UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7588 / September 28, 1998 INVESTMENT COMPANY ACT OF 1940 Release No. 23469 / September 28, 1998 ADMINISTRATIVE PROCEEDING File No. 3-9731 ------------------------------------------------------------------ ORDER INSTITUTING PUBLIC In the Matter of, ADMINISTRATIVE AND CEASE-AND-DESIST REID RUTHERFORD, PROCEEDING PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933 AND SECTIONS 9(b) AND Respondent. 9(f) OF THE INVESTMENT COMPANY ACT OF 1940, MAKING FINDINGS, IMPOSING CIVIL PENALTIES AND A CEASE-AND-DESIST ORDER ------------------------------------------------------------------ I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that a public administrative and cease-and-desist proceeding be, and hereby is, instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Sections 9(b) and 9(f) of the Investment Company Act of 1940 ("Investment Company Act") against Reid Rutherford ("Rutherford" or the "Respondent"). II. In anticipation of the institution of this proceeding, the Respondent has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, and without admitting or denying any findings contained herein, except as to the jurisdiction of the Commission over him and over the subject matter of this proceeding, which are admitted, the Respondent consents to the issuance of this Order Instituting Public Administrative and Cease-and-Desist Proceeding Pursuant to Section 8A of the Securities Act of 1933 and Sections 9(b) and 9(f) of the Investment Company Act of 1940, Making Findings, Imposing Civil Penalties and a Cease-and-Desist Order ("Order"). Accordingly, IT IS HEREBY ORDERED that a proceeding pursuant to Section 8A of the Securities Act and Sections 9(b) and 9(f) of the Investment Company Act be, and hereby is, instituted. III. FINDINGS On the basis of this Order and the Respondent's Offer, the Commission finds that[1]: RESPONDENT A. Rutherford, age 45, was a founder of a commercial finance company ("the Company"), which makes asset-backed loans to businesses which typically are unable to qualify for conventional bank loans. During all relevant times, Rutherford was chairman of the board, chief executive officer, and a 20% shareholder of the Company. Rutherford was also an independent director of a registered investment company (the "Fund") from the Fund's initial public offering on October 8, 1992 until his resignation on May 3, 1994. Rutherford resigned from the board after being advised that his participation created affiliate transaction problems for the Fund. BACKGROUND B. In or about early 1991, the president of a brokerage firm which acted as one of the Company's private placement agents heard a business seminar presentation on how to start and administer a mutual fund. The brokerage firm president later discussed with the Company's president the concept of a mutual fund that would invest in asset-backed loans like those originated and serviced by the Company. Thereafter, the seminar speaker, the president of the brokerage firm, Rutherford, the Company's president, and others, participated in the formation of the Fund. Rutherford became one of the Fund's initial four directors. THE FUND'S DISCLOSURES AND AFFILIATED TRANSACTIONS C. From October 8, 1992 to May 3, 1994, the Fund's entire investment portfolio consisted of loan participations purchased from, and originated and serviced by, the Company. Thus, the Company, acting as principal, sold loan participations to the Fund as an affiliate of Rutherford, an affiliate of the Fund. No prior approval to engage in these affiliate transactions was sought or received from the Commission. During this period, Rutherford and the other officers and directors of the Fund unsuccessfully attempted to find additional loan providers, originators and servicers for the Fund, and discussed the status of their unsuccessful diversification efforts at almost every meeting of the Fund's board of directors. D. During Rutherford's association with the Fund, the Fund used four registration statements to sell its shares to the public. The Commission declared these registration statements effective on: October 8, 1992; October 26, 1993; November 16, 1993; and April 22, 1994. Rutherford signed each of these four registration statements as a fund director. Each registration statement was drafted by Fund legal counsel. Rutherford and other Fund officers and directors were asked to review and comment on each draft registration statement prior to signing it. E. In each of the registration statements described in Paragraph D. above, the Fund failed to disclose that Rutherford was simultaneously a Fund director and 20% owner and officer of the Company. In registration statements filed after October 8, 1992, the Fund omitted to disclose fully its relationship with, and complete dependence on, the Company. Specifically, the Fund failed to disclose that the Company, an affiliate of a fund affiliate (Rutherford), was the Fund's only source of investments, and the Fund's only provider of servicing for the loans in which the Fund invested. Such omissions were material because the omitted information tended to reflect the extent of the Company's relationship with the Fund, the Fund's complete reliance on the Company as the source of investments, and the conflict of interest resulting from Rutherford's simultaneously being a Fund director and a 20% owner of the Company. Reasonable investors likely would have considered these facts to be material to an investment decision. F. In or about mid-1991, prior to the Fund's initial public offering, an attorney, who eventually became Fund counsel, was retained to examine certain legal issues relating to the Fund's formation. In late 1991, Fund counsel was asked to opine on whether the Fund should disclose in its initial registration statement the fact that the Company would be a provider, originator, and servicer of the Fund's loans. Fund counsel concluded that such disclosure was not necessary, and he conveyed his opinion by telephone to at least two persons associated with the Fund. The attorney based his opinion in part on the Fund's ongoing efforts to obtain additional loan providers and servicers. Fund counsel subsequently reaffirmed this opinion to at least one Fund director. G. Rutherford, who signed the registration statements described in Paragraph D. above, knew that, during his 18 months as a Fund director, the Company was the sole provider, originator, and servicer of loans for the Fund. He also reasonably should have known that the subject registration statements omitted these facts. As the Fund's total dependence on the Company for loans persisted through May 3, 1994, despite the Fund's efforts to diversify, Rutherford reasonably should have become aware that the subject omissions were material. THE VIOLATIONS H. By virtue of the conduct described in paragraphs III. A. through G. above, Rutherford willfully aided and abetted and caused the Company's violations of Sections 17(a)(1) and 17(a)(2) of the Investment Company Act, in that the Company, acting as principal, knowingly sold securities to the Fund at a time when it was affiliated with a person (Rutherford) affiliated with the Fund. I. By virtue of the conduct described in paragraphs III. A. through G. above, Rutherford caused violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act, and violated Section 34(b) of the Investment Company Act, in that he caused the Fund to offer and sell its securities using registration statements that omitted material information. IV. The Respondent has submitted an Offer of Settlement in which, without admitting or denying the findings herein, he consents to the Commission's entry of this Order which: 1) makes findings as set forth above; 2) orders the Respondent to cease and desist from committing or causing any violation and any future violation of Sections 17(a)(2) and 17(a)(3) of the Securities Act and Sections 17(a)(1), 17(a)(2), and 34(b) of the Investment Company Act; and 3) orders the Respondent to pay a civil money penalty of $5,000. V. Based on the foregoing, the Commission deems it appropriate and in the public interest to accept the Respondent's Offer of Settlement and institute the Order specified in the Offer of Settlement submitted by the Respondent. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Sections 9(b) and 9(f) of the Investment Company Act, that: Rutherford cease and desist from committing or causing any violation and any future violation of Sections 17(a)(2) and 17(a)(3) of the Securities Act, and Sections 17(a)(1), 17(a)(2), and 34(b) of the Investment Company Act; and Rutherford pay, within 30 days of the entry of this Order, a civil money penalty in the amount of $5,000 to the United States Treasury. Such payment shall be: (A) made by United States postal money order, certified check, bank cashier's check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (D) submitted under a cover letter that identifies Reid Rutherford as a Respondent in these proceedings, and the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Ronald E. Wood, Assistant Regional Director, Pacific Regional Office, Securities and Exchange Commission, 5670 Wilshire Boulevard, 11th Floor, Los Angeles, California 90036; By the Commission. Jonathan G. Katz Secretary **FOOTNOTES** [1]: The findings herein are made pursuant to the Respondent's Offer of Settlement and are not binding on any other person or entity named as a respondent in this or any other proceeding.