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SECURITIES AND EXCHANGE COMMISSION
|
In the Matter of BYRON G. BORGARDT
and ERIC M. BANHAZL |
OPINION OF THE COMMISSION
CEASE-AND-DESIST PROCEEDING
Ground for Remedial Action
Antifraud Violations
Two officers of a registered investment company, one of whom was also a director of the company, caused and committed violations of antifraud provisions of the federal securities laws by causing the company to file registration statements with the Commission from which material information was omitted. Held, it is in the public interest for each respondent to be ordered to cease and desist from committing or causing further antifraud violations.
APPEARANCES:
Kevin J. O'Brien, of Swidler Berlin Shereff Friedman, LLP, for Eric M. Banhazl.
Irving Einhorn, Law Offices of Irving Einhorn, for Byron G. Borgardt.
Gregory C. Glynn, for the Division of Enforcement.
Appeal filed: June 22, 2000
Last brief received: October 19, 2000
Oral argument: April 30, 2003
Respondents Byron G. Borgardt and Eric M. Banhazl, as well as the Division of Enforcement, appeal from the decision of an administrative law judge. 1 From April 28, 1992 to May 3, 1994, Borgardt was president and a director of Target Income Fund ("Target" or the "Fund"), a now-defunct registered investment company. Banhazl was vice president, secretary, and treasurer of the Fund from April 28, 1992 to April 1, 1997; he also served as interim president of the Fund from May 3, 1994 to November 1, 1995.
The law judge found that the Fund omitted material facts from five registration statements it filed with the Commission between 1992 and 1996, in violation of the antifraud provisions of the federal securities laws. The omitted facts pertained to the Fund's special relationship with Concord Growth Corporation ("Concord"), a privately held commercial finance company, and to the relationship that two Fund directors had with Concord. During the time in question, Concord provided to the Fund the loan participations that made up the Fund's entire investment portfolio. Concord also serviced all the participations it provided to the Fund. One director of the Fund was an officer, director, and 20% shareholder of Concord. The second Fund director, Borgardt, was in charge of selecting loan participations offered by Concord for both the Fund and another corporation. Borgardt signed three of the registration statements in question, and Banhazl signed all five.
The law judge found that the Respondents caused the Fund's violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 2 and Section 34(b) of the Investment Company Act of1940. 3 He ordered the Respondents to cease and desist from causing any violations or future violations of Sections 17(a)(2) and 17(a)(3) and from committing any violations or future violations of Section 34(b).
Respondents ask us to reverse and set aside all of the law judge's findings of fact, conclusions of law, and orders against them. The Division asks that we find additional violations. 4 We base our findings on an independent review of the record, except with respect to those findings not challenged on appeal.
The process that led to the creation of the Fund began in 1991 when Robert Lance Hicks heard Eric Banhazl speak at a seminar about the creation of mutual funds. Banhazl was senior vice president of Robert H. Wadsworth & Associates, Inc.("Wadsworth & Associates"), a mutual fund consulting and administration company. Hicks was the president and sole owner of Finance 500, a broker-dealer, and Finance 500 Advisory Services, an investment adviser. Finance 500 had been making private placements on behalf of Concord for six or seven years.
Concord provided capital primarily to companies that were too small, too new, or too undercapitalized to obtain bank loans. It also received revenue for servicing credit participations. Hicks thought that Concord's promissory notes would be attractive to the public and that a mutual fund would be a useful vehicle for marketing the notes. Hicks proposed to Banhazl that they discuss the creation of such a fund.
Hicks discussed his idea of starting a mutual fund with Matthew Carpenter, who was Concord's chief financial officer ("CFO"), chief operating officer, and corporate secretary. 5 Carpenter found the idea of such a fund attractive, among other reasons because it would increase the diversity of Concord's client base. Hicks subsequently brought Carpenter and Banhazl together for further discussions.
In the summer or fall of 1991, Wadsworth & Associates brought Michael D. Jeffers, an attorney who had been involved in the creation of at least 10 mutual funds, and Byron Borgardt, a business executive who, as a consultant, also reviewed investment ideas for Hicks, into the discussions about Hicks' proposed fund. Borgardt was familiar with Concord because he selected loan participations offered by Concord for James Hardie Credit Corporation ("Hardie"), a subsidiary of his employer. In late 1991, Jeffers attended several pre-organizational meetings at which Banhazl, Carpenter, Borgardt, and Hicks were present. Jeffers was assigned to review the initial registration statement that had been drafted for the Fund by Wadsworth & Associates. He was also involved in the selection of new Fund officers and board members.
By April 1992, the Fund's board of directors had been selected. Reid Rutherford and Borgardt were among the initial directors. Rutherford served as chairman of the board and chief executive officer ("CEO") of Concord; he was also a 20% shareholder. Finance 500 was the Fund's underwriter and distributor.
Concord was closely identified with the Fund from its earliest days. Concord initially paid the approximately $70,000 organizational costs of the Fund, costs which typically are assumed by a fund's sponsor. 6 A Wadsworth & Associates invoice dated August 7, 1991 referred to the Fund as "CGC Accounts Receivable Fund, Inc." Manuscript notes Jeffers made in November 1991 referred to the Fund as "Concord Fund."
It was well understood that Concord would be the initial provider of loan participations to the Fund. While consulting on the preparation of the Fund's first registration statement, 7Jeffers considered whether the registration statement should disclose that Concord would be the only originator and servicer of loan participations for the Fund. As he later testified before the law judge, he concluded that it should not for several reasons. First, he expected that other sources of loans would be found, and that the Fund itself would be a direct lender. Second, he was concerned that including such a disclosure might give investors the impression that Concord guaranteed the Fund's loans or stood behind the Fund in the event of a default. Finally, he knew that Concord was not legally obligated to provide any loans to the Fund.
The Fund's board of directors held its first meeting on April 28, 1992. Among other actions, the board ratified and approved various actions taken on behalf of the Fund before the meeting, including the preparation and filing of registration documents with the Commission. The board also selected Jeffers' law firm as counsel to the Fund. In addition to being a director of the Fund, Borgardt was its president and portfolio manager,and also was president of the Fund's investment adviser, Foothill Advisors, Inc. (the "Adviser"). Banhazl was vice president, secretary, and treasurer of both the Fund and the Adviser.
As of June 30, 1992, the net assets of the Fund were $103,569. A marketing plan prepared by Hicks projected that the Fund would have net assets of between $50 million and $100 million within three years. Carpenter told the Fund's board of directors that Concord could provide the Fund with at most $20 million in loan participations, so the Fund would have to find other sources in which to invest its assets as it grew.
Once the Fund was in operation, its distributor, Finance 500, began efforts to sell shares. Initially Hicks dealt with existing clients of Finance 500 and Finance 500 Advisory Services who had participated in private placements of Concord notes. In marketing the Fund, Hicks told potential purchasers that Concord would be the loan originator and servicer, as it had been for the private placements, "[j]ust to make them aware that, you know, they were dealing with the same party that they had known and had good relationships with." Hicks also informed the broker-dealers he recruited as selling agents for the Fund that Concord would be the Fund's loan originator and servicer.
The Fund began investing in loan participations after December 1, 1992. As expected, Concord initially provided all the participations.
Rutherford, Carpenter, Hicks, Jeffers, Borgardt, and Banhazl all made efforts to find additional suitable sources of loan participations for the Fund. Despite their efforts, however, no new lending relationships developed. 8 Thus, the Fund's entire investment portfolio, throughout Respondents' association with the Fund, consisted only of loan participations purchased from, and originated by, Concord.
Concord screened and serviced all of the loan participations it provided to the Fund. Concord did not charge these costs tothe Fund, but rather included them in the interest rate it charged the borrower. In determining the yield that the Fund would receive on its participations, Concord deducted costs for screening and servicing, as well as fixed costs, bad debt reserve, and profit, from its gross loan return. 9 The Fund's gross return was about 10-11% annually, while Concord's gross return was about 30% or more.
Concord also continued to support the Fund financially. The Fund was not permitted to spend more than 2.5% of its assets on ongoing operating expenses. 10 In at least two fiscal years, expenses exceeded this ceiling. Both times, Concord paid the overage. 11 Further, on two occasions when defaults could have resulted in losses to the Fund as a loan participant, Concord stepped in and absorbed the loss, paying a total of at least $120,000. Finally, Concord continued to provide participations to the Fund even after it found that other sources were interested in participating in its loans at lower rates of return.
While the Fund was investing in loan participations originated by Concord, so, too, was Hardie, often as a participant in the same loans in which the Fund participated. Borgardt reviewed and selected loan participations for the Fund. Acting for Hardie's parent corporation, his employer, Borgardt also arranged participations in Concord's loans forHardie. 12 In general, the Fund participated in a given loan to the full extent permitted by its diversification requirement, and Concord and Hardie divided the remainder of the loan equally. Over the life of the Fund, the Fund's yields on Concord participations were roughly equal to Hardie's yields.
On January 13, 1994, Jeffers was unable to attend a meeting of the Fund's board of directors. Another attorney from his firm, Barry Falk, attended in his place. After the meeting, Falk told Jeffers that he thought there were potential problems under Section 17 of the Investment Company Act of 1940, 13 arising from Rutherford's presence on the board and from Borgardt's arranging participations in the same Concord loans on behalf of both the Fund and Hardie. After some research, Jeffers concluded that Rutherford's presence on the board raised at least the possibility of a violation of Section 17 of the Investment Company Act, and that Borgardt's participations in the same loan on behalf of both the Fund and Hardie were prohibited transactions under that section. 14
Jeffers informed the board of his conclusions at its next meeting, on May 3, 1994. Jeffers recommended that Rutherford resign from the board and that Borgardt resign from either his positions with the Fund or his positions with Hardie. Both Rutherford and Borgardt resigned from their positions with the Fund on May 3, 1994.
On May 23, 1994, Commission staff began a routine examination of the Fund. The examination later developed into aninvestigation, which led to this proceeding. Partly as a result of this investigation, Hicks decided to stop marketing the Fund.
In May 1996, an attorney for the Division of Enforcement wrote to Jeffers about the Fund's relationship with Concord and Hardie. On July 30, 1996, about a month after Jeffers had replied to the inquiries, the Fund filed a post-effective amendment to its registration statement in which it disclosed for the first time that Concord was the originator of all loan participations in which the Fund had invested.
On January 17, 1997, a bank holding company agreed to acquire Concord and the holding company that owned it, effective March 17, 1997. The bank holding company wanted all of Concord's product, and the Fund had not found other acceptable loan originators. Concord and the Fund negotiated a repurchase by Concord of all outstanding loan participations and Fund investments. The Fund then repurchased all outstanding shares. Although the shareholders were repaid in full, Concord, Wadsworth & Associates, and others involved with the Fund received less than the full amount of fees and expenses owed them. The Fund withdrew its registration in July 1997.
Before the hearing began, the law judge granted the Division's motion to amend the OIP. Respondents argue that the amendment should not have been allowed, contending that the amendments went beyond the scope of the original OIP and were therefore impermissible under Rule 200(d)(2) of our Rules of Practice. 15 We conclude that the law judge, in ordering the amendments, acted consistently with our Rules of Practice and due process.
The amendments responded to the fact that the OIP contained allegations related to two sets of facts without separately charging failure to disclose those facts. First, it alleged that Borgardt, while serving as the portfolio manager and a director of the Fund, was also CFO and manager of investments of Hardie, which had a separate business relationship with Concord (the "Borgardt conflict"). Second, it alleged that Concord received returns of approximately 30% on loans to its borrowers using capital provided to it by the Fund, yet paid the Fund returns of only approximately 11% (the "rate differential"). 16
About four months after the OIP was filed, the Division filed the report of its expert witness, David L. Ratner (the "Ratner Report"). The Ratner Report concluded, among other things, that the Fund's registration statements failed to disclose the Borgardt conflict and the rate differential, and that both the conflict and the differential were material. About a month later, Banhazl filed the Report of his expert witness, John C. Coffee, Jr. (the "Coffee Report"). Among other things, the Coffee Report responded to the analysis of the Borgardtconflict and the rate differential contained in the Ratner Report.
Respondents subsequently moved to exclude Ratner's expert testimony regarding the materiality of the Borgardt conflict and the rate differential. 17 These issues, Respondents contended, were beyond the scope of the OIP. They argued that, because the OIP did not give them notice that these allegations could provide a basis for liability, testimony regarding them would be irrelevant, and the introduction of such testimony as part of the Division's case in chief would be unfair and a violation of due process. The Division opposed the motion, contending that the Borgardt conflict and the rate differential were disclosed in the OIP "in some detail" and that the law judge should allow testimony on those subjects both on direct examination and to rebut Respondents' affirmative defenses. In the alternative, the Division argued that the law judge should amend the OIP pursuant to Rule 200(d)(2) of the Commission's Rules of Practice, which allows a hearing officer to amend an OIP at any time before an initial decision is filed "to include new matters of fact or law that are within the scope of the original order instituting proceedings," 18 so that the Division could introduce evidence regarding the Borgardt conflict and the rate differential.
The law judge found that the evidence in question was relevant. He also found that the Respondents "could not reasonably have known from reading the OIP that the specific allegations at issue here could form a basis for liability." The law judge ruled that the Division could use the contested evidence "to rebut the anticipated defense of reliance on the advice of counsel," but that, in order to use the evidence as part of its case in chief, the Division would have to file a motion proposing specific language amending clearly identified paragraphs in the OIP.
The Division filed such a motion, which Respondents opposed. Respondents contended that the law judge's statement that they could not reasonably have known from reading the OIP that theallegations at issue could form a basis for liability was tantamount to a ruling that those allegations were outside the scope of the OIP. Therefore, they contended, the amendment was not permissible under Rule 200(d)(2).
The law judge granted the motion to amend. The law judge found that the proposed amendment
involves matters of fact and law that are 'within the scope' of the original OIP. The 'framework' of the original OIP remains the same: allegations of material omissions in the Fund's registration statements. All that has changed is the number of alleged material omissions: now, there are two more and it is explicit that they, too, can lead to a finding of liability.
Respondents now repeat their arguments to us.
We conclude that the law judge acted consistently with Rule 200(d)(2). The comment to that rule explains that
amendment of orders instituting proceedings should be freely granted, subject only to the consideration that other parties should not be surprised, nor their rights prejudiced. . . . Since, however, the Commission has not delegated its authority to authorize orders instituting proceedings, hearing officers do not have authority to initiate new charges or to expand the scope of matters set down for hearing beyond the framework of the original order instituting proceedings. 19
The amendments sought here were within the scope of the original OIP. The OIP set forth the salient facts regarding the Borgardt conflict and the rate differential. The amendments added detail about the Borgardt conflict, but did not introduce new factual issues. The original OIP charged violations of Sections 17(a)(2) and 17(a)(3) based on the failure to make adequate disclosure in six registration statements. The amendments do not charge violations of any additional laws orrules, 20 nor do they base charges on any registration statements not identified in the original OIP.
Borgardt and Banhazl were not surprised nor were their rights prejudiced by the amendments. The Ratner Report put Respondents on notice that the Division viewed the Borgardt conflict and the rate differential as potential grounds for liability. The Coffee Report filed by Respondents addressed both matters on the merits. Respondents thus knew months before the motion to amend was filed that these matters were potentially at issue, and the fact that their expert witness responded on the merits belies any claim of prejudice.
Respondents reiterate their claim that the law judge's ruling that the proposed amendments were within the scope of the original OIP was inconsistent with his statement that Respondents "could not reasonably have known from reading the OIP" that the Division's specific allegations regarding the Borgardt conflict and the rate differential could form a basis for liability. The law judge apparently did not intend the two to be inconsistent, because the same order in which the law judge made the statement to which Respondents point also informed the Division that he would entertain a motion to amend the OIP under Rule 200(d)(2) if the Division wanted to introduce evidence regarding the Borgardt conflict and the rate differential in its case in chief. The law judge required the Division to clarify its position by proposing specific amendments to the OIP, thus ensuring the adequacy of notice to the Respondents. Such a requirement is consistent with a finding that the proposed new charges were within the scope of the original OIP. In any event, even if the later ruling were inconsistent with the earlier statement, that would not render the ruling improper. When confronted with the precise question whether the proposed amendments were within the scope of the original OIP, the law judge found that they were. He was right.
1. Materiality of Omissions
Sections 17(a)(2) and (a)(3) of the Securities Act prohibit fraud in connection with the offer or sale of securities. 21 A material misrepresentation, or a material omission where there is a duty to speak, can constitute a violation of the antifraud provisions. 22 Section 34(b) of the Investment Company Act, among other things, makes it unlawful for any person filing a registration statement with the Commission to omit to state therein any fact necessary to prevent statements from being materially misleading. 23 An omission is material if there is a substantial likelihood that a reasonable investor would have considered the omitted fact important to his or her investment decision, and disclosure of the omitted fact would have significantly altered the total mix of information available. 24
The OIP, as amended, charged four material omissions from the registration statements filed between October 7, 1992 and March 11, 1996:
failure to disclose the Fund's special relationship with Concord;
failure to disclose the conflict of interest resulting from Rutherford's positions as chairman of the board, CEO, and 20% owner of Concord;
failure to disclose the Borgardt conflict; and
failure to disclose the rate differential. 25
The law judge found material Concord's special relationship to the Fund, the conflict of interest resulting from Rutherford's positions as Concord's chairman of the board and CEO, and the Borgardt conflict. 26 The law judge found not material Rutherford's 20% ownership interest in Concord and the rate differential. All of these findings were appealed.
a. Concord's Special Relationship to the Fund
From the time the Fund began making investments until the time it ceased operations, it purchased loan participations from only Concord, which also serviced all the loans. Concord also subsidized the Fund by advancing or paying certain costs and overages, and absorbing losses on two loans in which the Fund participated. Moreover, it continued to provide participations to the Fund even after it found other entities that were willing to participate for lower rates of interest.
A reasonable investor would have found this special relationship significant. Indeed, Hicks made a point of informing both potential purchasers and broker-dealers he wanted to recruit as selling agents that Concord would be providing and servicing loans to the Fund, because he anticipated theirinterest in the matter. 27 The Fund's singular reliance on Concord was important to the Fund's business and future prospects and, accordingly, it should have been disclosed.
Respondents argue that, although the Fund purchased participations only from Concord, that action was prudent because Concord's loans offered the best combination of low risk and high yield. They contend that the Fund's decision to invest in only Concord's loan participations was not important enough to require disclosure because the Fund could have invested in loans from other sources that were only marginally higher in risk or lower in yield. However, a materiality determination here does not turn on whether it was a prudent business decision for the Fund to purchase all its participations from Concord, nor on whether similar investments were available through other sources. 28
Respondents also contest the materiality of information concerning the relationship with Concord by claiming that the Fund did not face the usual risk posed by dependence on a single supplier -- abandonment by the supplier. They assert that the likelihood that Concord would abandon the Fund was not significant given Concord's interest in strengthening its relationship to the Fund and protecting the Fund. 29 While thelikelihood of changes in the relationship is speculative, the Fund's dependency on Concord made it vulnerable to any changes that might occur. We conclude that a reasonable investor would have considered the special relationship between Concord and the Fund significant to the total mix of information relevant to making an investment decision, and that the information was therefore material.
b. Rutherford's Relationship to Concord
As noted above, Rutherford was chairman of the board, CEO, and a 20% shareholder of Concord during the time that he served on the Fund's board of directors. The registration statements in question identified his positions as Concord's chairman of the board and CEO, but did not disclose his ownership interest in Concord.
The bare disclosure of Rutherford's executive roles within Concord was not sufficient to inform investors of the significance of those roles. Without an explanation of Concord's relationship to the Fund, the importance of Rutherford's positions at Concord was unclear.
Further, ownership of shares gave Rutherford a personal stake in Concord's economic well-being. This tie to Concord created a conflict of interest to the extent that the objectives of the Fund diverged from those of Concord. A reasonable investor would have considered this connection between Rutherford and Concord significant.
Respondents contend that disclosure of Rutherford's roles as chairman and CEO of Concord already informed potential investors that Rutherford controlled Concord and was strongly interested in its profitability. Since investors were already on notice that Rutherford had a strong interest in Concord, Respondents argue, information regarding Rutherford's share holdings would have added nothing that required disclosure under the securities laws.
We disagree. Rutherford's personal stake in Concord increased his incentive to favor Concord. Both the executive positions and the ownership interest should have been disclosed.
c. The Borgardt Conflict
With regard to selection of investments, Borgardt played the same role for the Fund as he did for Hardie. Borgardt's relationship to Hardie, like Hardie's relationship to Concord, was already established when the Fund was organized; both relationships continued until Borgardt resigned as director and president of the Fund in May 1994. When both Hardie and the Fund participated in Concord loans, Borgardt arranged the participations. The potential to favor one participant over the other when arranging the terms of the participations created a conflict of interest that was material and should have been disclosed.
Respondents argue that Borgardt's dual roles in fact posed no conflict of interest. They assert that there is no evidence that Borgardt ever acted to benefit Hardie at the Fund's expense. However, the materiality of his dual roles does not depend on whether Borgardt in fact favored Hardie at the Fund's expense.
d. The Rate Differential
Concord received returns of approximately 30% or more on loans to its borrowers using capital provided to it by the Fund, yet paid the Fund returns of only 10% to 11%. The registration statements did not disclose this rate differential. The Division contends that the Fund's failure to disclose the rate differential was misleading.
We find that a reasonable investor would have found the rate differential important to his or her investment decision in the factual context of this case. Disclosure of the differential would have highlighted the fact that the rates of return Concord received on the loans were dramatically higher than the rates of return Concord paid to the Fund. While the registration statements informed investors of various risks associated with investing in the Fund, 30 these narrative disclosures would be applicable to a wide range of investments that could be expected to yield varying rates of return. The risk disclosure provided was not a substitute for disclosure of the rate differential, particularly in the context of Concord's special relationship to the Fund and Rutherford's conflict.
We further conclude that the disclosure that the Fund paid a "service fee" to Concord did not adequately inform investors regarding the magnitude of the rate differential. We agree with the Division's expert, who testified,
"[S]ervice fee" is [not] an adequate way of conveying to an ordinary, unsophisticated investor the fact that there were two different sets of interest rates here with a difference amounting to 100 to 250 percent mark-up. . . . Service fees are something that are generally relatively minor and . . . [the term] impl[ies] something that is not a major component of the interest rate.
Investors should have been able to evaluate what the Fund was being charged. Again, the significance of the rate differential is heightened here, given the nature of the undisclosed relationship of Concord to the Fund and Rutherford's conflict. 31
Respondents argue that disclosure of the rate differential would have been misleading to investors. They contend that investors might construe the rate differential as suggesting that the Fund's loan portfolio was especially risky, which was not the case because Concord's screening function effectively reduced the risk to Fund investors. Thus, they argue, the differential between Concord's yield and the Fund's yield actually reflects the effort Concord expended to make loan participations offered to the Fund safe.
We reject Respondents' argument. Respondents could have accompanied disclosure of the rate differential with additional information that would have explained and put that information into context. Then investors would have had the material information from which to evaluate the risk of the loans that the Fund purchased and to determine for themselves whether theservices provided by Concord justified the differential between the returns enjoyed by Concord and those passed along to the Fund.
2. Respondents' Knowledge of Omitted Facts
The record reflects that Respondents knew of Concord's roles as sole provider and servicer of loan participations to the Fund, of Rutherford's positions as CEO and chairman of the board of Concord, of the Borgardt conflict, and of the rate differential. 32 We also find that Borgardt knew that Rutherford was a 20% shareholder of Concord. In contrast, the record does not establish that Banhazl either knew or should have known that Rutherford was a 20% shareholder of Concord when Banhazl signed the registration statements.
3. Standard of Care
We have held repeatedly, as have the federal courts, that negligent conduct can establish liability under Sections 17(a)(2) and 17(a)(3) of the Securities Act. 33 Negligence alsoestablishes liability under Section 34(b) of the Investment Company Act. 34
Negligence is the failure to exercise reasonable care or competence. 35 Using this standard, we find that Respondents did not exercise reasonable care. Respondents knew when they caused the Fund to file the registration statements that Concord was providing and servicing the loan participations that constituted the Fund's entire investment portfolio, that Concord's rate of return was approximately 30% or more while the Fund's rate of return was only 10% to 11%, and that Borgardt arranged participations for Hardie and the Fund in Concord loans. Additionally, Borgardt knew that Rutherford held a 20% interest in Concord. They signed multiple registration statements from which these material facts were omitted. In failing to see that appropriate disclosures were made, Respondents were negligent.
Respondents contend that they should not reasonably have known of the need to disclose either Concord's roles or the Borgardt conflict because both were beneficial to the Fund and thus raised no red flags to Respondents. This contention disregards Respondents' essential duties to shareholders -- Respondents were obligated to cause the Fund to disclose material facts, be they beneficial, detrimental, or neutral. 36
4. Advice of Counsel
Respondents contend that they acted in reliance on Jeffers' advice in deciding not to disclose (1) Concord's role as sole provider of loan participations to the Fund and (2) Borgardt's involvement in selecting Concord participations for Hardie and the Fund. They contend that this reliance precludes our finding the violations charged.
In considering assertions of reliance on the advice of counsel, we look to see whether four factors have been established: (1) a request to counsel for advice on the legality of a proposed action, (2) full disclosure to counsel of the relevant facts, (3) receipt of advice that the action to be taken will be legal, and (4) reliance in good faith on counsel's advice. 37
In one instance, Jeffers advised that disclosure of Concord's role was not necessary. It is undisputed that, before the Fund's initial registration statement was filed, Jeffers gave legal advice that Concord's role did not need to be disclosed at that time. Jeffers testified that he based this conclusion on the fact that Concord was expected to be only one of many providers. He explained that he also believed that including a discussion of Concord's role would create the misleading impression that Concord was acting as a guarantor of the Fund orwould be obligated to provide loans to the Fund. 38 But the OIP does not charge failure to disclose Concord's roles in the Fund's initial registration statement, so we make no finding as to whether Respondents could properly have relied on the advice Jeffers gave at that time. 39
a. Asking for and Receiving Advice
The record does not show that Respondents sought and received legal advice from Jeffers, Fund counsel, with respect to disclosure either of Concord's roles or of the Borgardt conflict, at any time after the initial registration statement was filed. Instead, it shows that Respondents discussed in general terms, in Jeffers' presence, these or related topics, and assumed that Jeffers would alert them if he noted any legal problems or impediments posed by the Fund's business model.
Respondents could not simply wait, as they did, for Jeffers to alert them to material omissions from the Fund's registration statement. Corporate officials have an independent duty to make certain that registration statements they sign contain adequate disclosures. They cannot satisfy this duty simply by discussing information in counsel's presence and relying on counsel to see that required disclosures are made and updated as circumstances require. 40 Additionally, Respondents could not assume thatJeffers' advice that certain arrangements were legal meant that those arrangements did not have to be disclosed. Legality and disclosure are separate questions, and treating them identically amounts, at a minimum, to negligence.
Jeffers testified that at some unspecified number of board meetings, on unspecified dates, he in fact advised that disclosure of Concord's role was not required. Notably, the minutes of the board meetings, including the minutes of three meetings recorded by Jeffers himself, reflect no such discussion. 41 The law judge gave little weight to Jeffers' testimony, noting that there were "glaring inconsistencies" between Jeffers' 1999 hearing testimony and his 1996 written responses to questions posed by the Division during its investigation. In 1996, Jeffers told the Division that he did not recall any discussion regarding disclosure of Concord's roles as master servicer and sole provider of loan participations to the Fund. The law judge noted that the 1996 responses were closer in time to the events in question, and that in 1996 Respondents had not yet fashioned their litigation strategy.
In reaching his conclusion that Jeffers' 1996 responses should be accorded more weight than his 1999 testimony, the law judge was able to hear Jeffers' testimony and observe his demeanor. We see no reason to depart from his assessment. 42 In any event, even if we disregard Jeffers' 1996 responses, we find his testimony at the hearing too vague to establish that his advice regarding nondisclosure of Concord's roles was repeated to Respondents after the initial registration statement was filed. 43
Respondents argue that the law judge's finding that Jeffers advised that Concord's roles should not be disclosed at the time the initial registration statement was filed is inconsistent with the law judge's interpretation of Jeffers' responses as evidence that Jeffers never had "any discussions" on that subject. In his 1996 responses, Jeffers wrote: "I do not recall any discussion regarding disclosure" of Concord's roles as master servicer and sole provider of loan participations to the Fund. We agree with the law judge that Jeffers' failure to remember any such discussions tends to prove that no such discussions were had. Nor are we troubled by the alleged inconsistency in the findings Respondents cite. Based on our independent review of the record, we find that Jeffers initially provided advice regardingdisclosure of Concord's roles, and that he subsequently had no further discussions of the subject until Falk brought the matter to his attention after the January 1994 board meeting. 44
b. Good-faith Reliance on Counsel's Advice
We find that Respondents could not, in good faith, have relied throughout the period at issue on the advice given by Jeffers before the initial registration statement was filed regarding disclosure of Concord's roles. While the omission of Concord's roles from the initial registration statement was not charged in the OIP, Jeffers' advice regarding disclosure of Concord's roles appears to have been highly questionable from the start. We have already found Concord's relationship to the Fund material. The expectation that other providers of participations would be found over time does not excuse the failure to disclose, at the outset, Concord's role as sole provider. Both the expectation of adding other providers and the fact that Concord was not a guarantor of the Fund could and should have been addressed by additional disclosures. Thus, Jeffers' initial advice was arguably so incorrect that Borgardt and Banhazl could not have relied on it in good faith even in connection with the initial registration statement.
In any event, even assuming the initial reliance on Jeffers' advice was in good faith, continued reliance became less and less defensible as time passed. Jeffers' initial advice assertedly was based on the expectation that Concord would soon become only one of many providers of loan participations to the Fund. In fact, despite efforts to find other providers, Concord continued to be the sole provider for more than four years, until the Fund withdrew its registration. Once the basis for Jeffers' opinion proved to be incorrect, Respondents, as officers (and in Borgardt's case, also a director) of the Fund, could not in good faith continue to rely unquestioningly on that opinion. Consistent with their own responsibilities to Fund shareholders, they needed to ask Jeffers whether his opinion had changed in light of changing circumstances, to inform him that they expected him to tell them if his opinion changed over time, and, ultimately, to assess for themselves the need for revised disclosure. 45
* * *
Based upon the foregoing, we find that Borgardt and Banhazl caused violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 and Section 34(b) of the Investment Company Act of 1940 by causing the Fund to issue registration statements from which material facts were omitted.
Securities Act Section 8A 46 and Investment Company Act Section 9(f) 47 authorize the Commission to impose a cease-and-desist order if it finds that any person has violated or caused violations of the federal securities laws or rules thereunder. As we specified in KPMG Peat Marwick LLP, we impose cease and desist orders only where there is some risk of future violations, although that risk need not be very great and is ordinarily established by a showing that a respondent has already violated the law. 48 In determining, in the exercise of our discretion, whether a cease-and-desist order is appropriate, we also consider the seriousness of the violation, the isolated or recurrent nature of the violation, whether the violation is recent, the respondents' state of mind, the sincerity of the respondents' assurances against future violations, the respondents' recognition of the wrongful nature of the conduct at issue, the respondents' opportunity to commit future violations, the degree of harm to investors or the marketplace resulting from the violation, and the remedial function to be served by the cease-and-desist order in the context of other sanctions being sought in the same proceeding. 49 Our inquiry is a flexible one, and no single factor is dispositive. 50
On the facts before us, we see a risk that Respondents may violate the antifraud provisions in the future. Their belief that it was sufficient to have an attorney present at meetings and that counsel would let them know if disclosure was required indicates a failure to appreciate the seriousness of the disclosure obligations of officers and directors. The failure to disclose Concord's role, which was crucial to the Fund's very existence, is in itself serious enough to justify the imposition of a cease-and-desist order. The violations persisted for eighteen months of Borgardt's tenure as an officer and director of the Fund and for almost three and a half years of Banhazl's tenure as an officer of the Fund.
Respondents fail to appreciate fully the wrongful nature of their misconduct. The fact that they may have made reasoned decisions about how to conduct their business does not relieve them of the obligation to disclose those decisions. Their attempts to shift responsibility for the accuracy of the registration statements at issue to counsel and their assumption that they reasonably could wait passively for counsel to let themknow if additional disclosures were needed suggest the need for remediation.
Looking to the range of additional considerations that guide our discretion, we find that both Respondents are in a position to repeat their violations. Banhazl has been active in the mutual fund industry for almost two decades, and he continues to be involved in the establishment of new mutual funds. Borgardt left the securities industry in May 1994, when he resigned from his positions with the Fund, but had returned to the industry by late 1999 as an officer of a company about to go public. The issuance of a cease-and-desist order may spur Respondents to take greater care to satisfy their disclosure obligations in the future. Although certain other factors, including Respondents' lack of disciplinary history, tend to counsel against such relief, on balance we believe that a cease-and-desist order is warranted in the public interest.
Thus, we find it appropriate to order Respondents to cease and desist from committing or causing any violations or future violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act and Section 34(b) of the Investment Company Act.
An appropriate order will issue. 51
By the Commission (Chairman DONALDSON and Commissioners GLASSMAN, and GOLDSCHMID); Commissioner ATKINS concurring in the result and dissenting from a portion of the opinion, and Commissioner CAMPOS not participating.
Jonathan G. Katz
Secretary
Commissioner ATKINS, concurring in the result and dissenting from a portion of the opinion:
I concur in part and dissent from the portion of the opinion that concludes that the failure to disclose the rate differential between Concord's rate of return and the Fund's rate of return was a material or misleading omission. This conclusion appears to be largely ungrounded in the record. The law judge's determination on this issue is more persuasive. Specifically, the law judge determined correctly that it was the "norm in the loan participation marketplace" for loan originators to charge these types of fees and to "pass on a lesser yield -- even a significantly lesser yield" to loan participants. The law judge correctly determined that the rate differential was a "function of the screening and servicing costs incurred by Concord" that was necessary to meet the Fund's investment criteria. Further, the law judge correctly found that the net yields were not "indicative of . . . unusual or excessive investment risk." I also agree with Respondents' expert's statement that the rate differential is not "per se suspicious or . . . needs to be rooted out and disclosed to investors."
The majority opinion on this point does not state that disclosure of the rate charged to a borrower in the portfolio loans might give an investor a better sense of the risk of the portfolio loans. The majority opinion on this point suggests that the failure to disclose the rate differential, i.e., Concord's fee, was a material and misleading omission. Concord absorbed significant Fund losses as part of its maintenance function. This maintenance function significantly reduced the Fund investors' risk exposure in the portfolio loans. The registration statement indicated that a fee of this nature was charged. Cf. Banco Espanol de Credito v. Security Pac. Nat'l Bank, 973 F.2d 51, 53 (2d Cir. 1992) (loan originator earned a "fee equal to the difference between the interest paid by the debtor and the lower interest paid to the purchaser" of loan participations) (emphasis added). Nothing in the record suggests that Concord's fee was excessive for the work that was performed.
I also note that the registration statements did inform investors of numerous risks associated with investing in the Fund. Specifically, the registration statements stated that the portfolio loans were: (1) typically issued by smaller companies, (2) unrated, and (3) not readily marketable. Each of these factors put investors on notice regarding the risks of the portfolio loans underlying their investment. In addition, the Opinion does not address the fact that an investment decision of this nature is primarily based on the investment's expectedreturn, as compared to other comparable investment vehicles, not on the mark-up or mark-down of the intermediaries creating this expected return.
I acknowledge that the special relationship between Concord and the Fund should have been disclosed to investors and that the failure to make this disclosure was material and/or misleading. I also concur that the failure to make this disclosure is itself serious enough to justify the imposition of the cease and desist order issued here. However, based on the foregoing reasons, I do not conclude, based on the total mix on information made available in the Fund's registration statements, that the failure to provide more specific information regarding the rate differential was, in itself, material and/or misleading.
In the Matter of BYRON G. BORGARDT
and ERIC M. BANHAZL |
ORDER IMPOSING SANCTIONS
On the basis of the Commission's opinion issued this day it is
ORDERED that Byron G. Borgardt and Eric M. Banhazl cease and desist from committing or causing any violations or future violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 and Section 34(b) of the Investment Company Act of 1940.
By the Commission.
Jonathan G. Katz
Secretary
| 1 | Byron G. Borgardt, Initial Decision Rel. No. 167 (June 1, 2000), 72 SEC Docket 1675. |
| 2 | 15 U.S.C. §§ 77q(a)(2), 77q(a)(3). Section 17(a)(2) prohibits the sale of securities by means of "any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading." Section 17(a)(3) prohibits a sellerof securities from "engag[ing] in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser." |
| 3 | 15 U.S.C. § 80a-33(b). Section 34(b) prohibits the making of any untrue statement of a material fact in any registration statement filed with the Commission. It also prohibits the omission from such a registration statement of any fact necessary in order to prevent the statements made therein from being materially misleading. |
| 4 | In its briefs, the Division also requested that we adopt a standard for issuance of cease-and-desist orders that does not require a finding of likelihood of future violations, and apply that standard here. Subsequent to the close of briefing in this matter, we articulated, in another litigated case, a standard for issuance of cease-and-desist orders that calls for a determination of some risk of future violations. See KPMG Peat Marwick LLP, Exchange Act Rel. No. 43862 (Jan. 19, 2001), 74 SEC Docket 384, 429-30, 435-36, motion for reconsideration denied, Exchange Act Rel. No. 44050 (Mar. 8, 2001), 74 SEC Docket 1351, petition for review denied, 289 F.3d 109 (D.C. Cir. 2002). That standard, which Division counsel acknowledged at oral argument is the governing standard, is explicated infra at nn. 48-50 and accompanying text. |
| 5 | Carpenter became president of Concord in early 1992. |
| 6 | Concord expected the Fund to reimburse these expenditures over time. It did so, within the first year and a half of the Fund's operation. |
| 7 | The Fund's initial registration statement was filed on January 21, 1992, and was declared effective on October 8, 1992. The filings at issue here constitute amendments to the January 1992 statement. In the interest of simplicity, we refer to them in this opinion generally as registration statements, as did the Order Instituting Proceedings ("OIP") and the initial decision. |
| 8 | The Fund had a diversification requirement that limited its participation interest in any given loan to five percent or less of the Fund's net assets; this level of participation was too small to interest some providers. Other providers refused to do business with the Fund because they could obtain capital more cheaply elsewhere. The Fund rejected some prospective providers because they offered unacceptable rates or posed unacceptable risks. |
| 9 | Concord's screening and servicing costs were significant, in part because many of the companies to which it provided capital were new, small, or undercapitalized and had inadequate back-office operations. Finding prospective borrowers, determining their credit worthiness, negotiating loan agreements, tracking accounts receivable, and running its in-house system of financial controls involved substantial expense to Concord. |
| 10 | The record does not identify the source of the 2.5% restriction. |
| 11 | Concord was reimbursed for about half of the overage payments. It absorbed the loss of the other half so that Fund shareholders could be made whole when the Fund closed down. |
| 12 | After May 3, 1994, Borgardt continued to invest in Concord loan participations on behalf of Hardie, and Banhazl invested in Concord participations on behalf of the Fund. |
| 13 | 15 U.S.C. § 80a-17. Section 17 prohibits certain acts by affiliated persons of registered investment companies. Section 2(a)(3)(D) of the Investment Company Act, 15 U.S.C. § 80a-2(a)(3)(D), defines officers and directors as affiliated persons. |
| 14 | Jeffers later concluded that the participations were not prohibited transactions under Section 17 of the Investment Company Act. The validity of that conclusion is not at issue in this proceeding. |
| 15 | 17 C.F.R. § 200(d)(2). |
| 16 | As the law judge noted, while Section 34(b) prohibits material omissions generally, the OIP charged Respondents with the omission of material information from the Fund's prospectus, a specific part of the registration statement. The law judge found that the Division established that the information concerning the Fund's special relationship with Concord should have been included in the prospectus, but did not prove that information regarding the directors' potential conflicts of interest necessarily belonged in the prospectus rather than elsewhere in the registration statements. This finding was not appealed. |
| 17 | The motion also sought to exclude any potential testimony from other witnesses "that similarly exceeds the scope of the Order." |
| 18 | 17 C.F.R.§ 201.200(d)(2). Rule 200(d)(1), by contrast, allows the Commission to amend an order instituting proceedings "to include new matters of fact or law." 17 C.F.R. § 201.200(d)(1). |
| 19 | Rules of Practice, 60 Fed. Reg. 32738, 32757 (June 23, 1995) (Rule 200 cmt. (d)) (citing Carl L. Shipley, 45 S.E.C. 589, 595 (1974)) (citations omitted). |
| 20 | Compare Carl L. Shipley, 45 S.E.C. at 595-96 (denying motion to amend OIP to add allegations of violations of antifraud provisions of Securities Act and Exchange Act and rules thereunder where OIP had originally charged only breach of fiduciary duty under Investment Company Act). |
| 21 | 15 U.S.C. §§ 77q(a)(2), (a)(3). |
| 22 | SEC v. Monarch Funding Corp., 192 F.3d 295, 308 (2d Cir. 1999); SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1467 (2d Cir. 1996). |
| 23 | 15 U.S.C. § 80a-33(b). |
| 24 | Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). |
| 25 | Not all alleged omissions were charged with respect to all six of the registration statements in question. Failure to disclose the special relationship with Concord was charged only with respect to the last five registration statements; the Fund had not yet made any investments when the initial registration statement was filed on October 7, 1992. Failure to disclose the alleged conflicts of interest pertaining to Rutherford and Borgardt was charged only with respect to the first four registration statements; Rutherford and Borgardt resigned from the Fund's board before the fifth and sixth registration statements were filed. |
| 26 | The law judge found that the Fund did not start purchasing loan participations until December 1992, at the earliest. Thus, he found, the Fund's exclusive relationship with Concord had not yet become firmly established when its registration initially became effective. Similarly, he found that the extent to which the relationships of Borgardt and Rutherford to Concord and the Fund would present conflicts of interest was not then clear. Additionally, there was no rate differential because the Fund had no portfolio. For these reasons, the law judge found that the charges as they related to the first registration statement were not sustained. This finding was not appealed. |
| 27 | As Hicks testified, he identified Concord to broker-dealers because they "want to know exactly who they're dealing with, and what is the relationship between the parties." |
| 28 | The record in fact indicates that, despite months of searching, no alternative investments were found. The fact that the Fund did not invest in loans from other providers, even when Concord decided to stop offering participations to the Fund, belies the level of independence from Concord that Respondents assert.
Indeed, Respondents acknowledge that the loss of Concord as a source of loan participations played a role in the decision to liquidate the Fund. Respondents also attribute the Fund's decision to liquidate in part to "a climate of declining interest rates which gradually made it more difficult for the Fund to find alternative loan sources." Since the Fund had never found an alternative loan source it considered worthy of investment, a climate in which such sources were becoming scarcer further emphasizes the importance of Concord to the Fund. |
| 29 | As examples of Concord's interest, Respondents citeConcord's repurchase of two defaulted loans from the Fund and Concord's advancement to the Fund of monies to cover organizational expenses and certain operating expenses. |
| 30 | Among other things, the registration statements disclosed that the loans in which the Fund invested (1) were typically issued by smaller companies, (2) were unrated, and (3) were not readily marketable. |
| 31 | Respondents also argue that it is the norm in the loan participation marketplace for loan originators to charge for their services by in effect taking a portion of the loan interest rate and passing on a lesser yield to all loan participants. Particularly here, given the magnitude of the differential, Rutherford's conflict and the relationship between the Fund and Concord, disclosing the rate differential would have allowed investors to have before them information material to their assessment of the Fund's operation. |
| 32 | By arguing that they relied on Jeffers' advice that Concord's roles and the Borgardt conflict did not need to be disclosed, see infra, Respondents implicitly admit that they knew of those roles and that conflict. They could not have sought advice without explaining the factual basis for the advice, nor could they have understood unsolicited advice without knowing the facts to which it related. |
| 33 | E.g., Jay Houston Meadows, 52 S.E.C. 778, 785 n.16 (1996), aff'd, 119 F.3d 1219 (5th Cir. 1997); Donald T. Sheldon, 51 S.E.C. 59, 82 n.94 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995); SEC v. Hughes Capital Corp., 124 F.3d 449, 453-54 (3d Cir. 1997); SEC v. Steadman, 967 F.2d 636, 643 & n.5 (D.C. Cir. 1992). See also Aaron v. SEC, 446 U.S. 680, 695-702 (1980) (Commission need not establish scienter to establish violation of Sections 17(a)(2) and 17(a)(3)).
In light of this established body of law, we reject Respondents' argument that we should instead apply the law of Maryland, the state of the Fund's incorporation. Moreover, because negligence suffices to establish liability, we decline to address the Division's contention that Respondents' conduct amounted to gross negligence. |
| 34 | SEC v. Advance Growth Capital Corp., 470 F.2d 40, 52 (7th Cir. 1972). |
| 35 | SEC v. Hughes Capital Corp., 124 F.3d at 453; SEC v. Fitzgerald, 135 F. Supp. 2d 992, 1028 (N.D. Cal. 2001). |
| 36 | Relying on Gould v. American Hawaiian S.S. Co., 351 F. Supp. 853, 866 (D. Del. 1972), Respondents contend that "where an omission [rather than a false or misleading statement] is at issue, officers and directors should not be liable for negligence unless it can be said that they ought to have known of the 'importance and need for . . . inclusion' of the omitted information."
In Gould, the court stated that requiring a higher level of proof regarding knowledge of materiality could be appropriate where the omissions in question relate to subjects "about which the proxy materials are completely silent and the noninclusion of which does not render misleading an affirmative statement made in the proxy materials." Gould, 351 F. Supp. at 866. The omissions fromthe registration statements in this case were not of this type: instead, their absence rendered statements in the registration statements regarding the Fund's business and management misleading. |
| 37 | Marc N. Geman, Securities Exchange Act Rel. No. 43963 (Feb. 14, 2001), 74 SEC Docket 999, 1016 n.38 (citing Savoy Indus., Inc., 665 F.2d 1310, 1314 n.28 (D.C. Cir. 1981)), aff'd, 334 F.3d 1183 (10th Cir. 2003); Louis Feldman, 52 S.E.C. 19, 21 n.9 (1994). Respondents argue that we should depart from this established jurisprudence and apply Maryland law instead. The Geman/Savoy Industries analysis provides a nationwide legal standard that furthers the purposes of the federal securities laws; application of varying state standards would not. See Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 98 (1991) (use of uniform federal rules to fill interstices of federal remedial schemes is appropriate where scheme in question evidences distinct need for nationwide legal standards). |
| 38 | Jeffers admitted that the Fund could have included in the registration statement a disclaimer to the effect that Concord was not a guarantor of the loans. |
| 39 | As discussed below, however, we have serious doubts as to whether such reliance would have been justified. |
| 40 | E.g., SEC v. Enterprises Solutions, Inc., 142 F. Supp. 2d 561, 576 (S.D.N.Y. 2001) (corporate president and CEO was liable for failure to disclose material information in registration statement; although he supplied the information to counsel preparing registration statement in questionnaire responses, he neither sought specific advice from counsel regarding disclosure of that information nor received specific advice that such disclosure was not required); see also SEC v. Savoy Indus., 665 F.2d at 1314 n.28 (individual who controlled entities that filed various documents with Commission held liable for failure to fulfill disclosure obligations despite assertion that documents were prepared by outside law firm).
Our conclusions as to Respondents' liability are based on their failure to satisfy this duty. While Jeffers was not named as a respondent here and his conduct is thus not before the Commission, it appears from the record before us that the passive role Jeffers played with respect to the key disclosure issue in this matter -- the Fund's relationship to Concord -- does not represent the kind of active counseling that the Commission expects of a securities lawyer engaged to advise a registered investment company. |
| 41 | Given Jeffers' authorship of the minutes, the lack of references to such discussion, or proferred advice, suggests that there was none. |
| 42 | See Anthony Tricarico, 51 S.E.C. 457, 460 (1993) (credibility determination of initial decision maker is entitled to considerable weight, and can be overcome only when record contains substantial evidence for doing so). See also Jacob Wonsover, Exchange Act Rel. No. 41123 (March 1, 1999), 69 SEC Docket 694, 707-08 (leavingundisturbed law judge's determination not to credit respondent's testimony at administrative hearing when respondent had previously provided "less 'self-serving'" version of events in investigative testimony), petition for review denied, 205 F.3d 408 (D.C. Cir. 2000). Similarly, we leave undisturbed the law judge's decision to accord little weight to Borgardt's testimony that Jeffers gave advice regarding nondisclosure of Concord's role at least four times. |
| 43 | Respondents contend that the Division is bound by an "admission" in a related Commission proceeding that Jeffers "reaffirmed [his opinion that Concord's roles need not be disclosed] to at least one Fund director" at some point after "late 1991." See Reid Rutherford, Securities Act Rel. No. 7588 (Sept. 28, 1998), 68 SEC Docket 288, 290. The alleged "admission" by the Division is actually a finding by the Commission. The order in question explicitly disavows the binding impact of findings it contains outside the proceeding settled by the order. Id., 68 SEC Docket at 289 n.1. Moreover, even if the Division were bound by an earlier concession that Jeffers reiterated his advice after late 1991, that would not alter our conclusion that Respondents could not rely on that advice for registration statements filed after December 1992. See infra text accompanying n.45. |
| 44 | Respondents contend that the law judge should not have admitted Jeffers' 1996 responses into evidence. They assert that Jeffers was not given an opportunity to explain the responses, which they characterize as "fundamentally ambiguous," and that absent such clarification, the responses do not constitute "reliable, probative, and substantial evidence" within the meaning of Section 556(d) of the Administrative Procedure Act, 5 U.S.C. § 556(d).
Respondents' assertion that Jeffers was not afforded an opportunity to explain his responses lacks record support. In tendering the documents, Division counsel proposed that Jeffers "may be cross-examined at great length on the document." Counsel for Respondents failed to take up the subject and thus passed up the opportunity to clarify any ambiguity. We find that the responses, and the Division's letter that elicited them, were properly admitted. Jeffers testified that the letter containing his responses was accurate, to the best of his recollection, as of the day he wrote it. |
| 45 | Respondents argue that, even if their asserted reliance on Jeffers' advice did not satisfy the Geman/Savoy Industries test, see supra n. 37 and accompanying text, it nonetheless counters the Division's assertion that they were deficient in the exercise of due care. We disagree. Given the central importance of Concord to the Fund, a reasonably careful and competent officer or director would have been well aware that reasonable investors would consider the Fund's dependence on Concord significant, notwithstanding Jeffers' early advice to omit the disclosure. |
| 46 | 15 U.S.C. § 77h-1. |
| 47 | 15 U.S.C. § 80a-9(f). |
| 48 | See KPMG Peat Marwick LLP, 74 SEC Docket at 429-30, 435-36 (issuing cease-and-desist order pursuant to Section 21C of the Exchange Act, 15 U.S.C. § 78u-3). |
| 49 | Id. at 436. |
| 50 | Id. |
| 51 | We have considered all of the parties' contentions. We have rejected or sustained them to the extent that they are inconsistent or in accord with the views expressed herein. |
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