SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40244 / July 22, 1998 Admin. Proc. File No. 3-9332 ------------------------------------------------- In the Matter of the Application of | | KEVIN ERIC SHAUGHNESSY | 7189 Saltsburg Rd. | Pittsburgh, PA 15235 | | For Review of Disciplinary Action Taken by the | | NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.| ------------------------------------------------- OPINION OF THE COMMISSION REGISTERED SECURITIES ASSOCIATION -- REVIEW OF DISCIPLINARY PROCEEDINGS Violations of Conduct Rules Failure to Disclose Material Information to Customers Failure to Disclose Outside Compensation to Employer Registered representative received compensation from a stock promoter for effecting sales of certain securities without disclosing the fee arrangement or the payments to the representative's customers or employer. Held, association's findings of violation and sanctions are sustained. APPEARANCES: Walter L. Baumgardner, of Musilli, Baumgardner, Wagner & Parnell, P.C., for Kevin Eric Shaughnessy. Alden S. Adkins and Deborah F. McIlroy, for NASD Regulation, Inc. Appeal Filed: June 9, 1997 Briefing Completed: October 7, 1997 I. Kevin Eric Shaughnessy, a registered representative formerly associated with Gruntal & Co., Inc. ("Gruntal"), a member firm of the National Association of Securities Dealers, Inc. ("NASD"), appeals from NASD disciplinary action. The NASD found that Shaughnessy violated Conduct Rules 2110 and 2120 by soliciting sales of, and selling securities to, individual customers of Gruntal without informing them that he would be paid by a stock promoter for the sales. [/] The NASD further found that Shaughnessy failed to provide prompt written notice to Gruntal, in violation of Conduct Rules 2110 and 3030, of the payments he accepted from the stock promoter. [/] The NASD censured Shaughnessy; fined him $5,000 for failing to disclose material information to customers, $5,000 for failing to provide prompt written notice to Gruntal of the stock promoter's payments, and an additional $1,675 (representing the payments he received from the promoter); ordered him to make restitution of $1,916.37 to his customers (representing commissions charged on and repayment of certain losses incurred as a result of the transactions); and barred Shaughnessy in all capacities from association with a member firm. [/] We base our findings on an independent review of the record. II. Shaughnessy expressly states that he "does not dispute the facts which gave rise to the Disciplinary Hearing" in this appeal. The uncontested facts, which support the NASD's findings of violation, are as follows. Shaughnessy began working as a registered representative of Gruntal in May 1992. At that time, Shaughnessy received a copy of Gruntal's compliance manual and signed a document that stated: I understand that I should thoroughly familiarize myself with the Gruntal & Company, Incorporated, Policy and Procedures manual and understand its contents and requirements. I agree to abide by the same. Gruntal's compliance manual warned employees of the firm against engaging in various enumerated activities, "generally deemed to be violative of securities laws, regulatory rules, Firm policies and/or ethical business practices." The manual specified that "[e]mployees should generally not engage in . . . [a]ccepting gratuities, fees (including finders' fees), or other renumeration [sic] without the Firm's approval." In the summer of 1993, Shaughnessy entered into an agreement with a stock promoter to sell shares of Metallurgical Industries, Inc. ("Metallurgical") in exchange for 15% of the cash value of any Metallurgical shares sold. Shaughnessy subsequently recommended Metallurgical and sold $20,000 worth of the stock to a Gruntal customer and received $1,000 from the promoter for those sales. In January 1994, Shaughnessy entered into a similar arrangement to sell common stock in MusicSource USA, Inc. ("MusicSource"), another company touted by the stock promoter. As a result of Shaughnessy's recommendations, three Gruntal customers (including Shaughnessy's mother) purchased MusicSource shares and Shaughnessy received a $675 "kickback" from the promoter for those sales. [/] Shaughnessy did not disclose the receipt of these payments or his fee arrangement with the promoter to any of these customers who purchased the Metallurgical or MusicSource securities based on Shaughnessy's recommendations. Shaughnessy testified that "probably" during the "summer, maybe late spring" of 1994, Gregory Shutok (the Vice President and General Manager of the Pittsburgh branch office of Gruntal and Shaughnessy's supervisor) held a meeting where he told the assembled Gruntal brokers, including Shaughnessy, that "taking a kickback of any kind was against the rules and that we would be fired if we did it." Even at this point, however, despite admittedly realizing that he had a "problem" because he had accepted money from a stock promoter for selling Metallurgical and MusicSource stock, Shaughnessy did not come forward with the fact that he had accepted the promoter's payments. In early 1995, while the NASD was investigating this matter, Shutok directly asked Shaughnessy about payments from outside sources. Shaughnessy untruthfully denied receiving such payments. Shaughnessy later told NASD staff during an informal interview that he accepted funds from the promoter for investor leads and provided a false, back-dated letter to the NASD from the promoter to that effect. Subsequently, during an on-the- record interview with NASD staff, Shaughnessy admitted that he had never sold leads to the promoter and that the letter had been fabricated. III. A. The NASD found that Shaughnessy violated both its rule requiring adherence to high standards of commercial honor and just and equitable principles of trade, and its antifraud rule, by failing to inform his customers to whom he recommended Metallurgical and MusicSource stock that he was receiving compensation from a stock promoter to sell the stocks. We agree with this finding. A fundamental purpose of the federal securities laws is to "substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry." [/] In order to achieve this high standard, investors must be provided with all material facts relating to their investment decisions. [/] Here, Shaughnessy recommended stock purchases to his customers without disclosing his self-interest in the transactions. We agree with the NASD that a reasonable investor would consider his or her broker's acceptance of kickbacks to sell particular securities material to the investor's decision whether to purchase those securities based on the broker's recommendations. [/] We also agree with the NASD's determination that Shaughnessy acted with scienter in failing to disclose to his customers his fee arrangement with the promoter and his receipt of the kickbacks. Scienter with respect to violations of the NASD's antifraud rule may be established by demonstrating intentional or reckless conduct. [/] At a minimum, Shaughnessy acted recklessly here. "A broker-dealer, by holding itself out as a securities professional with special knowledge and ability, impliedly represents that it will deal fairly, honestly, and in accordance with industry standards with the public investor." [/] The acceptance of secret payments from a stock promoter for selling particular stocks to investors is antithetical to this fundamental principle of fair and honest dealing with the investing public. Shaughnessy, a registered securities industry professional, acted recklessly in flouting this principle. [/] B. Conduct Rule 3030 requires registered representatives who receive outside compensation to provide prompt written notice of such remuneration to their employers. It is undisputed that Shaughnessy failed to provide written notice to Gruntal of the payments he accepted from the stock promoter. We accordingly also find that Shaughnessy, in this connection, violated Conduct Rules 2110 and 3030. C. In sustaining the NASD's findings of violation, we reject Shaughnessy's contention that the NASD failed to identify a specific rule that "particularly forbids the receipt of compensation from stock promoters." We also reject Shaughnessy's related claim that the charges against him are based on "general rules" which are "vague." The violations here did not arise simply because he received money from the promoter -- the charges against Shaughnessy stemmed from his failure to disclose to his customers and to Gruntal (his firm), the material fact that he accepted the promoter's payments for selling Metallurgical and MusicSource stocks. In addition, "to claim that a requirement is void for vagueness, the claimant must demonstrate that he did not have fair notice of the conduct or activities proscribed or covered by the requirement." [/] As we have discussed above, the fundamental nature of the obligation at issue defeats any claim that Shaughnessy could not have known that his conduct was improper. In sustaining the NASD's findings, we further reject Shaughnessy's suggestion that his acceptance of the kickbacks is no different from a registered representative's receipt of trips and prizes in sales contests, which Shaughnessy suggests is permitted "without disclosure to investors" by Conduct Rule 2830(l)(1)(3)(B). The cited rule, which deals with retail sales of investment company securities, provides, in relevant part, that "no member or associated person shall solicit or accept anything of material value, in addition to the concessions disclosed in the prospectus." [/] Rule 2830, then, expressly prohibits the solicitation or acceptance of non-disclosed compensation in connection with mutual fund sales -- conduct closely analogous to that at issue in this proceeding. IV. Section 19(e) of the Securities Exchange Act of 1934 governs our review of the sanctions imposed by a self-regulatory organization. Consistent with that statutory provision, we find no basis for concluding that the sanctions imposed here, including the bar, are excessive, oppressive, or impose an unnecessary or inappropriate burden on competition. While the Market Regulation Committee ("MRC") suspended Shaughnessy for six months and ordered that he requalify by examination, the National Business Conduct Committee ("National Committee") barred Shaughnessy from associating with any NASD member. Shaughnessy contends that the bar constitutes a "penalty" for exercising his right to appeal and "chills" the appeals process. Shaughnessy further contends that, since no new facts have been adduced since the proceeding before the MRC, the only basis for an increase in sanctions was the "legal arguments of counsel." We do not agree with Shaughnessy's claims. The NASD procedural rules expressly permit the National Committee, where appropriate, to "affirm, modify, reverse, increase, or reduce any sanction, or impose any other fitting sanction." [/] As we have observed previously, the exercise of the National Committee's power to impose additional sanctions in appropriate circumstances does not infringe on the right of appeal. [/] The mere fact that the National Committee increased the sanctions here does not render the bar invalid on fairness grounds. Shaughnessy further contests the bar as "unjust" and unduly harsh. He supports these contentions by referring to other disciplinary cases (involving a variety of misconduct) where the sanctions imposed did not include a bar. It is well settled, however, that the appropriate remedy in a given case depends on the unique facts and circumstances of that particular proceeding. [/] The National Committee determined that a bar, rather than a suspension with the requirement of requalification, was justified because of the "serious underlying misconduct" and "Shaughnessy's attempts to conceal his actions during the [NASD's] investigation." This determination was consistent with the NASD Sanction Guidelines ("Guidelines"), which provide a "starting point" for the consideration of the appropriate sanction to impose in a particular case. [/] Those Guidelines suggest a bar where "materially false statements or omissions were intentionally or recklessly made." [/] The Guidelines also recommend a suspension of up to 30 days for a Conduct Rule 3030 violation that involves activity that results in a conflict of interest with the customer. [/] As noted previously, Shaughnessy acted, at a minimum, recklessly in failing to inform his customers of the kickbacks he received for selling them Metallurgical and MusicSource securities. Shaughnessy also admitted that he did not want anyone at Gruntal to know about his acceptance of these kickbacks from the stock promoter. Shaughnessy's attempts to conceal this misconduct included an untruthful denial to his general manager, Shutok, that he had taken compensation from outside sources, and his presentation of a fabricated document to the NASD. Under these circumstances, we see no basis for reducing the sanctions. Shaughnessy contends that the National Committee failed to consider, in mitigation of sanctions, his contrition (as expressed at the proceeding before the MRC) and his acceptance of responsibility for his misconduct. Shaughnessy also argues to us, however, that if he had received "more than a cursory education in the securities business and the rules of the NASD, the act complained of may never have happened." Our review of the record leads us, like the National Committee, to conclude that Shaughnessy, in fact, has not accepted responsibility for his actions. Instead, he attributes his misconduct to what he claims was inadequate training. Moreover, it is also clear from the record that the National Committee thoroughly reviewed all of the statements made by Shaughnessy before the MRC, including Shaughnessy's expression of contrition, but nevertheless concluded that additional sanctions were warranted. Shaughnessy also seeks leniency on the asserted basis that he did not intend to cause harm to the investing public. Shaughnessy further argues that the Metallurgical and MusicSource securities were "suitable" for his customers. These contentions, even if true, do not justify a reduction in sanctions. Shaughnessy also would characterize his misconduct as the result of "youthful indiscretion." As already noted, Shaughnessy's violations are serious. Additionally, Shaughnessy's experience, while limited, was not confined to his work at Gruntal. Shaughnessy also worked as an account executive at another brokerage firm from July 1991 through April 1992 prior to his association with Gruntal. Thus, Shaughnessy had had approximately two years of securities industry experience at the time of the Metallurgical and MusicSource sales. An appropriate order will issue. [/] By the Commission (Chairman LEVITT and Commissioners Johnson, HUNT, and UNGER); Commissioner CAREY not participating. Jonathan G. Katz Secretary **FOOTNOTES** [/]:/Conduct Rule 2110 requires members to observe high standards of commercial honor and just and equitable principles of trade. NASD Manual (CCH), p. 4111. Conduct Rule 2120 provides that NASD members may not "effect any transaction in, or induce the purchase or sale of, any security by any manipulative, deceptive or other fraudulent device or contrivance." NASD Manual (CCH), p. 4141. [/]:/Conduct Rule 3030 requires registered representatives to provide prompt written notice to their firms if compensated by "any other person as a result of any business activity, other than a passive investment, outside the scope of his relationship with his employer firm . . . ." NASD Manual (CCH), p. 4836. [/]:/The NASD also assessed costs. [/]:/In fact, the $675 amounted to an overpayment. Shaughnessy testified that he overstated to the promoter the amount of MusicSource stocks sold. [/]:/SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186 (1963). [/]:/See Basic Inc. v. Levinson, 485 U.S. 224, 231-232 (1988)(fact is material if there is a "'substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available'" (quoting TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)). [/]:/Compare Stone v. Kirk, 8 F.3d 1079, 1087 (6th Cir. 1993) (accountant violated Rule 10b-5 when he failed to disclose the material fact that he received an 18% commission on securities sold to his customers); Laird v. Integrated Resources Inc., 897 F.2d 826 (5th Cir. 1990) (claim that investment adviser failed to disclose to customers that he earned commissions on the investments he recommended and sold must be evaluated in determining adviser's liability under Investment Advisers' Act provision prohibiting any practice operating as a fraud or deceit upon any client or prospective client); United States v. Bilotti, 380 F.2d 649 (2d Cir.), cert. denied, 389 U.S. 944 (1967) (failure to disclose commissions received from company insiders properly considered in determining whether defendants, principals of a brokerage firm, committed fraud in violation of section 17(a) of the Securities Act of 1933). See also Louis Loss, The SEC and the Broker-Dealer, 1 Vand. L. Rev. 516, 522 (1948) ("When one is engaged as agent to act on behalf of another, the law requires him to do just that. He must not bring his own interests into conflict with his client's. If he does, he must explain in detail what his own self-interest in the transaction is in order to give his client an opportunity to make up his own mind whether to employ an agent who is riding two horses."). [/]:/ Meyer Blinder, 50 S.E.C. 1215, 1229 and n. 64 (1992) (scienter for a fraud charge under NASD rules may be established by demonstrating that the person acted intentionally or recklessly). Compare Stone, 8 F.3d at 1086 ("Proof of recklessness is sufficient to establish the scienter requirement in  10(b)/Rule 10b-5 cases . . . ."). [/]:/Blinder, 50 S.E.C. at 1228 and n. 56. [/]:/Compare Richfield Securities, Inc. et al., 51 S.E.C. 797 (1993)(firm president found to have acted with scienter in implementing markup policy inconsistent with the fundamental standard that the public be charged fair prices). [/]:/Christopher J. Benz, Securities Exchange Act Rel. No. 38440 (March 26, 1997), 64 SEC Docket 483, 488-489, appeal filed, No. 97-3257 (3d Cir.). See also id. at 489 n. 20. [/]:/Conduct Rule 2830(l)(1)(3)(A), NASD Manual (CCH), p. 4627 (emphasis supplied). [/]:/Rule 9351 of the NASD's Code of Procedure, NASD Manual (CCH), p. 7372 (previously Rule 9313). [/]:/Dillon Securities, Inc., 51 S.E.C. 142, 151-152 (1992); Paul F. Wickswat, 50 S.E.C. 785, 787-788 (1991); Remmele & Company, 45 S.E.C. 432, 434 (1974). [/]:/Butz v. Glover Livestock Commission Co., Inc., 411 U.S. 182, 187 (1973); Martin J. Cunnane, Jr., Securities Exchange Act Rel. No. 39242 (October 15, 1997), 65 SEC Docket 2217, 2220. [/]:/Hattier, Sanford & Reynoir, Securities Exchange Act Rel. No. 39543 (January 13, 1998), 66 SEC Docket 922, 930 n. 17, appeal filed, No. 98- 60134 (5th Cir.); Peter C. Bucchieri, Securities Exchange Act Rel. No. 37218 (May 14, 1996), 61 SEC Docket 2771, 2779, quoting from Schellenbach, 50 S.E.C. 798, 803 (1991), aff'd, 989 F.2d 907 (7th Cir. 1993). [/]:/NASD Sanction Guidelines at 34 (1996). [/]:/NASD Sanction Guidelines at 36. [/]:/All of the arguments advanced by the parties have been considered. They are rejected or sustained to the extent that they are inconsistent or in accord with the views expressed in this opinion. UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40244 / July 22, 1998 Admin. Proc. File No. 3-9332 ------------------------------------------------- In the Matter of the Application of | | KEVIN ERIC SHAUGHNESSY | 7189 Saltsburg Rd. | Pittsburgh, PA 15235 | | For Review of Disciplinary Action Taken by the | | NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.| ------------------------------------------------- ORDER SUSTAINING DISCIPLINARY ACTION TAKEN BY REGISTERED SECURITIES ASSOCIATION On the basis of the Commission's opinion issued this day, it is ORDERED that the disciplinary action taken by the National Association of Securities Dealers, Inc. against Kevin Eric Shaughnessy, and the Association's assessment of costs, be, and they hereby are, sustained. By the Commission. Jonathan G. Katz Secretary