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SECURITIES AND EXCHANGE COMMISSION
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In the Matter of KENNETH R. WARD
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OPINION OF THE COMMISSION
BROKER-DEALER PROCEEDING
Ground for Remedial Action
Fraud in the Offer and Sale of Securities
Salesman of registered broker-dealer made fraudulent statements and omitted material facts, and made fraudulently unsuitable recommendations, in connection with the offer and sale of securities. Held, it is in the public interest to bar salesman from association with a broker or dealer; order him to cease and desist from committing or causing any violation or future violation of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; and order him to pay civil money penalty and disgorge illegal profits, plus prejudgment interest.
APPEARANCES:
Kenneth Ward, pro se.
Jeffrey B. Norris, for the Division of Enforcement.
Appeal filed: October 19, 2001
Briefing completed: February 1, 2002
I.
The Division of Enforcement appeals from the decision of an administrative law judge dismissing proceedings against Kenneth R. Ward, formerly a registered representative with Government Securities Corporation of Texas ("GSC"), formerly a registered broker-dealer. 1 The Division alleged that Ward willfully violated various antifraud provisions of the federal securities laws 2 in connection with the offer and sale of securities to two municipal government clients between 1992 and 1994. More specifically, the Division charged that Ward made material misrepresentations and omitted to state material facts in recommending the purchase of "inverse floater" securities to the cities of League City, Texas and Bryan, Texas, and that these securities were fraudulently unsuitable for these clients. The law judge dismissed the allegations finding that Ward did not misrepresent the risks associated with inverse floaters and that such securities were not unsuitable for these customers. 3 Webase our findings on an independent review of the record, except with respect to those findings not challenged on appeal. 4
II.
A. Background. Inverse floaters are securities that are "'structured' to provide a rate of return that [is] equal to a fixed rate less a multiple of a floating rate index," such as the London Interbank Offered Rate ("LIBOR"). 5 Such securities are backed by collateralized mortgage obligations ("CMOs"), which in turn are derived from pools of mortgages. The holders of CMO-backed securities receive payments generated by the mortgages in the underlying collateral pool. 6
Payments with respect to CMO-backed securities are subject to "prepayment risk" because of the mortgagors' ability to prepay the balance owed on the underlying loan. The tendency of mortgagors to prepay their mortgages is highly sensitive to changes in interest rates. Thus, as interest rates decline, mortgagors are more likely to prepay their mortgages by refinancing their debt with lower-rate mortgages. 7 Because the cash flow generated by an inverse floater is "greatly affected by the prepayment rates of the mortgages in the underlying pool�.�.�. the choice of a projected prepayment rate [is] critical in evaluating and pricing" an inverse floater. 8 The leading industry measure of prepayment rates for theseinstruments is the "Public Securities Association prepayment model" or "PSA." 9
Between 1986 and the beginning of 1994, the market for inverse floaters remained strong because of decreasing or stable interest rates. However, "[t]he numerous increases in short-term rates throughout 1994 had a dramatically negative effect upon rate-sensitive structured notes," including inverse floaters. 10 The rise in interest rates reduced principal prepayments and dramatically extended the average maturity of inverse floaters. As a result, liquidity in the CMO market was substantially reduced. 11
In October 1993, several months before this rise in interest rates, the National Association of Securities Dealers, Inc. (the "NASD") issued a Notice to Members (the "NASD Notice") regarding a broker's disclosure obligations to customers when selling CMOs. 12 The NASD Notice raised significant concerns regarding liquidity in the CMO market:
While there is a sizable secondary market for CMOs generally, there is less of a market for the more risky and complex tranches. CMOs are less uniform than traditional mortgage-backed securities and more expensive to trade. It is also harder to obtain current pricing information. Matching up buyers and sellers is often difficult, especially for the more esoteric tranches. 13
The NASD Notice raised particular concerns regarding certain "high risk tranches" or classes of CMOs, including inverse floaters. Observing that such securities "have high price volatility as interest rates move," the NASD Notice stated that inverse floaters "are only suitable for sophisticated investors with a high-risk profile and the investor must be made aware of the risks and characteristics of [the inverse floater] being purchased." 14
GSC circulated a copy of the NASD Notice to all of its brokers, traders, and trading assistants on October 27, 1993. In its cover memorandum, GSC summarized several of the points made in the NASD Notice, including the potential liquidity problem and suitability issues, and directed Firm personnel involved in CMO sales to read the NASD Notice "carefully." The memorandum also advised GSC personnel that the NASD "has targeted the sale of CMOs for active enforcement." 15 With this background, we now turn to Ward's CMO sales to the two Texas cities at issue.
B. Ward's Activities Related to League City. League City, Texas had raised funds for various public construction projects through a bond offering and needed to invest the funds until the start of construction. League City's written investment policy, which it provided to Ward in February 1993, stated that the city's investment objectives were, in order of importance, safety, liquidity "so as to provide adequate and timely working capital," and return. The policy further expressly prohibitedthe city from purchasing securities with maturities that exceeded two years. 16
League City's investment policy also required securities firms with which the city dealt to execute a Broker/Dealer Questionnaire & Certification form. On February 2, 1993, Ward executed such a form on GSC's behalf. In this form, GSC expressly represented that it would "determine the suitability of any securities sold" to League City. The firm also represented that it "will always adhere to the investment objectives and guidelines as set forth by ea[ch] individual client."
League City's new account form, which was prepared in January 1993, stated that the city's investment objective was "income" and that its risk tolerance was "invest grade." In September 1993, GSC's compliance department directed Ward to update the city's new account form. In this updated form, League City's investment objectives were listed as average maturities of no more than 1.5 years, safety of principal, and "low" risk.
Michael Campbell, League City's finance officer from 1987 until July 1993, testified that he had little understanding of inverse floaters. Among other things, Campbell was unfamiliar with the terms "extension risk" -- the possibility that rising interest rates would slow the anticipated prepayment speeds, resulting in a delay in the investor's return of principal 17 --and "PSA," and did not appreciate the impact of changes in interest rates on inverse floaters. Campbell told Ward that League was not interested in purchasing inverse floaters because he "considered those to be exotics or beyond -- beyond [his] comprehension . . . because [he] was naive and very, very inexperienced in this. [He] wanted nothing except straight CMOs."
1. Despite his reservations, Campbell eventually purchased inverse floaters based on Ward's recommendations. According to Campbell, Ward never disclosed that the securities he was recommending were subject to extension risk or that their maturities could extend thirty years, and thus were inconsistent with League City's expressly stated investment objectives. During May through June 1993, Campbell bought, on Ward's recommendation, the following inverse floaters:
Campbell relinquished his position as director of finance at some point in late June or early July of 1993. 20 In the wakeof Campbell's departure, Paul Nutting, the League City administrator, reviewed the city's portfolio. According to Nutting, he was "shocked" when he reviewed the city's finances following Campbell's departure. League City had "originally planned on buying very short-term securities, something that would last, you know, several months." Nutting testified that the city "had done pretty well in bank deposits, CDs and TexPool," an investment vehicle operated by the state of Texas for the short term investment of funds by municipalities. Accordingly, after Campbell's departure, Nutting sought to return the city to those types of very conservative investments.
Nutting, who had not previously had any direct contact with Ward, met with Ward to discuss the city's holdings sometime in July or August 1993. According to Nutting, "we had discovered some interesting developments in our investments and we wanted to have the opportunity to talk to [GSC] about those investments, so we invited Mr. Ward in to visit with us." Ward, who was admittedly aware that the city was "dissatisfied" with its holdings of inverse floaters, nonetheless persuaded Nutting to exchange them for other securities, including additional inverse floaters. Nutting stated that he "went into the meeting [with Ward] not wanting to buy securities" but accepted Ward's "offer to help [the city] with its situation," and thereafter "just put [the city] in [Ward's] hands." Nutting agreed to purchase on Ward's recommendation three additional inverse floaters:
Ward's commission from these transactions and the earlier purchases of inverse floaters by League City between May and June 1993 totaled $126,664. Nutting told Ward that these newly acquired securities would have to pay out by 1995, when LeagueCity would need the funds to pay for a sewer construction project. 21
Nutting authorized Lonna Stein, who had succeeded Campbell as League City's finance officer, to carry out the investment strategy he had discussed with Ward. Stein testified that she had no training or expertise in portfolio management and relied on Ward in making investment decisions. Like Campbell, Stein was unfamiliar with inverse floaters or the associated terminology. Among other things, Stein did not appreciate how these securities were affected by changes in interest rates. Stein testified that she "was pretty naive about the whole security market" and "trust[ed] Ward based on his relationship with Campbell."
During the fall of 1993, Stein purchased additional inverse floaters on League City's behalf based on Ward's recommendations. 22 According to Stein, Ward recommended at least certain of these securities without identifying them as inverse floaters. League City transaction records and related correspondence support Stein's testimony that she was unaware that the securities Ward recommended, and the city purchased, were inverse floaters.
2. As discussed supra, the NASD issued a warning in October 1993 about the sale of inverse floaters to unsophisticated customers with little risk tolerance. Officials within GSC raised similar concerns. Charles Mitchell, a GSC compliance principal, testified that, "at some point, [the compliance department] started questioning the wisdom of selling inverse floaters to public fund accounts." After September 1993, when Ward had completed an updated new account form for League City which continued to reflect conservative investment objectives, Mitchell approached GSC "senior management" about whether inverse floaters were suitable for League. According to Mitchell, management "disagreed with him and with the NASD that these were high risk securities." Mitchell then wrote a memorandum, dated February 14, 1994, for League City's file stating that:
Although the NASD . . . states that inverse floaters should "only be sold to accounts that can tolerate high risk," senior management of GSC was comfortable with the suitability of the particular CMOs that the City of League City has purchased (short average life/duration; no supports) and with the investment strategy that has been recommended by the broker. Neither the broker (Ken Ward) nor senior management feel that the securities should be classified as "high risk" or that this account should be classified as a "high risk" account. 23
The memorandum also noted that League City held $5.3 million invested in inverse floaters, which represented 35% of its portfolio. The memorandum concluded by noting that GSC's sales manager would "review this information with Ken Ward."
In late spring 1994, League City officials "were really getting worried about [the city's] situation" because the cash flow generated by the inverse floaters it had purchased from Ward was less than had been projected. In September 1994, League City brought a civil lawsuit against Ward and GSC based on its purchases of inverse floaters. The record indicates that LeagueCity recovered at least a portion of its losses through a settlement of that lawsuit.
C. Ward's Activities Related to the City of Bryan. The City of Bryan, Texas had been a client of Ward's since 1991, when Ward was associated with a broker-dealer other than GSC. According to Ward, he and another individual from his former firm approached the city in the fall of 1990 "to see if we could make recommendations and become one of their lists of brokers." The City of Bryan began buying "bonds" based on Ward's recommendations in the summer of 1991.
The City of Bryan adopted an investment policy on April 28, 1992. Its "primary objectives" were, in order of priority, safety, liquidity, and yield. The City of Bryan provided GSC with its investment policy and Ward retained a copy of the policy in his permanent file. The City of Bryan opened an account at GSC when Ward became associated with that firm in the fall of 1992. The City of Bryan's new account form for GSC, which was dated October 20, 1992, indicated the lowest level of risk tolerance, "Invest Grade," 24 and "Long Term Capital Gain" as its investment objective. While Ward testified that the new account form was prepared by GSC's compliance department, Ward signed it and admittedly was aware of the city's conservative investment objectives.
Kathy Davidson, who was the City of Bryan's accounting manager, had direct responsibility for handling the city's investment portfolio from October 1993 through March 1994. 25 Davidson had been the City of Bryan's accounting manager since the early 1980s and, prior to that time, was a teller/bookkeeper in a small bank. Davidson did not have a college degree or any formal training regarding portfolio management other than "information [she] obtained through the mail from the Government Finance Officers Association" and from occasional seminars she attended. Davidson stated that she relied on Ward to provide information as to the nature and quality of the securities herecommended and Ward admittedly was aware that Davidson had little training in portfolio management.
1. Davidson testified that, during late 1993 and early 1994, the City of Bryan "had a good bit of capital improvement that [it] wanted to make throughout the city." According to Davidson, the city was "in the process of doing some electrical construction which had drawn down [its] investment balance substantially, so [it] did not have a large excess of funds available." Davidson told Ward that the City of Bryan's investments needed to "be fairly short-lived" because the city would need the cash over the next two to three years. Ward assured her that the securities he was recommending would meet the city's two-year criterion.
During October and November 1993, the City of Bryan purchased the following inverse floaters based on Ward's recommendations:
Ward received total commissions from these transactions of $42,250.
The record contains Davidson's contemporaneous notes based on Ward's representations regarding certain of these securities. Although Ward testified that he informed city officials that the "prepayment speeds could slow down and there would be extension risks," Davidson's notes indicate that Ward recommended thesesecurities based on the representation that they would mature within two to three years, and the notes included nothing to suggest that Ward discussed the extension risk.
At some point after November 1993, Davidson told Ward that the City of Bryan "didn't want to purchase any more inverse floaters." According to Davidson, Ward responded that she "was really being nervous over nothing." Ward further told Davidson that the inverse floaters the city had purchased "were performing the way that he told [the City of Bryan] that they would, and basically reassured [her] that [her] concerns were unfounded."
In late November 1993, Ward recommended that the City of Bryan sell Freddie Mac 1400 J and 1409 F securities and use the proceeds to purchase a Fannie Mae 1993 225 SM inverse floater with an original face amount of $2,400,000. Ward testified that he made the recommendation, which the City of Bryan accepted, to try to improve the city's yield. In connection with this recommendation, Ward sent to the City of Bryan by facsimile transmission an analysis of the prospective maturity for the Fannie Mae 1993 225 SM inverse floater based on different PSAs. Ward circled the projection based on 350 PSA and wrote on the facsimile transmission that October 25, 1997 was "the projected final pay." Davidson assumed that the analysis Ward provided "was an industry-type standard document [and] . . . the 350 PSA speed that he had circled there was something that any broker/dealer could access and would come up with the same scenario as this printout." Ward did not provide the basis for his projection or tell Davidson how changes in interest rates could affect the projection. Ward received a commission of $28,800 from this transaction.
2. As discussed supra, certain GSC officials echoed concerns voiced by the NASD regarding the sale of inverse floaters to unsophisticated, risk-adverse investors. On January�26, 1994, compliance principal Mitchell expressed, in an e-mail to GSC's compliance director, suitability concerns about Ward's practice of selling inverse floaters to the City of Bryan. Mitchell noted in this e-mail that the compliance department routinely reviewed the account forms of customers buying inverse floaters and certain other securities to verify that "the account is marked as 'high risk' . . . and the investment objectives do NOT include liquidity." Observing that the City of Bryan's investment objectives included liquidity, Mitchell noted in the memorandum that he did not "particularly think of inversefloaters as liquid." Mitchell concluded by asking whether there was "any reason for concern here." 28
At roughly the same time, Mitchell directed Ward to prepare an "updated" new account form for the City of Bryan. According to Mitchell, he told Ward that the original form, which indicated that the City of Bryan's investment objective was "Investment Grade," the most conservative listed, did not give Mitchell "much information." Davidson, who was then handling the City of Bryan's portfolio, stated that she at no time discussed with Ward any change in the city's risk tolerance. Nonetheless, in a new account information form dated January 27, 1994, which was signed -- and Mitchell assumed had been prepared -- by Ward, 29 the City of Bryan's risk tolerance was changed to "high," the most aggressive level presented on the form.
3. In March 1994, Ward recommended that the City of Bryan purchase a Fannie Mae 1993 115 SD inverse floater, with a maturity date of July 25, 2023 (the "115 SD"). GSC, which had purchased the 115 SD in January 1994, had trouble finding a buyer. The Firm therefore tripled the sales credit it gave any salesperson who could sell the security.
Davidson initially rejected Ward's recommendation to purchase the 115 SD, telling him that the city already had "more than enough" inverse floaters in its portfolio. Davidson testified that she was becoming concerned about the effect of interest rate increases on the city's portfolio. Davidson understood that, with inverse floaters, the "yield declines inversely with increases in market interest rates and then thepayout extends." 30 She failed to appreciate, however, that, as she put it, "just minor changes in the interest rate could drastically extend the life of an inverse floater."
Ward countered Davidson's concerns by telling her that "he felt that the security would pay out within two years . . . which he knew was [Bryan's] criteria [sic]." According to Davidson, "Ward assured [her] that it would pay out by September of 1995 and if it didn't, that he would purchase it back from me at the same price that we had paid for it." 31
On March 11, 1994, in a follow-up telephone conversation, Ward told Davidson that "this bond is just so good and so perfect for what you want, which is a high degree of liquidity, the cash flow to come back like its going out of style . . . ." 32 Ward also sent to Davidson, by facsimile transmission on March 11, an analysis showing the projected cash flow for the 115 SD. This analysis, which assumed a 500 PSA, showed the final payment date for the security as September 25, 1995, readily satisfying the two-year maturity date criterion set by Davidson.
On March 28, 1994, in a continuing effort to obtain Davidson's agreement to purchase the 115 SD, Ward told Davidson in a telephone conversation that "this guy" would like to purchase certain securities held by the City of Bryan and that, as a result, the city might be able to "swap[] things with longer average lives, going into things with shorter average lives and with some beginning principal pay down already." 33 Later, Ward told Davidson, "My guy called me back just a few minutes ago. I think he's getting close to giving me what you have in book." Ward was referring to certain securities that he had recommended selling to finance the purchase of the 115 SD. These securities included "PAC" or "planned amortization class" bonds; unlike inverse floaters, PACs generally are considered relatively low risk CMOs. 34
Contrary to Ward's representations to Davidson, there was no "guy" interested in buying Bryan's securities; rather, Ward planned to buy them for GSC's inventory account. Although Ward claimed at the hearing that the person to whom he referred might have been the GSC sales manager, Aubrey O'Connor, he could not recall whether he ever told Davidson that the potential purchaser was GSC.
Mary Campion, GSC's former director of financial strategies, testified extensively about Ward's recommendation of the 115 SD, which she characterized as "a really bad deal" for the City of Bryan. According to Campion, Ward and O'Connor had one of Campion's subordinates prepare an analysis of the swap for the City of Bryan while Campion was out of the office. When Campion discovered what Ward and O'Connor had done, she was "very angry" because they had "circumvented the procedures that [GSC] had put in place in order to keep GSC from showing analysis that . . .didn't go through compliance and go through the proper procedure." 35
Campion was sufficiently concerned about Ward's 115 SD analysis that she informed GSC's compliance department about it. Compliance principal Mitchell agreed that the analysis needed to be revised but, according to Campion, Ward and O'Connor refused to make the revisions and "insisted on the most advantageous-looking PSA assumptions in order to facilitate this transaction." Eventually, GSC's compliance director determined that Campion and Mitchell could, in Campion's words, "put together an analysis that would disclose as much as . . . needed to [be] disclosed to the client and still get the trade done." A revision was then undertaken, although the revised analysis was not provided until after the City of Bryan had executed the transaction.
On March 29, 1994, Ward continued to press Davidson to buy the 115 SD and sent to her by facsimile transmission a cash flow analysis of the security using various PSA assumptions, ranging from 350 to 1100. In a follow-up conversation (also taped), Ward assured Davidson that the security would pay out no later than July 1996 as follows:
This bond is set to be gone at the latest, at the latest, at the 400 PSA speed that I ran at 7/25 of '96 will be the last payment. If you look at the cash flow, the cash flow shows the last payment on 7/25 . . . This is -- I would say this is probably still conservative yet, because I expect prepayment speed to pick back up over the summer . . . but I'm trying to tell you that at the down side -- this is the down side.
Davidson ultimately agreed to the trade on March 31, 1994, paying roughly $3 million for the 115 SD. 36 Ward's commission on the sale was $51,997.
Shortly after this transaction, in April 1994, Debra Canant assumed responsibility for handling the City of Bryan's portfolio. Canant reviewed the portfolio with various other securities professionals who advised her that the city's holdings were excessively concentrated "in CMO-related instruments." 37 These professionals also raised concerns about the lengthy maturities of certain of the securities, and the prices paid by the city to acquire them.
Canant contacted Ward after her review of the city's portfolio. Among other things, she was "concerned" that the "market value" he was providing her regarding the City of Bryan's holdings was "not at all in keeping with what [she] was hearing from the other experts that [she] had contacted regarding the value of these securities." 38 According to Canant, the City of Bryan was "taking a huge hit in their decline in market value and because their lives had extended out to such a long period, [the securities] were not appropriate for our portfolio."
Based on the values represented to her by Ward, Canant directed Ward to sell certain securities held by the city, including the 115 SD. By this point, however, the CMO market had collapsed, significantly reducing prices and liquidity for the security. When Ward did not execute the sell order 39 and theCity of Bryan's attempts to resolve the matter with GSC were unsuccessful, the City of Bryan sued GSC and Ward. GSC settled the suit by agreeing to pay the City of Bryan $1 million.
4. In recommending the inverse floaters at issue here, Ward failed to provide city officials with the forecasts, prepared by the major dealers in these securities, of the securities' likely future prepayment rates, which were expressed as a percentage of PSA. Ward described these projections, to which he admittedly had ready access, 40 as "what dealers are projecting in their best guesstimate the prepayment speeds of a particular collateral will be." The dealer projections of the 115 SD's PSA were substantially below those of 350 to 1100 PSA that Ward gave to the City of Bryan on March 29, 1994, and offered a much less favorable assessment of the security's potential return. For example, on March 11, 1994, the dealer median PSA for the 115 SD was 213. By March 29, 1994, the PSA had fallen to 193. Using the dealer median PSA, the 115 SD had an extension risk of thirty years. Based on a PSA of 200, the 115 SD would not pay off until 2023.
Ward acknowledged at the hearing that, when he was recommending the 115 SD to the City of Bryan, he was aware that the dealer median PSA was much lower than the range of PSAs he had used as an assumption in the analysis he provided to the city. According to Ward, he based his assumptions on the "historical" PSAs for the security which he claimed had previously been a good predictor of future prepayment rates. This was because market conditions had been, until that time, favorable to inverse floaters. 41 These favorable marketconditions, however, changed significantly in early 1994, a fact reflected in less optimistic dealer PSA projections. 42
Before the law judge, Ward sought to discount the importance of dealer PSA projections in favor of historical PSAs and claimed that "[m]edian PSA speeds were not important at the time." During investigative testimony, in contrast, he acknowledged that the dealer median PSAs were important in evaluating the security. Ward's earlier testimony is consistent with expert testimony offered at the hearing. 43
III.
A. Misrepresentations and Omissions. The record establishes that Ward made material misrepresentations and failed to provide material information to League City and to the City of Bryan in connection with the offer and sale of the inverse floater securities identified above, and that he did so with scienter. 44 Ward misrepresented the inverse floaters he recommended as conservative, short-term instruments that satisfied the low risk investment objectives of his customers. For example, Ward represented to City of Bryan officials, both verbally and in written analyses, that the inverse floaters he recommended would pay off within two years, and would thereby satisfy one of the city's stated investment criteria. These representations left the false impression that the maturities forthese securities could be predicted with a high degree of certainty and were flatly contradicted, in at least one case, by dealer forecasts which Ward knew about and recklessly disregarded.
More generally, Ward deceived his customers by recommending inverse floaters without also disclosing the associated risks. 45 As the NASD Notice, which was issued in October 1993 made clear, inverse floaters are highly risky securities, subject to dramatic changes in maturity, cash flow, and liquidity based on relatively minor changes in interest rates. 46 Consequently, recommendations of such securities are materially misleading --as were Ward's -- to the extent they fail to highlight those risks. 47 The record also establishes that Ward acted withscienter in that, although he was aware of the associated risks and of his customers' lack of sophistication, he failed to make the appropriate disclosures but instead chose to exploit their limited understanding for his own gain. 48
Our findings of violation rest in part on the testimony of city officials regarding their contacts with Ward. The law judge found, and Ward argues, 49 that Ward was credible and these officials were not credible. While we have held that a fact finder's "explicit credibility" findings are to be accorded "considerable weight," 50 we do not accept such findings "blindly." 51 Rather, there are circumstances where, in the exercise of our review function, we must disregard explicit determinations of credibility. 52 In this proceeding, Ward's testimony was the only evidence supporting his claim that he made the appropriate disclosures to city officials, and the only evidence suggesting that city officials were not forthcoming about their contacts with Ward and their level of sophistication and appreciation of the risks associated with inverse floaters. Ward's testimony was vague and self-serving. 53 Moreover, Ward's testimony was contradicted by overwhelming testimonial and documentary evidence in the record. That evidence included the consistent testimony of city officials from the two distinct municipalities involved, misleading facsimile transmissions he sent to city officials, and contemporaneous notes taken by one of those officials that supported the officials' testimony. 54 The testimony of city officials that Ward failed to disclose, and misrepresented, the risks associated with these investments also was supported by transcripts of taped conversations between Ward and one of these officials, and by the testimony of GSC officialsCampion and Mitchell. 55 Under the circumstances, we therefore reject the law judge's credibility findings as untenable and conclude that the weight of the evidence makes plain that Ward did not make the requisite disclosures.
In his defense, Ward introduced evidence that established that, in some cases, the inverse floaters sold to League City and to the City of Bryan paid out early as Ward had predicted. 56 Indeed, League City official Campbell testified that the inverse floaters "normally" paid out the way Ward told him they would. This evidence is largely irrelevant because it is not Ward's ability to predict the future that is at issue in this case but, rather, his duty to warn his clients about the risks associated with the investments he recommended. Nor is it relevant whether Ward's projections regarding future prepayment speeds were accurate. Rather, the question here is whether Ward adequately informed his customers about the basis for his projections and the implications for their investments if his projections were wrong. He did not. We hold Ward liable because he failed to balance his recommendations with a discussion of the facts that, depending on market conditions, these securities ultimately could have long maturities and little liquidity.
In addition, we find that Ward's misrepresentation regarding a third party's interest in buying the securities the City of Bryan needed to liquidate to purchase the 115 SD was materially misleading. This misrepresentation, and the pressure Ward put on Davidson, encouraged the city to believe that it needed to act quickly or it could lose the opportunity.
B. Suitability. The record establishes that Ward made recommendations to League City and to the City of Bryan that heknew were unsuitable. These recommendations, which were accompanied by material misrepresentations and omissions of material facts, violated the antifraud provisions. 57 Both cities sought securities with short maturities, not exceeding two to three years. 58 Although inverse floaters are guaranteed as to principal, they can have very lengthy maturities and, because of this extension risk, were unsuitable for these customers. The potential illiquidity of such securities -- indeed, Ward conceded that the market for inverse floaters became illiquid during 1994 -- further supports a finding of unsuitability because liquidity was one of the primary investment objectives identified by both League City and to the City of Bryan. Ward's recommendation of the 115 SD, in particular, was unsuitable for the City of Bryan because, at the time of the recommendation, the instrument had a projected dealer median PSA that made its anticipated maturity approach thirty years, far exceeding Bryan's specified maturity needs.
The law judge found, and Ward contends before us, that there is "no evidence that Ward knew or reasonably believed that the inverse floaters were unsuitable," noting as support that,"[b]efore the instant case, Ward had never sold an inverse floater that resulted in a client loss." 59 This reasoning betrays a troubling misunderstanding of the duty of a securities professional to make customers aware of the potential downside of an investment even if a decline in an investment's value is outside the salesperson's experience. The prior favorable performance of inverse floaters in no way lessened the associated risks. It was those risks -- which were recognized by the NASD and by GSC officials -- that Ward was obligated to consider in determining suitability and that precluded the sale of such securities here to customers with clearly stated conservative investment objectives.
Ward claims that he relied on his GSC supervisors to determine whether inverse floaters were suitable for his customers. According to Ward, he "was putting good faith in their ability to control what was purchased and what wasn't purchased." It is undisputed that senior GSC personnel, including the sales manager and the director of compliance, had knowledge of and participated in the transactions at issue. 60 Their involvement, however, does not exonerate Ward. 61 The complicity of others, whether through overt assistance and encouragement or through neglect, did not relieve Ward of his fundamental duty to make suitable recommendations to hiscustomers. 62 Moreover, while certain GSC personnel may have approved of Ward's sales practices, others, most notably Mitchell and Campion, did not and, in fact, raised suitability concerns on more than one occasion.
In addition, we note that Ward's ability to continue selling inverse floaters to the City of Bryan was facilitated by a change in the city's stated risk level from Investment Grade to High Risk. This change, which was reflected on a revised new account form signed by Ward, was inconsistent with the city's true risk level, which remained conservative. Ward's role in this unwarranted revision of the City of Bryan's new account form, along with his circumvention of GSC procedures to get a misleading analysis of the 115 SD transaction prepared for the City of Bryan, further undermine his claim of good faith and support our finding of scienter.
* * * *
Accordingly, we find that Ward willfully violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by engaging in the conduct described above.
IV.
The Division requests that Ward be barred from associating with any broker or dealer and that he be ordered to cease and desist from committing future violations of the antifraud provisions he was found to have violated. The Division also requests that Ward be directed to disgorge $279,633.90, plus prejudgement interest, the amount of commissions he received during 1992 through 1994, and to pay a "third tier" civil money penalty of $100,000.
We agree with the Division that Ward represents a threat to the investing public and that severe sanctions are warranted by the public interest. Ward made fraudulent misrepresentations and omissions and fraudulently unsuitable recommendations on numerous occasions to two different municipal customers. Ward's actions compromised the fiscal integrity of two different communities. Those actions demonstrate a callous willingness to exploit, forpersonal benefit and without regard for the impact on others, the trust placed in him by customers with limited understanding of the securities he recommended.
Aside from these proceedings, Ward also has been the subject of Texas state court proceedings involving securities violations and of disciplinary action by GSC. In 1997, a Texas court found that Ward "engaged in fraud and fraudulent practices" as defined in the Texas Securities Act, and ordered that he be "enjoined from continuing such fraudulent practices or engaging therein or doing any acts in furtherance thereof or in violation of the Texas Securities Act" for one year. 63 In 1993, Ward was sanctioned by GSC for violating the Firm's compliance procedures by sending written correspondence to customers without the approval of his supervisors.
Testimony by GSC personnel further heightens our concerns regarding Ward's fitness to remain employed in the securities industry. Compliance officer Mitchell testified that "there was just a general concern involving Mr. Ward with compliance." According to Mitchell, Ward, who was one of GSC's "top producers," 64 "tended to dismiss compliance issues, requests, as simply involving more paperwork, not being meaningful . . . didn't give much weight to it." Mitchell further stated that, when Mitchell would talk to Ward about compliance matters, Ward's response was: "I'll take care of it . . . whatever it was . . . in general, Ken would say he'd do it, and then maybe he would or he wouldn't." In July 1994, Mitchell recommended that Ward be fined $500 and required to appear before the Firm's Compliance Committee "to demonstrate to him the seriousness of repeated violations" of the firm's compliance procedures. 65
Although Ward asserts that he has not worked in the securities business since leaving GSC in October 1994, he has indicated a desire to return if given the opportunity. 66 Under all the facts and circumstances, the public interest requires that Ward be denied that opportunity through the issuance of a bar.
With respect to the remedy of a cease and desist order, as we stated in KPMG Peat Marwick LLP, 67 "[i]n the ordinary case, and absent evidence to the contrary, a finding of past violation raises a risk of future violation sufficient to support our ordering a respondent to cease and desist." To put it another way, "evidence showing that a respondent violated the law once probably also shows a risk of repetition that merits our ordering him to cease and desist." 68 Here, Ward's serious misconduct and disciplinary history raise at least "some risk" of future violations.
While, in the ordinary case, such as the one before us, a finding of a past violation will give rise to a sufficient risk of future violations to warrant cease-and-desist relief, it also is appropriate to consider other factors that may either militate against imposition of the sanction, or further emphasize the need for this forward-looking remedy. Here, the record establishes the need for relief. Specifically, the violations were with respect to two municipal clients and numerous transactions. 69 Moreover, Ward does not acknowledge any wrongdoing, which suggests that he may engage in future misconduct.
Additionally, we conclude that Ward's actions justify a third tier civil penalty. Section 21B of the Exchange Act authorizes the imposition of civil money penalties where it is in the public interest to do so. 70 That section authorizes a money penalty of $100,000 for each violative act or omission where "fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement" is involved and the misconduct resulted in or created a significant risk of "substantial losses . . . to other persons or resulted in substantial pecuniary gain to the person who committed the act or omission." 71 Ward's misconduct amply satisfies the statutory standards because it involved fraud, and resulted in substantial gain to himself, and, at the least, created a significant risk of substantial losses to his customers.
We further believe that Ward should be required to divest himself of his "ill-gotten gains." 72 We therefore will order that Ward disgorge $249,711, an amount equal to the commissions he received in connection with his fraudulent misconduct, 73 plus prejudgment interest. 74
An appropriate order will issue. 75
By the Commission (Chairman DONALDSON and Commissioners GLASSMAN, GOLDSCHMID and ATKINS); Commissioner CAMPOS not participating.
Jonathan G. Katz
Secretary
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 47535 / March 19, 2003
Admin. Proc. File No. 3-9327
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In the Matter of KENNETH R. WARD
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ORDER IMPOSING REMEDIAL SANCTIONS
On the basis of the Commission's opinion issued this day, it is
ORDERED that Kenneth R. Ward be, and he hereby is, barred from association with any broker or dealer; and it is further
ORDERED that Kenneth R. Ward cease and desist from committing or causing any violation and committing or causing any future violation of Section 17(a) of the Securities Act of 1933, and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; and it is further
ORDERED that Kenneth R. Ward disgorge $249,711, plus prejudgment interest determined in conformity with 26 U.S.C. § 6621(a)(2) from March 31, 1994, the date of the last transaction at issue in this matter, to the date of this order, and it is further
ORDERED that Kenneth R. Ward pay to the United States Treasury a civil money penalty of $100,000, pursuant to Section 21B of the Securities Exchange Act of 1934, within 21 days of the issuance of this Order. Such payment shall be: (i) made by United States postal money order, certified check, bank cashier's check, or bank money order; (ii)�made payable to the Securities and Exchange Commission; (iii) delivered by hand or courier to the Comptroller, Securities and Exchange Commission, 450 FifthStreet, N.W., Washington, D.C. 20549; and (iv) submitted under cover letter which identifies the respondent in these proceedings, and the file number of these proceedings. A copy of this cover letter and check shall be sent to Jeffrey B. Norris, Counsel for the Division of Enforcement.
By the Commission.
Jonathan G. Katz
Secretary
1 Ward stated that GSC subsequently merged with Coastal Securities L.P., a registered broker-dealer which remains in operation.
2 Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a), and Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5.
3 Four other GSC employees were named as respondents in the Order Instituting Proceedings in this matter. Three settled with the Commission by agreeing to findings that they violated antifraud provisions of the federal securities laws and to sanctions. See Aubrey O'Connor, Exchange Act Rel. Nos. 42062-42064 (Oct. 27, 1999), 70 SEC Docket 2986, 2991, 2995. The fourth died subsequent to the institution of proceedings, and proceedings were discontinued as to him. James Winter, Exchange Act Rel. No. 41231 (March 31, 1999), 69 SEC Docket 1327.
In related proceedings, GSC, its president, Christopher LaPorte, and its compliance director, Frank Klaus, agreed to findings, without admitting or denying those findings, that they had failed reasonably to supervise GSC employees who violated antifraud provisions of the securities laws, and to sanctions. See Frank Klaus, Exchange Act Rel. No. 39165 (Sept. 30, 1997), 65 SEC Docket 1608 and ChristopherLaPorte, Exchange Act Rel. No. 39171 (Sept. 30, 1997), 65 SEC Docket 1623.
4 The Division further alleged that Ward sold an inverse floater to one of these customers at a price that included a fraudulent markup. The law judge dismissed this allegation finding that Ward "reasonably reli[ed]" on GSC data and employees. The Division has not appealed the law judge's finding and dismissal, and, accordingly, that aspect of the decision is not before us.
5 Derivative Financial Instruments Relating to Banks and Financial Institutions, Hearings Before the Senate Committee on Banking, Housing and Urban Affairs, 104th Cong. 1st Sess. 57 (Jan. 5, 1995) (statement of Arthur Levitt, Chairman of the SEC) (hereafter "Levitt Statement"), text accompanying n.21 (available at www.sec.gov/news/testimony;testarchive/1995/spch022.txt). See also Lyle Roberts, Suitability Claims Under Rule 10b-5: Are Public Entities Sophisticated Enough to Use Derivatives, 63 U. Chi. L. Rev. 801, 835 n.3 (1996).
6 See generally Kenneth G. Lore & Cameron L. Cowan, Mortgage-Backed Securities §3.03 (1999).
The structuring of floating rate securities based on fixed rate payment streams works as follows. As a stream of payments from a pool of mortgages (with fixed interest rates) is paid to a particular bond class, those payments are divided into two payment streams based on a specified floating interest rate. One payment stream varies directlywith the specified interest rate (floaters) and the other payment stream varies inversely with the specified interest rate (inverse floaters). The extent to which floaters/inverse floaters vary with the specified interest rate is calculated so that the total return of both payment streams equals the total payment stream from the (fixed interest rate) mortgage pool at any point in time.
7 Securities may be structured so that the underlying CMO payments are distributed on a prioritized basis and thereby mitigate the prepayment risk. This structuring makes CMOs more marketable to customers with different income stream needs. See generally Frank J. Fabozzi, The Handbook of Fixed Income Securities, (5th ed. 1997). To accomplish this, securities derived from the underlying mortgage pool are sold in classes where each class has a different payment priority. For example, three classes of CMO bonds may be offered, Class A, Class B, and Class C. Holders of Class A bonds then receive all interest and principal from the underlying mortgage pool until the payments equal the Class A bonds' full par value. After holders of Class A bonds have received payments equal to par, holders of Class B bonds receive all interest and principal for those bonds until par value for those bonds is reached. After Class B bonds have received full payment of interest and principal, all remaining payments from the mortgage pool go to the Class C bonds.
8 Advances & Innovations in the Bond and Mortgage Markets, 267 (Frank J. Fabozzi ed., 1989).
9 See generally id. at 269-70. The PSA benchmark of 100% of PSA, or "100 PSA" as it is typically expressed, assumes prepayment rates are low in the early months of a 30-year mortgage and then speed up to a rate of 6% per year by month 30, after which the rate remains at 6% for the remaining years. An assumed prepayment rate of 300 PSA means prepayments are expected to be three times as fast as the PSA benchmark; 50 PSA means prepayments are expected to be half as fast. See Steven Davidson, A Summary of CMO Structures, 6 America's Community Bankers 36 (1997); Frank J. Fabozzi, Bond Markets, Analysis and Strategies, 242-44 (1993).
10 See Levitt Statement at text preceding n.22. See also Merrill Lynch, Pierce, Fenner & Smith Inc., 53 S.E.C. 745, 749 (1998) (settled case) (noting that interest rates began rising in February 1994, reducing interest income from inverse floaters).
11 See generally Banca Cremi, 132 F.3d 1017, 1023 (4th Cir. 1997) (noting that "CMO liquidity" during 1994 "which had never been a problem in the stable or declining interest rate environment that had existed since their introduction, dried up as all CMO holders tried to sell [and] the market in CMOs virtually collapsed").
12 NASD Notice to Members 93-73 (Oct. 1993).
13 Id. at 432.
14 Id. at 433.
15 In July 1994, following the trades at issue in this case, GSC prohibited its salespersons from selling inverse floaters to public fund accounts.
16 The law judge held that League City "probably did not have" a written investment policy" because "there is no indication that the policy" contained in the record was approved by city officials. The law judge further held that, if League City did have a written investment policy, it had not provided that policy to Ward "as late as February 1993." Contrary to the law judge's findings, testimony by a League City official and documentary evidence introduced by the Division indicate that League City had adopted a written investment policy early in 1993 and that a copy of that policy was provided to Ward shortly after its adoption. In testimony, Ward himself initially acknowledged receiving a copy of the policy in early 1993 but later claimed that he could not recall whether in fact he did so. In any event, Ward does not deny awareness of League City's conservative investment objectives, which were unambiguously reflected in GSC's new account form, as discussed below.
17 See Frank J. Fabozzi, Bond Markets, Analysis and Strategies,254 (1993). See also text preceding n.7, supra.
18 "Freddie Mac" is short for the Federal Home Loan Mortgage Corporation.
19 "Fannie Mae" is short for the Federal National Mortgage Association.
20 According to Campbell, he left "because there was a political controversy about the mayor and some funds that had disappeared." Campbell subsequently pled guilty toofficial misconduct and felony theft and was placed on probation.
21 Although written after the events in question, a letter written by Nutting to Ward in March 1994 evidences Nutting's limited understanding of the inherent risks associated with inverse floaters. In this letter, Nutting asked Ward "what guarantee does the City have that the timely payments of both principal and interest will be received by the City according to the cash flow schedules provided by you." As this letter indicates, Nutting fundamentally failed to appreciate the uncertainty of Ward's cash flow projections. Ward responded to Nutting's letter by stating that "[w]hether or not these [principal and interest] payments will be received according to the cash flow tables which I have provided depends on the movement of interest rates and the prepayment speeds at which they pay." Thus, although Ward qualified the projections he provided, he did so after the fact.
22 Although evidence of these additional transactions was introduced at the hearing, they were not included in a list of trades at issue in the proceeding provided by the Division, at the law judge's direction, to Ward, prior to the hearing. These additional transactions also were not included in the Division's, or our own, disgorgement calculations.
23 The memorandum further stated that the account had a "high level of activity (approximate turnover of 189% over the past 12 months) [which was] due primarily to a change in city officials and to the rapid pay down of some of the CMOs purchased."
24 GSC's new account form presented in the following order four risk levels: "Invest Grade, Good Quality, Speculative, High Risk."
25 Prior to October 1993, Glenda Ross, another Bryan employee, handled the city's investment portfolio. Ross did not testify at the hearing and there is no record evidence regarding discussions between Ross and Ward.
26 The purchase price paid by the City of Bryan is unclear from the record.
27 The maturity date for this security is unclear from the record.
28 According to Mitchell, GSC's compliance director answered "no" when Mitchell asked him whether there was any cause for concern. Mitchell did not elaborate regarding the basis for the compliance director's lack of concern.
29 Mitchell testified that he "would think that" Ward prepared the new account information form. The record also contains an updated "new account form" from the same date, which also indicates that the City of Bryan's desired risk level was "High Risk," rather than "Investment Grade," as it originally had been. As was the new account information form, this new account form was signed by Ward, although he claimed he signed a blank form and that the form was completed by the compliance department.
30 Davidson also testified that she understood that the PSA reflected the "payment speed," and that the higher the speed the more quickly it would pay down," although she did not "understand exactly how that speed is calculated or anything."
31 Davidson understood Ward to mean that, if the city "had not received [its] final principal payment . . . by September of '95, that GSC would repurchase the balance at the same price that [the city] had paid."
32 This conversation was tape recorded pursuant to GSC's policy of recording all telephone conversations between salespersons and customers. The law judge admitted this transcript and certain others but failed to include them on the exhibit list. The Division has moved to correct this omission by adding these exhibits. While Commission Rule of Practice 351(b), 17 C.F.R. § 201.351(b), states that parties are to file proposed corrections to the record index within fifteen days of service of the index, Ward has not opposed the Division's request for correction and we see no possible prejudice to Ward from the correction, which will conform the exhibit list to the proof. We therefore have determined to grant the Division's motion.
33 This call also was tape recorded.
34 See Steven Davidson, A Summary of CMO Structures, 6 America's Community Bankers 36 (1997) (observing that, while certain CMOs "have more risk than that of the underlying collateral . . . others, most notably PACs, have less risk"). See also Banca Creme, S.A., 132 F.3d at 1023 (noting that PACs "have little prepayment risk" and are considered the "least risky . . . of CMO tranches"). PACs "provide for a specified amortization rate within a wide band of prepayment scenarios," and thereby provide "insulation from prepayment volatility." Frank J. Fabozzi, The Handbook of Fixed Income Securities, 570, 1264 (5th ed., 1997).
35 Campion also "objected vehemently" to the transaction analysis because Ward "did not disclose [on the face of the document] the fact that he was selling [Bryan] an inverse floater [or] even name the security," and because Ward did not disclose that the inverse floaters he was recommending "were floating rate securities, that the final pay -- there was no such thing as a final pay on these securities. There's only an average life, and its subject to prepayment assumptions." Campion observed that "[s]upport tranche bonds such as the 1993 115 SD . . . have th[e] characteristic that they kind of change . . . from being a short bond to a long bond in a small PSA range." This information was not conveyed to Davidson by Campion, Ward, or anyone else.
36 In addition to the 115 SD, Bryan purchased a U.S. Treasury Note and a PAC security.
37 The concentration of inverse floaters in the City of Bryan's portfolio is unclear from the record.
38 For example, Canant testified that she had been told by other securities professionals that the 115 SD the city had just bought was now worth "43 cents on the dollar, yet he was reporting it to [her] at eighty-eight eighty-nine."
39 The circumstances surrounding Ward's failure to sell the securities are not well established on this record. Ward testified that city officials asked him what the bid pricewas for the 115 SD, but chose not to sell when he told them that it was between $.50 and $.70.
40 According to Ward, "the dealer median [information] shows up on every [Bloomberg computer] screen when you first turn them on, and you pull up a yield page, it pulls up a dealer median."
41 According to Davidson, the favorable interest rate environment through 1993 contributed to the City of Bryan's misunderstanding of the risks involved: "the prepayments that were received in . . . '92 and '93 . . . lulled [the city] into a sense of false security in thinking that that could be expected for other securities that we purchased aswell."
42 See n.10, supra, and accompanying text.
43 We note that Ehud Ronn, a finance professor at the University of Texas, Austin, who testified as an expert witness regarding valuation of inverse floaters, stated that projected prepayments by market professionals using the "best available information," not historical prepayment rates, are "what's relevant" in determining the value of an inverse floater.
44 See generally Basic Inc. v. Levinson, 485 U.S. 224, 238-240 (1988) (antifraud violations based on misleading statements as to material facts or silence where party had duty to disclose material facts); Aaron v. SEC, 446 U.S. 680, 691, 701-02 (1980) (scienter is an element of violations of Securities Act 17(a)(1) and Exchange Act Section 10(b) and Rule 10b-5 thereunder).
45 See, e.g., Joseph J. Barbato, 53 S.E.C. 1259, 1274 (1999) ("Where a registered representative omits to disclose material information necessary to make his statements not misleading to customers about an investment he is recommending, including known risk factors and negative information . . . the representative violates the antifraud provisions.").
46 Although publicly available, NASD Notices are communications that are distributed to NASD members, such as GSC, and their associated personnel, and were not provided to officials of the cities involved here.
47 See SEC v. First Jersey Securities, Inc., 101 F.3d 1450, 1466 (2d Cir. 1996) ("A fact will be considered material . . . if there is a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information available.") (internal quotations and citations omitted).
The law judge found that certain statements appearing on GSC promotional materials and facsimile transmission sheets informed city officials about the risks associated with inverse floaters and qualified Ward's recommendations. The law judge, for example, construed as risk disclosure the disclaimer printed at the bottom of a GSC fax cover sheet, which stated that GSC did "not guarantee that [the material] being sent is accurate or complete, and it should not be relied upon as such." To the contrary, such general "boilerplate" disclaimers in no way overrode Ward'sunqualified recommendations regarding specific securities. Moreover, it is unclear from the record when, if ever, these written materials were provided to city officials. At least one of the documents identified by the law judge was provided to the City of Bryan, at the insistence of GSC compliance personnel, after Bryan had purchased the security at issue, and thus was too late to qualify Ward's recommendation.
48 Ward's failure to discuss the risks associated with these securities following the issuance of the NASD Notice and the raising of concerns by GSC officials is further evidence of his scienter.
49 Ward's brief is virtually a restatement of the law judge's initial decision.
50 Dan A. Druz, 52 S.E.C. 130, 134 n.16 (1995), aff'd, 103 F.3d 112 (3d Cir. 1996)(Table); see also Anthony Tricarico, 51 S.E.C. 457, 460 (1993).
51 Warren R. Schreiber, 53 S.E.C. 912, 914 (1998).
52 Valicenti Advisory Serv., Inc., 53 S.E.C. 1033, 1040 n.9 (1998) (rejecting credibility findings because "the record contain[ed] 'substantial evidence' for doing so").
53 For example, when, during the investigation, Ward was asked whether he discussed the extension risks associated with inverse floaters with his customers, Ward answered:
[I]n most cases, you know, we discussed that . . . I would suppose that I have done that on most every occasion, but I can't remember exact instances where I sat down and said, This is the PSA speed that gives you the extension risk. I mean I'm sure I've done that several times, but I can't remember the exact instances.
The law judge found that Ward "always accurately described the risks and characteristics of inverse floaters . . . ." Specifically, she credited his statement that he and the City of Bryan "talked about prepayment speeds and the extension risks on securities on a regular basis, on a monthly basis." The law judge also found that, [a]lthough Ward never discussed [how minor changes in interest rates could drastically extend the life of an inverse floater] at great length, there were discussions of particular securities and of his estimate of its [sic] performance."
54 See Herbert Moskowitz, Exchange Act Rel. No. 45609 (March�21, 2002), 77 SEC Docket 481 (rejecting credibility finding where there was substantial contradictory evidence in the record).
We note that, while he cross-examined Davidson, Ward failed to challenge her testimony that he had not warned the City of Bryan about the risks of the investments he recommended.
55 Our decision to credit Campbell's testimony with respect to Ward's lack of disclosure, notwithstanding his criminal record, see n.20, supra, is based on its consistency with that of other city officials and other evidence in the record.
56 Ward also emphasized that the City of Bryan chose to retain the 115 SD after settling with GSC, notwithstanding the claimed inconsistency with the city's investment objective. City of Bryan official Canant testified that, because "[t]he security had dropped dramatically in market value . . .[t]he city could not afford to sell that and take the loss." She added that "[t]here was a lot of political heat surrounding that issue at the time."
57 See Clark v. John Lamula Investors, Inc., 583 F.2d 594 (2d Cir. 1978) (Rule 10b-5 violated where defendant recommended unsuitable securities that he knew or reasonably believed were unsuitable); Cruse v. Equitable Securities of New York, Inc., 678 F. Supp. 1023, 1030, 1031 (S.D.N.Y. 1987) (Rule 10b-5 is violated where the "defendant believed the securities traded were unsuitable in light of the investment objectives and needs of a client, and that defendant nevertheless traded in those securities"); Laurie Jones Canady, Exchange Act Rel. No. 41250 (Apr. 5, 1999), 69 SEC Docket 1468, 1482-83 (salesperson's securities recommendation were fraudulent where she knew that the transactions were unsuitable for customers and failed to disclose associated risks), pet. denied, 230 F.3d 362 (D.C. 2000).
58 As discussed supra at n.16, the law judge found that League City had either not adopted a written investment policy or failed to provide a copy of such a policy to Ward. We reject that finding of the law judge as inconsistent with the record. Moreover, even if Ward had not been given a copy of the policy -- or if a written policy did not exist -- League City's conservative investment objectives (including its need for investments with short maturities) were clearly expressed in its new account form.
59 This reasoning mirrors Ward's faulty logic that he could ignore industry prepayment forecasts in favor of historical prepayment rates. While historical prepayment rates properly can be presented to a customer, such data should not be used, as it was in this case, to mislead the customer regarding the associated risks.
60 See n.3, supra.
61 See, e.g., Sharon M. Graham, 53 S.E.C. 1072, 1084 (1998) (salesperson aided and abetted antifraud violations by executing "wash" trades for customer notwithstanding compliance officer's assurance that trades were "fine"), aff'd, 222 F.3d 994 (D.C. Cir. 2000); Robert A. Amato, 51 S.E.C. 316, 319-20 (1993) (salespersons efforts to blame others at firm for their securities pricing violations "wholly unpersuasive"), aff'd, 18 F.3d 1281 (5th Cir. 1994).
Ward's claims of naivete are particularly unpersuasive in light of the fact that his securities career began in 1980.
62 See Donald T. Sheldon, 51 S.E.C. 59, 88 n.130 (1992) (duties owed by securities professional to customers are "not abridged by a failure on the part of his supervisors"), aff'd, 45 F.3d 1515 (11th Cir. 1995).
63 Texas v. GSC, Cause No. 153,629-B (146th Texas Judicial District Court Apr. 21, 1997). The Division asserts, without challenge by Ward, that the Texas proceeding is based on the same activities at issue in this case. The court's order, which is part of the record, does not provide details of the misconduct.
64 Ward testified that his annual compensation at GSC ranged from $250,000 to $400,000.
65 According to a memorandum to GSC's "Compliance Committee" written by Mitchell at the time, Ward caused an unidentified customer to have "a concentration level of approximately 44% in non-traditional securities"; "prospect[ed]" for newcustomers in states where he was not registered; and engaged in a questionable repurchase transaction with a customer without first obtaining approval from GSC's compliance department.
66 Ward testified that he tried to associate with another securities firm following GSC but that Texas state securities authorities denied him a license.
67 KPMG Peat Marwick LLP, Exchange Act Release No. 43862 (Jan.�19, 2001), 74 SEC Docket 384, motion for reconsideration denied, Exchange Act Release No. 44050 (Mar.�9, 2001), 74 SEC Docket 1351, petition denied, 289 F.3d 109 (D.C. Cir. 2002).
68 Id. at 430.
69 The only factor here that might militate against a cease-and-desist order is the age of conduct at issue. This factor is outweighed by the egregious, continuing nature of the violations and Ward's apparent lack of understanding of his obligations as a securities salesman.
70 15 U.S.C. § 78u-2(a).
71 15 U.S.C. § 78u-2(b)
72 See, e.g., Canady, 69 SEC Docket at 1486-87.
73 We have reduced the disgorgement amount requested by the Division by $29,922. This amount roughly represents the commission earned by Ward on an additional transaction involving the City of Bryan. The record contains insufficient evidence regarding the circumstances surrounding this transaction to support a finding of violation and, accordingly, disgorgement of the commission.
74 See SEC v. Moran, 944 F.Supp. 286, 295 (S.D.N.Y.1996) ("Requiring payment of interest prevents a defendant from obtaining the benefit of what amounts to an interest freeloan procured as a result of illegal activity.").
75 We have considered all of the arguments advanced by the parties. We reject or sustain them to the extent that they are inconsistent or in accord with the views expressed herein.
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Modified: 03/20/2003