Penny Stock 101

In November and December 1997, when Patterson Travis, Inc. ("the Firm") was making a market in the penny-stock Turner Group, Inc. ("TG"), Michael A. Rooms, who was a general securities principal and representative with the Firm, sold 2,425 shares of the stock to customers. Although Securities Exchange Act Rule 15g-1(e) exempts "transactions that are not recommended" from penny stock disclosure requirements, Rooms recommended (and sold) TG stock to at least three customers (Heasley, Contursi, and Debski). In violation of the Penny Stock Rules and NASD Conduct Rule 2110, these customers were not furnished with a risk disclosure document, nor were they told the amount of Rooms’ compensation (this allegation is unchallenged by Rooms). 

NASD 8210 Requests

Following an NASD examination of the Firm in April 1998, NASD sent David Travis, the Firm's owner and president, several requests for information pursuant to Procedural Rule 8210.  

1.  The initial May 26, 1998 request, asked, among other things, whether the Firm's TG transactions during the period November 1997 to February 1998 had been recommended to customers and, if not, that documentation be provided substantiating that claim. 

Travis replied on June 30, stating that all of the Firm's TG transactions were exempt from the penny stock rules because, among other things, the transactions had not been solicited. He supplied some customer letters to that effect, and stated that a few such letters were missing, and that he was trying to locate them. 

2.  On August 11, 1998, in response to a second NASD request, Travis supplied additional non-solicitation letters. 

3.  On May 28, 1999, NASD sent Travis a third request for information. NASD's letter noted that Travis had provided non-solicitation letters for only some of the accounts in question, and requested documentation in support of the exemption claimed for each of the accounts on NASD's attached schedule. The letter warned that a failure to respond completely could result in the imposition of sanctions. 

In June 1999, after receiving this letter, Travis asked Rooms to get signed non-solicitation forms from every customer who did not have one in his file. Rooms then contacted the three customers noted above. 

Rooms' Contacts Clients

Rooms called Heasley and told him that TG (whose stock had done poorly) had misled the Firm, and that, if Heasley would sign a document that Rooms was sending him and send it back within two days, Heasley would be compensated with stock worth the same amount as the amount he had invested in TG. The document that Rooms sent to Heasley, entitled "Affirmation of Non-Solicitation," noted Heasley's purchase of TG and the date of that purchase, November 21, 1997. Below that notation was a printed statement reciting that Heasley's purchase of TG had not been "solicited in any way, nor made on the basis of any recommendation or information from [the Firm], its research department, or any of its employees." Next to the signature line on this form, Rooms had entered the same date that appeared above, the date of Heasley's purchase of TG. Heasley wanted the stock that Rooms offered but was very uncomfortable signing a backdated form. Before sending the signed form back to Rooms, he added the date he actually signed it (June 25, 1999) both underneath his signature and next to the date that Rooms had entered on the signature line. However, when Rooms received the signed form from Heasley, he admittedly removed the 1999 dates before turning the form over to Travis. 

Rooms told Contursi that he knew that the price of TG had dropped, that TG had given the Firm inaccurate information, and that customers who had purchased TG were being compensated with additional stock. However, in order to get the additional stock, Contursi would have to sign the non-solicitation form that Rooms was sending him. After Contursi received the form, he noticed that it was backdated to the date of his TG purchase. He decided not to sign the document because his purchase of TG had been solicited, and he would not sign anything that was untrue. 

Rooms told Debski that, prior to Rooms' sale of TG, somebody connected with that company had given a presentation to the Firm that painted a rosier picture of TG's prospects than turned out to be the case. Rooms stated that Debski would be given enough additional shares of stock roughly to equal the price he had paid for TG, but that, in return for that stock, he would have to sign a document stating that his purchase of TG had not been solicited. Debski told Rooms not to send him the document because it was untrue, and Rooms did not send it. 

PENNY STOCK RULES

The Securities Exchange Act Rules 15g-1 thorugh 15g-9 essentially describe a "penny stock" as a speculative security that trades below $5 on the OTC Bulletin Board or the Pink Sheets (not the New York Stock Exchange or NASDAQ).  Before a broker-dealer can sell a penny stock, SEC rules require the firm to 

• approve the customer for the transaction;
• receive from the customer a written agreement to the transaction;.
• furnish the customer a document describing the risks of investing in penny stocks;
• tell the customer the current market quotation, if any, for the penny stock and the compensation the firm and its broker will receive for the trade. 

Additionally, the BD must send monthly account statements showing the market value of each penny stock held in the customer’s account.

NASD Business Conduct Rule 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.

NASD Procedural Rule 8210. 
Provision of Information and Testimony and Inspection and Copying of Books 

(a) Authority of Adjudicator and Association Staff : For the purpose of an investigation, complaint, examination, or proceeding authorized by the NASD By-Laws or the Rules of the Association, an Adjudicator or Association staff shall have the right to: 
(1) require a member, person associated with a member, or person subject to the Association's jurisdiction to provide information orally, in writing, or electronically. . . and to testify at a location specified by Association staff, under oath or affirmation administered by a court reporter or a notary public if requested, with respect to any matter involved in the investigation, complaint, examination, or proceeding; and 
(2) inspect and copy the books, records, and accounts of such member or person with respect to any matter involved in the investigation, complaint, examination, or proceeding. . . 

. . .

(c) Requirement to Comply: No member or person shall fail to provide information or testimony or to permit an inspection and copying of books, records, or accounts pursuant to this Rule. . . .

(d) Notice: A notice under this Rule shall be deemed received by the member or person to whom it is directed by mailing or otherwise transmitting the notice to the last known business address of the member or the last known residential address of the person as reflected in the Central Registration Depository. . . .

Public Customers Contursi and Debski did not testify at the hearing. Instead, their written declarations were introduced into evidence. Rooms objects to this as hearsay evidence. 

Contursi's and Debski's declarations were sworn and no evidence suggested that the customers in question were biased against Rooms; and their statements are mutually corroborative and consistent with the testimony of public customer Heasley, who testified at the hearing. 

The SEC found the two declarations reliable and probative. 

He was unaware of any NASD examination.  He thought he was simply assisting Travis in correcting the Firm's records.  At the time he contacted customers seeking their signatures on non-solicitation forms, he did not know that the forms would be turned over to NASD.

Rooms admitted in his Answer to the NASD's Complaint that when Travis instructed him to obtain non-solicitation letters from his customers, Travis told Rooms that NASD staff had requested this information. His answer also admitted that he gave the signed customer forms to Travis for submission to NASD staff. Notwithstanding, Rooms argued that the admissions in his Answer should be given "minimal weight" by the SEC since he could not afford counsel at the time and the Answer was drafted by Travis' attorney. 

The SEC gave weight to Rooms' admissions in his Answer, but said that for argument's sake, even if they didn't give those statements due consideration, the admissions were repeated and amplified in Rooms' testimony at the NASD hearing. Pointedly, Rooms testified that Travis told him that NASD was seeking the non-solicitation letters, and that was why Rooms was attempting to obtain them from his customers. Rooms also stated, "I'm sure I was aware there was an NASD examination going on in the Firm, and that's what (the non-solicitation letters) were being requested for." Rooms' claim that his testimony was based on what he learned subsequent to the period in question was contradicted by his own words at the hearing. 

Rooms argued that the NASD never invoked NASD Rule 8210 with respect to him personally. 

Rule 8210 gives NASD staff the right to require persons associated with member firms to supply information in connection with an NASD examination. Nonetheless, such a request was only first sent to Rooms personally in December 1999, several months after the period in question.  It is undisputed that, during the relevant period, Rooms never received any such notice. No request for information pursuant to Rule 8210 was ever directed to Rooms during that time. NASD's requests were directed to Travis, not Rooms. 

On its face, the language of Rule 8210 appears to limit its scope to obtaining information from, and ensuring compliance by, those persons and firms to whom such requests are directed. Liability under the rule may possibly extend to associated persons of a firm who are aware of an 8210 request directed to the firm and seek to falsify or impede the firm's response. Here, however, the record does not establish that, during the relevant period, Rooms was aware of the 8210 requests directed to Travis. Under the circumstances, the SEC was unable to conclude that Rooms violated Rule 8210 and would not sustain that portion of the NASD's decision. 

Rooms describes his conduct as nothing more than the procurement of documents for his employer, and states that he was merely an unwitting pawn in Travis' scheme to deceive NASD. He argues that a finding that he violated Rule 2110 would constitute a denial of due process since that rule did not give him fair notice that the conduct in which he engaged was prohibited.

The SEC viewed the evidence as showing that, with knowledge of NASD's pending examination, and aware that the form letters he was seeking to obtain from customers would be turned over to NASD, Rooms deliberately sought to deceive NASD with respect to his prior sales of TG. He offered bribes to his customers in an effort to get them to sign false non-solicitation forms, and backdated the forms to make it appear that they had been signed at the time of his sales. When one customer entered the actual date of signing on his form, Rooms deleted it. Finally,  Rooms' brief on appeal, states, "If . . . [I had been] . . . made aware of [NASD's] investigation . . . and thereafter acted intentionally to falsify documents to obstruct that investigation, [I] would undoubtedly have [had] reasonable notice that [my] conduct was prohibited." In fact, Rooms was aware of NASD's examination and sought to obstruct it. 

Due process requires that "laws give the person of ordinary intelligence a reasonable opportunity to know what is prohibited."  Rooms could hardly have been unaware that the deliberate deception he sought to practice on NASD did not comport with high standards of commercial honor and just and equitable principles of trade. The rule "has long obligated NASD members to cooperate with [NASD] in its effort to perform its regulatory functions." The SEC sustained NASD's finding that he violated Conduct Rule 2110. 

In arguing for a more lenient sanction, Rooms notes that

• during his 13 years in the securities business, he has no prior disciplinary record and has had no customer complaints;
• he acted without scienter;
• when he did receive an NASD request for information after the period at issue, he responded fully and truthfully; and
• his sanction is inconsistent with others imposed in more egregious circumstances, and that he is being held accountable for Travis' misconduct.

The SEC concluded that Rooms was not being disciplined for anyone's conduct but his own. His claim that he was an "unwitting pawn" who did not understand the wrongfulness of his conduct was rejected outright. Pointedly, the SEC ruled that Rooms sought to conceal his penny stock violations by supplying NASD with false information. 

Restating its long-held views that self-regulation requires cooperation of members and associated persons, the SEC admonished Rooms that his actions subverted the NASD's regulatory processes. Pointedly, the SEC warned that his conduct was worse than merely refusing to respond because he mislead the NASD. Moreover, the SEC agreed with the NASD that Rooms' subsequent truthful testimony provided him with little credit because it was essentially "capitulation after NASD staff learned of the misconduct from customer statements."

Notwithstanding that the SEC did not sustain the NASD's finding that Rooms violated Procedural Rule 8210, the remaining misconduct (described as "deliberate deception") was deemed sufficiently serious to warrant a Bar, and such was sustained.