Opinion ID: 675852
Heading Depth: 2
Heading Rank: 1

Heading: markup violations

Text: 31 Orkin poses a two-pronged challenge to the SEC's finding of markup violations on the facts of this case. He first asserts that the evidence was insufficient to support the SEC's finding of excessive markups. His second challenge is that when the SEC rejected the prevailing market price utilized by the NASD, as reflected on Schedule A, it should have determined that the violations as charged were not supported. According to Orkin, by calculating the prevailing market price differently, the SEC in effect required him to defend against a new charge. 32 The NASD adopted its 5% markup policy as an interpretation of Article III, Sections 1 and 4 of the NASD Rules. Handley Inv. Co. v. SEC, 354 F.2d 64, 65 (10th Cir.1965). Section 1 requires NASD members to observe high standards of commercial honor and just and equitable principals of trade. Section 4 requires that prices charged retail customers be fair, taking into consideration all relevant circumstances.... Five percent is merely a guideline; larger markups may be justified in some situations, while in other situations, lesser markups may be excessive. Id. 33 The SEC reviewed its markup policy in, In re Alstead, Dempsey & Co., Inc., Securities Exchange Act Release No. 20,825 (April 5, 1984), 30 S.E.C. Docket. 208, 1984 WL 50800,  1 (S.E.C.), noting that [a]s early as 1939, this Commission [the SEC] held that a dealer violates antifraud provisions when he charges retail customers prices that are not reasonably related to the prevailing market price at the time the customers make their purchases. 10 Under the NASD's policy, a markup of no more than 5% above the prevailing market price generally is considered fair. The SEC has consistently held that a markup of more than 10% in the sale of equity securities is unfair or fraudulent. See, e.g., In re LSCO Sec., Inc., Securities Exchange Act Release No. 28,994 (March 21, 1991) 48 S.E.C. Docket 681, 1991 WL 296502,  2 (S.E.C.). The key issue in markup cases thus is determining the prevailing market price for the security at issue. 34 The prevailing market price is the price at which dealers trade with one another. See, e.g., Alstead, Dempsey, 30 S.E.C. Docket 208, 1984 WL 50800 at  1. The general rule is that in the absence of countervailing evidence, the best evidence of prevailing market price is the dealer's contemporaneous cost, unless a dealer is simultaneously making a market in a security. See, e.g., F.B. Horner & Associates v. SEC, 994 F.2d 61, 63 (2d Cir.1993); Barnett v. United States, 319 F.2d 340, 344 (8th Cir.1963); LSCO Sec., 48 S.E.C. Docket 681, 1991 WL 296502 at  1; Alstead, Dempsey, 30 S.E.C. Docket 208, 1984 WL 50800 at  2. The general rule reflects the fact that prices a dealer has actually paid for a security in transactions occurring at the same time as retail sales are normally a highly reliable indicator of the prevailing market price. Alstead, Dempsey, 30 S.E.C. Docket 208, 1984 WL 50800 at  1. 35 Where a market maker is involved, markups may be computed using the price charged by the firm or other market makers in actual sales to other dealers. See, e.g., LSCO Sec., 48 S.E.C. Docket 681, 1991 WL 296502 at  3; Alstead, Dempsey, 30 S.E.C. Docket 208, 1984 WL 50800 at  2. However, the nature of the inter-dealer market must be reviewed to determine if it can serve as a reliable basis to set the prevailing market price. Alstead, Dempsey, 30 S.E.C. Docket 208, 1984 WL 50800 at  2. For example, if a dealer dominates and controls the inter-dealer market for a security, the best evidence of prevailing market price is the price that the dominating and controlling dealer is willing to pay other dealers. E.g. In re Meyer Blinder, Securities Exchange Act Release No. 31,095 (August 26, 1992), 52 S.E.C. Docket 1145, 1992 WL 216702,  2 (S.E.C.). Where an integrated 11 dealer, dominates the market to the extent that there is no independent, competitive market, it controls wholesale prices absent evidence to the contrary. Id.at  3. Thus, the price a dominating and controlling dealer pays for a security is the best evidence of the inter-dealer market and therefore the prevailing market price. Id. at  4. 36 A dealer charged with markup violations may prevent application of these general rules by presenting countervailing evidence that another measure is better evidence of prevailing market price. Nevertheless, the use of quotations to establish the prevailing market price, as urged by Orkin in this case, is widely recognized as problematic. See, e.g., LSCO Sec., 48 S.E.C. Docket 681, 1991 WL 296502 at  3; Alstead, Dempsey, 30 S.E.C. Docket 208, 1984 WL 50800 at  2. As an initial matter, quotations merely propose a transaction, they do not represent an actual sale. Id. Quotations for obscure securities with limited inter-dealer trading activity have particularly little value as evidence of the current market. Id. Conversely, published quotations are reliable indicators of prevailing market price only if there is an active, viable market for the stock. Id. 37 We must concur with the SEC's application of its precedent on the facts of this case. The fact that Brownstone dominated and controlled the Ortech market is a relevant circumstance in determining whether the retail prices Tri-Bradley charged were fair, even though Tri-Bradley was not a market maker in Ortech stock. Throughout the NASD and SEC proceedings, Orkin himself argued the unfairness of ignoring prices paid by other dealers, and of strictly using Tri-Bradley's contemporaneous cost as the best evidence of prevailing market price. Orkin attempted to present countervailing evidence justifying the use of the unpublished quotations obtained by Mernah from Ortech market makers as evidence of the prevailing market price. He maintained that the quotations Mernah obtained were validated by a single inter-dealer sale of Ortech stock by Brownstone shown on Schedule A and three inter-dealer sales after the relevant period. Orkin cannot have it both ways. 38 Applying well-established precedent, the SEC found that the unpublished quotations and the single sale by Brownstone during the relevant period were not indicative of the prevailing market price for Ortech stock. There is no question that quotations are unreliable for assessing the prevailing market price in a thinly traded, obscure market. The single sale by Brownstone does not evidence the reliability of the quotations in this case because Brownstone dominated and controlled the Ortech market; it could charge any price it wanted for Ortech stock due to the purchasing dealer's lack of bargaining power. 39 When a dealer dominates the market to the extent that it controls wholesale prices, the only reliable basis for determining prevailing market price is the price the dominating dealer is willing to pay other dealers. See, e.g., Alstead, Dempsey, 30 S.E.C. Docket 208, 1984 WL 50800 at  3. The record amply demonstrates that the market for Ortech stock was non-competitive and thinly traded in that Brownstone was involved in all inter-dealer trades during the relevant period and the vast majority of all trades in Ortech stock. As a result, prices paid by other dealers are not reflective of the prevailing market price. We conclude that sufficient evidence supports the SEC's finding that 201 sales of Ortech stock listed on Schedule A were executed in violation of the NASD's 5% markup policy because the prevailing price for Ortech stock was no higher than $.03 per share: the highest price paid by Brownstone during the relevant period. 40 The SEC's determination did not amount to a new charge against Orkin. Discerning the prevailing market price and computing the resulting markup for any retail stock sale must be done on a case by case basis. Accordingly, the nature of the violations charged in the NASD complaint placed Orkin on notice that all relevant circumstances would be considered. The SEC based its finding of markup violations on evidence in the record since the initial hearing before the DBCC. This Court cannot ascribe as error the SEC's consideration of sales by a dominating and controlling dealer during the relevant period. We find that the SEC appropriately and fairly applied its precedent to the facts before it in concluding that the markups charged in 201 sales of Ortech stock listed on Schedule A were unfair.