SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40663 / November 12, 1998 Admin. Proc. File No. 3-9389 : In the Matter of the Application of : : SHAMROCK PARTNERS, LTD. : 111 Veterans Square : Media, Pennsylvania 19063 : : and : : JAMES T. KELLY : : 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 Member firm of registered securities association and its president and general securities principal charged excessive markdowns in purchasing securities from a retail customer. Held, association's findings of violation and the sanctions it imposed sustained in part and modified in part. APPEARANCES: Harley W. Shaver, Shaver & Licht, for Shamrock Partners, Ltd. and James T. Kelly. Alden Adkins, Norman Sue, Jr., and Francine Norz Tobin for NASD Regulation, Inc. Appeal Filed: September 3, 1997 Last Brief Filed: December 11, 1997 I. Shamrock Partners, Ltd. ("Shamrock"), a member of the National Association of Securities Dealers, Inc. ("NASD") and James T. Kelly, at all relevant times president and general securities principal of Shamrock, appeal from NASD disciplinary action. The NASD found that Shamrock and Kelly violated Article III, Sections 1 and 4 of the NASD Rules of Fair Practice (recodified as Rules 2110 and 2440) by effecting, in a principal capacity, five purchases of Stylex Homes, Inc. ("Stylex") common stock from two customers at prices that were not fair and reasonable. The NASD censured Shamrock and Kelly, fined them $15,000 jointly and severally, assessed hearing costs jointly and severally, and required restitution jointly and severally to two customers of $10,674.22. We base our findings on an independent review of the record. II. In October 1992, Robert C. Hackney and Ron Hayes, Sr., who were both promoters of Stylex, contacted Shamrock's Florida branch office to determine if Ron Hayes, Jr., a registered representative at that office and the son of Ron Hayes Sr., could sell on their behalf shares of Stylex common stock. Art Ring, manager of the Florida branch, referred Hackney and Hayes Sr. to Kelly in Shamrock's Pennsylvania office. Hackney informed Kelly that Merrill Lynch had quoted him a price of $.75 per share, less $.07 per share commission, for their block of Stylex stock. Kelly contacted Stylex market makers and confirmed that the then-current best bid quotation was $.75. He also asserts that he was told that, while trading volume was light, there recently had been more buyers than sellers. Kelly testified that he agreed to "stop" Hayes Sr.'s and Hackney's orders; that is, he agreed that Shamrock would pay Hayes Sr. and Hackney a minimum of $.75 per share. Kelly stated that he was willing to "stop" the order at $.75 because he wanted to obtain more business from Hayes Sr. in the future. Although he claims that Shamrock was acting as a principal, Kelly further testified that he told Hackney and Hayes Sr. that, if they were willing to wait, Shamrock could probably sell the shares over the next few weeks for $1 per share or more. Following their conversations, Hackney sent Hayes Jr. a letter, which stated: This letter is to confirm that I will be sending you my certificate for 40,000 shares of Stylex Homes, Inc. common stock and have asked you to arrange the sale of the shares at $1.00 per share. I also agree to pay Shamrock Partners, Ltd. a commission of $.05 per share sold. Thank you for assisting me in this transaction. I look forward to working with you on this and future transactions. Although Hackney's letter makes no reference to the "stop," Kelly testified that he understood that "I stopped him at 75 cents, and I was working the order at a dollar or better." On October 26, 1992, Shamrock purchased Stylex stock from Hayes Sr. Between November 4 and November 11, 1992, Shamrock made four additional purchases of Stylex stock from Hackney. Shamrock then executed six sales of Stylex to Paragon, another broker-dealer, for prices ranging from $1.21875 to $2.000 per share. Shamrock's purchases from Hackney and Hayes Sr. resulted in markdowns ranging from 11.8% to 37.5%. [1] The transactions occurred as follows: ----------------------------------------------------------------- |Date |No. |Purchase |Sale |Total |% mark-| |Bought |Shares |Price |price [2] |Profit |down | ----------------------------------------------------------------- |Oct. 26 | 7,500 |$1.125 |$1.21875 | $621.09 |11.8% | ----------------------------------------------------------------- |Nov. 4 | 2,500 |$1.250 |$1.875 |$1,328.13 |33.3% | ----------------------------------------------------------------- |Nov. 5 | 2,500 |$1.250 |$1.875 |$1,328.13 |33.3% | ----------------------------------------------------------------- |Nov. 9 | 1,000 |$1.250 |$2.000 | $650.00 |37.5% | ----------------------------------------------------------------- |Nov. 11 |12,700 |$1.250 |$1.875 |$6,746.88 |33.3% | ----------------------------------------------------------------- |Total |26,200 | | |$10,674.22 | | ----------------------------------------------------------------- III. Rule 2440 requires NASD member firms to buy or sell securities at a price that is fair, taking into consideration all relevant circumstances. A transaction for a customer must be at a price reasonably related to the security's market price. Markdowns on equity securities exceeding five percent of the prevailing market price are generally viewed as excessive and violative of Rules 2110 and 2440. [3] Markdowns that are less than five percent may also be considered excessive. [4] Markdowns are generally smaller than markups. [5] As we have repeatedly stated, the best evidence of the prevailing market price is the price that dealers pay one another in arms-length transactions. [6] A. Applicants admit that, prior to October 18 and after December 4, 1992, Shamrock was not a market maker in Stylex. Nevertheless, applicants contend that Shamrock was an "unpublished" market maker in Stylex between October 18 and December 4, 1992, when the transactions at issue occurred and thus was permitted to base Shamrock's purchase prices on bid quotations. Section 3(a)(38) of the Securities Exchange Act of 1934, 15 U.S.C. 78c(a)(38), defines a market maker as "any dealer who, with respect to a security, holds himself out (by entering quotations in an inter-dealer communications system or otherwise) as being willing to buy and sell for his own account on a regular or continuous basis." We do not find persuasive the claim that Shamrock was a market maker in Stylex stock during the period in which it sold shares for Hackney and Hayes Sr. Shamrock was not listed in the National Quotation Bureau Pink Sheets as a market maker for Stylex, and it did not enter quotations on the Bulletin Board for Stylex. Kelly claims that he told certain dealers that Shamrock was a market maker in Stylex. This statement by itself would not be sufficient to make Shamrock a market maker. We have previously stated, "to be treated as a market maker, a dealer must, among other things, advertise its willingness to buy and sell securities for its own account and stand ready to buy and sell to other dealers at its quoted prices. [7] Shamrock, however, was not active in the inter-dealer market for Stylex on a regular and continuous basis. Shamrock's transactions consisted solely of purchasing a block of stock from retail customers to dispose of the stock in the inter-dealer market. Kelly admitted that, while he provided quotes to any market maker who contacted him, he did not buy any stock and would have told any market makers who offered him stock that he was not interested at the time. Kelly asserts, however, that his lack of purchases is not dispositive of whether Shamrock was a market maker. He asserts that he did not buy any Stylex shares because he already had 40,000 shares in inventory. Indeed, Kelly admitted that he did not want to indicate interest in Stylex for fear of "spooking" the price. Showing an interest in a stock, however, and being ready to buy or sell at any time, is the role of a market maker. The NASD properly calculated the markdowns on these transactions based on Shamrock's contemporaneous sales to Paragon. Contrary to applicants' assertions, Shamrock was not entitled to rely on bid quotations as evidence of prevailing market price. Where a dealer is not a market maker, the best evidence of the prevailing market price in computing markdowns is the dealer's contemporaneous proceeds from its sale. [8] B. Even if a dealer is a market maker, it cannot base its retail markdowns on bid quotations unless the reliability of those quotations can be validated by comparing them with actual inter-dealer transactions in an active, independent market. [9] Kelly admitted that the market in Stylex was extremely thin and that volume was light. Moreover, Shamrock's transactions at issue confirm that bid quotations for Stylex were unreliable measures of prevailing market price. Although Paragon disseminated bid quotations ranging from $.75 to $1.375 (and other Stylex market makers were quoting bids ranging from $.75 to $1.25), Paragon nonetheless bought Stylex from Shamrock at prices ranging from $1.218 to $2.00, prices that were close to Paragon's ask quotation. Therefore, Shamrock had evidence that the quotations on which applicants purported to rely in determining the prices paid to Hackney and Hayes Sr. were subject to negotiation. [10] Applicants also argue that Hackney and Hayes Sr. received a price equal to the best bid quotation available, which applicants assert was a much better price than they would have received elsewhere. Applicants argue that, if they had tried to sell the entire block of shares, or even a block of 10-15,000 shares on an agency basis, it would have dramatically lowered the price because the shares were thinly traded. They do not explain, however, why they could not do on an agency basis what they did in these transactions: sell portions of the block to a market maker at these prices. C. Respondents argue that all of Shamrock's transactions in Stylex for Hayes Sr. and Hackney -- not just the transactions at issue here -- should be combined for the purpose of determining whether there were excessive markdowns because the different sales to Paragon "are all part of the executions on one agreement." We have held, however, that "[t]ransactions occurring over a period of time cannot be lumped together for the purpose of determining whether markdowns or markups are fair." [11] The transactions here occurred over several weeks. The NASD correctly calculated the trades based on the closest individual contemporaneous transactions. D. We do not find persuasive applicants' argument that Shamrock could charge high markdowns because it was "at risk" of loss. We understand applicants to assert that they had assumed the risk of a market decline because Kelly had agreed to "stop" Hayes Sr.'s and Hackney's orders at $.75. Kelly, however, testified that he was willing to "stop" the order because he wanted to attract future business from Hayes Sr. His desire to attract new business does not justify excessive markdowns. Moreover, we question the degree to which Shamrock was at risk. Shamrock generally was able to sell the shares of Stylex contemporaneously with its purchases. But, even if Shamrock had been at risk, we have held that a dealer is not entitled to charge excessive prices because it is at risk. [12] E. Shamrock and Kelly argue that these trades were negotiated with Hackney and Hayes Sr. and that full disclosure was made to these customers. The NASD Mark-Up Policy states that disclosure is a "factor to be considered" in determining the fairness of a markdown. [13] Thus, Kelly and Shamrock argue that Hayes Jr. fully disclosed the markdown to his father, Hayes Sr., and Hayes Sr. consented to it. Shamrock and Kelly introduced an unsworn written statement from Hayes Sr., in which Hayes Sr. states that he was informed of a 3/32 markdown plus a $375 commission on his sale of $7500 and that he consented to that price. We also note that the markdown on the transaction for Hayes Sr., 11.8 percent, was much lower than the markdowns on the purchases from Hackney. Hayes Sr. was a promoter of the stock. He agreed not only to a markdown but also to a commission in a sale that benefitted his son. Under these extraordinary circumstances, given the family relationship between the two Hayes, Hayes Sr.'s status as a promoter, and his statement that he was aware of and consented to the markdown, the record does not support a finding of violation with regard to the markdown on Hayes Sr.'s shares. In contrast, we find that the alleged disclosure to Hackney was inadequate. Kelly claims that Ring and Hayes Jr. told Hackney about the prices that Shamrock received for the stock Hackney sold to Shamrock. The record here, however, does not demonstrate whether the disclosure to Hackney was full and fair. Kelly has provided no evidence of how or when disclosure was made to Hackney, nor did Kelly indicate at the hearing before the NASD what precisely Hackney was told. Kelly did not explain how he, located in Pennsylvania, could know what Ring and Hayes Jr., located in Florida, told Hackney. Neither Ring nor Hayes Jr. testified. Thus, we cannot conclude that Hackney was informed of or consented to the markdowns. F. Kelly contends that he should not be held responsible for any violations because he asserts that he did not personally receive the commissions, Hackney and Hayes Sr. were not his clients, and he did not even execute most of the trades. Kelly, however, was the president of Shamrock, the principal in charge of trading at Shamrock, and one of two principals responsible for the establishment and enforcement of the firm's markdown policy. He testified that he negotiated the transactions with Hackney. He was aware of all of the trades at issue, wrote the trade tickets, and executed some of the trades. He therefore bears responsibility for the conduct at issue. [14] * * * * We conclude that applicants violated Rules 2110 and 2440 with respect to the four transactions between the Firm and Hackney. IV. Applicants argue that the NASD violated their due process rights by delaying the institution of this proceeding until three years and four months after the violative conduct occurred. They assert that they could no longer obtain exculpatory evidence. [15] Specifically, Shamrock and Kelly claim that, while the NASD collected "blue sheet" information [16] on other stocks traded by Shamrock, it failed to collect similar information for Stylex. Shamrock and Kelly argue that they could have used such evidence to show that Shamrock's contemporaneous sales of Stylex stock to Paragon were not the best measure of prevailing market price. Applicants do not cite any basis for believing that other inter-dealer transactions in Stylex were effected at different prices. Moreover, there is nothing in the record to indicate that Shamrock or Kelly ever asked the NASD to "blue sheet" Stylex. Nor did they ever ask for the blue sheet information the NASD had collected on other shares traded by Shamrock. [17] V. Shamrock and Kelly challenge that part of the sanction requiring that they pay restitution. They argue that restitution is inappropriate because Kelly did not profit from the transactions. Moreover, they claim that Shamrock lost $3,759.82 on remaining shares from Hackney's block of shares, which subsequently became worthless. They claim that restitution to Hackney therefore would be unfair. We do not find the sanction of restitution excessive or oppressive. Shamrock and Kelly did not pay Hackney an adequate price in the four transactions at issue here. This is a serious breach of the firm's obligation to deal fairly with investors. The fact that the firm lost money on subsequent transactions does not change the unfairness of the markdowns here. Restitution is an appropriate sanction in a markup or markdown case, and we believe it is appropriate here to make the customer whole. [18] Based on our finding that the markdown on the trade for Hayes Sr. was not violative, we reduce the restitution to $10,053.13. **FOOTNOTES** [1]: The NASD did not allege that subsequent Shamrock purchases of the remainder of the 40,000 Stylex shares were violative. [2]: The sales occurred either the same day that Shamrock purchased the shares or within four days of the purchase. We have calculated the markdowns based on contemporaneous inter-dealer trades between Shamrock and market maker Paragon. [3]: Hamilton Bohner, Inc., 50 S.E.C. 125, 128 (1989). See also, NASD Mark-Up Policy (now designated as IM-2440). [4]: Hamilton Bohner at 128. [5]: D.E. Wine Investments, Inc., Securities Exchange Act Rel. No. 39517 (January 6, 1998), 66 SEC Docket 763, 766. [6]: Adams Securities, Inc., 51 S.E.C. 1092, 1094 (1994) and cases cited therein. [7]: Sacks Investment Company, Inc., Securities Exchange Act Rel. No. 32436 (June 9, 1993), 54 SEC Docket 784, 788. Even being listed as market maker in a quotation medium (which Shamrock was not) is not determinative. Network 1 Financial Services, Inc., Securities Exchange Act Rel. No. 34930 (Nov. 3, 1994), 57 SEC Docket 2824 (where firm listed itself on the pink sheets for stock but did not publish quotations for the subject stock and only occasionally provided quotations to other dealers, firm was not a market maker in subject stock). [8]: Century Capital Corp., 50 S.E.C. 1280, aff'd, 22 F.3d 1184 (D.C. Cir. 1992)(Table). See also Bison Securities, Inc., 51 S.E.C. 327, 331 n.15 (1993) ("quotations, particularly in low-priced, thinly traded securities . . . are an extremely flawed measure of price.") [9]: R.B. Webster Investments, Inc., Securities Exchange Act Rel. No. 35754 (May 23, 1995), 59 SEC Docket 1194; Orkin v. SEC, 31 F.3d 1056, 1064 (11th Cir. 1994). [10]:See Kenneth L. Lucas, Securities Exchange Act Rel. No. 33922 (April 19, 1994), 56 SEC Docket 1482 (where broker sold shares to customers at $.07 but sold the same shares to dealers at $.05 or less and where broker was able to buy at $.03, quotations were subject to negotiation and were not a reliable indicator of market price). [11]:Hamilton Bohner, Inc., 50 S.E.C. at 128. [12]:See James E. Ryan, 47 S.E.C. 759 (1982) (broker-dealer not entitled to charge customers excessive markups simply because it is in a risk position). [13]:NASD Mark-Up Policy (now designated as IM-2440). [14]:See Michael H. Novick, 51 S.E.C. 1258 (1994) (where president responsible for firm's retail pricing and for reviewing trade tickets, liable for unfair markups). [15]:To the extent applicants are arguing that the delay in bringing these proceedings is itself a violation of due process, this argument fails. Frederick C. Heller, 51 S.E.C. 275, 280 (1993) (no statute of limitations applies to the issuance of complaints by the NASD). The five-year statute of limitations discussed in SEC v. Johnson, 87 F.3d 484 (D.C. Cir. 1996), reh'g denied (August 28, 1996), does not apply to NASD proceedings. Many courts and this Commission have determined that SROs are not subject to the requirements applicable to a government agency. See, e.g., Shultz v. SEC, 614 F.2d 561, 569 (7th Cir. 1980) (Chicago Board Options Exchange not "authority of the government" and thus not governed by the Administrative Procedure Act); Larry Ira Klein, Securities Exchange Act Rel. No. 37835 (October 17, 1996), 63 SEC Docket 70. Cf., Henry James Faragalli, Jr., Securities Exchange Act Rel. No. 37991 (November 26, 1996), 63 SEC Docket 826 (three-year statute of limitations announced by the Supreme Court in Lampf v. Gilbertson, 501 U.S. 350 (1991), inapplicable to SRO proceedings). [16]:"Blue sheets" consist of information from broker- dealers, generally market makers, including the firm's inter-dealer and agency trades in a subject security by date, price, size and contra-party. Escalator Securities, Inc., Securities Exchange Act Rel. No. 37601 (Aug. 26, 1996), 62 SEC Docket 1927, 1929 n.4. [17]:Applicants also argue that the NASD violated their due process rights by delaying the case until after the normal record-keeping requirements had passed so that Applicants could no longer obtain the price information themselves. Applicants are in error. 17 C.F.R. 240.17a-4(a)(1) requires member firms to preserve information on the purchases and sales of securities for six years. [18]:R.B. Webster Investments, Inc., 59 SEC Docket at 1204. We also do not find the amount of the fine -- $15,000 -- excessive or oppressive. The NASD Sanction Guidelines recommend a fine of the gross amount of the excessive markdown plus $5,000 to $50,000. [19] An appropriate order will issue. [20] By the Commission (Chairman LEVITT and Commissioners JOHNSON, HUNT and CAREY); Commissioner UNGER not participating. Jonathan G. Katz Secretary **FOOTNOTES** [19]:NASD Sanction Guidelines at 28 (1993). [20]: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. UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. 40663 / November 12, 1998 Admin. Proc. File No. 3-9389 : In the Matter of the Application of : : SHAMROCK PARTNERS, LTD. : 111 Veterans Square : Media, Pennsylvania 19063 : : and : : JAMES T. KELLY : : For Review of Disciplinary Action Taken by the : : NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. : : ORDER SUSTAINING DISCIPLINARY ACTION TAKEN BY REGISTERED SECURITIES ASSOCIATION On the basis of the Commission's opinion issued this day, it is ORDERED that the disciplinary action taken by the National Association of Securities Dealers, Inc. against Shamrock Partners, Ltd. and James T. Kelly, be, and it hereby is, sustained, except that the amount of restitution is reduced to $10,053.13. By the Commission. Jonathan G. Katz Secretary