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dence at applicants' request, suspended the firm from membership for 2 years and assessed it with full costs of the proceedings. The Board found that the transactions were induced in part by Bernheimer's "glowing statements”, and were contrary to Sections 1 and 2 of the NASD Rules of Fair Practice, and that while there was no formal guarantee, certain statements made by Bernheimer could be construed by uninformed persons such as the complainants to be something in the nature of a guarantee and that for all practical purposes Bernheimer did make a guarantee. The Board concluded that this guarantee, or the illusion created by Bernheimer through his appraisal of the security, and the statements made led the customers beyond their means and induced them to make purchases, perhaps through their own greed, which good judgment would not otherwise have led them to do.
Before examining applicant's contentions, we shall consider the facts with respect to the transactions.
One of the customers, Mr. R., head porter in the building in which the applicant firm has its offices, on Bernheimer's solicitation purchased 500 shares of Quebec stock at $1 per share in 1951 and a like number at $2.10 per share in January 1952. These were his first securities transactions. Mr. R. testified that prior to the second purchase, which is the only one complained of, Bernheimer urged him to buy more stock because the price would increase and make him a rich man, and that when he told Bernheimer that he really could not afford the first purchase, Bernheimer guaranteed his money back if the price of the stock did not rise to $5 a share in 2 years. When Mr. R. later needed money to pay medical bills and sought to invoke the guarantee, Bernheimer denied the existence of a guarantee.
Mr. E., a foreman in a garment factory who had never effected any securities transactions prior to those with the applicant firm, and his wife complained with respect to a purchase of 1,500 shares of Quebec in February 1952 at $3.125 per share. They had known Bernheimer socially for many years, and beginning in May 1951 they had purchased from applicant approximately 1,400 shares of an oil company stock at prices ranging from $2.05 per share to $2.675, and 1,800 shares of Quebec at prices ranging from $1 to $2.70 per share. The applicant firm employed Mr. E. as a part-time securities salesman on a commission basis to sell securities to his friends and relatives.
Mrs. E testified that from time to time while making the earlier purchases Bernheimer was told that she and her husband had no free cash for investment and were borrowing money. She further testified that in September 1951 Bernheimer, who had been urging the the purchase of Quebec stock, sent a confirmation for a purchase of 1,000 shares of Quebec at $1 per share, but she refused the shares, telling Bernheimer that she and her husband were without funds; and that when Bernheimer continued his urgings and stated that the stock would shortly double in price and guaranteed them against loss, she and her husband made the 1,500 share purchase in February 1952 with funds which, as Bernheimer knew, they borrowed for the purpose. Although Bernheimer testified that he had made no guarantee and that Mr. E was very enthusiastic about the Quebec stock, he also stated that he offered stock to Mr. E and that in reply to Mr. E's inquiry whether to borrow money to make the purchase he advised “That's up to you, but the way things are going, it looks very good."
In 1954 Mrs. E called upon Bernheimer to make good his guarantee. He paid her an aggregate of $710 in cash and delivered to her 700 shares of a mining stock which was to be used by Mrs. E as a pledge for a loan she proposed to make. He also agreed to advance Mrs. E $700 if the price of the mining stock reached $2 per share and she returned 500 shares of such stock to him, and that she would not have to repay the $700 until she sold 1,500 shares of Quebec stock at $3.125 per share. Mrs. E claimed that the payments were in discharge of the guarantee, but Bernheimer claimed they were a loan.
Mr. Z, a taxicab driver, and his wife, a garment worker, who had been introduced to Bernheimer by Mr. E. complained with respect to a purchase in April 1952 of 500 shares of Quebec stock at $2.75 per share. Prior thereto, from June 1951 they had purchased from the firm other low-priced stock and warrants for an aggregate of $3,825, and 2,500 shares of Quebec at $1 per share. In connection with the purchase complained of Mrs. Z testified that Bernheimer solicited her repeatedly, telling her she was “making a big mistake” not to buy more Quebec stock, that she told him she herself did not have much money, but that she had some money belonging to her brother, and that Bernheimer told her to "beg, borrow or steal and buy that stock" because the price of the stock would rise shortly, and he guaranteed to repurchase the stock at her purchase price if the price of Quebec did not rise within 6 months. She borrowed the purchase money from her brother, and later repaid him with the proceeds of a loan. Subsequently customer Z requested Bernheimer to repurchase the stock and he paid them $350 in cash and delivered 200 shares of a mining stock to be used as a pledge for a loan. Bernheimer testified that he had made no guarantee, that the $350 was a loan, and that he expected to be repaid out of the proceeds of the sale of 500 shares of Quebec
stock, but that he was prepared to forfeit the remainder of the debt if such proceeds were less than $350.
Applicants contend that in recommending the purchase of the Quebec stock Bernheimer had no reason to believe that it was not suitable to the customers under the circumstances, that the customers were mature and intelligent persons who at the time of the purchases complained of had an unrealized profit on their prior purchases from applicants, and that their own independent judgment and desire to make more profits was the chief reason for making further purchases. They also point out that after the transactions complained of, customers Z and E recommended to another person, and themselves purchased from a former employee of applicant, stock of an affiliate of Quebec, which it is stated is of the same type as the Quebec stock, and that the customers considered such purchases suitable.
We cannot accept applicants' contention that Bernheimer had no reason to believe his recommendations were not suitable. Bernheimer knew that the customers were of very modest means who had already made substantial purchases in Quebec stock, and two of them, who had purchased from Bernheimer another speculative oil stock, had disclosed to him that they did not even have funds to make the purchases. Nevertheless Bernheimer recommended the purchase of Quebec stock, an admittedly speculative security. The customers were not informed in securities matters and relied implicitly upon Bernheimer's advice, no doubt in part because of their unrealized profits on his earlier recommendations. To overcome their resistance Bernheimer engaged in a persistent and aggressive sales campaign with optimistic forecasts of an increase in the price of the stock and statements which led them to believe that their investment was free of risk. Whether or not customers Z and E considered a purchase of the stock of Quebec's affiliate or of Quebec a suitable investment is not the test for determining the propriety of applicants' conduct in the situation before us. The test is whether Bernheimer fulfilled the obligation he assumed when he undertook to counsel the customers, of making only such recommendations as would be consistent with the customer's financial situation and needs. The record shows that Bernheimer knew all the facts necessary to enable him to realize that reasonable grounds for his recommendations did not exist.
Applicants argue that the proceedings should have been dismissed because the NASD found there was no formal guarantee. However, in our opinion the issues in this case are not disposed of on the basis of whether or not Bernheimer did make a formal or legally binding guarantee. The NASD action and our conclusions are based, as we have pointed out, on Bernheimer's entire course of conduct in effecting the transactions complained of. Moreover, it seems clear that even if a formal guarantee was not created, the observance of just and equitable principles of trade does not permit the use of statements which lead an unwary purchaser to the mistaken belief that his transactions are free of risk.
We also find no merit in applicants' contention that since the price charged for the Quebec stock was not found to be improper there can be no violation of Rule 1. The contention erroneously assumes that no misconduct, other than that of over-reaching as to price, could be inconsistent with just and equitable principles of trade.3
On the basis of the foregoing we find that the applicant firm conducted itself as found by the NASD and that its conduct violated Sections 1 and 2 of Article III of the NASD Rules of Fair Practice and was inconsistent with just and equitable principles of trade. The only question remaining is whether the penalty imposed by the NASD is excessive or oppressive having due regard to the public interest and should be cancelled or reduced. In view of the nature of the misconduct and its repetition in the case of three customers we are of the view that the penalty imposed is neither excessive nor oppressive. Accordingly, we shall dismiss these review proceedings.
An appropriate order will issue.
By the Commission (Chairman Armstrong and Commissioners Adams, Orrick, Patterson and Hastings).
* Applicants have also contended that the decision of the NASD should be set aside because two affidavits were introduced at the hearing before the Board of Governors without an opportunity on applicants' part to cross-examine the affiants. We do not find that there was any prejudice. The affidavits insofar as they were relevant to the transactions before us dealt with the guarantee of customer Z and were cumulative in nature. The Board of Governors in reaching their conclusions made no reference to the affidavits and the NASD stated we could disregard them in considering the record. In reaching our conclusions we have attached no weight to the afidavits.
* Applicants contend that the Board of Governors improperly Inferred that applicants hed acted wrongfully in employing Mr. E as a registered representative when his background was in the textile business. As we read the opinion of the Board of Governors so i propriety was attached to the fact that Mr. E was employed in the textlle business. His background was merely referred to incidentally in connection with the board's observathen that Mr. E had no knowledge of the securities business and its conclusion that he was used by the applicants to induce his friends to buy securities.
37 S. E.C.
IN THE MATTER OF
File No. 812-984. Promulgated April 18, 1956
(Investment Company Act of 1940—Sections 18 (a) (2) and 17 (a))
TRANSACTIONS AMONG AFFILIATED PERSONS—MERGER OF AFFILIATED INVESTMENT COMPANIES AND OTHER AFFILIATED COMPANIES
Where terms of proposed merger of controlled registered closed-end investment company and other affiliated companies into controlling registered closed-end investment company are reasonable and fair and do not involve over-reaching and are consistent with the stated policies of the registered investment companies and the general purposes of the Investment Company Act of 1940, and new preferred stock to be issued meets the requirements of Section 18 (a) (2), held the proposed merger transactions between affiliates exempted from Section 17 (a). APPEARANCES:
Benjamin C. Miller, III, Chester C. Davis, and John C. Meleney, of Simpson Thacher & Bartlett, New York, New York, for Atlas Corporation, Wasatch Corporation, Airfleets, Inc., Albuquerque Associated Oil Company, and San Diego Corporation.
Edward F. McCabe, of Donovan, Leisure, Newton & Irvine, New York, New York, for RKO Pictures Corporation.
James E. Birdsall and Jerome P. Schneider, New York, New York, for Louis Schneider, a stockholder of Wasatch Corporation.
Milton S. Gould and Herbert L. Scharf, of Gallop, Climenko and Gould, New York, New York, for Peter G. Treves, et al., stockholders of Albuquerque Associated Oil Company.
Frank Field for the Division of Corporate Regulation of the Commission. 37 S. E. C.-I. C. 40 -2339