Source: https://www.sec.gov/litigation/opinions/34-41813.htm
Timestamp: 2019-04-25 10:14:57+00:00

Document:
c/o Michael R. Koblenz, Esq.
Registered securities association, after considering an individual's statutory disqualification resulting from the entry of a permanent injunction, denied member firm's application to retain its membership if it employed the individual as a registered representative. Held, as the injunction did not relate to conduct or practice in connection with the purchase or sale of any security, association's action set aside.
Michael R. Koblenz and David W. Kenna, of Mound, Cotton & Wollan, for Jacob Adoni.
Alden S. Adkins, Susan L. Beesley, and Shannon V. Lane, for NASD Regulation, Inc.
Jacob Adoni appeals from the denial by the National Association of Securities Dealers, Inc. ("NASD") of an application by Whitehall Wellington Investments, Inc. ("Whitehall") to remain an NASD member if Adoni becomes associated with the firm. The NASD denied Whitehall'sapplication based on a 1997 final judgment of permanent injunction ("Permanent Injunction") entered against Adoni in federal district court. We base our findings on an independent review of the record.
In March 1997, the United States District Court for the District of New Jersey entered a final judgment of permanent injunction against Adoni 1 prohibiting him from violating Section 13(b)(5) of the Securities Exchange Act of 1934, 2 and Exchange Act Rules 13b2-1 and 13b2-2. 3 Adoni consented to the entry of the Permanent Injunction without admitting or denying the allegations in the complaint.
On December 31, 1992, Simone filed with the Commission an S-1 registration statement for a $3.5 million rights offering. While conducting an audit of the company's financial statements for the fiscal year ended January 31, 1993, Simone's independent auditor discovered that the company improperly had credited sales figures from unshipped goods as revenue. The auditor resigned from the audit without issuing an audit report. Simone withdrew the registration statement in April 1993.
After a hearing before a hearing panel, at which Adoni also appeared, the National Adjudicatory Council ("NAC") denied Whitehall's application to associate with Adoni. The NAC observed that "the activity for which Adoni was enjoined is serious" and that the injunction had been in effect for "only a little over" a year. This appeal followed.
This proceeding raises the issue of whether the injunction imposed on Adoni renders him subject to a "statutory disqualification" within the meaning of the Exchange Act and the NASD By-laws. Section 15A(g)(2) of the Exchange Act provides that a registered securities association may "bar from becoming associated with a member any person, who is subject to a statutory disqualification." 9 As relevant here, Sections 3(a)(39) and 15(b)(4) of the Exchange Act include within the definition of "statutory disqualification" any injunction that enjoins conduct or a practice in connection with the purchase or sale of a security. 10 Based on the facts here, we concludethat Adoni is not subject to a statutory disqualification because the Permanent Injunction does not enjoin conduct or a practice "in connection with" the purchase or sale of a security.
Simone, as a company with shares registered under Section 12(g) of the Exchange Act, was required to file with the Commission various reports disclosing to the investing public financial information about the company.�13 However, the complaint in the injunctive action did not allege, and the record does not support a conclusion, that false or misleading information reached the public as a result of Adoni's actions.
Douenias allegedly began the improper accounting practices at Simone in December 1992. In December 1992, Simone filed with the Commission an S-1 registration statement for a proposedpublic offering that contained financial information on the company. The period covered by the financial information, however, ran only through October 31, 1992, before any of the questionable accounting practices began. Simone later withdrew the registration statement in April 1993. Although Adoni allegedly transmitted the tainted books and records to Simone's independent auditor, the auditor's resignation from the company's January 31, 1993 year-end audit, without issuing an audit report, prevented the incorporation of any inflated revenue figures into a public filing with the Commission.
The NASD contends that Simone's improper characterization of revenue, which was the basis for Adoni's injunction, also resulted in the allegation that Douenias falsified Simone's accounting records in violation of Section 10(b) of the Exchange Act. The NASD argues that, therefore, "even Adoni's 'prebilling' activity occurred 'in connection with the purchase and sale of any security.' " However, the complaint did not allege that Adoni committed a violation of Section 10(b) of the Exchange Act or any other activity "in connection with" the purchase or sale of a security.
ORDERED that the action taken by the National Association of Securities Dealers, Inc. denying the application of Whitehall Securities, Inc. seeking to continue its membership if it associates with Jacob Adoni, be, and it hereby is, set aside.
-- SEC v. Adoni, Final Judgment of Permanent Injunction as to Jacob Adoni, Civil Action No. 97-350 (D.N.J. filed March 25, 1997). The District Court also imposed a civil penalty of $37,500. Adoni's counsel represented to the NASD that Adoni had paid the fine.
-- 15 U.S.C. � 78m(b)(5) (providing, in relevant part, "[n]o person shall knowingly circumvent or knowingly fail to implement a system of internal accounting controls or knowingly falsify any book, record or account . . . .").
-- 17 C.F.R. � 240.13b2-1 (providing that "[n]o person shall directly or indirectly, falsify or cause to be falsified any book, record or account . . . ."); 17 C.F.R. � 240.13b2-2 (prohibiting any officer or director of an issuer from making or causing to be made any materially false or misleading statement in connection with the preparation of reports and documents required by the Exchange Act).
-- Simone's common stock was registered with the Commission pursuant to Section 12(g) of the Exchange Act, 15 U.S.C. ��78.
-- The complaint also charged Douenias with unlawfully generating invoices for unshipped orders and creating false books and records in violation of Section 13(b)(5) of the Exchange Act and Exchange Act Rule 13b2-1. The complaint further alleged that Douenias violated Section 10(b) of the Exchange Act, 15 U.S.C. � 78j(b), and Exchange Act Rule 10b-5, 17 C.F.R. � 240.10b-5, by obtaining funds from one of Simone's factors based on the inflated revenue figures.
-- 15 U.S.C. � 78c(a)(39)(F); 15 U.S.C. � 78o(b)(4). The NASD relied upon that part of the subsection that provides, in relevant part, that a person is subject to a "statutory disqualification" with respect to participation in a self-regulatory organization when such person has been enjoined from any conduct or a practice "in connection with the purchase or sale of any security."
-- In a letter dated May 19, 1998, NASD's department of Member Regulation informed Whitehall that it would recommend approval of Adoni's association if Whitehall agreed: to permit Adoni to work only from the office where Frederick Blumer (Adoni's proposed supervisor at Whitehall) is physically located; to amend its supervisory procedures to clearly establish Blumer's responsibility to supervise Adoni; to incorporate the heightened supervision relating to Adoni into Whitehall's written supervisory procedures; toinclude within Blumer's heightened supervision the review and approval of any business conducted by Adoni for a customer as a Whitehall representative; to prohibit Adoni from assuming any primary responsibility or authority over Whitehall's books and records; to deny Adoni any managerial or supervisory authority over Whitehall's business or employees; and to limit Adoni to acting as a registered representative. Whitehall agreed to these conditions at the hearing before the Statutory Disqualification Committee.
-- 15 U.S.C. � 78s(f).
-- 15 U.S.C. � 78o-3(g)(2).
-- 15 U.S.C. � 78c(a)(39)(F); 15 U.S.C. � 78o(b)(4). Article II, Section 4(h) of the NASD By-laws contains similar language. NASD Manual (CCH) pp. 1306-07 (providing that a person is subject to a "disqualification" if permanently enjoined by judgment of any court of competent jurisdictionfrom any conduct or practice "in connection with the purchase or sale of any security.").
Section 3(a)(39) of the Exchange Act includes within the definition of "statutory disqualification," injunctions of the type specified in Exchange Act Section 15(b)(4)(C). Section 15(b)(4)(C) includes injunctions that prohibit a person from acting as a securities or commodities professional; acting as an affiliated person or employee of any investment company, bank, insurance company, or an entity or person registered under the Commodity Exchange Act or equivalent foreign statute; or engaging in any conduct or practice in connection with these activities. 15 U.S.C. �� 78(c)(a)(39); 78o(b)(4)(C). These types of injunctions are not at issue here.
-- 17 C.F.R. � 240.10b-5 (prohibiting fraud, misleading statements or omissions, and any act, practice or course of business that operates as a fraud "in connection with the purchase or sale of any security.").
-- SEC v. Rana, 8 F.3d 1358, 1362 (9th Cir. 1993).
-- Section 13 of the Exchange Act, 15 U.S.C. � 78m.
-- See e.g. SEC v. Falstaff, 624 F.2d 62 (D.C. Cir. 1980) (misstatements and omissions in company's Form 8-K, Form 10-K and proxy statements violate Rule 10b-5); SEC v. Benson, 657 F. Supp. 1122, 1131 (S.D.N.Y. 1987) (misstatements and omissions in company's annual and quarterly reports, proxy statements and security registration statements violate Rule 10b-5).
-- See Wessell v. Buhler, 437 F.2d 279, 282 (9th Cir. 1971) (where allegedly misleading financial statements were not publicly disseminated and there was no evidence that any investor saw the statements, plaintiffs did not establish a Rule 10b-5 claim); see also Zoelsch v. Arthur Andersen, 824 F.2d 27, 33-35 (D.C. Cir. 1987) (citing to Wessell v. Buhler, 437 F.2d 279 (9th Cir. 1971) and concluding that alleged misrepresentations there were "merely preparatory" to any fraud perpetrated on foreign investors).
For this reason, the cases relied on by the NASD are inapposite here. In the cases cited by the NASD, the fraudulent or allegedly fraudulent information was incorporated in documents either filed with the Commission or otherwise disseminated to the public. See e.g. SEC v. Softpoint, Inc., 958 F. Supp. 846, 862-863 (S.D.N.Y. 1997) (consultant to company helped prepare and disseminate press releases, Form 10-K annual reports, Form 10-Q quarterly reports, and Form S-8 registration statements containingmaterial misrepresentations and omissions), aff'd, 159 F.3d 1348 (2d Cir. 1998); SEC v. Gallagher, 1989 U.S. Dist. LEXIS 9556 (E.D. Pa. 1989) (company's Form 10-K and Form 10-Q reports filed with the Commission were inaccurate and misleading because of false information provided by company's controller); SEC v. Joseph Schlitz Brewing Co., 452 F. Supp 824, 829 (E.D. Wis. 1978). (omissions in company's reports filed with the Commission and press releases alleged to violate antifraud provisions of the Exchange Act).
-- Since we conclude that the Permanent Injunction does not subject Adoni to a statutory disqualification, we do not address his contentions that the statutory disqualification provisions of the Exchange Act and the NASD's By-laws are unconstitutionally vague as applied to him and that the NASD's denial of Whitehall's application was arbitrary and capricious.
-- We have considered all of the parties' contentions. We have rejected or sustained them to the extent that they are inconsistent or in accord with the views expressed herein.

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