Exchange Hearing Panel Decision 96-06
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January 23, 1996
Thomas C. Adams
Former Registered Representative
Effected trades without customers' knowledge or authorization, recommended unsuitable investments, engaged in excessive trading, made a misrepresentation to a customer, effected margin transactions without the customers' knowledge or authorization, violated Exchange Rule 723 in that he recommended opening transactions in options contracts without having a reasonable basis for believing that the customers were capable of evaluating and bearing the risks, caused a violation of Exchange Rule 405 by causing his firm to fail to learn the essential facts about one or more customers, and caused a violation of SEC Regulations 240.17a-3 and 240.17a-4 and Exchange Rule 440 in that he caused inaccurate information to be entered on the Firm's books and records -- Consent to censure and thirty month bar.
Appearances: For the Division of Enforcement For the Respondent
Kathleen P. Schobel, Esq.
Susan Axelrod, Esq. Carl F. Schoeppl, Esq.
An Exchange Hearing Panel met to consider a Stipulation of Facts and Consent to Penalty entered into between the Exchange's Division of Enforcement and Thomas C. Adams, a former registered representative with Prudential Securities Inc. (the "Firm"). Without admitting or denying guilt Mr. Adams consented to a finding by the Hearing Panel that he:
Engaged in conduct inconsistent with just and equitable principles of trade in that he:
Effected trades in the accounts of one or more customers without the customers' knowledge or authorization;
Recommended investments in the account of a customer which were unsuitable in view of the customer's investment experience, financial resources and/or investment objectives;
Engaged in excessive trading in a customer account;
Made a misrepresentation to a customer concerning their account; and
Effected margin transactions in the accounts of one or more customers without the customers' knowledge or authorization.
Violated Exchange Rule 723 in that he recommended opening transactions in options contracts in the accounts of one or more customers without having a reasonable basis for believing, that the customers had such knowledge and experience in financial matters that they may reasonably have been expected to be capable of evaluating the risks of the recommended transactions, and were financially able to bear the risks of the recommended positions in the options contracts;
Caused a violation of Exchange Rule 405 by causing his member organization employer to fail to learn essential facts about one or more customers in that he provided inaccurate information on customer account documentation; and
On one or more occasions caused a violation of SEC Regulations 240.17a-3 and 17a-4 and Exchange Rule 440 in that he caused inaccurate information to be entered on the books and records of his member organization employer.
For the sole purpose of settling this disciplinary proceeding, the Division of Enforcement and Mr. Adams stipulate to certain facts, the substance of which follows:
Background and Jurisdiction
Adams was born on April 6, 1947. His employment in the securities industry began in May 1971. Between May 1971 and April 1985 he had a number of employers. From April 1985 until October 1995 he was employed by the Firm. (Adams was on disability from June 1993 through October 1995.)
On or about June 10 and July 29, 1992, the Exchange received Form RE-3s from the Firm disclosing that settlements had been made with two of Adams' former customers. Subsequently, the Firm received additional filings reporting additional customer complaints regarding Adams.
By letters dated April 5 and August 31, 1993, which he received, the Exchange notified Adams of its investigation.
Adams, while employed as a registered representative at the Firm, engaged in sales practice violations including unauthorized, unsuitable and excessive trading, unsuitable options trading and the unauthorized use of margin in the accounts of customers MJ, TC, ME and BL.
Customer Accounts
MJ Account
In or about 1979, MJ received monies in settlement for the wrongful death of her husband who was killed in a construction accident. MJ's lawyer referred her to Adams, who at the time, was employed by another member organization. MJ had approximately $575,000 to invest.
MJ has a ninth grade education, an IQ that is considered borderline for mental retardation, mathematical skills at a fourth grade level and reading skills at a fifth grade level.
During her life MJ has held menial jobs and from approximately 1980 to 1984 owned a "beer and wine" establishment, where she did the cooking. She later sold the establishment because she could no longer fund it.
In or about November 1980, MJ opened an individual account with Adams at another member organization and when he left there to join the Firm in April 1985, she transferred her account with him.
MJ was a totally unsophisticated securities investor. Accordingly, she trusted and relied on Adams as to the maintenance of her securities account.
The New Account Form ("NAF") for MJ at the Firm, completed by or at the direction of Adams, reflected that in 1985 she was 41 years old, widowed, had three dependents and was the owner of a restaurant. Her income was reflected as being in the range of $35,000-74,999, liquid assets in the range of $75,000-$124,999 and her net worth was noted as over $125,000. Her prior investment experience as reflected on the NAF, consisted of five years in stocks and bonds and five years in commodities. The investment objectives noted for MJ were speculation and income.
The NAF, completed by or at the direction of Adams, was inaccurate in that MJ's actual investment objective for her account was to invest the funds conservatively.
In or about April 1985 an Option Client Information and Agreement Form (the "Option Form") was completed for MJ. The Option Form reflected an income of $42,000, net worth of $150,000 and liquid net worth of $325,000. The Option Form indicated that her prior trading had been moderate in frequency, in various strategies and on margin. The objectives noted for the account were income and speculation. The account was approved for Level 3 options trading which included writing covered listed options, buying listed options, spreading listed options, buying straddles and combinations, writing puts, selling uncovered call options including variable hedging, straddles and combinations.
The information noted above in paragraph 12 regarding MJ's option investment objectives was inaccurate as she desired conservative investments.
Despite the fact that MJ signed the Options Form, she did not have the appropriate background to understand she should review the information for its accuracy. As noted above, MJ trusted and relied upon Adams.
During the period June 1985 through July 1987, MJ's account had an opening equity of $71,000. She withdrew approximately $55,000 to support her various expenses. The adjusted equity in the account was $22,000 and due to the trading which occurred, she lost approximately $18,000. The annualized turnover ratio was 10 and the account incurred margin interest and fee charges in excess of $10,000. The account incurred commission charges of approximately $30,000 from 1985 through 1988.
The trading in the account, which was controlled by Adams, involved active short-term equity trading as well as index and equity option trading.
Adams did not speak with MJ to obtain prior authorization for trades which occurred in the account. The majority of the trades were effected without the customer's knowledge or authorization.
Adams did not obtain prior authorization from MJ to utilize margin in her account. MJ did not know what margin was.
The trading in MJ's account, which included equities and options, was excessive and unsuitable for her in light of her conservative objectives, prior investment experience, level of education, financial resources including, but not limited to, the source of the funds and her future earning potential.
In or about December 1991, a civil action was initiated on behalf of MJ against Adams and the Firm alleging, among other things, fraud, gross negligence and breach of fiduciary duty. The Firm settled the matter for $40,000. Adams contributed $20,000 to the settlement.
ME Account
ME opened an individual account with Adams in June 1987. ME was referred to Adams through a friend who Adams had hired as a cold-caller. At the time, ME opened the account with Adams, she explained to him that she knew nothing about investing, had conservative objectives and was not interested in risk.
The NAF, completed for ME's account in July 1987, by or at the direction of Adams, reflected that she was 18 years-old, a college student, with an income of $5,000, net worth of $66,000 and liquid net worth of $68,000. The objectives noted for the account were long-term growth and income. The source of the funds was an inheritance and the purpose of the account was to finance her college education and living expenses. ME had no prior investment experience.
At or about the time the NAF was completed, an Options Form was completed for ME by or at the direction of Adams. The Options Form reflected the same financial information as the NAF. The objectives noted were income and investment hedge. Also reflected was that trades in the past year had been on both a cash and margin basis, the activity had been moderate and consisted of writing calls. This information was inaccurate in that prior to the opening of this account, ME had no prior trading experience.
The account was approved for Level 2 options activity which included buying listed options, spreading listed options, buying straddles and combinations and writing puts.
During the period July 1987 through July 1988, at the direction of Adams, the ME account engaged in a strategy which involved maintaining long stock positions and shorting puts and calls on the underlying long security. Securities where such strategy was employed included ABC, DEF and GHI, among others.
The trading noted in paragraph 25 above was unsuitable for ME in light of her financial resources including the source of the funds, lack of prior investment experience and conservative investment objectives.
Adams did not contact ME to obtain prior authorization for specific investments made in her account. ME was unaware of his obligation to do so. The majority of the trading in the account was done without her authorization.
From July 1987 through July 1988, of the $66,000 initially deposited into the account by ME, approximately $30,000 was withdrawn for expenses. Due to the trading in the account, losses of approximately $26,000 occurred.
ME initiated an arbitration in or about June 1989. The Firm settled ME's claim in April 1990 for approximately $21,000. Adams did not contribute to the settlement.
TC Account
TC, a friend of ME, opened an account with Adams at the Firm in June 1987.
The NAF completed for the account in June 1987 by or at the direction of Adams, reflects that TC was an 18 year-old student with an income of $10,000, net worth of $50,000 and liquid net worth of $33,000. The objective noted on the form was long-term growth. The NAF also reflects five years' prior investment experience in stocks and bonds. This statement was inaccurate in that TC had no prior investment experience.
The sources of the funds deposited into the account were an inheritance and monies TC had earned during summer employment. TC wanted to earn slightly more than he would at the bank and wanted his money in safe investments.
In or about July 1987, an Options Form was completed for the TC account by or at the direction of Adams. The form reflected that TC had an objective of investment hedge and prior experience consisting of six months in stocks and bonds. The account was approved for Level 2 options trading which included writing covered listed options, buying listed options, spreading listed options, buying straddles and combinations and writing puts.
TC's prior investment experience, as reflected on the options form, was inaccurate as he did not have six months experience in stocks and bonds in July 1987.
During the period August 1987 through January 1989, the majority of the activity in the account involved the same options strategy Adams employed in the ME account whereby Adams would purchase a stock and short the puts and calls on the underlying security. Securities included in such strategy were GHI, ABC and JKL.
The trading in the account was recommended by Adams and all trades were solicited by him.
The trading noted in paragraph 35 above, which was recommended and directed by Adams, was unsuitable for TC in light of his financial resources, lack of prior investment experience and investment objectives.
When TC questioned Adams as to the value of his account, Adams misrepresented to TC that his monthly account statements did not reflect the actual value of his account, which was not true.
Due to the trading in the account directed by Adams, TC suffered losses of approximately $19,500.
In or about June 1989, an arbitration was initiated on behalf of TC. The Firm settled TC's claim in April 1990 for approximately $22,000. Adams did not contribute to the settlement.
BL Account
Adams began handling the BL account in January 1991 when the account was transferred to him from another registered representative.
The NAF, completed by or at the direction of Adams in January 1991, reflects that BL was an executive chef at a hotel, single, 41 years-old with an income of $100,000, net worth of $1 million and liquid net worth of $100,000. These figures misrepresented BL's financial information. In actuality, his income was approximately $30,000 and his net worth and liquid net worth were approximately $30,000.
The NAF also reflected two years' option experience and five years' experience in stocks and bonds. The investment objectives noted on the form were long-term growth and speculation.
The information in paragraph 43 above concerning BL's prior experience and investment objectives was inaccurate. BL did not have prior options experience and wanted his money safely invested. He did not want to speculate.
During the period January 1991 through January 1993, the account traded equity securities. Due to the trading in the account, approximately 50% of its equity, $21,000, was lost. Additionally, the account incurred margin interest costs of approximately $4,400.
During January 1991 through January 1993, Adams effected one or more transactions in BL's account without the customer's prior knowledge or authorization.
Additionally, BL did not understand margin nor did he consent to its use for his account.
In or about February 1993, BL complained to the Firm about his account. The Firm settled BL's claim for $17,500 in June 1993. Adams was asked to contribute the entire amount of the settlement.
DECISION
The Hearing Panel, in accepting the Stipulation of Facts and Consent to Penalty found Mr. Adams guilty as set forth above by unanimous vote.
PENALTY
In view of the above findings, the Hearing Panel, by unanimous vote, imposed the penalty consented to by Mr. Adams of a censure and a thirty month bar from membership, allied membership, approved person status, and from employment or association in any capacity with any member or member organization.
For the Hearing Panel
Vincent F. Murphy
Hearing Officer
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