SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 43296 / September 15, 2000
Admin. Proc. File No. 3-9938
In the Matter of
The Application of
KEVIN LEE OTTO
908 W. Oklahoma
Milwaukee, Wisconsin 53215
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
Registered representative of a member firm of registered securities association deposited customer's funds in his personal bank account without the customer's knowledge or authorization and used the funds for his own personal benefit. Held, association's findings of violation and sanctions it imposed are sustained.
APPEARANCES:
James A. Bolt, for Kevin Lee Otto.
Vickie R.Olafson, for the National Association of Securities Dealers, Inc.
Appeal filed: July 20, 1999
Briefing Completed: October 25, 1999
I.
Kevin Lee Otto, during the period at issue, was a registered representative of members of the National Association of Securities Dealers, Inc. Otto was registered as a general securities representative with Hamilton Investments, Inc. from May 1991 through August 1992, with Wellington Investment Services Corporation from October 1992 to August 1993, and with First Montauk Securities Corporation from November 1993 to December 1996. The NASD found that Otto obtained $22,000 from customer Mary Sue Smith and used those funds for some purpose other than the benefit of the customer for over two years without the customer's knowledge or authorization,before returning the funds to her.1 The NASD censured Otto, fined him $35,000, and barred him from association with any member firm in any capacity. We base our findings on an independent review of the record.
II.
Smith maintained securities accounts at the various firms where Otto worked throughout the time period relevant to the complaint. Otto handled Smith's accounts. In early 1992, Otto solicited money from Smith to invest in an entity he described to her as the "Wisconsin Business Consortium" or "WBC." Otto told Smith that WBC was a group of investors that found special long-term investments with a rate of return equal to the Treasury Bill rate "plus a couple of percentage points."2 Otto received $22,000 from Smith for investment in WBC at about the same time he gave her the February 1992 letter describing WBC.
Otto conceded at the hearing that no investment group by the name of WBC ever existed. He stated that he deposited Smith's funds into his personal bank account and a Charles Schwab account maintained in the names of Donna Lebrecht and a company called PowerSource Battery Corporation ("PowerSource").3
Otto said that he used Smith's funds for "whatever [he] had to for personal stuff." He also used Smith's funds for expenses related to the operations of PowerSource. Otto and LeBrecht formed PowerSource in March 1991. It steadily lost money, and decided to file for bankruptcy in February 1992, the same month Otto solicited Smith's money. Otto never informed Smith that he used her funds to pay his personal and PowerSource's operating expenses.
Throughout the two-year period that Otto had Smith's funds, he sent her periodic portfolio update statements ("Portfolio Updates"). These updates referenced Smith's other investments with Otto and, under the designation "Tax-Free," also listed the amount she had given him for investment with WBC. In April 1994, Smith wanted some money from her "WBC account," and requested a payment. Although Otto disputed that Smith made the request, it is corroborated by a handwritten letter from Otto to Smith, stating that the "investment club" had invested the money and that it could take "a few weeks to find a replacement" for Smith's position. The letter also stated that "[o]nce we sell your seat, we are out unless another opens up." Otto informed her that she could have approximately $3,000, but would have to leave a balance of $25,000 to stay in the "club."4 However, it was not until June 1994 that Otto made a payment of $3,576.24 (later returned for insufficient funds) to Smith. The Portfolio Update dated June 30, 1994, stated that the "Tax-Free" account was "liquidated June, 1994."5
Smith indicated in a notation to a copy of Otto's April 1994 letter that, because it had taken so long (two months) for Otto to return the $3,576.24 portion of her funds, she decided to seek the return of the balance of her funds from the WBC investment. Apparently, she communicated this decision to Otto because, in another handwritten letter dated July 27, 1994, he again attempted to delay paying Smith by stating that he had not yet received the "exit papers for the investment club."6 Otto statedthis despite the fact that he had already sent Smith the June�24, 1994 Portfolio Update in which he described Smith's `investment" account as having been "liquidated." Otto eventually sent Smith a check for $26,346 on October 22, 1994. When questioned about the "liquidation" and the whereabouts of Smith's money from July 1 to October 22, 1994, Otto testified that he did not know where her money was, and that he may have spent it.
The District Business Conduct Committee ("DBCC") determined that Otto had violated Rule 2110 of the NASD Conduct Rules because he obtained $22,000 from Smith and used those funds for some purpose other than Smith's benefit for over two years without Smith's knowledge or authorization. As a consequence, the DBCC barred him from association with any member in all capacities, and fined him $110,000. On June 28, 1999, the National Adjudicatory Council ("NAC") affirmed the DBCC's decision, but modified the fine amount to $35,000.7
III.
From the time he solicited Smith throughout the period he had Smith's money, Otto deceived his client with a network of lies. He represented to Smith that her funds had been invested in an "investment club" that, by his own admission, did not exist. In 1994, when Smith sought to retrieve herfunds, rather than informing her that he was using her money to fund PowerSource and "for personal stuff," Otto repeatedly delayed returning her money with statements such as: the "investment club has invested cash, [s]o it may take a few weeks to find a replacement for your position;" "[i]n order to keep your account active it is requested that you keep a minimum of $25,000 on deposit . . . . If you have any questions please contact your club representative;" and "I've not yet received our exit papers for the investment club." Such deception of a client about the use of money is unethical and reprehensible.
Otto claims that Smith knew what he was doing with her money and authorized him to use the funds as he did. This is patently false. Otto's own testimony and handwritten documents introduced at the hearing contradict this claim. All of the evidence indicates that Smith knew only that Otto was investing her money in WBC. On the basis of the facts described above, we find that Otto engaged in conduct that is inconsistent with high standards of commercial honor and just and equitable principles of trade.8
Otto raises various procedural and constitutional objections to the NASD proceedings; we find that they are without merit. First, Otto claims that the complaint does not give him adequate notice of the claims against him, as required by Section 15A of the Securities Exchange Act of 1934.9 Otto does not provide a substantive basis for his objections. He merely complains that the complaint is only five paragraphs long, and that NASD Conduct Rule 2110 is vague.10 The complaint references Otto's February 1992 memorandum to Smith describing a "private business opportunity" known as "Wisconsin Business Consortium." It then states that Smith provided Otto with $25,000, and that Otto informed Smith that her funds would be pooled with funds provided by other individuals and used by WBC for investment. The complaint further states that Otto did not invest in any "business opportunities" other than corporations or business entities which he operated or controlled, without her knowledge or authorization. The complaint states that Otto deposited Smith's funds in a bank account or bank accounts in which he had an interest or which he controlled, and used Smith's funds for some purpose other that her benefit. Finally, the complaint states that Otto's acts, practices and conduct constitute violations of NASD Conduct Rule 2110. Thus, we believe that the complaint adequately notified Otto of the conduct and the NASD rule that were the subjects of the proceeding. We find the complaint and the ensuing hearing met the requirements of Section 15A of the Securities Exchange Act.
Otto also claims that he was denied due process because Smith did not testify at the hearing, and as a result, the NASD's entire case was based upon hearsay.11 Specifically, Otto cites the case of Gibbs v. SEC, 25 F.3d 1056 (10th Cir. 1994) for the proposition that, in the NASD hearing process, a respondent must be allowed to cross examine prosecution witnesses. Gibbs is not relevant here. In Gibbs, resolution of the case turned on the telephonic testimony of the complaining witness, which was disputed by the respondent. The court ruled that it was proper for the hearing panel to make a credibility determination on the basis of telephonic testimony. Here, there is no such dispute to be resolved because Otto admits all of the facts necessary to determine his guilt. Specifically, he admits that he: (a) recommended investment in a fictitious "investment group," (b) received money from Smith for investment in the "investment group," (c) continually represented to Smith over a two year period that her funds were invested in the "investment group," and (d) used Smith's funds for his personal use. Thus, the NASD's case is not based entirely on hearsay.
Further, Otto's objections to the inclusion of hearsay statements by Smith are inapposite. The Commission has held repeatedly that hearsay is admissible in administrative proceedings and, in appropriate circumstances, may even constitute the sole basis for findings of fact.12 We evaluate hearsay for its probative value, reliability, and the fairness of its use. The factors to consider include the possible bias of the declarant, the type of hearsay at issue, whether the statements are signed and sworn to rather than anonymous, oral, or unsworn, whether the statements are contradicted by direct testimony, whether the declarant was unavailable to testify, and whether the hearsay is corroborated.13
The written statements provided by Smith meet a number of these criteria. Although Smith's statements are not sworn, they are written, signed, and confirmed and corroborated by Otto's own testimony and documents. Since Otto eventually returned Smith's money, plus an amount of interest, she had little incentive to give a false statement.14 As to Smith's availability as a witness, the NASDcannot compel a customer such as Smith to appear at a hearing before it.15 Thus, we see no barrier to relying on Smith's statements as probative evidence.
Otto further claims that he was prejudiced by a delay in the filing of the complaint and the setting of the matter for hearing because of the death of two key witnesses and the memory failure of another witness. He claims that the two deceased witnesses, plus two other persons, were also investors in WBC, along with Smith and LeBrecht.
This claim is frivolous. Otto conceded that WBC did not exist. LeBrecht denied being an investor in WBC. Otto made no excuse for his failure to obtain evidence from the two purported investors who were still alive. He made no showing of what relevant evidence the two "key" witnesses might have provided.
Moreover, during an earlier Wisconsin state investigation based on the same misconduct, Otto did not mention these "key" witnesses,16 although they were alive when the Wisconsin case concluded17 and Otto stated in his brief that "all relevant witnesses were interviewed" and "all relevant documents were produced."18 Finally, Otto's claim of prejudice is further compromised by the fact that it was his own failure to produce documents for almost two years, despite repeated requests and visits from NASD representatives, that caused much of the delay.19 We find that Otto's claim of prejudicial delay is without merit.
Otto contends that the decision to impose a permanent bar is overly severe. Exchange Act Section 19(e) governs our review of sanctions imposed by a self-regulatory organization. That provision requires that we sustain the sanctions imposed, unless we find they are excessive, oppressive, or impose an unnecessary or inappropriate burden on competition.
It is undisputed that Otto co-mingled his and Smith's funds for the sake of his own personal convenience and use, and deprived her of the opportunity to invest those funds in a legitimate investment. It is also undisputed that he concealed his use of the funds from Smith, and delayed returning Smith's funds for at least four months. Through his mishandling of these funds, Otto put Smith's funds at risk for over two years. Otto has refused to accept responsibility for his action. He does not appear to recognize the wrongful nature of his conduct.20 Otto's refusal to acknowledge his misconduct and actions demonstrate a serious misunderstanding of the obligations he owes to a customer as a registered representative. His actions make us doubt his commitment to the high standards demanded by the securities industry. Under the circumstances, we do not find that either the bar or the $35,000 fine were excessive, oppressive or an undue burden on competition.21
� An appropriate order will issue.22 �
By the Commission (Chairman LEVITT and Commissioners HUNT, CAREY and UNGER).
Secretary�
Footnotes
1
The NASD found that this conduct violated Rule 2110 of the NASD's Conduct Rules. Rule 2110 provides that "a member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade."
2
In a letter to Smith dated February 1992, Otto described the "investment group" as follows:
WBC is a group of people that network and bring to the table business opportunities which enable us to make some cash. These are opportunities that you and I as individuals probably wouldn't see, i.e., industrial equipment that we purchase cheaper and sell, foreclosure of homes or buildings, business ventures and so on. Again as I stated on the phone this is not an investment nor is it offered by any securities company. It has nothing to do with me as a broker or my brokerage firm. This is a private thing. It is kind of fun. I think you'll like it.
3
Otto claimed that Smith asked him to hide the funds that she had given him to invest in WBC. According to Otto, Smith wanted to conceal them from her husband, because she was having problems in her second marriage and had lost a lot of money in a previous divorce. The record contains no evidence corroborating Otto's claim. In fact, Otto's claims are undercut by the testimony of Smith's former husband, who was married to Smith from June 1990 to June 1996. He testified that in early 1992 he had no contemplation of separation or divorce. He also stated that Smith was investing money with Otto she had received from her prior divorce, but that he did not know and never asked her the name or nature of any of her investments.
Moreover, Otto's statement of where he deposited Smith's funds is not supported by the record. The account records Schwab produced show no activity in the LeBrecht-PowerSource account after early September 1991. The responses received by the NASD from the two banks where Otto maintained personal accounts indicate that one account was not opened until Summer 1993, and the second account had no available records prior to Spring 1993.
4
Smith signed an acknowledgment dated May 13, 1994, in which she agreed to keep $25,000 on deposit.
5
In a letter dated May 13, 1994, Otto advised Smith that the current value of her funds was $28,576.24. There is nothing in the record to show the source of this figure. As noted above, although Otto claims he deposited Smith's funds into his personal bank accounts and the Charles Schwab account maintained in the names of Donna LeBrecht and PowerSource, the record does not show this.
6
This letter also demonstrates that Otto continued to deceive Smith as to the existence of the "investment group," his control over the funds, and their disposition:
As your request is unusual things don't happen that fast. The group has assured me that the funds will not be less than its value at the time the funds were requested. . . . At the time I requested your distribution the funds were at $25,207.19. They were to be invested in (all group funds) in a private placement deal in an upcoming high tech area of computer technology. I believe it is too late to ask to stay in, besides for the recent requests which they view as (my fault) problems (requests and indecision of funds) they have booted me out of the club�.�.�.�. The group is not happy with me.
This is an exclusive club with most people of professional investment background. I pushed to get us in, therefore I can't cause a lot of wave [sic]. I should hope to receive our exit papers soon and subsequently the funds.
According to Otto's own testimony, everything in this letter is false.
7
The NAC stated that, although the DBCC decision did not specify the Sanction Guideline that it used to calculate the $110,000 fine, it appeared from the staff's brief that the DBCC used the Guideline for conversion, which recommends a fine of five times the amount converted. The NAC noted that the complaint did not charge conversion, and the DBCC did not make a finding of conversion. The NAC found that Otto misused Smith's funds and that the Sanction Guideline for Improper Use of Funds or Securities was more analogous to this case. This Guideline recommends a range of $2,500 to $20,000. The NAC concluded that a fine above the recommended maximum was warranted in view of the facts of this case. The NAC particularly noted that Otto did not "mistakenly" believe that he had authority to use Smith's funds as he did, that he misrepresented his use to her, and that she had no knowledge of his use.
8
See e.g., John F. Lebens, 52 S.E.C. 606 (1996) (violation of just and equitable principles may be based merely on unethical conduct); Thomas E. Jackson, 45 S.E.C. 771, 772 (1975) (even wrongdoing not involving securities sufficient for finding violation of rules, because NASD could justifiably conclude that on another occasion it might involve securities.)
9
15 U.S.C. Section 78o-3. This section, in pertinent part, provides that the NASD is required to notify a respondent of, and give him an opportunity to be heard upon, the specific charges against, and grounds for denial of membership, bar, or prohibition or limitation under consideration and keep a record.
10
We have previously stated that Rule 2110 "is sufficiently specific and provides an adequate standard of compliance." Stephen J. Gluckman, Exchange Act Rel. No. 41628, 70 SEC Docket 418, 427 n. 30 (July 20, 1999), citing Benjamin Werner, 44 S.E.C. 622, 629 & n. 11 (1971), and Vail v. S.E.C., 101 F.3d 37, 39 (5th Cir. 1996) (predecessor to Conduct Rule 2110 was not unconstitutionally vague).
11
The NASD, as a private corporation, is not subject to the due process requirements of the Constitution. Datek Securities Corp., 875 F. Supp. 230, 233-34 (S.D.N.Y. 1995). Nonetheless, in applying Section 19(e)(1)(A) of the Exchange Act, 15 U.S.C. Section 78s(e)(1)(A), which governs our review of disciplinary actions taken by SROs, we have indicated that a fundamental principle governing all SRO disciplinary proceedings is fairness. See U.S. Associates, Inc., 51 S.E.C. 805, 810 (1993).
12
See, e.g., Harry Gliksman, Exchange Act Rel. No. 42255, 71 SEC Docket 892,901 (December 20, 1999), and cases cited therein. The hearsay statements of Smith are not, of course, the sole basis for our findings of fact here.
13
Charles D. Tom, 50 S.E.C.1142, 1145 (1992).
14
Otto's testimony provides direct and independent evidence that he used Smith's money for his own personal use and never informed Smith that he did so. Further, his handwritten and other contemporaneous documents show that he continually referred to Smith's participation in an "investment club" that did not exist.
15
Id. In Tom, the customer was not available because "[he] was reluctant to have any type of confrontation with Mr. Tom."
16
Smith sent a letter of complaint to the state of Wisconsin dated October 26, 1994. The Office of the Commissioner of Securities for the State of Wisconsin began an investigation on October 31, 1994, which culminated in a consent order issued May 26, 1995. The consent order suspended Otto's agent's license for six months.
17
Otto stated that these "key" witnesses died in late 1996 and February 1998 respectively.
18
Appellant's Brief at 20.
19
The NASD sent Otto detailed requests for documents on December 20, 1994 and September 28, 1995, to which Otto provided incomplete responses. In the September 28, 1995 letter, a NASD special investigator, Mark Tomlin, volunteered to come to Otto's office after Otto confirmed that he had the information there. Tomlin testified that he arranged with Otto to visit Otto's office, and that he went there at the scheduled time and date. Tomlin testified that, after he arrived, Otto said that he did not have any of the records, but that he (Otto) thought his attorney might have them. When Tomlin contacted the attorney, the attorney informed him that he was not aware of any of the records. It was not until near the end of October 1996 that Otto provided all the requested information.
20
Otto's testimony indicates his lack of awareness that his conduct was wrongful. He contends that Smith did not file her complaint because she was unhappy with his services, but because she wanted to support her father's separate complaint against him. Smith's father's case is irrelevant to this case. Otto's attempt to deflect the focus from his actions shows his continued refusal to accept any blame, and ignores the fact that the main reason Smith may not have expressed unhappiness is because he repeatedly concealed from her his use of her funds.
21
The monetary sanction imposed on Otto is above the range recommended by the NASD Guideline for improper use of funds not amounting to conversion or misappropriation. However, in this case, Otto's deception and concealment are sufficient aggravating factors to warrant an amount exceeding the recommended maximum. Similarly, although the Guideline does not specifically provide for a bar for improper use of funds, the Commission agrees with the NASD that a bar is essential based on the egregious nature of Otto's deception, misconduct, and his continued lack of understanding of his responsibilities as a registered broker.
22
We have considered all of the contentions advanced by the parties. We have rejected or sustained them to the extent that they are inconsistent or in accord with the views expressed in this opinion.
UNITED STATES OF AMERICA
before the
SECURITIES AND EXCHANGE COMMISSION
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 43296 / September 15, 2000
Admin. Proc. File No. 3-9938
In the Matter of
The Application of
KEVIN LEE OTTO
908 W. Oklahoma
Milwaukee, Wisconsin 53215
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 Kevin Lee Otto, and the Association's assessment of costs, be, and they hereby are, sustained.
By the Commission.
Jonathan G. Katz
Secretary
http://www.sec.gov/litigation/opinions/34-43296.htm
