SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 39520 / January 7, 1998 Admin. Proc. File No. 3-9192 : In the Matter of the Applications of : : EQUITY SECURITIES TRADING CO., INC. : 2820 IDS Center : 80 South 8th Street : Minneapolis, MN 55402 : : NATHAN NEWMAN : 2110 Austrian Pine Line : Minnetonka, MN 55305 : : and : : LAURENCE STUART ZIPKIN : 2801 Westridge Road : Minnetonka, MN 55305 : : 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 Rules of Fair Practice Failure to Comply with Free-Riding and Withholding Interpretation Failure to Supervise Registered representatives sold shares of "hot issues" in contravention of association's Free-Riding and Withholding Interpretation. Member firm of registered securities association and its president failed reasonably to supervise all but one of these transactions. Held, association's disciplinary action sustained in part and reversed in part. APPEARANCES: Matthew D. Wayne and Robert A. Vanasco, of Fishman & Merrick, P.C., for Equity Securities Trading Co., Inc., Nathan Newman, and Laurence Stuart Zipkin. Alden S. Adkins and Susan L. Beesley, for NASD Regulation, Inc. Appeal filed: November 13, 1996 Briefing completed: March 5, 1997 I. Equity Securities Trading Co., Inc. ("Equity" or the "Firm"), a member firm of the National Association of Securities Dealers, Inc. ("NASD"); Nathan Newman, Equity's president and a registered general securities principal, financial and operations principal, and options principal; and Laurence Stuart Zipkin, a sales representative with Equity and a registered general securities representative (collectively "Applicants"), appeal from NASD disciplinary action. The NASD found that Zipkin violated Article III, Section 1 of the NASD's Rules of Fair Practice ("Rules") when, in contravention of the NASD's Free-Riding and Withholding Interpretation (the "Interpretation"), he sold "hot issues" to broker-dealers and associated persons of broker-dealers. The NASD also found that Equity, acting through Newman, failed to supervise properly and adequately Zipkin's sales, as well as a sale of a "hot issue" by another Firm registered representative, in violation of Article III, Sections 1 and 27 of the Rules. <(1)> The NASD censured each Applicant, fined Equity and Newman $7,500 jointly and severally, and fined Zipkin $2,500. <(2)> Our findings are based on an independent review of the record. II. <(1)> The NASD recently revised and renumbered its Rules, but no substantive changes were made to the particular rules at issue here. Article III, Section 1 of the Rules [new Conduct Rule 2110] requires that members, in the conduct of their business, observe high standards of commercial honor and just and equitable principles of trade. The Interpretation [new IM-2110-1] requires members to make a bona fide public distribution of securities of a public offering that trade at a premium in the secondary market whenever such secondary market begins. Article III, Section 27 [new Conduct Rule 3010] requires a member to establish, maintain, and enforce a supervisory system with written procedures. <(2)> The NASD also assessed costs against Applicants, jointly and severally. ======END OF PAGE 2====== ======END OF PAGE 3====== A. The Applicants admit that, on February 22, 1993, April 5, 1993, and October 27, 1993, Zipkin sold the securities of Gaming Corporation of America, Casino Data Systems, and Acres Gaming Incorporated in twenty-two transactions to a total of thirteen customers. Each of these offerings was a "hot issue," that is, a security issued in a public offering that began trading in the after-market at a substantial premium. <(3)> On the applicable transaction date, each customer was a member of and a "local trader" on the Chicago Board Options Exchange, Inc. ("CBOE"). Each customer was also registered as, or associated with, a broker-dealer. None of the broker-dealers was a member of the NASD. Zipkin knew that each customer was a CBOE member at the time Zipkin opened the customer's account at Equity although he testified that he was not aware that each customer was or associated with a broker-dealer. The Interpretation requires NASD members to make a bona fide public distribution of hot issues. This obligation is designed to prevent the restriction of the supply of a hot issue by withholding shares from the market and forcing public customers who want to purchase that hot issue to acquire it in the aftermarket at a higher price. <(4)> In furtherance of this requirement to make a public market, the Interpretation generally prohibits the sale of hot issues to any broker-dealer or any person associated with a broker-dealer. <(5)> <(3)> The February 22, 1993 offering of Gaming Corporation of America, for which Equity was an underwriter, was priced at $6.75 per unit and at the opening of the secondary market sold for an immediate aftermarket premium at $10.75 per unit. The April 5, 1993 offering of Casino Data Systems, for which Equity was an underwriter, was priced at $5.00 per share and at the opening of the secondary market sold for an immediate aftermarket premium at $7.00 per share. The October 27, 1993 offering of Acres Gaming Incorporated, for which Equity was a member of the selling group, was priced at $5.00 per unit and at the opening of the secondary market sold for an immediate aftermarket premium at $10.00 per unit. <(4)> First Philadelphia Corp., 50 S.E.C. 360, 361 (1990). <(5)> Specifically, the Interpretation precludes selling hot issues: to any officer, director, general partner, employee or agent of the member or of any other broker/dealer, or to a person associated with the member or with any other broker/dealer, or to a member of the immediate family of any such person . . . [or] to any broker/dealer (continued...) ======END OF PAGE 4====== While Applicants agree that Zipkin's transactions may fall within the literal language of the Interpretation, they suggest a variety of reasons why the Interpretation should not be applied to these transactions. Applicants argue that the fact that the CBOE local traders are registered as broker-dealers is "merely technical." They assert that these particular CBOE local traders "trade on the floor . . . with their own capital, for their own accounts and have no retail transactions." Section 3(a)(5) of the Securities Exchange Act of 1934 ("Exchange Act") defines the term "dealer" as "any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise, . . . as part of a regular business." Section 3(a)(10) of the Exchange Act further defines a "security" to include "any put, call, straddle, option, or privilege on any security." Thus, persons, such as CBOE members, who trade as part of a regular business in securities, are required to register as broker-dealers. <(6)> Applicants also assert that Zipkin's sales to CBOE local traders did not violate the "purpose and intent" of the Interpretation. They claim that "there is absolutely no business that these individuals ever referred or can ever refer to Equity or any other member firm." Under fundamental principles of construction, there is no need to refer to the purpose or intent of a rule when the rule is unambiguous. <(7)> The language of the Interpretation is not ambiguous. It <(5)>(...continued) unless that broker-dealer gives written assurance that the purchases are to fill orders for bona fide public customers. <(6)> Applicants also assert that the CBOE local traders engage in transactions that are equivalent to transactions on the Chicago Mercantile Exchange ("CME"). They claim that an NASD member would not be prohibited from selling a hot issue to a CME member. The CME is not a national securities exchange, but rather a contract market designated pursuant to the Commodity Exchange Act. Assuming arguendo that the instruments traded by the CME may in certain instances be economically similar to those traded by the CBOE, the fact remains that the CME does not trade in securities as defined in Section 3(a)(10) of the Exchange Act. Thus, a CME member that restricts its activity to instruments that are not securities is not required to register as a broker-dealer. Of course, if the particular CME member engaged in securities transactions that required registration as a broker- dealer, the Interpretation would apply. <(7)> Cf. Natural Resources Defense Council, Inc. v. Browner, 57 F.3d 1122, 1127 (D.C. Cir. 1995) ("[w]here the terms (continued...) ======END OF PAGE 5====== plainly prohibits selling hot issues both to a broker-dealer or any associated person thereof. <(8)> Moreover, we disagree that these or similar transactions could not violate the purpose of the Interpretation. As discussed above, one of the purposes of the Interpretation is to prevent broker-dealers from withholding a hot issue until the aftermarket, forcing public customers to pay more in the secondary market for that issue. We are not suggesting that the record before us indicates that the CBOE members purchased these hot issues for a purpose prohibited by the Interpretation. However, failure to comply with the Interpretation does not require such a showing. Moreover, the record before us does not demonstrate why transactions by registered broker-dealers who are also CBOE local traders would never result in improper withholding of a hot issue from public customers. We also reject Applicants' argument that Zipkin should not be sanctioned because his conduct was merely a "technical" violation of the Interpretation. They assert that Zipkin did not know, nor could he have known, that CBOE local-traders were registered broker-dealers. In determining whether the Interpretation was violated, it is irrelevant that the violation was technical or inadvertent. As we have previously stated, the Interpretation does not require scienter to support a finding of violation. <(9)> Moreover, if any of the Applicants had checked the Central Registration Depository ("CRD") or reviewed the requirements of the Exchange Act, the fact that these CBOE local traders were registered as, or associated with, a broker-dealer would have been apparent. <(10)> <(7)>(...continued) of a statute are unambiguous, further judicial inquiry into the intent of the drafters is generally unnecessary"). <(8)> We have previously made clear that persons associated with an NASD member are obligated to be familiar with and comply with the Rules such as the Interpretation. See, e.g., Gilbert M. Hair, 51 S.E.C. 374, 378 n.12 (1993) (an associated person has a duty to be aware of and comply with applicable agency rules and regulations). <(9)> First Philadelphia Corp., 50 S.E.C. at 361. <(10)> As a precondition of membership and in accordance with the Securities Exchange Act of 1934, the CBOE requires its members to register with this Commission as, or associate with, a broker or dealer. See CBOE Rule 3.2 ("Individual memberships may be owned by a natural person who . . . is registered as a broker or dealer pursuant to Section 15 of the Securities Exchange Act of 1934, as amended, or is associated with a registered broker or dealer . . . .") ======END OF PAGE 6====== Applicants request that we direct the NASD to modify or amend the Interpretation to exclude transactions in hot issues with CBOE local traders. The Exchange Act provides specific procedures for review of self- regulatory organization rules, such as the Interpretation. <(11)> The NASD has in the past considered and modified the Interpretation -- the most recent amendment becoming effective in August 1996. In each instance, however, the proposed modification or amendment was submitted to this Commission and published for public comment before we approved the change, as required by the Exchange Act. We believe this procedure permits the consideration of potential concerns and the impact of a proposed modification on the securities market place and its participants. <(12)> For these reasons, we find that Zipkin violated the Interpretation, and thereby Article III, Section 1 of the Rules, when he sold hot issues to Equity customers who were registered as, or associated with, broker- dealers. B. We also agree with the NASD's finding that Equity and Newman failed to supervise Zipkin properly and adequately with respect to Zipkin's sales of hot issues to CBOE members. Newman, who had supervisory authority over all of Equity's operations, reviewed all accounts for hot issue restrictions. Newman also knew that these particular customers were CBOE members at the time Zipkin opened accounts for the customers at Equity. Newman failed to recognize that the customers were broker-dealers or associated persons and failed to prevent these customers from purchasing hot issues. <(13)> Therefore, we find that Equity, acting through Newman, and Newman violated Article III, Sections 1 and 27, by failing to supervise Zipkin and permitting the execution of trades in hot issues that were prohibited by the Interpretation. <(11)> Compare Exchange Act Section 19(e)(1)(A) and Exchange Act Sections 19(b) and 19(c). <(12)> Applicants argue that the Interpretation predates the formation of the CBOE by three years and suggest that the Interpretation did not properly consider the role of CBOE local traders. However, as discussed above, the NASD has amended the Interpretation from time to time since both the Interpretation's and the CBOE's inception. We also note that Applicants petitioned the NASD to modify the Interpretation after Zipkin executed the contested transactions, but before the NASD initiated this proceeding. The NASD rejected Applicants' petition. <(13)> As with the allegations against Zipkin, we reject Newman's contention that he did not know, nor should he have known, that the CBOE members were registered broker-dealers. ======END OF PAGE 7====== III. Michael J. O'Brien was a registered representative at Equity. In March 1992, O'Brien opened an account at Equity in the name of Stillwater Junior Scholarship Fund (the "Scholarship Fund"). O'Brien gave as the address and telephone number of the Scholarship Fund his home address and both his home and business telephone numbers. However, he submitted a separate tax identification number for the Scholarship Fund. He also provided the Firm with the Scholarship Fund's by-laws, dated 1983. The by- laws stated that the Scholarship Fund had been created by the members of the Stillwater Country Club and had as its purpose the granting of "scholarships for post-high school educational opportunities to qualified students." O'Brien also tendered a resolution from the Scholarship Fund that authorized O'Brien and a third party to effect securities transactions on behalf of the Scholarship Fund. Newman, on behalf of Equity, approved opening the Scholarship Fund account. He was aware at the time that the Scholarship Fund's address and telephone numbers belonged to O'Brien. He asked O'Brien whether O'Brien had any beneficial interest in the Scholarship Fund, and O'Brien denied it. Newman testified that the cashier would not have questioned a deposit by O'Brien into the Scholarship Fund because O'Brien was an officer of the fund. At the time, the Firm did not review endorsements on checks issued from a customer account. In September 1992, O'Brien deposited an $8,000 cashier's check, which identified O'Brien as the remitter, in the Scholarship Fund account. The source of these funds was in fact a bank loan to O'Brien although that information did not appear on the face of the cashier's check. Thereafter, he caused the account to issue 16 checks of $500 each to various colleges and universities for the benefit of 16 separate individuals. <(14)> During 1993, Newman placed O'Brien on "heightened" supervision although the record does not indicate the nature of that supervision or its cause. In the winter of 1993, O'Brien deposited two additional checks into the Scholarship Fund, for $500 each. After each deposit, an additional scholarship check for $500 was issued from the account. On or about April 23, 1993, the Scholarship Fund account purchased 5,000 shares of Developed Technology Resources, Inc. ("DTR"). DTR was a hot issue. On May 7, 1993, O'Brien deposited his personal check for $25,000 into the account. Thereafter, O'Brien deposited his own funds into the Scholarship Fund account with greater frequency, and withdrew a total of $40,448.18 in the form of eight checks. The eight checks were made payable to the Scholarship Fund and subsequently endorsed by O'Brien. It <(14)> The checks, which are in the record, contain the endorsement of the college or university and, in some instances, of the individual recipient. There were checks made payable to at least 13 separate post- secondary institutions. None of the individuals had the last name "O'Brien." ======END OF PAGE 8====== is not alleged that the Scholarship Fund engaged in any further transactions in hot issues. The NASD found that the Scholarship Fund account was beneficially owned by O'Brien because he "repaid" himself "loans" made to the account. <(15)> The NASD held that Newman had sufficient red flags that O'Brien owned the account. The address on the account was O'Brien's. O'Brien was the registered representative on the account, and one of two persons authorized to enter transactions for the account. The NASD further found that the 1983 date on the by-laws should have caused Newman to question whether the by-laws were current. The NASD faulted Newman for failing to establish special procedures regarding deposits and withdrawals of funds from the account or to note that an account established for an allegedly charitable purpose was engaging in speculative transactions. We conclude, however, that the record does not demonstrate by a preponderance of the evidence a failure of supervision by Newman. While Newman knew that the Scholarship Fund account used O'Brien's address and telephone numbers, O'Brien denied that he had a beneficial interest in the account. O'Brien's denial was bolstered by other documents. A certified copy of a resolution designated O'Brien as an officer of the Scholarship Fund and authorized him and another person to act on its behalf. In addition, the by-laws indicated that the Scholarship Fund was to provide scholarships. <(16)> Thereafter, the account paid out what appear to be bona fide scholarship checks. Between September 1992 and April 1993, each deposit by O'Brien was followed by the issuance of a scholarship check. O'Brien's sole hot issue violation occurred in April, but O'Brien did not deposit his funds into the Scholarship Fund account until May. Thereafter, we agree that he used the account as his own. However, we cannot say that conduct after the violation serves as a red flag for a violation that has already occurred. We therefore do not find that the Firm and Newman failed to supervise O'Brien with respect to O'Brien's violation of the Interpretation. IV. In imposing less than the minimum sanction suggested by the NASD Guidelines on Zipkin, the NASD noted that Zipkin's violations were "inadvertent" and that Zipkin had no prior disciplinary history, no beneficial interest in the CBOE members' accounts, made no effort to conceal the nature of these accounts, and had not been adequately <(15)> O'Brien was the subject of a separate NASD disciplinary proceeding for this conduct. <(16)> While the 1983 date on the by-laws could indicate that the by-laws were somehow stale, the date on the by-laws could also be indicative of the long-standing existence of the Scholarship Fund. The payment of scholarship checks would appear to verify the fund's purpose. ======END OF PAGE 9====== supervised. <(17)> In light of our determination with respect to the Firm and Newman's supervision of O'Brien, we remand the sanctions to the NASD for further consideration. We do not intend to suggest any view as to the outcome. An appropriate order will issue. <(18)> By the Commission (Chairman LEVITT and Commissioners JOHNSON, HUNT, CAREY, and UNGER). Jonathan G. Katz Secretary <(17)> The NASD Guidelines (1993) suggest fining an applicant the amount of any commissions, plus $2,500 to $15,000 for violating the Interpretation, as well as a suspension in egregious circumstances. <(18)> 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. Admin. Proc. File No. 3-9192 : In the Matter of the Applications of : : EQUITY SECURITIES TRADING CO., INC. : 2820 IDS Center : 80 South 8th Street : Minneapolis, MN 55402 : : NATHAN NEWMAN : 2110 Austrian Pine Line : Minnetonka, MN 55305 : : and : : LAURENCE STUART ZIPKIN : 2801 Westridge Road : Minnetonka, MN 55305 : : For Review of Disciplinary Action Taken by the : : NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. : : ORDER SUSTAINING IN PART AND REVERSING IN PART DISCIPLINARY ACTION TAKEN BY REGISTERED SECURITIES ASSOCIATION On the basis of the Commission's opinion issued this day, it is ORDERED that the findings of violation made and sanctions imposed by the National Association of Securities Dealers, Inc. against Laurence Stuart Zipkin, and the Association's assessment of costs, be, and they hereby are, sustained; and it is FURTHER ORDERED that the findings of the Association that Equity Securities Trading Co., Inc. and Nathan Newman failed to supervise Laurence Stuart Zipkin be, and they hereby are, sustained; and it is FURTHER ORDERED that the findings of the Association that Equity Securities Trading Co., Inc. and Nathan Newman failed to supervise Michael J. O'Brien be, and they hereby are, reversed; and it is FURTHER ORDERED that the sanctions imposed by the Association on Equity Securities Trading Co., Inc. and Nathan Newman, and the Association's assessment of costs, be, and they hereby are, remanded to the Association. By the Commission. Jonathan G. Katz Secretary