SEC ISSUES THREE MAJOR DECISIONS ON AIDING AND ABETTING BY REGISTERED PERSONS:

Part One: The Broumas Scheme

On November 30, 1998, the Securities and Exchange Commission ("SEC") issued three separate Opinions addressing the appeals of three cases involving four registered persons and their liability for aiding and abetting a customer's manipulative scheme. We will analyze these cases in a multi-part series. This first installment will describe the scheme. Upcoming installments will describe the registered persons' roles, the regulatory/compliance issues involved, and steps you can take to avoid such entanglements.

On September 27, 1991, the SEC filed a Complaint alleging that from January 1989 through July 1990 John G. Broumas, former chairman of the board of Madison National Bank of Virginia ("MNBV") and a former director of James Madison, Limited ("JML"), a holding company for a family of banks, violated federal law by engaging in a manipulative scheme of marking the close and executing wash trades involving JML Class A common stock ("JML stock"). JML stock was listed on the American Stock Exchange ("AMEX"), but the trades at issue were executed in the over-the-counter market. SEC v. John G. Broumas, Civil Action No. 91-2449 (D.D.C.) Lit. Rel. No. 12999, (Sept. 27, 1991). Broumas consented, without admitting or denying the allegations, to the entry of a permanent injunction prohibiting him from future violations of Sections 9(a)(1), 9(a)(2), 10(b), and 16(a) of the Exchange Act and Rules 10b-5 and 16a-3 thereunder.

In November 1994, Broumas pled guilty to a federal Criminal Information charging him with misapplication of bank funds. The Information alleged that, from April through June 1990, Broumas engaged in a check-kiting scheme by writing checks against insufficient funds in order to meet margin calls. It also charged that Broumas improperly used his position as board chairman of MNBV to exchange personal checks drawn on falsely inflated balances for cashier’s checks in order to meet margin calls and pay other expenses. United States v. Broumas, Crim. No. 94-442 (D.D.C.) (Nov. 23, 1994).

Broumas was personally liable on more than $2,000,000 worth of notes to banks, had mortgage debt in excess of $900,000, and was having difficulty meeting the loan payments. He could not borrow more money from the JML banks because he had reached his credit limit. As a result of his inability to repay his liabilities, Broumas filed for personal bankruptcy in early 1991.

Broumas owned about 190,000 shares of JML stock ("JML stock"), which he held in about 25 margin accounts (including those of nominees). He controlled those accounts at 14 different broker-dealers.

From January 1989 through June 1990, Broumas engaged in the following activity:

Marking at the Close:

• Of those purchases, 54 were the last trade of the day and 47 of these trades were executed on an uptick.

Broumas' purchases at the close of trading had two beneficial results for him. First, the closing price is used to determine whether a given stock is marginable, whether a customer's account satisfies margin requirements, and the value of a customer's margin account. Each of these issues was of great importance to Broumas' accounts. Second, by influencing the closing price of JML stock, Broumas controlled the day-ending quote issued to the public and, by ensuring sufficient volume in the stock, he kept the stock "in play" by creating interest in its daily movement.

Broumas’ wash trades operated as a fraud and deceit on the marketplace by creating a deceptive appearance of market activity. Broumas’ creation of deceptive market activity was manipulative. As described above, a substantial number of the trades were in fact reported, giving false information to the market. On the days when the trades were reported, however, they were a substantial proportion of the daily volume. Broumas’ wash trades also were effected at a contrived price. While the prices of these trades were within the pre-existing trading range, the prices did not reflect the market’s view of the sale of such large blocks into the thinly-traded market for JML Class A common stock. The price did not reflect supply or demand, but simply Broumas’ trading with himself.

Broumas began to effectuate trades through a series of accounts in the names of relatives and business associates. The trades in these nominee accounts were placed by Broumas or at his direction, with funds provided by Broumas, and for Broumas’ benefit. Broumas instructed registered representatives on each side of the trades to contact one another and to trade a specified number of shares of JML stock at a specified price. Since Broumas’ stock was held in margin accounts, he was able to obtain the proceeds from a sale one day after the transaction was completed while he could wait at least five business days until the settlement date to pay for a corresponding purchase. When the settlement date arrived, he sometimes executed another set of wash trades or matched orders.

Is there anything wrong with opening multiple accounts for one customer?
Is the registered person accepting customer orders responsible to ensure their reporting?
Are you required to investigate unusual customer trading?
Does notifying your supervisors of unusual trading protect you?
If you have no actual knowledge of a crime, can you be charged with aiding and abetting?

For Future Reference:

In the Matter of Richard D. Chema, 34-40719, Admin. Proc. 3-8508 (November 30, 1998) In the Matter of Adrian C. Havill, 34-40726, Admin. Proc. 3-8510 (November 30, 1998)

In the Matter of Sharon M. Graham and Stephen C. Voss, 34-40727, Admin. Proc. 3-8511 (November 30, 1998).