Muth’s Association with Schneider
Muth Joins Schneider and is Subjected to Heightened Supervisory Procedures
Until September 2000, Muth was a registered representative associated with Kirkpatrick, Pettis, Smith, and Polian, Inc. (Kirkpatrick Pettis), where he was the top salesperson. (Tr. 22, 38.) While at Kirkpatrick Pettis, Muth recommended margin purchases of Bonso Electronics International, Inc. (Bonso), and Creative Host stock to a large portion of his customers and Kelli Bates worked as his personal assistant. (Tr. 41, 58, 225-29.)
Muth’s conduct while he was associated with Kirkpatrick Pettis was the subject of at least four customer complaints. (Tr. 34; Div. Exs. 26; 2050.) These complaints included unauthorized trading and failure to execute a sell order, and one referred to suitability for margin trading. (Div. Exs. 7 at 207-11; 8 at 370-74; 26; 2050.) In May 2000, Kirkpatrick Pettis initiated an internal review of Muth’s sales activities, which was terminated prior to completion when Muth resigned.6 (Tr. 62-63; Div. Ex. 26 at 4-5.)
Schneider recruited Muth because he was a big producer. (Tr. 47, 263-64.) Rouse, Driver, and Thomas O’Rourke (O’Rourke),7 participated in the decision to hire Muth. (Tr. 228-29, 259-60, 788.) Rouse was aware of the customer complaints made against Muth and that Muth believed the complaints were unjustified.8 (Tr. 260-61, 788.)
Rouse knew that Muth was very active in, and passionate about, Bonso and Creative Host stocks. (Tr. 264, 307.) Rouse knew that many of Muth’s customers at Kirkpatrick Pettis, whose accounts Muth ultimately transferred to Schneider, had positions in Bonso and Creative Host on margin. (Tr. 264.) Rouse also knew that Muth had left Kirkpatrick Pettis because it had prohibited margin purchases of Bonso and Creative Host. (Tr. 59, 265.) Muth joined Schneider because the firm agreed to give him more freedom than he had at Kirkpatrick Pettis with respect to margin transactions in Bonso and Creative Host stocks. (Tr. 59, 635-36, 684, 734-35; Div. Ex. 2094.)
Bonso and Creative Host were high-risk stocks, suitable only for investors that had a high risk tolerance and preferred aggressive or speculative investments. (Tr. 53-57, 307; Div. Exs. 50; 51.) Creative Host was a NASDAQ Consolidated Small-Cap market stock. (Div. Ex. 50.) Its closing stock price declined steadily, from a high of $8.75 per share on October 9, 2000, to a low of $0.75 per share on April 12, 2001. (Div. Ex. 50.) Its daily trading volume ranged from a high of 381,400 shares on November 29, 2000, to a low of 200 shares on January 26, 2001. (Div. Ex. 50.)
Bonso’s stock was listed on the NASDAQ National Market System. (Div. Ex. 51.) From October 2, 2000, until late March 2001, its closing stock price was unstable, ranging from $6.00 to $12.87 per share. (Div. Ex. 51.) After March 2001, it generally closed between $4.00 and $6.00 per share. (Div. Ex. 51.) Bonso’s daily trading volume ranged from a low of 1,100 shares on November 17, 2000, to a high of 295,000 shares on April 5, 2001. (Div. Ex. 51.)
Rouse believed that Muth’s concentration solely on these speculative stocks was very unusual and cause for concern as a supervisor. (Tr. 306-07.) Muth discussed with Rouse a fifty percent or less margin requirement on purchases of Bonso and Creative Host.9 (Tr. 60.) Schneider made a market for Bonso and Creative Host, at Muth’s request. (Tr. 59-61, 264-65, 868.)
Before Muth could associate with Schneider, the State of Colorado Division of Securities required that he be subject to heightened supervisory procedures. (Tr. 64-65; Div. Ex. 2050.) In addition to Colorado, several other states in which Muth sought to be registered imposed special supervisory procedures, granted conditional registration status, requested additional information, or requested Muth’s application be withdrawn. (Tr. 71-74; Div. Exs. 2114-2116; 2118-2120; 2122; 2124.) By letter dated October 2, 2000, and sent to the Colorado Division of Securities, Schneider agreed to adopt the following procedures to provide heightened supervision over Muth:
Muth will act only as a Series 7 registered agent conducting the majority of his business in equity securities in states in which he is registered;
Muth’s direct supervisor is Rouse. Muth and his supervisor will hold quarterly reviews, which will consist of daily and monthly reviews of Muth’s accounts with Colorado residents and a review for excessive activity. All new accounts with Colorado residents will be reviewed and approved by Muth’s supervisor to determine the suitability of the transaction prior to the execution of the initial transaction;
All of Muth’s transactions will be reviewed on a daily basis by Rouse or his designee in his absence;
Muth and Rouse will meet monthly to discuss the transactions during the period. Muth will maintain a journal of all conversations that result in a transaction with Colorado residents, and this journal will be reviewed and initialed by Rouse on a monthly basis; and
Schneider will provide the Colorado Division of Securities any written customer complaints on Muth within fifteen days of receipt.
(Div. Ex. 2050.) These supervisory procedures were the only additional ones Schneider imposed. According to Rouse, the call log requirement were the only supervisory procedure the state required that was not already required pursuant to Schneider’s compliance manual. (Tr. 274-76.)
Muth joined Schneider in September 2000, and initially worked at Schneider’s main office in downtown Denver. (Tr. 22, 40, 216, 788, 852.) Muth brought with him to Schneider a group of people he had worked with at Kirkpatrick Pettis, including Kelli Bates and Dan Murphy (Murphy). (Tr. 35-42, 261-62, 310-11.) In early November 2000, Schneider opened a branch office and Muth and his group relocated to that office. (Tr. 40, 53-54, 216, 266, 454, 852.) Muth was a part-owner of this branch office.10 (Tr. 45, 261-62, 310-11.)
Bruce J. Bates is Hired as Branch Office Manager
Bruce J. Bates (Bates)11 is the husband of Kelli Bates, Muth’s personal assistant. (Tr. 41, 451-55.) Bates learned about the branch office manager position at the new branch office from his wife and Muth. (Div. Ex. 1 at 83-84.) On October 19, 2000, Bates was hired as branch office manager.12 (Tr. 449.) Bates had virtually no prior experience supervising registered representatives, having supervised only himself and one other broker for a period of one month. (Tr. 300-01, 450.) Rouse knew about Bates’s limited supervisory experience. (Tr. 300-01.) Bates received no formal training before becoming branch office manager. (Tr. 455.)
Bates received a salary of approximately $3,500 per month and an override on commissions of the branch. (Tr. 454; Div. Ex. 2176.) The owners of the branch office, including Muth, paid Bates’s salary. (Tr. 53.) The payment of Bates’s salary is best illustrated as follows. For every one dollar of revenue that was earned, Schneider took twenty cents and the branch office retained the remaining eighty cents. (Tr. 267-69.) Bates’s salary was paid from the eighty cents the branch retained. (Tr. 267-69.) Rouse was not concerned by this arrangement. (Tr. 303-04.)
Bates’s wife worked as Muth’s personal assistant for several years, including while Muth was at both Kirkpatrick Pettis and Schneider. (Tr. 41, 451-55.) According to her compensation agreement, Muth and Todd Dirks agreed to pay Kelli Bates an unspecified amount in salary, plus $3,000 or 1.50% of their gross pay per month, whichever was greater. (Tr. 50-52; Div. Ex. 2180.) Rouse was not concerned that the wife of the branch manager was Muth’s personal assistant whose salary was paid by Muth. (Tr. 304.)
Bates was an employee of the branch office, whose continued employment was subject to the branch directors’ review of his performance every six months. (Tr. 198-99; Div. Ex. 2176.) Muth was a director of the branch. (Tr. 201.) The owners of the branch could replace Bates if they wanted to do so. (Tr. 383.) Rouse and Bates never discussed any conflicts that may arise as a result of Muth owning the branch and Bates being the branch office manager. (Tr. 456.)
At the time he became branch manager, Bates knew that Muth primarily recommended margin purchases of Creative Host and Bonso. (Tr. 456-58.) According to Bates, Muth was very enthusiastic about Bonso and Creative Host; he had his customers buy all day. (Tr. 466-67.) Bates became aware of the aforementioned customer complaints after he joined Schneider. (Tr. 457.) He does not recall discussing with Rouse Muth’s concentration on Bonso and Creative Host or the customer complaints and the supervisory vigilance required. (Tr. 456-58, 467.)
Muth’s Conduct While Associated With Schneider
In the period December 2000 through April 2001, Muth recommended Bonso and Creative Host stock to many of his customers, including the seven customers who testified. Muth’s conduct surrounding the transactions of Bonso and Creative Host in these customers’ accounts is summarized below.
Gert DeHerrera
Gert DeHerrera (DeHerrera) is a 47-year-old resident of Denver, Colorado. (Tr. 386; Div. Ex. 2136.) He attended college for two years, worked for the Kmart Corporation for ten years, and has been involved in real estate for the past twenty years. (Tr. 386.) DeHerrera opened his first brokerage account in 1999 at Piper Jaffray. (Tr. 387.) He traded mostly blue-chip stocks in this account and conducted twenty to thirty trades during a one-year period. (Tr. 387, 428.)
DeHerrera first met Muth approximately eight to ten years ago. (Tr. 387-89.) He loaned Muth $5,000, which Muth never repaid. (Tr. 388-89, 424-26.) DeHerrera did not have any further contact with Muth until 1999 or 2000, at which time DeHerrera mentioned the outstanding loan to Muth. (Tr. 389-90.) Muth responded by taking DeHerrera on an all-expenses-paid business trip to China. (Tr. 390-91.)
In early November 2000, DeHerrera transferred his account to Muth at Schneider. (Tr. 392; Div. Ex. 2136.) He did not open a discretionary account. (Tr. 399.) At the time, DeHerrera’s account had a $67,000 margin balance and approximately $85,000 in stock. (Tr. 433; Div. Ex. 2139.) Kelli Bates filled out DeHerrera’s new account form, which accurately set forth his net worth as $1.5 million, his annual income as $100,000, and his liquid net worth as $250,000. (Tr. 393-94; Div. Ex. 2136.) She also filled out his investment objectives and risk tolerance, which were described as eighty percent speculation and twenty percent aggressive growth, and eighty percent high risk and twenty percent maximum risk, respectively. (Tr. 394-97; Div. Ex. 2136.) DeHerrera was told that he was required to have these investment objectives and risk tolerance to have Muth as his broker. (Tr. 394-97.) His true investment objectives were twenty percent speculation, twenty percent capital appreciation, and sixty percent aggressive growth. (Tr. 396.) Contrary to the representation Schneider made to the Colorado Division of Securities, no one at Schneider contacted DeHerrera to verify his investment objectives or risk tolerance, and neither Rouse nor Bates contacted DeHerrera when he opened his account or at any time thereafter. (Tr. 398-99.)
In addition to opening a new account, DeHerrera signed a margin agreement. (Tr. 397-98; Div. Ex. 2137.) No one, including Muth, discussed with DeHerrera the risks of margin trading. (Tr. 398-99.)
The same day DeHerrera opened his account, Muth asked him if he was interested in purchasing a $50,000 block of Creative Host stock. (Tr. 399-400.) Muth represented that its price would soon increase. (Tr. 400-01.) DeHerrera informed him that he had a large margin balance and insufficient funds to cover the purchase. (Tr. 399-403, 421, 433-35.) Muth told him that they would check his margin balance and he was sure he could obtain the stock for DeHerrera. (Tr. 400-03, 421.) DeHerrera believed that Muth would take care of him by purchasing the stock and holding it for him because Muth had told him that he felt badly about the unpaid loan. (Tr. 422, 433-36.) Based on Muth’s recent generosity, I find that DeHerrera reasonably believed that Muth was going to acquire and hold the stock for him.
Thereafter, DeHerrera embarked on a six-week vacation. (Tr. 403.) While DeHerrera was away, there was a purchase of Creative Host stock in his account, which was subsequently rescinded due to insufficient cash and margin. (Tr. 407-08.) DeHerrera did not authorize this purchase of Creative Host.13 (Tr. 420-22, 433-36.)
During his trip, DeHerrera spoke with Kelli Bates, who informed him that there had been a margin call on his account and that they would have to liquidate his stocks to pay for it. (Tr. 404.) DeHerrera informed her that he should have cash in his account. (Tr. 404-06.) He requested that she notify him as to what stocks they sold, and that they use his cash first, followed by his stock holdings. (Tr. 418.)
A few days later, DeHerrera spoke to Kelli Bates again and she informed him that his stocks were liquidated to pay for the margin call. (Tr. 404-05, 439.) DeHerrera told her that there was supposed to be cash in his account and asked why they had not used it first, before they started selling his stock. (Tr. 405.) She informed him that there was no cash in his account, only stock. (Tr. 405.) In fact, the cash in DeHerrera’s account at Piper Jaffray had not been properly transferred into his account at Schneider. (Tr. 401-10.) As a result, stocks were sold from DeHerrera’s account. (Tr. 402-10.)
On December 19, 2000, the day after his account was liquidated and while he was still on vacation, there was a margin purchase of 10,000 shares of Creative Host stock into DeHerrera’s account. (Tr. 406-08; Div. Ex. 2140.) DeHerrera, again, did not authorize this purchase. (Tr. 407-08, 420-22, 438.)
In January 2001, DeHerrera met with Muth to complain about these transactions, and Muth assured him that he would look into it. (Tr. 410.) Neither Bates nor Rouse attended this meeting. (Tr. 411.) In February 2001, DeHerrera faxed Schneider a letter complaining about the unauthorized trades and the failure to transfer his cash properly. (Tr. 410-11; Div. Exs. 32; 2138.) Bates responded within minutes and told DeHerrera that he had received the letter and would have to send it to the main office. (Tr. 411-12.) He also told DeHerrera to send a second letter requesting his complaint be tabled, because it would cause less trouble and be handled more expeditiously. (Tr. 413.) DeHerrera complied with Bates’s request. (Tr. 413; Div. Ex. 32.) DeHerrera understood Bates to be Muth’s subordinate, based on his past dealings with both. (Tr. 413-15.)
Subsequently, DeHerrera met with Muth, Bates, and others at the Schneider branch office. (Tr. 415.) After discussing the Creative Host trades in his account, he was informed that Schneider had misplaced his cash during the transfer and it had ended up in a separate account. (Tr. 415-16.) DeHerrera provided Muth and Bates with documents relating to his accounts at Schneider, which were never returned to him.14 (Tr. 419-20.) The meeting ended with Bates and Muth agreeing to handle the matter within ten days. (Tr. 416-17.)
Approximately two weeks later, DeHerrera unsuccessfully attempted to contact Muth. Another two weeks later, Todd Dirks called him, stating that he was his new account manager and Muth had left. (Tr. 417.) DeHerrera’s complaint was never resolved. (Tr. 418.) When he closed his account, all that remained in DeHerrera’s account was $20,000 he invested following the transfer to Schneider. (Tr. 420-21.) DeHerrera does not know what a “market not held order” is, but understands how margin trading works and the basics of options.15 (Tr. 421, 427.)
Gloria Poljanec
Gloria Poljanec (Poljanec) is a 75-year-old widow, and a resident of Littleton, Colorado. (Tr. 525-27.) Her sole sources of income since 2000 have been Social Security and her husband’s pension. (Tr. 526.) Poljanec trusted and relied on Muth. (Tr. 561, 578; Muth Ex. K.)
On October 25, 2000, Poljanec transferred her account from Kirkpatrick Pettis and opened an account with Muth at Schneider.16 (Tr. 527, 536-37; Div. Exs. 2067; 2068.) Poljanec did not fill out the investment objectives, financial information, and risk tolerance portions on her new account form. (Tr. 531; Div. Ex. 2067.) Her net worth is accurately described as $300,000, but her annual income was actually $36,000, not $70,000, as stated on the form. (Tr. 531-32; Div. Ex. 2067.) Poljanec’s previous investment experience was accurately described as more than ten years. (Tr. 532.) Poljanec’s investment objectives were set forth as including fifty percent speculation and thirty percent aggressive growth. (Tr. 533-34; Div. Ex. 2067.) Her risk tolerance was described as fifty percent maximum risk, thirty percent high risk, and twenty percent businessman’s risk. (Div. Ex. 2067.) Poljanec had never discussed these figures with anyone at Schneider before they were entered on her form. (Tr. 533.) No one at Schneider contacted Poljanec to verify her risk tolerance or investment objectives, and she was not contacted by Rouse or Bates upon opening her account. (Tr. 533-36.)
Since before opening her account, Poljanec took care of her husband and sister, both of whom had been suffering from Alzheimer’s disease. (Tr. 528.) In addition, Poljanec’s daughter had undergone brain surgery. (Tr. 528.) Poljanec’s husband entered a nursing home in 1999 and she knew the bills would accumulate, so she did not want to take any unnecessary investment risks. (Tr. 528-29.) Her husband’s nursing home, for example, cost at least $3,000 per month. (Tr. 536.) Poljanec wanted to be very conservative with her investments because she knew that she would need the money. (Tr. 534-35; Muth Ex. K.) She did not want to invest in risky or speculative stocks. (Tr. 534, 543-44, 561.) When she opened her account, Poljanec informed Muth of her personal circumstances and that she did not want to take risks. (Tr. 172, 528-29, 536; Muth Ex. K.) She also told Muth that she was an elderly woman with little investment experience, and needed the money in her account to pay for medical bills. (Tr. 534-36; Muth Ex. K.)
On January 23, 2001, Poljanec signed a margin trading agreement. (Tr. 560; Div. Ex. 2069.) Although Poljanec previously told Muth repeatedly that she did not want to trade on margin and could not afford margin calls, Muth pressured her until she could not say no to opening a margin account and trading on margin. (Muth Ex. K.) In particular, Muth told her that margin trading would not cost her any money, she would become a millionaire, and he could double her money quickly. (Tr. 539; Muth Ex. K.) No one at Schneider, including Muth, explained margin trading or its risks to Poljanec. (Tr. 539.)
No trades were made in Poljanec’s account from November 2000 through January 2001. (Div. Exs. 2070-72.) In February 2001, Poljanec made two margin purchases of Bonso, one for 1,200 shares and the other for 500 shares, based on Muth’s representations that a research report would be published that week that would drive its price up and enable her to get 100 percent of her investment back. (Tr. 540-43; Div. Ex. 2073; Muth Ex. K.) He also told her that he had mortgaged his home and put all of his money towards buying Bonso. (Muth Ex. K.) She remembers that Muth was “really pushing hard” to have her buy Bonso stock. (Tr. 541-42.) Contrary to Schneider’s representation to the Colorado Division of Securities, no one at Schneider, including Rouse and Bates, contacted Poljanec about these transactions, her first since transferring her account to Schneider. (Tr. 542.)
On March 7, 2001, one day before the death of her husband, a margin purchase of 1,000 shares of Creative Host was made in Poljanec’s account. (Tr. 543-45; Div. Ex. 2074.) Poljanec does not recall having any conversations with Muth about Creative Host. (Tr. 543-44.) She seriously doubts that she authorized Muth to make this purchase due to the stress that she was under at that time. (Tr. 544-45.) Given the proximity in time to her husband’s death, her condition around this same time, and the fact that she does not remember discussing Creative Host with Muth, I find that Poljanec did not authorize this transaction.
Thereafter, Poljanec instructed Muth to sell Bonso to pay for expenses, but he repeatedly talked her out of selling the shares by representing to her that she would throw off the market and the price would drop if she sold. (Tr. 545-51, 564, 573; Muth Ex. K.) On March 29, 2001, Poljanec received a margin call. (Tr. 548; Div. Ex. 2075.) She instructed Muth to get her out of the investment. (Tr. 548-49; Muth Ex. K.) He told her that he would sell her stock only if she paid the margin calls. (Muth Ex. K.) Poljanec received another margin call on April 4, 2001, after which she called Muth to obtain an explanation. (Tr. 550-51; Div. Ex. 2076.) She spoke with Murphy and told him that she needed to get out of the investment, and he told her that he would have Muth call her back. (Tr. 551.) Muth never returned her phone call. (Tr. 551.) Poljanec also paid $2,040 to satisfy a margin call because Muth told her that she needed to make payment immediately or she would lose everything. (Tr. 552-54, 564, 577; Div. Ex. 2081.)
In April 2001, Poljanec’s account was essentially liquidated to cover the margin calls. (Tr. 551-52; Div. Ex. 2079.) In July 2001, Poljanec filed a complaint with the Commission. (Tr. 555; Div. Ex. 2077.) Schneider was notified about the complaint on July 12, 2001. (Div. Ex. 2077.) Poljanec reached a settlement with Schneider relating to Muth’s handling of her account, pursuant to which Schneider reinstated 3,800 shares of Bonso and 500 shares of New China Homes, Ltd., and credited her account $2,040. (Tr. 555-58; Div. Ex. 2078.)
Muth never told Poljanec that she was investing in risky and speculative stocks. (Tr. 562.) She does not know what a market not held order is, and Muth never informed her that he was entering such an order. (Tr. 556.)
Tina Saltzman
Tina Saltzman (Saltzman), Poljanec’s daughter, is a 55-year-old resident of Sadalia, Colorado. (Tr. 173, 583.) She has a master’s degree in organizational management. (Tr. 625.) She does not consider herself to have been an experienced investor in 2000. (Tr. 583.) Saltzman had brain surgery in 1998, and during 2000 and 2001, her father was in a nursing home, prior to which she had helped her mother care for him. (Tr. 603-04.) Muth was the registered representative on Saltzman’s account since before he worked at Kirkpatrick Pettis.17 (Tr. 583-84.) Saltzman trusted and relied on Muth. (Tr. 603-05.)
When Saltzman transferred her account to Schneider, it had positions in Bonso and Creative Host, a margin balance of more than $4,400, and total value of more than $19,000.18 (Tr. 584, 601-02; Div. Ex. 2163.) Saltzman’s risk tolerance was moderate, a fact which she had previously communicated to Muth. Her investment objectives were income and growth for her son. (Tr. 584-85, 607.) She never informed Muth that she wanted to pursue a high-risk investment strategy. (Tr. 585-86, 607.) No one at Schneider inquired about her risk tolerance and investment objectives when she opened her account or at any point thereafter. (Tr. 586.)
On December 29, 2000, Saltzman purchased 1,000 shares of Creative Host on margin, based on Muth’s representations that Creative Host was a phenomenal company, it would be one of the hottest stocks around, and she had to have it. (Tr. 588-90; Div. Ex. 2164.) He also represented that its stock price would soon reach $20, $40, and even $80 per share. (Tr. 589-90.) Muth never told her that he was making the purchase on margin, and she never authorized him to do so. (Tr. 589.) Contrary to Schneider’s representation to the Colorado Division of Securities, neither Rouse nor Bates contacted Saltzman following this transaction, her first transaction at Schneider. (Tr. 594; Div. Ex. 2164.)
Saltzman purchased additional Bonso stock based on Muth’s representations that its price would soon reach $20, $40, and even $100 per share. (Tr. 590.) Muth also represented that a research report on Bonso would be released soon that would affect its price favorably. (Tr. 591.)
Saltzman instructed Muth to sell her Bonso stock on several occasions because it had risen in value and the proceeds would enable her son to pay off some debts and buy a house. (Tr. 591-93.) Muth refused and convinced her to not sell, saying that its price would go up, he was unable to sell it, and selling the stock would “upset the balance.” (Tr. 591-93.) Saltzman complained only to Muth about his failure to sell because she believed he was the person in charge. (Tr. 594-95, 619-20.)
After Muth refused to execute Saltzman’s sell orders, Bonso’s stock price dropped. (Tr. 597.) As the balance in her account declined, she started owing money due to margin calls. (Tr. 597-98.) Saltzman estimates that she paid almost $30,000 in margin calls. (Tr. 598.) She had also received margin calls when her account was with Kirkpatrick Pettis. (Tr. 616.)
Saltzman signed a margin agreement on April 16, 2001, after there had been margin trading in her account. (Tr. 593, 608; Div. Ex. 2162.) She signed it only after Muth called her and told her that she had to sign it, otherwise she would lose everything. (Tr. 593-94, 608.) No one at Schneider explained the risks of margin trading to Saltzman, and she has never heard of a market not held order. (Tr. 594-95.)
Robert J. Cassidy
Robert J. Cassidy (Cassidy) is a 76-year-old retired plumber, and a resident of Denver. (Tr. 634-35.) He retired in 1993. (Tr. 635.) Muth has been Cassidy’s representative since before Muth worked at Kirkpatrick Pettis. (Tr. 635-36.) Cassidy transferred his account to Schneider because he had invested in Bonso and Creative Host and Muth was the only broker who knew anything about these stocks. (Tr. 636-37.) Cassidy had never traded on margin prior to meeting Muth. (Tr. 640-41.) Muth was aware that Cassidy had a heart condition. (Tr. 655, 673.)
Murphy filled out Cassidy’s new account form, dated January 31, 2001, which Cassidy signed without reading over in detail. (Tr. 637-39; Div. Ex. 38.) The form identified Cassidy’s risk tolerance as fifty percent businessman’s risk, thirty percent high risk, and twenty percent maximum risk. (Div. Ex. 38.) Cassidy is unaware how this was determined and believes these risk tolerance levels were inappropriate due to his age. (Tr. 639.) His net worth was described accurately as $535,000, and his annual income and liquid net worth were described as $40-45,000 and $25,000, respectively. (Tr. 637; Div. Ex. 38.) While his investment objectives included twenty percent speculation and thirty percent aggressive growth, Cassidy believes that he should not have been invested in speculative or risky stocks, due to his health problems. (Tr. 654-55; Div. Ex. 38.) Muth did not inquire as to Cassidy’s investment objectives or risk tolerance, and neither Rouse nor Bates contacted him when he opened his account. (Tr. 640-41.)
Cassidy signed a margin agreement, dated January 18, 2001, without reading it. (Tr. 640, 654; Div. Ex. 38.) No one at Schneider explained margin trading and its risks to Cassidy. (Tr. 640-48, 654.) The words “Doesn’t Qualify” are written across the top of the margin agreement, which indicates that someone at Schneider determined that Cassidy did not qualify to trade on margin. (Div. Ex. 38.)
When Cassidy transferred his account to Schneider, it had positions in Bonso and Creative Host, a margin balance of approximately $100, and a total value of almost $102,000. (Div. Ex. 38.) Thereafter, Cassidy “got talked into [buying stock]” by Muth on several occasions. (Tr. 655.) In December 2000, Cassidy purchased 4,700 shares of Bonso on margin in three separate transactions based on Muth’s representations that it would go “sky high” and its price would reach at least $40 per share. (Tr. 642-44; Div. Ex. 38.) Muth never informed him that Bonso was a risky investment. (Tr. 642-44.) Cassidy also purchased 3,500 shares of Creative Host on margin in December 2000 based on Muth’s representations that Creative Host was a good stock with no risk and its price would go sky high. (Tr. 645; Div. Ex. 38.) These transactions occurred before Cassidy had signed the margin agreement or new account form. (Tr. 136-38; Div. Ex. 38.) At least one of Cassidy’s purchases of Bonso was entered as a market not held order. (Div. Ex. 2060.)
In February 2001, Cassidy purchased 3,000 more shares of Bonso on margin at Muth’s recommendation. (Tr. 647; Div. Ex. 38.) More specifically, Muth called Cassidy and told him to buy Bonso, whereupon Cassidy told Muth that he did not have enough money. (Tr. 647.) Muth told Cassidy that it “would not cost him a dime” if he bought it on margin. (Tr. 647.) In March 2001, Cassidy purchased 3,000 more shares of Creative Host on margin based on Muth’s representation that it was a sure thing. (Tr. 647; Div. Ex. 38.)
Cassidy soon received margin calls. (Tr. 640-41, 648-49, 670.) In April 2001, shares of Creative Host and Bonso were sold from Cassidy’s account to pay margin calls after Cassidy refused to pay them. (Tr. 649; Div. Ex. 38.) As a result, Cassidy’s account balance at the end of April 2001 was a little more than $1,000. (Div. Ex. 38.)
At one point, Cassidy told Murphy that he wanted to sell some of his Creative Host stock, but Murphy initially refused, telling Cassidy it would hurt the stock price. (Tr. 646-52.) According to Cassidy, Muth knew that he wanted to sell because Murphy worked for Muth and Murphy would not sell without Muth’s prior approval. (Tr. 646, 662-63.) Cassidy also asked Muth directly to sell his Bonso stock on three or four occasions, but Muth talked him out of it by representing that the price would go up. (Tr. 646-52, 662.) In May 2001, Cassidy transferred his account from Schneider. (Tr. 650.) He has never heard of Bates or Rouse. (Tr. 649-50.)
Bernald Acker
Bernald Acker (Acker) is a 68-year-old resident of Castle Rock, Colorado, who has been retired since 1998. (Tr. 683-84.) Muth was Acker’s account executive at Kirkpatrick Pettis. (Tr. 684.) Acker transferred his account to Schneider for convenience. (Tr. 685.) At the time of the transfer, Acker’s account held shares of Bonso, had a margin balance of more than $4,000, and a total value of approximately $55,000. (Div. Ex. 2097.)
No transactions took place in Acker’s account during November 2000. (Div. Ex. 2098.) In late December 2000, Acker called Muth because he wanted to sell his Bonso stock, but Muth talked him out of it by representing that its price would go up. (Tr. 687.) Muth then told Acker that he should buy Creative Host because its stock price would go up significantly due to the disposition of pending litigation against the company. (Tr. 687-88, 699.) Muth predicted the price would explode and it was “a steal” at its current price. (Tr. 689, 699.)
Acker informed Muth that he did not have sufficient funds to make the purchase, and Muth responded by telling him that he could buy it on margin. (Tr. 688.) Acker told Muth that he did not like margin accounts, but Muth kept reiterating that the price would increase significantly in a matter of days. (Tr. 688.) Acker relented and told Muth that he would buy 5,000 shares; however, Muth insisted that Acker buy 10,000 shares. (Tr. 688.) Acker relented again and purchased 10,000 shares of Creative Host on margin based on Muth’s representations. (Tr. 687-88; Div. Ex. 2099.) Acker had not signed a margin agreement or new account form at the time of this purchase. (Tr. 692; Div. Exs. 2095; 2096.)
Muth never told Acker that Creative Host was a speculative, risky stock, and Acker never told Muth that he was interested in purchasing such stocks. (Tr. 689.) Muth did not disclose to Acker any risks associated with purchasing Creative Host. (Tr. 689.) At the time of the purchase, and contrary to Schneider’s representation to the Colorado Division of Securities, no one at Schneider inquired as to Acker’s risk tolerance or investment objectives. (Tr. 692-93.) At the time margin trading began in his account in December 2000, no one at Schneider had explained to Acker the risks of margin trading. (Tr. 699.)
On January 9, 2001, Acker received a margin call and told Muth that he did not have the funds to cover it. (Tr. 690-91; Div. Ex. 2101.) Muth informed Acker that he would have to sell stock in Acker’s account to pay for it. (Tr. 691.) After receiving this margin call, Acker repeatedly tried to sell all of the Bonso and Creative Host stock he held to recoup his losses, but Muth refused, telling him that the prices would increase. (Tr. 691, 700-06, 713.) Muth also predicted that Bonso’s price would increase dramatically, due to the imminent release of a glowing research report. (Tr. 700-01.)
Subsequently, Schneider sent Acker a new account form, that Acker signed on January 31, 2001, and Acker was told that he needed to return it quickly. (Tr. 692-94; Div. Ex. 2095.) When Acker received the new account form, the investment objectives and risk tolerance portions were already filled out for him. (Tr. 693-95.) The form set forth Acker’s investment objectives as fifty percent speculation, thirty percent aggressive growth, and twenty percent capital appreciation. (Tr. 693-94; Div. Ex. 2095.) It set forth his risk tolerance as fifty percent maximum risk, thirty percent high risk, and twenty percent businessman’s risk. (Tr. 694-95; Div. Ex. 2095.) Acker is unaware as to how these determinations were made because no discussions had taken place. (Tr. 694-95.) His true investment objectives and risk tolerance are speculative growth and moderate, respectively. (Tr. 696.)
The form accurately described Acker’s net worth as $1.2 million. (Tr. 697; Div. Ex. 2095.) Acker’s annual income in 2000 was less than $60,000 and was derived from his pension and Social Security. (Tr. 684, 697.) His liquid assets were approximately $100,000, not $800,000, as described on the form. (Tr. 709; Div. Ex. 2095.)
Acker received a margin agreement after he had already purchased Creative Host on margin and received a margin call. (Tr. 695; Div. Exs. 2096; 2101.) Acker understood what a margin agreement was but did not understand how margin trading worked. (Tr. 731.) Acker signed the agreement on January 19, 2001, without reading it because he believed it was simply a standard form. (Tr. 731.)
Thereafter, Acker received additional margin calls and had to sell Bonso and Creative Host.19 (Tr. 702-04; Div. Exs. 2104; 2105.) In or about May 2001, Acker closed his account at Schneider with a zero balance. (Tr. 707; Div. Ex. 2107.) Acker does not know what a market not held order is, and Muth never told him that he was entering transactions in Acker’s account as market not held orders. (Tr. 708.)
Paul V. Lundy, Jr.
Paul V. Lundy, Jr. (Lundy), is a 75-year-old resident of Boulder, Colorado, who is a college graduate and retired employee of the federal government. (Tr. 734, 767.) He worked part-time as a securities broker from 1958 through 1960 and has traded commodities and stocks in the past. (Tr. 734, 767-68.) Lundy transferred his account to Schneider from Kirkpatrick Pettis in October 2000, at which time he owned positions in Bonso and Creative Host, and his account had a total value of more than $49,000, with minimal margin debt. (Div. Exs. 2009; 2010.)
Lundy did not fill out most of his new account form at Schneider, including his financial information, investment objectives, and risk tolerance. (Tr. 735-40, 757; Div. Ex. 2007.) He was not consulted before these portions were filled out. (Tr. 740.) Rather, per Muth’s instructions, Lundy signed and returned to Muth a blank form quickly because he trusted Muth. (Tr. 741, 757-60.) Lundy’s net worth is described accurately therein as $250,000. (Tr. 736-37; Div. Ex. 2007.) His annual income for 2000 was $45,000, not $50,000 as set forth on the form, and his liquid net worth was described as twice its actual amount. (Tr. 735-37; Div. Ex. 2007.)
The new account form described his investment objectives incorrectly as thirty percent speculation, fifty percent aggressive growth, and twenty percent capital appreciation. (Tr. 738, 756; Div. Ex. 2007.) His true investment objectives were thirty percent aggressive growth, fifty percent capital appreciation, and twenty percent conservative income. (Tr. 739.) This is consistent with his investment objectives while at Kirkpatrick Pettis. (Div. Ex. 2009.) The form also overstated Lundy’s risk tolerance, describing him as more risk-oriented than he actually was. (Tr. 739-40, 756; Div. Ex. 2007.) Lundy never told Muth that he was interested in high-risk trading. (Tr. 739.) Lundy did not sign a margin agreement when he opened his account. (Tr. 741, 752.)
No transactions were effected in Lundy’s account during October or November 2000. (Div. Exs. 2010; 2011.) In December 2000, however, Lundy purchased 5,000 shares of Bonso on margin after receiving a telephone call from Muth. (Tr. 743-44; Div. Exs. 2012-14.) Lundy recorded the conversation, which is summarized as follows:
Muth: We’re the biggest franchiser of Schneider . . . We make money through research, we control the research of Schneider . . . And the beauty of this, we have two big research reports and guess who they’re on? Creative and Bonso.
Lundy: Creative sure as hell needs it.
Muth: Right. You just wanna hold tight on Creative, you don’t wanna be buying it right now even though it’s cheap, I think it’s gonna be the buy of the century in my opinion soon. The problem is I—we’ve been buying up blocks of stock from Kirkpatrick Pettis and we’re finishing up all the resistance. Once we get those guys out . . . then I think the Creative is gonna start running like crazy.
Muth: The Bonso, we—we’ve got a major report on them and I talked to the company. In my opinion the biggest announcement in the company’s history is going to come out as early as next week. We’re getting ready to come—and I told you like I told you in the beginning I was gonna call ya and take care of you before things start happening. But anyway, in my opinion, this Bonso is gonna start taking off hard.
Muth: [L]et me explain our company. . . As of Friday, we’re hoping to have all of our paperwork complete. We can—see, we can buy and sell, but once our company is complete, we have sort of a mutual fund with our company. So our mutual fund, it’s like a hedge fund, can go in—it—it’s our inventories, we can go and buy up $4 million worth of these stocks or Bonso and stuff.
Lundy: Yeah.
Muth: That we believe in through our company, because we have our inventories up which could show a significant difference in the stock. And that’s what we expect to be up Friday. So we—once our inventories are up, we plan on comin’ in and utilizing all of our money to buy up the Bonso like crazy where then I think the Bonso’s gonna come out with some huge numbers as well as announcements here soon.
Lundy: When you say soon, what do you mean, next week or so?
Muth: I think next week.
Muth: And not only that, I think our research report which is an eight page research report—and by the way I—I’ve been reading it, you won’t get it for about another two, three weeks, in fact, this is how I feel pretty confident there’s a huge announcement coming. . . [A]nd [the president of Bonso] says, Just wait one more-two more weeks. This was last week when I talked to him. Two more weeks, two more weeks. And I says, if we can come out with something, we can incorporate that in our research report. And he goes, biggest announcement in history, two weeks, just wait two weeks. . . But I do know this, the numbers that are coming out in January, I expect to be, in my opinion, at least a 400 percent increase in earnings and at least a 200 percent increase in sales. . . [T]heir sales alone could triple without any new contracts just because they’re purchasing raw materials. . . [T]heir earnings would probably increase by about ten percent or so, fifteen percent. But their sales would increase by literally probably 300 times.
Muth: I’m gonna take care of you before they start comin’ in big time in this thing. And—and what I was gonna recommend is buying and—and looking, if you know, the margins made you a lot and remember why I told you we came over to—to this company? Because PaineWebber is our clearing agent and PaineWebber give—gave us when we first negotiated our deal—remember Kirkpatrick Pettis kept giving us margin calls?
Lundy: Yeah.
Muth: No more.
Lundy: I got—it’s a death, you know, up to eighty percent.
Muth: Oh, I know. They—they were cockroaches. Here we negotiated a fifty percent rate and that’s our deal. Fifty percent.
Lundy: Yeah, but is it gonna stay that way?
Muth: That’s what we negotiated on. No messing around. And remember, I told ya, we own the company now. So the—we negotiated a fifty percent rate; we own the company. And I’ll give you an example—
Lundy: Can you guarantee no increase in the margin?
Muth: No, I can’t. But I can tell you this much, if they go in to increase it, which I can tell you according to our contracts with ‘em, they said that they’re—they told us it would be fifty percent. And we didn’t say the words, guaranteed, but they said, fifty percent ratio. That’s the deal. They—I can tell you this much, that we’ve negotiated—if there are any problems, we have the ability to put up what’s called subordinated loans against our margin.
Muth: Dragon Productions is what owns our company, Dragon Productions will own the—the hedge fund which could put up the subordinated loans. Now, at this point in time, 100 percent PaineWebber has honored, 100 percent everyone that came over—that came over is sitting, you know, loaded with money, because the deal we structured.
Muth: But I think you’re gonna start seeing a very big move starting right—today. In fact, in minutes. That’s why I promised you I’m taking care of you as much as I can, and that’s why I started this company so we could have research come out.
Muth: We also have our own trading here and then once our fund is set up Friday I think you’re gonna see huge, huge, huge money comin’ into—into the Bonsos and Creatives. That’s why I wanna get my customers up before the fund is set up. . . [T]hat’s why we’re getting ready to go berserko on this thing. So what I would recommend is we can do 5,000 no problem whatsoever. No mar—no money, you know, your margin should be no problem whatsoever. You could probably go about 8 or 9 but I’m goin’ just conservative, so I don’t even have to worry about anything. . . And then next week cross your fingers this is humongous, I mean who knows, maybe this thing finally runs like crazy.
Lundy: Well, I sure can’t take any more margin calls.
Muth: I know.
Lundy: [T]his—you nickeled and dimed me to death—
Muth: I know.
Lundy: --on this—
Muth: I know.
Lundy: --last go ‘round.
Muth: I know.
Lundy: [H]ell, I’m retired.
Muth: I know.
Lundy: I’m 72 years old and I’m just telling you this is where I’m at.
Muth: I know.
Lundy: I had to go into hock.
Muth: Well, I’ll put it this way, I really believe the Bonso’s about ready to run on us. And I do believe this, if Bonso runs, you might as well hang onto your pants and start up buying up Creative, because hang on—because we’re gonna come in with so many millions of dollars it ain’t even gonna be funny in Creative.
Lundy: You got research on Creative, too?
Muth: Yes, An eight-pager.
Muth: [I]f Bonso was to trade equivalent to that company’s valuation on a book-to-price earnings per share—and you’ll see this in our research report, we show broken down all the contract manufacturers, we show the scale companies, Bonso would be trading literally at like $150. . . It’s pretty unbelievable what’s happening over there. I—I mean I’m so excited, I can’t stand it.
Muth: [W]e’re excited. I am so excited, and I think finally this darn stock is gonna take off and go to an appropriate level like one of these measurement companies or one of these—
Lundy: What do you see it—
Muth: --luxury—
Lundy: --going to reasonably?
Muth: Well, if you read the—
Lundy: Conservatively, okay.
Muth: --research report, I think we’re gonna, I mean I don’t—I don’t know what projection price the analyst is gonna put on it, but after reading some of the compatibles, I think it’s an $80 stock this year.
Lundy: This year?
Muth: Yeah.
Lundy: Now, wait before—before the first of the year?
Muth: No, no. [I mean the next twelve months.]
Muth: I promised I’d take care of you and just hang tight is all I can say. We’re gonna start jammin’ on this thing. And just watch it next week and cross your fingers, you know, and—and give it about two weeks maybe three weeks on our research report.
Lundy: Okay.
Muth: But the research we—I—if you wanna come in the office, I’ll let you read it, but I can’t sen[d] it out to ya.
Lundy: Until when?
Muth: In fact, I promise, we’re gonna have dinner, I’m gonna—we’re gonna celebrate. Let’s celebrate right now.
Lundy: I’m conservative.
Muth: I—I honestly believe we finally have—okay, let’s see if next week we have something.
Lundy: So you’re talking about 5,000 shares on margin now?
Muth: Yes, Yes. And I think—I think you’re gonna be—
Lundy: With no margin calls?
Muth: No margin calls, no money due, no none of that.
Lundy: Okay. That seems pretty—pretty great if it works out that way, but it hasn’t in the past and that’s why I’m a little—
Muth: Well—
Lundy: --leery.
Muth: --that’s why we started our own company.
Lundy: Okay. . . But I’ve . . .got your word on this now there’s not gonna be any margin call ‘cause I’m getting—this is the Christmas season, I’m pretty—
Muth: I know.
Lundy: --damn short.
Muth: You—no, you’ll be fine. And I’ll call you if there’s any problems, but I’ve already double-checked, triple-checked and we’ve already structured our deal, so I’m not concerned in the least bit.
Lundy: Okay.
(Tr. 743-46; Div. Exs. 2013; 2014.)
Muth filled out portions of the order ticket for Lundy’s margin purchase of 5,000 shares of Bonso and entered it as a market not held order, although they did not discuss such an order during their conversation. (Tr. 192; Div. Exs. 2013; 2014; 2060.) Subsequently, Lundy received margin calls and immediately tried to contact Muth, because Muth had assured him repeatedly that there would be no margin calls. (Tr. 162-63, 746, 748, 762, 777; Div. Ex. 2015.) Muth, however, evaded Lundy for the most part, and Lundy felt that he had been had. (Tr. 748.) Eventually, Muth and his associates, including Driver, spoke with Lundy and told him that the margin call was binding and he had to cover it immediately. (Tr. 749.) Lundy expressed disbelief at this, because he had not signed a margin agreement. (Tr. 749.) On December 28, 2000, shares of Bonso in Lundy’s account were sold to cover the margin call without any prior notice to Lundy. (Tr. 752-53; Div. Ex. 2012.)
In early January 2001, Lundy received a margin call for approximately $4,700. (Tr. 750.) Lundy, again, expressed disbelief, due to the lack of a margin agreement. (Tr. 750.) Lundy eventually paid the second margin call by wire transfer because he felt that he had no alternative. (Tr. 750.) Thereafter, Lundy participated in a teleconference with Muth and Bates, during which Lundy complained about the margin trading. (Tr. 751-52.)
On January 18, 2001, Lundy sent a complaint letter to the Commission. (Tr. 753; Div. Ex. 2059.) By the end of that month, Schneider received a letter from the Commission, which indicated that Lundy had taped his conversation with Muth. (Tr. 353-54; Div. Ex. 9 at 429.) Muth subsequently drafted a response in which he attempted to explain his representations. (Div. Ex. 2019.) Ultimately, Schneider received a copy of the tape and played it at a meeting held on May 10, 2001, which was attended by Muth and members of Schneider’s board of directors, including Rouse. (Tr. 344-45, 353; Div. Ex. 2132.) After listening to the tape, the attendees discussed its contents and Muth agreed that Lundy was not suitable for the transaction. (Tr. 345-50; Div. Ex. 2132.) Driver agreed with this assessment. (Tr. 345-46.) Following the meeting, Muth was suspended for two weeks and then permitted to resign. (Tr. 243, 293.)
In May 2001, Driver sent Lundy a letter outlining proposed settlement terms between Lundy and Schneider, based on Muth’s conduct. (Div. Ex. 2021.) In July 2001, Lundy entered into a settlement with Schneider, which restored his account to where it was when he transferred it to Schneider. (Tr. 755; Div. Ex. 2022.)
John Nabozniak
John Nabozniak (Nabozniak) is a 67-year-old resident of Edmonton, Alberta, Canada. (Tr. 804.) He attended college in Montreal, and is an engineer. (Tr. 805.) Nabozniak began investing shortly after college and, since that time, has typically made medium-risk investments while avoiding high-risk investments. (Tr. 805.) Nabozniak’s policy was to invest primarily in blue-chip stocks, with small amounts in speculative investments. (Tr. 805-07.) He considers himself to be of “average” sophistication in terms of investing experience. (Tr. 824.)
Muth took over Nabozniak’s account while at another firm. (Tr. 806-07.) Nabozniak told Muth that he had a medium risk tolerance and was not willing to purchase on margin because he had previously lost money purchasing blue-chip stocks on margin. (Tr. 806-07.) Based on his positive experience with another representative at the firm, Nabozniak gained trust in the firm’s employees, including Muth. (Tr. 807, 829.) As a result, Muth convinced Nabozniak to purchase on margin, telling him there was no other way to make money. (Tr. 806-07; Div. Ex. 39.)
Nabozniak transferred his account to Schneider around the time when its value had declined, causing him to panic. (Tr. 818; Div. Ex. 39.) He was under a great deal of work-related stress and did not inspect his account statements and forms in detail. (Tr. 817.) He owned positions in Bonso and Creative Host, had a margin balance of more than $5,500, and his account had a total value of more than $28,000. (Div. Ex. 39.)
Nabozniak did not fill out his new account form; rather, he was sent a blank form, which he signed and returned for Muth to complete afterwards. (Tr. 817-18, 825.) This was consistent with his relationship with Muth at other firms. (Tr. 825-26.) In his new account form, his risk tolerance was described as including fifty percent maximum risk, which was too high. (Tr. 809; Div. Ex. 39.) He never noticed that the risk tolerance was inaccurate because he did not inspect his account statements in detail. (Tr. 817-19.) His net worth, annual income, and liquid net worth were described as more than $500,000, $80,000, and $50,000, respectively. (Div. Ex. 39.)
In December 2000, Nabozniak purchased 2,700 shares of Bonso on margin at $11.80 per share based on Muth’s representations. (Tr. 809-11, 840-42; Div. Ex. 39.) More specifically, Muth represented that Bonso was a good stock with the potential of going up to at least $20 per share. (Tr. 810, 841-42.) Muth also represented that a favorable research report on Bonso would be forthcoming. (Tr. 810.) Nabozniak was aware that margin trading was risky, because he had purchased on margin in the past. (Tr. 820.) Muth never informed him that Bonso was a speculative stock. (Tr. 833.)
Shortly thereafter, Nabozniak decided to sell Bonso. (Tr. 812, 820, 823.) He attempted to contact Muth by telephone approximately four to six times in order to sell, but would inevitably end up talking to Murphy because Muth was purportedly unavailable. (Tr. 812-16, 820-21.) Upon informing Murphy of his desire to sell, Murphy resisted and told him that Muth would not let him sell Bonso because it would affect Bonso’s stock price. (Tr. 812-13, 823.) Nabozniak told Murphy that he believed he was being subjected to “boiler-room tactics.” (Tr. 838-39.) Nabozniak always believed that Muth was his broker, not Murphy. (Tr. 818-21.) He believed that Murphy acted as Muth’s administrative person to convey bad news. (Tr. 835.) The only occasions Nabozniak communicated with Muth occurred when Muth wanted him to purchase stock. (Tr. 827.)
Subsequently, Nabozniak received margin calls resulting from his purchase of Bonso, and Murphy sold off some stock from his account to cover it. (Tr. 813; Div. Ex. 39.) The margin calls resulted in Nabozniak’s account having a closing balance of $39.70 on May 31, 2001. (Div. Ex. 39.) Nabozniak has not yet retired due, in part, to the losses he sustained while his account was with Muth at Schneider. (Tr. 814.)
Muth
Muth knew his customers trusted him. (Tr. 128.) He “zealously believed” in Creative Host and Bonso, which he admitted were high-risk stocks, suitable only for investors that had a high risk tolerance and preferred aggressive or speculative investments. (Tr. 53-57, 155.) Muth further admitted that buying a stock on margin is more risky than buying that same security not on margin and that there is no guarantee whether the price goes up or down or whether there will be a margin call. (Tr. 56, 146.)
Muth maintains that his customers were risk-oriented investors who were suitable to invest in Bonso and Creative Host. (Tr. 53-56, 223-25.) He described the customers who testified as sophisticated, savvy, and speculative investors. (Tr. 128-30, 135, 171, 174.) He also maintains that he rarely predicted a specific stock price and never failed to execute a sell order. (Tr. 129-31, 171-74, 212.) Muth denies making any misrepresentations to his customers and offers various explanations for his statements to Lundy. (Tr. 129-33, 143-57, 171-73.)
Muth testified that although his customers did not specifically request a market not held order, he entered such orders nonetheless because he believed that most of them wanted that type of order. (Tr. 101-06.) Muth believes that most trades are in the form of market not held orders and that such orders are in customers’ best interests. (Tr. 102-03.)
Witness Credibility
I find that Muth was not credible for several reasons. First, much of the evidence directly contradicts his hearing testimony. For example, Muth maintains that Kirkpatrick Pettis’s internal review was completed and he was exonerated of all wrongdoing, whereas his Form U-5 explicitly states the review ended when he resigned. (Tr. 62-64; Div. Ex. 26 at 4-5.) Furthermore, he claimed that all his customers were suitable to invest in Bonso and Creative Host, but later admitted that Lundy was unsuitable to purchase Bonso.
Next, Muth’s professed zealous belief in Bonso and Creative Host is also contrary to the evidence. For instance, Muth gave his customers conflicting opinions about Creative Host. Specifically, Muth told a customer that he was “not too excited about [Creative Host].” Then, fifteen minutes later, he told a different customer that he liked Creative Host technically and fundamentally. (Tr. 114-16; Div. Ex. 22 at 4.) Moreover, in August 2003, Muth sued Bonso for securities fraud, alleging that he knew the company did not prepare its financial statements in accordance with generally accepted accounting principals around the time of the events at issue here. (Div. Ex. 2181.) In addition, much of Muth’s testimony is littered with references about being unable to remember certain events, yet he recalled specific facts and details when it served his interests to do so, especially insofar as his customers were concerned.
In contrast to Muth, I find his customers each to be truthful and credible. These customers were generally: unsophisticated and risk-averse investors; retired or near retirement; with modest financial profiles; who trusted and relied on Muth in selecting investments. As a result, I find the risky and speculative margin purchases of Bonso and Creative Host that Muth recommended to Poljanec, Saltzman, Acker, Cassidy, Lundy, and Nabozniak were unsuited to their needs.
Furthermore, when the customers’ testimony is considered collectively, patterns emerge that bolster the credibility of the individual witnesses. A few illustrations suffice to make this point. First, the customers testified that they did not fill out their new account forms, which usually set forth their financial situation, investment objectives, and risk tolerance at inflated levels. Second, the customers testified consistently as to Muth’s representations and sales tactics. For example, when a customer wanted to sell, Muth refused to do so and frequently referred to the harm it would inflict on the stock price or that the price of the stock would soon increase. Muth also frequently referred to favorable research reports that would soon be issued and quoted specific prices that he believed the stock would reach, often within a short period of time. Next, none of the customers have even heard of a market not held order, let alone requested one. Finally, the customers uniformly testified that Muth failed to explain the risks of margin trading and the speculative nature of Bonso and Creative Host.
Muth Misrepresented Material Facts, Gave Baseless Stock Price Predictions,
and Engaged in Sales Practice Abuses While Associated with Schneider
The Division alleges that Muth willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder by making misstatements of material facts to, and engaging in sales practice violations with, numerous Schneider customers. (OIP at 2-4.) Proving willful conduct requires a showing of intent to commit the act that constitutes the violation, not intent to violate. Wonsover v. SEC, 205 F.3d 408, 413-15 (D.C. Cir. 2000); Arthur Lipper Corp. v. SEC, 547 F.2d 171, 180 (2d Cir. 1976).
Section 17(a) of the Securities Act proscribes fraudulent conduct in the offer and sale of securities, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder proscribe fraudulent conduct in connection with the purchase and sale of securities. These provisions prohibit essentially the same type of conduct. See United States v. Naftalin, 441 U.S. 768, 773 n.4 (1979). To establish violations of Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder, the Division must establish: (1) misrepresentations or omissions of material facts or other fraudulent devices; (2) made in connection with the offer, sale, or purchase of securities; and (3) that the respondent acted with scienter. Scienter is not required for violations of Sections 17(a)(2) or 17(a)(3) of the Securities Act; rather, negligence is sufficient to establish liability. Aaron v. SEC, 446 U.S. 680, 697 (1980); SEC v. Solucorp Indus., 274 F. Supp. 2d 379, 419 (S.D.N.Y. 2003); SEC v. Scott, 565 F. Supp. 1513, 1525-26 (S.D.N.Y. 1983).
Scienter is defined as “a mental state embracing intent to deceive, manipulate or defraud.” Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). The scienter requirement may be satisfied by a showing of recklessness. Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990); David Disner, 52 S.E.C. 1217, 1222 & n.20 (1997) (citation omitted). Recklessness is defined as “an extreme departure from the standards of ordinary care . . . present[ing] a danger of misleading buyers or sellers that is either known to the [respondent] or is so obvious that the [respondent] must have been aware of it.” Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1044-45 (7th Cir. 1977) (citation omitted), cert. denied, 434 U.S. 875 (1977). Proof of scienter can be demonstrated by circumstantial evidence. Herman & MacLean v. Huddleston, 459 U.S. 375, 390 n.30 (1983).
A fact is material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision and would view disclosure of the omitted fact as having significantly altered the total mix of information made available. Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). Materiality is a mixed question of law and fact. TSC Indus., 426 U.S. at 450.
Courts have interpreted broadly the requirement of Exchange Act Section 10(b) and Rule 10b-5 that violations must occur “in connection with” the purchase or sale of a security. See SEC v. Zandford, 535 U.S. 813, 819-25 (2002); Superintendent of Ins. v. Bankers Life & Cas. Co., 404 U.S. 6, 12 (1971); In re Ames Dep’t Stores, Inc., Stock Litig., 991 F.2d 953, 964-65 (2d Cir. 1993). The jurisdictional requirements of the antifraud provisions are also interpreted broadly. SEC v. Softpoint, Inc., 958 F. Supp. 846, 865 (S.D.N.Y. 1997), aff’d, 159 F.3d 1348 (2d Cir. 1998).
Misrepresentations of Material Fact
The Division alleges that Muth misrepresented, among other things, that: (1) analyst research reports for Creative Host and Bonso existed and would be published by Schneider in December 2000; (2) a hedge fund purportedly would be formed t |
