SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40436 / September 14, 1998 Admin. Proc. File No. 3-9298 ------------------------------------------------- In the Matter of the Application of | | FIRST COLORADO FINANCIAL SERVICES | COMPANY, INC. | Post Office Box 6785 | Denver, Colorado 80206 | | and | | MARK P. AUGUSTINE | 9073 South Bear Mountain Drive | Highlands Ranch, Colorado 80126 | | 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 the Rules of Fair Practice Failure to Comply with Reporting Requirements Allged Net Capital Violation Member firm of registered securities association and firm's FINOP filed inaccurate FOCUS report but did not violate the net capital rule as the firm did not participate in a firm commitment underwriting. Held, association's findings of violation are sustained in part and set aside in part, sanctions are vacated, and proceedings are remanded for redetermination of sanctions. APPEARANCES: Mark P. Augustine, pro se and for First Colorado Financial Services Company, Inc. Alden S. Adkins, Norman Sue, Jr. and Shirley H. Weiss, for NASD Regulation, Inc. Appeal filed: April 11, 1997 Last brief received: July 9, 1997 I. First Colorado Financial Services Company, Inc. ("First Colorado" or the "Firm"), a member of the National Association of Securities Dealers, Inc. (the "NASD") during the relevant time period, and Mark P. Augustine, the Firm's registered financial and operations principal ("FINOP"), appeal from NASD disciplinary action. The NASD found that First Colorado filed an inaccurate Financial and Operational Combined Uniform Single Report ("FOCUS Report") for the period ending April 30, 1994, in violation of Rule 17a-5 under the Securities Exchange Act of 1934 ("Exchange Act") and Article III, Section 1 of the NASD's Rules of Fair Practice. [1]/ The NASD further found that First Colorado participated in a firm commitment underwriting without maintaining the required minimum net capital in violation of Exchange Act Rule 15c3-1 and Article III, Section 1 of the NASD's Rules of Fair Practice. The NASD censured applicants, assessed $1,530.20 in costs and imposed a joint and several fine of $5,000. The NASD also suspended Augustine for 10 days and required him to requalify by examination as a FINOP. We base our findings upon an independent review of the record. /[2]/ II. Augustine entered the securities industry in March 1983 and became associated with First Colorado as the Firm's FINOP in April 1993. In connection with First Colorado's sale to Christine Chandler and Augustine, the Firm went through a pre-membership interview with the NASD in 1993. First Colorado was accepted for membership in August 1993 on condition that it operate pursuant to certain limitations set forth in a restriction agreement with the NASD. The restriction agreement required First Colorado to introduce and clear all transactions through Hanifen, Imhoff Inc. ("Hanifen") and prohibited the Firm from holding customer funds or customer securities. First Colorado also agreed that it would "not engage in any underwriting or selling group activity of firm commitment offering (sic) without first notifying and obtaining District approval." Operating pursuant to these restrictions allowed First Colorado to maintain a minimum net capital of $5,000. /[3]/ In 1993, an NASD compliance examiner reviewed First Colorado's FOCUS Reports for the periods ending October 31, 1993 and November 30, 1993. During the review, the examiner discovered that furniture and equipment had been improperly included as allowable assets in calculating the Firm's net capital. Although the examiner informed Augustine that these items were not allowable assets for net capital purposes, a subsequent FOCUS Report, filed for the period ending April 30, 1994, erroneously included the value of furniture and equipment in the Firm's net capital calculations. During a routine examination of First Colorado in June 1994, a senior NASD compliance examiner discovered confirmation tickets from Hanifen, First Colorado's clearing firm, bearing the legend, "UNDERWRITING-PROSP TO FOLLOW." The examiner concluded from these documents that First Colorado had participated in a firm commitment underwriting. Since a broker or dealer that participates in a firm commitment underwriting must maintain more than $5,000 in net capital, the amount First Colorado claimed as its required minimum, the examiner began questioning the Firm's compliance with the net capital rule. /[4]/ After discussions between NASD staff, Augustine, and Chandler about the Firm's net capital requirements, Chandler reaffirmed First Colorado's intent to remain a $5,000 broker-dealer. In a letter to the NASD dated June 30, 1994, Chandler pledged, First Colorado Financial Services Company, Inc. will engage only in those securities activities traditionally conducted by a "$5,000 broker/dealer". First Colorado Financial Services Company, Inc. will not participate in the distribution of any new issue securities until such time as those securities are "free to trade". Although primarily engaged in transactions involving municipal and fixed income securities, First Colorado placed orders with Hanifen for equity securities when asked to do so by the Firm's clients. From February 1994 through the end of October 1994, First Colorado engaged in transactions in equity securities encompassing 12 companies and totalling 11,250 shares where Hanifen was a firm commitment underwriter. In October 1994, First Colorado placed an order for 500 shares of an offering by Parker & Parsley Petroleum on behalf of its client, Circuit Industries, after the client expressed an interest in purchasing the securities. The Firm placed the order with Hanifen, First Colorado's clearing agency, which was a firm commitment underwriter in the Parker & Parsley issue. In filling out the "buy" order ticket, applicants marked the transaction "unsolicited." Hanifen filled the order for the Parker & Parsley shares on October 31, 1994 and sent a confirmation to Augustine's attention at First Colorado. In response to an inquiry from our Central Regional Office, Hanifen identified the transaction as an allocation of its firm commitment in the underwriting, stating, in a letter dated May 30, 1995: Hanifen, Imhoff Inc. has allocated small portions of their (sic) firm commitments in certain underwritings to First Colorado Financial Services Company, Inc. . . . The allocations made to First Colorado Financial Services Company, Inc. by Hanifen, Imhoff Inc. were the result of indications of interest received from a First Colorado Financial Services Company, Inc. client. There was not a firm commitment from First Colorado Financial Services Company, Inc. Hanifen also disclosed that it paid First Colorado a portion of its selling concession with respect to the transaction involving 500 shares of the Parker & Parsley offering. On the date of the Parker & Parsley transaction, First Colorado's net capital totaled $31,400. III. A. The NASD found that First Colorado, through Augustine, its FINOP, submitted an inaccurate FOCUS Report for the period ending April 30, 1994. Applicants do not contest the NASD's conclusion that the report incorrectly characterized certain property and equipment as allowable assets in calculating the Firm's net capital. Instead, applicants argue that they did not intentionally misclassify the disallowed items and that they reasonably relied on the NASD's "approval" of earlier FOCUS Reports that also contained similar inaccuracies. According to applicants, NASD staff silently "approved" the previously filed FOCUS Reports by failing to catch and object to any errors that they may have contained. Applicants' position is without merit. As First Colorado's FINOP, Augustine was responsible for the Firm's compliance with applicable financial reporting requirements and was responsible for the errors in the April 1994 FOCUS Report. /[5]/ As we have repeatedly stated, a "regulatory authority's failure to take early action neither operates as an estoppel against later action nor cures a violation." /[6]/ In any event, an NASD examiner told Augustine in 1993 that the Firm's October and November FOCUS Reports erroneously classified furniture and equipment as allowable assets, the same type of reporting violation at issue here. Thus, Augustine's claims of inadvertence and reasonable reliance are contradicted by the record. The reporting and recordkeeping provisions of the securities laws are "important both to monitor the financial status of broker-dealers and (to protect) public investors." /[7]/ Violations of these provisions are serious, and adversely impact the monitoring function exercised by regulatory authorities. This, in turn, interferes with the goal of protecting public investors. The requirement that a firm file various reports encompasses the requirement that the reports be true and correct. /[8]/ We sustain the NASD's finding that applicants violated Rule 17a-5 under the Exchange Act and Article III, Section 1 of the NASD's Rules of Fair Practice. B. The NASD also found that First Colorado participated in a firm commitment underwriting on October 31, 1994, and that the Firm, through Augustine, failed to maintain the required net capital on that date. /[9]/ Applicants deny that they violated the net capital rule, arguing that First Colorado did not participate in any firm commitment underwritings. Applicants assert that First Colorado engaged in only those activities permitted a broker or a dealer operating under a minimum net capital requirement of $5,000. Introducing broker-dealers, such as First Colorado, usually submit their customer orders and accounts to a carrying firm that executes those orders and carries those accounts. /[10]/ Broker-dealers that never receive or hold customer funds or securities, or owe customers any funds or securities, may operate under a $5,000 net capital requirement. /[11]/ An introducing broker or dealer who "receives but does not hold customer or other broker or dealer securities" must maintain at least $50,000 in net capital. /[12]/ These firms may also participate in a firm commitment underwriting, an activity prohibited to the $5,000 broker- dealer, "so long as the introducing firm is not the statutory underwriter, but a marketing agent with no commitment to purchase any of the securities." /[13]/ In determining whether a violation of the net capital rule occurred here, we must evaluate First Colorado's business activity in light of the limitations imposed by the net capital rule. As a $5,000 broker-dealer, First Colorado was prohibited from receiving customer funds or securities and from owing funds or securities to any customer. The NASD has not alleged and there is no evidence in the record suggesting that First Colorado's transmittal of the order for Parker & Parsley securities did not comply with these conditions of the net capital rule. Therefore, First Colorado did not engage in any prohibited "dealer" activities permitted to only those firms operating under a higher net capital requirement. In proceedings before the District Business Conduct Committee ("District Committee"), NASD staff argued that a broker or dealer who acts solely as an order-taker for securities in a firm commitment underwriting participates in that underwriting for purposes of the net capital rule. The District Committee concluded that First Colorado had participated in several firm commitment underwritings, stating, "(p)lacing the orders and receiving compensation for the resulting transactions are certainly indicia of participation . . . ." /[14]/ On appeal, the National Business Conduct Committee ("National Committee") found that First Colorado had participated in the Parker & Parsley firm commitment underwriting (although not as an underwriter or a member of a selling group) and therefore was required to maintain $50,000 in net capital. The National Committee based its conclusion on the following: First Colorado had placed an order for the Parker & Parsley securities knowing that they were part of a public offering; First Colorado knew from Hanifen's confirmation that the Parker & Parsley securities were part of a public offering; the sales of these securities to First Colorado's client occurred on the offering date of the distribution and at the public offering price; and Hanifen stated that it "allocated" a portion of its commitment in this underwriting to First Colorado. As discussed below, we disagree with the conclusion of the NASD and we do not find, on this record, that First Colorado participated in the Parker & Parsley underwriting. Whether a broker or dealer has "participated" in a firm commitment underwriting within the meaning of the net capital rule is a fact-specific question requiring careful consideration of the broker-dealer's conduct and circumstances of the underwriting. Among the factors to be considered are whether a broker or dealer is a member of a selling group pursuant to either a written or unwritten agreement, and whether the broker or dealer has actively promoted or solicited the sales of securities in a firm commitment underwriting. /[15]/ Such activities indicate a level of involvement in an underwriting requiring at least $50,000 in net capital because of potential financial risks to a participating broker or dealer in the event a distribution fails. The mere transmittal of one order for securities involved in a firm commitment underwriting by a $5,000 broker-dealer, however, without additional evidence of solicitation or activities indicating promotion of the underwriting, is insufficient to demonstrate that a firm has participated within the meaning of the net capital rule. Thus, the NASD's position that "participation" encompasses the mere forwarding of an unsolicited customer order to a firm commitment underwriter is too extreme. Here, the National Committee's finding that First Colorado did not participate in the underwriting as a member of the selling group in the Parker & Parsley offering comports with the evidence and our review of the record. /[16]/ Further, it is undisputed that First Colorado's client approached the Firm about obtaining the shares, and that First Colorado did not solicit the sale of securities in the underwriting. First Colorado's receipt of compensation from the underwriter for such isolated order- taking activity is insufficient to demonstrate participation. Moreover, First Colorado's single transaction in the Parker & Parsley securities involved a relatively small number of shares. We believe that under the facts demonstrated on this record, First Colorado's order for Parker & Parsley securities was an accommodation to an existing client who contacted the Firm upon hearing about a public offering rather than the Firm's participation in a firm commitment underwriting. /[17]/ We do not mean to suggest that evidence of an express agreement or solicitation are the only methods of establishing participation within the meaning of the net capital rule. Circumstantial evidence of active involvement in a firm commitment underwriting may suffice. For example, a pattern of order-taking activity in connection with a particular public offering, or a recurring pattern of orders in different offerings may establish that a broker or dealer has participated in firm commitment underwritings. We are unable to conclude from this record that First Colorado participated in a firm commitment underwriting or engaged in any other dealer type activity prohibited to a $5,000 broker-dealer. Thus, we set aside the NASD's finding that First Colorado violated our net capital rule during the period it conducted the transaction in the Parker & Parsley underwriting. IV. Applicants charge NASD staff with bias, improper conduct, and selective enforcement. Many of these allegations have been raised for the first time in this appeal. Applicants allege that an NASD supervisor improperly influenced the findings of the District Committee by serving a document pertaining to a matter unrelated to the current proceeding in full view of the District Committee panel members. Applicants filed a complaint against the supervisor with the NASD protesting this conduct. Although advised to raise the issue with the District Committee, the record indicates that applicants did not bring the matter before that panel or before the National Committee. The record lacks any evidence supporting applicants' contention of improper influence. Applicants also contend that despite frequent requests, the NASD failed to produce a letter from the "local Securities and Exchange Office" allegedly written after the "local SEC office reviewed the books and records of the (applicants) during an audit of the NASD oversight." Applicants fail to state why any such letter from Commission staff to the NASD about unspecified oversight matters would be relevant to the merits of the particular charges of violation brought against them here. Applicants' general and vague contention that such a letter "could shed some light on this matter" is insufficient to demonstrate that the letter would have been relevant to these proceedings. Applicants further contend that Hanifen refused to produce various documents despite repeated requests. Applicants also assert that Hanifen colluded with NASD staff to create documents that were not disclosed to the applicants and that presumably were relevant to these proceedings. However, applicants have not provided any information on the topics or type of documents that were allegedly requested from Hanifen and there is no indication in the record that applicants requested the NASD's assistance in obtaining them. Applicants have also failed to state the basis for their suspicion that documents were improperly manufactured or how they might have played a role in these proceedings. Since applicants have not substantiated their vague and general assertions about the existence and relevance of any of these documents, we find no basis for their claims that NASD staff acted improperly. Applicants also argue that the NASD unfairly applied "more stringent criteria and scrutiny" to First Colorado than to larger member firms. During the proceedings below, Chandler referred to what she characterized as the NASD's "reputation of unfair treatment of small firms" before the District Committee, but did not allege any specific instances of bias, misconduct, or selective enforcement on the part of NASD staff toward any of the applicants. In the proceeding before the National Committee, Augustine argued that NASD staff's interpretation of "participation" within the context of this case constituted evidence of the association's unfairness toward smaller firms. However, Augustine did not present any evidence of disparate treatment accorded other firms in similar circumstances. Although we disagree with the NASD's finding that applicants participated in a firm commitment underwriting, we find no evidence in the record of bias toward the applicants, NASD staff misconduct, or selective enforcement of NASD rules. Moreover, our de novo review of the record indicates that it contains ample support for the finding that applicants filed an inaccurate FOCUS Report for the period ending April 30, 1994. Applicants also make vague and unsupported allegations that the pre-membership interview process required by the NASD was overly "rigorous and extended" and placed "undue hardship" on the applicants, that two NASD staff members were verbally abusive, and that the Firm's clearing agency committed numerous errors with respect to transactions that were not at issue in these proceedings. Since these contentions are unrelated to the merits of this appeal, we need not address them here. V. Although we have sustained the NASD's finding that applicants violated Rule 17a-5 of the Exchange Act and the NASD's Rules of Fair Practice by filing an inaccurate FOCUS Report, we have set aside the finding of a net capital violation. Since we are unable to determine from the record what sanctions the NASD deemed appropriate for only the recordkeeping violation, we vacate the sanctions imposed and remand the proceedings for a redetermination of sanctions. An appropriate order will issue. /[18]/ By the Commission (Chairman LEVITT and Commissioners JOHNSON, HUNT, and CAREY); Commissioner UNGER not participating. Jonathan G. Katz Secretary **FOOTNOTES** [1]://Article III, Section 1 of the NASD's Rules of Fair Practice, now Conduct Rule 2110, requires that a member observe "high standards of commercial honor and just and equitable principles of trade." Conduct Rule 2110, NASD Manual (CCH), p. 4111. [2]://Our review of NASD disciplinary actions occurs de novo and we make findings based on a preponderance of the evidence standard. Larry Ira Klein, Securities Exchange Act Rel. No. 37835 (October 17, 1996), 63 SEC Docket 70, 83; Carlton Wade Fleming, Jr., Securities Exchange Act Rel. No. 36215 (September 11, 1995), 60 SEC Docket 595, 597 n.4; Fundclear, Inc., 51 S.E.C. 1316, 1319 n.13 (1994). The NASD's assertion that substantial evidence supports its findings of violation does not articulate the correct standard of review. [3]://17 C.F.R.  240.15c3-1(a)(2)(vi) (1997). [4]://At the time of the routine examination, the net capital rule required a broker or dealer participating in a firm commitment underwriting to maintain a minimum of $35,000 in net capital. See 17 C.F.R.  240.15c3-1e (1997). [5]://NASD Membership and Registration Rule 1022(b)(A), NASD Manual (CCH), p. 3116; George Lockwood Freeland, 51 S.E.C. 389, 392 (1993). [6]://W.N. Whelen & Co., Inc., 50 S.E.C. 282, 284 (1990); Sherman, Fitzpatrick & Co., Inc., 51 S.E.C. 1048, 1052 (1994). [7]://Palm State Equities, Inc., Securities Exchange Act Rel. No. 35873 (June 20, 1995), 59 SEC Docket 1812, 1819. [8]://Fundclear, Inc., 51 S.E.C. 1316, 1318 and n.7 (1994); Hutchison Financial Corporation, 51 S.E.C. 398, 399 and n.6 (1993). [9]://The net capital rule requires, generally, that broker-dealers involved in dealer activities maintain at least $100,000 in net capital. 17 C.F.R.  240.15c3-1(a)(2)(iii) (1997). Firms not engaged in dealer activities, as that term is defined for purposes of the net capital rule, may maintain lower levels of net capital. [10]://See Net Capital Rule, Securities Exchange Act Rel. No. 31511 (November 24, 1992), 52 SEC Docket 4148, 4153 ("1992 Release"). [11]://17 C.F.R.  240.15c3-1(a)(2)(vi) (1997). [12]://17 C.F.R.  240.15c3-1(a)(2)(iv) (1997). [13]://1992 Release, 52 SEC Docket at 4156. See also 17 C.F.R. 240.15c3-1(a)(2)(iv) (1997). [14]://The complaint against First Colorado included allegations of net capital violations in connection with five other offerings. From February through July 1994, at the request of the Firm's clients, First Colorado also placed orders for securities in these offerings. As with the Parker & Parsley transaction, the "buy" order tickets were marked "unsolicited," and First Colorado received a portion of Hanifen's selling concession for these transactions. Although the National Business Conduct Committee considered evidence relating to these offerings in reaching its conclusions, it dismissed the allegations pertaining to them as the complaint did not allege that First Colorado failed to meet its net capital requirement on the dates that the securities in those offerings were sold. [15]://See, Townsley Associates & Company, Inc., 50 S.E.C. 755 (1991) (broker-dealer that entered into an agreement with firm commitment underwriter to become a member of the selling group participated in the underwriting within the meaning of the net capital rule); 1992 Release, 52 SEC Docket at 4156 (an introducing broker-dealer that acts as a marketing agent for a firm commitment underwriting but that does not enter into a commitment for the purchase of any shares is a participant in the underwriting and subject to a $50,000 net capital requirement). [16]://The National Committee's reliance on Townsley Associates, 50 S.E.C. at 757, where we concluded that a $5,000 broker-dealer may not participate in a firm commitment underwriting even where such participation is arguably "riskless," is inapposite to these proceedings. The firm in Townsley entered into an agreement with the underwriter to become a member of the selling group. Pursuant to that agreement, the firm placed 25,000 shares of an initial public offering by the underwriting's settlement date. The NASD, however, found that here, First Colorado was not a member of the selling group in the Parker & Parsley underwriting and the record does not contain any evidence to the contrary. [17]://As mentioned earlier, the record included some evidence that First Colorado transmitted orders for clients in other offerings besides the Parker & Parsley underwriting. See n. 14. The record indicates that these transactions were, like the Parker & Parsley transaction, unsolicited. They were also isolated, contrary to the Firm's usual business in debt securities, and involved a small volume of securities. These facts are consistent with our conclusion as to the Parker & Parsley transaction. [18]://All of the contentions 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 herein. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40436 / September 14, 1998 Admin. Proc. File No. 3-9298 ------------------------------------------------- In the Matter of the Application of | | FIRST COLORADO FINANCIAL SERVICES | COMPANY, INC. | Post Office Box 6785 | Denver, Colorado 80206 | | and | | MARK P. AUGUSTINE | 9073 South Bear Mountain Drive | Highlands Ranch, Colorado 80126 | | For Review of Disciplinary Action Taken by the | | NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.| ------------------------------------------------- ORDER SUSTAINING IN PART AND SETTING ASIDE IN PART ACTION TAKEN BY REGISTERED SECURITIES ASSOCIATION, AND REMANDING THE PROCEEDINGS FOR A REDETERMINATION OF SANCTIONS On the basis of the Commission's opinion issued this day, it is ORDERED that the finding of the National Association of Securities Dealers, Inc. (the "NASD") that First Colorado Financial Services Company, Inc. and Mark P. Augustine violated Rule 17a-5 under the Securities Exchange Act of 1934 ("Exchange Act") and Article III, Section 1 of the NASD's Rules of Fair Practice be, and is hereby, sustained; and it is FURTHER ORDERED that the finding of the NASD that First Colorado Financial Services Company, Inc. and Mark P. Augustine violated Rule 15c3-1 under the Exchange Act and Article III, Section 1 of the NASD's Rules of Fair Practice be, and is hereby, set aside; and it is FURTHER ORDERED that the sanctions imposed by the NASD be, and hereby are, vacated, and the proceedings remanded to the NASD for a redetermination of sanctions. By the Commission. Jonathan G. Katz Secretary