Opinion ID: 163281
Heading Depth: 3
Heading Rank: 3

Heading: The Formation of Kunz & Cline

Text: In December 1994, Kunz left VesCor and formed Kunz & Cline with Jeffrey Cline (“Cline”). Southwick, through VesCor, agreed to furnish the required start-up funds. According to Kunz’s testimony, Southwick expected Kunz & Cline to be VesCor’s “captured broker.” The NASD approved Kunz & Cline’s application on December 13, 1994. D. The Simultaneous Rescission-Reinvestment Offers VesCor created six Private Placement Memoranda (“PPMs”) to accompany the simultaneous rescission-reinvestment offers, providing two different PPMs for each of the three investment products. VesCor used one set of three for residents of Nevada, and the other set of three for non-Nevada residents. -3-
At the time VesCor issued the PPMs, $1.8 million in civil judgments were outstanding against Southwick, stemming from previous business activities. The Nevada PPMs contained five paragraphs concerning Southwick’s litigation history, 2 but the non-Nevada PPMs did not disclose this information. Further, none of the PPMs disclosed the relationship between VesCor and Kunz & Cline. 3 All six PPMs included the same financial statement, which Kunz testified that he saw for the first time in November 1994. According to Kunz’s testimony, he was surprised by the sizeable net operating loss that VesCor had accumulated since 1991. Although Kunz questioned Southwick about the losses, he conducted no investigation of the information contained in the financial statements. The financial statements contained a balance sheet dated September 30, 1994, listing VesCor’s assets. Included in the “Assets” information was an entry for “Investments” valued at $12,265,322. The balance sheet indicated that, of this amount, $9,191,509 was attributable to a single asset — 20,000 acres in Cannon 2 The Nevada settlement agreement required this disclosure. 3 Kunz testified that he relied on VesCor’s counsel concerning these omissions. Concerning the relationship between VesCor and Kunz & Cline, Kunz testified that he assumed disclosure was not necessary since VesCor’s counsel never raised the issue during the drafting of the PPMs. Regarding Southwick’s litigation history, Kunz testified that he did inquire whether disclosure of Southwick’s litigation history was legally required and VesCor’s counsel informed him that inclusion was not required. -4- County, Tennessee — acquired in exchange for 750 shares of VesCor stock four days prior to the closing date of the balance sheet. The financial statement also contained a “Statement of Shareholders’ Equity” showing that (1) on September 26, 1994, 750 shares of stock were issued for the Tennessee land, with each share valued at $12,177.85; (2) on September 15, 1994, 250 shares of stock were issued “for services,” with each share valued at $63.80; and (3) on December 31, 1993, the remaining outstanding shares were valued at $1,250.92 per share. The balance sheet and accompanying notes documented that, without the inclusion of the Tennessee land, VesCor had assets of $5,671,761 and liabilities of $6,454,673, resulting in a negative net worth of $782,912. Kunz testified that he understood the purpose of the Tennessee land deal to be a “balance sheet enhancement, meaning that [Southwick] would acquire the property for a short period of time to make [the] private placement look good and sellable.” Kunz also testified that he sought confirmation from VesCor’s counsel that VesCor had proper title to the Tennessee land. VesCor’s counsel responded only that a deed was recorded. Kunz conducted no further investigation. 4 4 Apparently, the Tennessee land was comprised of numerous land grants dating from the 1820’s, when the North Carolina legislature issued the grants to encourage westward settlement. In many instances, the land grants had not been converted to actual locations, tax maps, or legal descriptions. Rather, the deed merely referenced land-grant numbers in describing the property and contained no language typical of a contemporary land description. -5- E. Kunz & Cline’s Dealings with Bruce Anderson In 1994, Kunz met Bruce Anderson (“Anderson”) through Southwick. Prior to entering into two consulting agreements with Kunz & Cline 5 in 1994, Anderson had sold VesCor securities to numerous customers. Anderson was not properly registered under NASD rules to offer the VesCor securities for sale. Since Anderson could not present the simultaneous rescission-reinvestment offers to his clients, Kunz met with Anderson and then personally or by mail furnished Anderson’s clients with the PPMs. Approximately eighty of Anderson’s clients reinvested their funds in the VesCor investment products. Kunz paid Anderson a “consulting fee” of $88,936. At the NASD hearing, Kunz conceded that this was the same amount Anderson would have received as a commission for sales of the VesCor securities. Specifically, Kunz testified that “[t]he reason we formalized the consulting agreement was to compensate [Anderson] in a manner that would have been consistent with commissions that he would have earned had he been licensed.” 5 Originally, Kunz and Anderson had intended that Anderson would register and become a principal of Kunz & Cline. These plans were abandoned after Kunz and Anderson discovered that Anderson could not participate in the VesCor investment product offerings because he was not properly registered in accordance with NASD rules. -6- F. The Commission’s Decision 6 On January 16, 2002, the Commission concluded that petitioners had violated Rule 2110 of the NASD’s Conduct Rules, finding that petitioners: (1) created offering documents for the sale of securities that contained material misstatements and omissions, (2) failed to comply with the Securities Act of 1933’s registration requirements, and (3) compensated a person not properly registered pursuant to NASD requirements, in connection with the sale of securities. The Commission also sustained the sanctions imposed by the NASD. This appeal followed. 6 The Commission reached this conclusion in the posture of reviewing de novo the NASD’s earlier findings of violations and sanctions. In 1996, the NASD’s District Business Conduct Committee (“DBCC”) filed a complaint against petitioners, alleging that petitioners committed the following wrongful conduct: (1) selling securities through PPMs containing material misrepresentations and omissions, in violation of NASD Conduct Rule 2110 and 2120; (2) selling securities that were neither registered pursuant to Section 5 of the Securities Act of 1933, nor exempt from registration, in violation of Section 5 and Conduct Rule 2110; (3) making unsuitable recommendations of VesCor securities in light of customers’ financial situations and needs, in violation of Conduct Rules 2310 and 2110; and (4) paying brokerage commissions to Anderson, who was not properly registered under NASD regulations, in violation of Conduct Rule 2110. On November 3, 1997, the DBCC entered its final decision, finding for complainant on all counts (with the exception of the Conduct Rule 2120 allegation) and imposing sanctions. Petitioners then appealed the DBCC’s decision to the National Adjudicatory Council of the NASD (“NAC”). The NAC affirmed on all counts, with the exception of the unsuitable recommendations count, and reduced the fine by $10,000. -7-