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2004
CASE ANALYSIS

In the Matter of MARK H. LOVE For Review of Disciplinary Action Taken by the NASD
Securities NYSE Act of 1934 Release No. 49076, January 13, 2004

http://sec.gov/litigation/opinions/34-49248.htm

 A Little Background

Mark H. Love, an RR formerly associated with NASD member PaineWebber Inc. seeks review of a May 2003 NASD disciplinary action, which found that he had participated in private securities transactions while employed at PaineWebber without giving prior written notice of such transactions in violation of NASD Conduct Rule 3040 and NASD Conduct Rule 2110, and imposed on Love a $25,000 fine and a suspension of 30 business days in all capacities.

3040. Private Securities Transactions of an Associated Person

(a) Applicability

No person associated with a member shall participate in any manner in a private securities transaction except in accordance with the requirements of this Rule.

(b) Written Notice

Prior to participating in any private securities transaction, an associated person shall provide written notice to the member with which he is associated describing in detail the proposed transaction and the person's proposed role therein and stating whether he has received or may receive selling compensation in connection with the transaction; provided however that, in the case of a series of related transactions in which no selling compensation has been or will be received, an associated person may provide a single written notice.

(c) Transactions for Compensation

(1) In the case of a transaction in which an associated person has received or may receive selling compensation, a member which has received notice pursuant to paragraph (b) shall advise the associated person in writing stating whether the member:

(A) approves the person's participation in the proposed transaction; or

(B) disapproves the person's participation in the proposed transaction.

(2) If the member approves a person's participation in a transaction pursuant to paragraph (c)(1), the transaction shall be recorded on the books and records of the member and the member shall supervise the person's participation in the transaction as if the transaction were executed on behalf of the member.

(3) If the member disapproves a person's participation pursuant to paragraph (c)(1), the person shall not participate in the transaction in any manner, directly or indirectly.

(d) Transactions Not for Compensation

In the case of a transaction or a series of related transactions in which an associated person has not and will not receive any selling compensation, a member which has received notice pursuant to paragraph (b) shall provide the associated person prompt written acknowledgment of said notice and may, at its discretion, require the person to adhere to specified conditions in connection with his participation in the transaction.

(e) Definitions

For purposes of this Rule, the following terms shall have the stated meanings:

(1) "Private securities transaction" shall mean any securities transaction outside the regular course or scope of an associated person's employment with a member, including, though not limited to, new offerings of securities which are not registered with the Commission, provided however that transactions subject to the notification requirements of Rule 3050, transactions among immediate family members (as defined in IM-2110-1, "Free-Riding and Withholding"), for which no associated person receives any selling compensation, and personal transactions in investment company and variable annuity securities, shall be excluded.

(2) "Selling compensation" shall mean any compensation paid directly or indirectly from whatever source in connection with or as a result of the purchase or sale of a security, including, though not limited to, commissions; finder's fees; securities or rights to acquire securities; rights of participation in profits, tax benefits, or dissolution proceeds, as a general partner or otherwise; or expense reimbursements.

 

 

 

 

RRs must provide prior written notice to the member firm before participating in any manner in a private securities transaction.

Notice must disclose proposed transaction in detail; RR's role; and compensation.

 

Firm must approve/disapprove in writing .

 

If "approved," the transaction is carried on firm's books.

2110. Standards of Commercial Honor and Principles of Trade

A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade.

 

In 1994, three sets of Love's customers expressed a desire to invest in initial public offerings ("IPOs") and a need for greater returns than Love believed he was able to provide them through PaineWebber. A fellow PaineWebber representative and Love's personal friend, Thomas Zirbel, had introduced Love to Bryan Foster, who operated Summit West Partners ("Summit West"), which invested in IPOs. Zirbel informed Love that he was considering leaving PaineWebber to work for Foster, who was a personal friend. Love told his customers these things when he gave them Foster's contact information. Love also told one of his customers, at the time he referred the customer to Foster, that he personally was interested in making an investment in Summit West. Love provided his customers with a basic explanation of Summit West's investment strategy and explained to them that Summit West could provide them with greater access to IPOs than the customers could obtain in their accounts with the Firm. Love assisted the customers in transferring funds from their PaineWebber managed accounts to make the investments in Summit West. In the case of one set of Love's customers, this involved liquidating the entirety of their PaineWebber account. 

Love did not provide written notice to PaineWebber either that these withdrawals were effected to allow the customers to invest in Summit West or that Love had introduced the customers to Foster. After making their investments in Summit West, Love's customers occasionally had difficulty withdrawing funds invested with Summit West and asked Love to contact Foster directly to try to resolve the issues. Love called Foster on these occasions.  

Summit West ultimately failed as a business entity in 1996, and Love's customers lost most of their investments. Certain of the customers filed arbitration claims against Love and PaineWebber, and PaineWebber settled those claims in September 1997. PaineWebber itself then filed an arbitration claim against Love, and Love settled that claim.

NASD began its investigation in 1997. NASD filed a complaint against Love in January 2001. After a hearing, an NASD panel found that Love had violated Rules 3040 and 2110 and imposed a ninety-day suspension, a $25,000 fine, and $1,879.52 in costs on Love. Love appealed the hearing panel decision to the National Adjudicatory Council of NASD (the "NAC"). The NAC affirmed the hearing panel's findings of violations, but reduced Love's suspension from ninety days to thirty business days. This appeal followed.

Love introduces customers to Summit West, a firm purportedly providing greater IPO access; and helps them transfer funds from PaineWebber to Summit West.

He does not provide written notice of the transactions to PaineWebber.

Summit West fails and Love's customers file arbitration claims.

NASD files regulatory cases.  Love fined and suspended.

Love disputes that his limited involvement in the transactions amounts to "participation" in a private securities transaction under Rule 3040. He took no fee and received no other form of compensation. Essentially, he argued that all he did was make a referral.

Q. Is an RR required notify his member firm in writing of a private securities transaction if there hasn't been the payment of any fee or compensation?

Rule 3040 requires written notice "prior to participating in any private securities transaction," (whether for compensation or not) See, e.g., Terry Don Wamsganz, 48 S.E.C. 257, 258 (1985)( "in any manner"). Moreover, Rule 3040 subparts (b), (c), and (d) specify, respectively, that the required written notice must state whether the representative may or will receive compensation for his or her participation in the transaction, that the representative must receive written authorization from the member firm to engage in the transaction if receiving compensation therefore, and that the firm may apply specific conditions to the representative's participation, even if the representative is not receiving compensation. 

Q. But is the mere referral and assistance in transferring customer accounts sufficient to constitute participation in a private securities transaction?

The SEC analyzed it this way.  Love's clients came to him with specific investment goals and asked for help to accomplish those goals. None of Love's customers knew of Foster or Summit West before Love mentioned them, and, without his introduction, they would not have made the investments. See Keith L. Mohn, Securities Exchange Act Rel. No. 42144 (Nov. 16, 1999), 71 SEC Docket 198,at 203 (citing the fact that clients did not know about investments prior to representative's introduction as a factor in finding that representative participated in the transactions for purposes of Rule 3040). The SEC concluded that Love went further than merely passing along a telephone number. He effectively vouched for Foster, telling the customers that Foster was a close friend of Zirbel and that Zirbel, whom Love knew well from their prior work together, was considering going to work for Foster. In addition, Love told at least one customer of his own interest in investing with Foster during the initial conversation in which the customer's potential investment with Foster was discussed. He also facilitated the transfers of funds from the customers' PaineWebber accounts to Summit West to make the investments. When the customers had difficulty withdrawing funds from Summit West, Love interceded with Foster on their behalf.  Although the SEC emphasized that a broker who does nothing more than refer a customer to another investment opportunity should not ordinarily run afoul of Rule 3040, where, as here, the broker becomes involved in a customer's investment choice through a specific recommendation and by facilitating the mechanics of transactions,  such participation fits within the broad range of behavior prohibited by Rule 3040. Nonetheless, the NASD Sanction Guidelines for violations of Rule 3040 provide that fines ranging from $5,000 to $50,000, and a suspension ranging from ten days to a bar, depending on the severity of the violation. Love's thirty-day suspension falls on the low end of the range of potential suspensions under the Guidelines, and his fine falls at the mid-range. In fact, in reducing Love's suspension from ninety days, as recommended by the hearing panel, to thirty business days, the NASD National Adjudicatory Council recognized that his participation in his customers' Summit West transactions was not as great as that found in some other violations of Rule 3040. 

Q. Okay, but it seems clear that the customers were looking for more aggressive returns and would likely have gone elsewhere anyway.  Love disclosed the personal relationships, told them to independently investigate Summit, and tried to help his customers. So what's the big deal?  

The SEC held in Stephen J. Gluckman, Exchange Act Rel. No. 41628 (July 20, 1999), 70 SEC Docket 418, that the "responsibility to give notice under Rule 3040 does not hinge on whether the investors also independently discussed and negotiated the transactions with [the sponsor]." Rule 3040 serves not only to protect investors, but also to permit securities firms, which may be subject to liability in connection with transactions in which their representatives become involved, to supervise such transactions. Gilbert M. Hair and Vladimir Chorny, 51 S.E.C. 374, 378 (1993). Love's involvement in his customers' Summit West transactions was, in many respects, analogous to his involvement in any investments the customers made through PaineWebber, in that he made specific recommendations, vouched for the validity of the investments, and facilitated to some degree the transaction process. If the investments had been made through PaineWebber, however, PaineWebber would have had the ability to exercise its supervision to protect its customers. The notice provisions thus serve the interests of both the member firm employer and the investing public, to which the member firm is obligated.

Q. Isn't the key issue here the fact that Love's customers lost money?

Oddly, the answer is no. In Gilbert M. Hair and Vladimir Chorny, 51 S.E.C. 374, 378 (1993)., the SEC sustained a finding of violation of Rule 3040 in a "selling away" case in which the customers were apparently satisfied with their investments.

Q. Isn't this a First Amendment violation?  Doesn't anyone --- even an RR --- have the right to make a referral of a customer to another individual or entity?

The SEC notes that even if NASD were deemed to be a state actor, commercial speech, such as Love's referral of his customers to Summit West, receives a lesser degree of constitutional protection than do other forms of speech, and the restrictions on speech imposed by Rule 3040 are within the constitutional parameters set forth under applicable precedent. Martin Lee Eng, Exchange Act Rel. No. 44224 (Apr. 26, 2001), 74 SEC Docket 1194A, 1194D (First Amendment not applicable to NASD). See also Desiderio v. Nat'l Ass'n of Securities Dealers, Inc., 191 F.3d 198, 206-07 (2d Cir. 1999), cert. denied, 531 U.S. 1069 (2001)(NASD is not a state actor, and constitutional requirements generally do not apply to it).

STALE PROSECUTIONS

The record indicates that NASD filed its complaint against Love approximately seven years after Love initially referred one of his customers to Foster, approximately six-and-one-half years after the last of Love's customers made an initial investment in Summit West, approximately four years after the date that NASD learned of Love's potential participation in the transactions, and approximately three-and-one-half years after NASD commenced its investigation of Love. Love claims that NASD delayed in filing its complaint against him and, in doing so, rendered the proceedings unfair. The Exchange Act requires that self-regulatory organizations, such as NASD, provide a fair procedure for the disciplining of associated persons of member firms.15 U.S.C. § 78o-3(b)(8).

In recent years, the SEC has addressed the effect that a delay by a self-regulatory organization ("SRO") in the filing of a complaint against a representative may have on the overall fairness of proceedings against the representative. Jeffrey Ainley Hayden, Exchange Act Rel. No. 42772 (May 11, 2000), 72 SEC Docket 1125; William D. Hirsh, Exchange Act Rel. No. 43691 (Dec. 8, 2000), 73 SEC Docket 3597. These decisions, however, do not establish bright line rules about the impact of the length of a delay in filing a complaint on the fairness of the disciplinary proceedings. In William D. Hirsh, he SEC affirmed the consistently-held principle that no statute of limitations applies to disciplinary actions of SROs. For this reason, a comparison of the length of the time lags at issue in Jeffrey Ainley Hayden and Hirsh against the corresponding periods in this matter does not, in itself, resolve the fairness question here. The SEC notes that it has never employed a mechanical test and declines to endorse a de facto statute of limitations using the time frames presented by the facts in Hayden as limits defining the border of fairness in SRO proceedings. Although the SEC stated in Hayden that it was unable to find, as a factual matter, that the respondent's ability to mount an adequate defense had been prejudiced by the delay in his proceedings, the SEC determined that the record in this case clearly established that Love suffered no prejudice.

 

VERDICT

The disciplinary action taken by NASD against Mark H. Love was sustained.



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