UNITED STATES OF AMERICA
COMMODITY FUTURES TRADING COMMISSION
In the Matter of
First Commercial Financial Group, Inc.,
CFTC Docket No. 95-10
Opinion and Order
The Division of Enforcement ("Division") and respondent Mark Rehn ("Rehn") cross-appeal from an initial decision of an Administrative Law Judge ("ALJ") finding respondents First Commercial Financial Group, Inc. ("FCFG"), Rehn and John Hermanson ("Hermanson") liable for various net capital and reporting requirements under the Commodity Exchange Act ("Act") and Commission Regulations.1 The ALJ found Rehn liable as a controlling person for FCFG's violations and found Hermanson liable as an aider and abettor. The ALJ revoked the respondents' registrations and ordered them to cease and desist from further violations of the Act. He imposed a $200,000 civil penalty upon each of FCFG and Rehn and a $50,000 penalty on Hermanson.
Rehn asks that the Commission reverse all adverse findings against himself or, in the alternative, that it impose a minimal sanction. The Division's sole issue on appeal is the asserted insufficiency of the civil monetary penalties imposed below. For the reasons that follow, we affirm the findings and conclusions of the initial decision except that we increase the monetary penalties assessed against the respondents.
I. The Complaint
On May 2, 1995, the Division issued a four-count complaint against FCFG, an Illinois corporation registered as an FCM;2 Rehn, FCFG's president and chief executive officer; and Hermanson, who was registered as an associated person ("AP") of FCFG from May 1991 to May 1994.
Count I of the complaint alleged that, between June 1993 and August 1994, FCFG failed to maintain the minimum amount of adjusted net capital prescribed in Section 4f(b) of the Act, 7 U.S.C.§ 6f(b), and Commission Regulation 1.17(a)(1).3 Count I also charged that, during the period when FCFG was undercapitalized, it failed to transfer its customer accounts and immediately to cease doing business as required by Section 4f(b) of the Act and Commission Regulation 1.17(a)(4). Count I further alleged that Rehn should be held liable as a controlling person for FCFG's violations and that Hermanson was liable as an aider and abettor.
Count II charged that FCFG and Rehn violated Section 6(c) of the Act and Commission Regulation 1.10(d)(1) by willfully making false and misleading statements in periodic financial reports ("1-FRs") filed with the Commission.4 Count II named Hermanson as an aider and abettor.
Count III alleged that FCFG did not comply with Commission Regulations 1.12(a)(1)-(2), which require an FCM to notify the Commission and to provide certain financial information when the FCM knows or should know that it is undercapitalized.5 Count IV claimed that FCFG violated Commission Regulation 1.12(b) by failing to notify the Commission when it knew or should have known that it was in an "early warning net capital position."6 Counts III and IV maintained that Rehn controlled FCFG and was therefore liable as a controlling person.
The allegations in the complaint stemmed from financial arrangements that FCFG entered into with Hermanson and another individual, Robert Schillaci, and with two financial entities, Burling Bank and Dearborn Financial Corporation. The complaint challenged the manner in which FCFG accounted for these financial arrangements when it computed its monthly net capital position in financial statements filed with the Commission for reporting periods concluding between June 30, 1993, and August 31, 1994.
II. The Hearing
A six-day hearing was held on December 16-19, 1996, and March 19-20, 1997, in Chicago, Illinois. At the hearing, the Division presented its case through submission of FCFG's 1-FRs and other financial audit reports, loan documents, and transaction records such as wire transfers, bank statements and check receipts. To determine FCFG's actual capital position from June 30, 1993, to August 1994, the Division had its expert witness, Walter Maksymec, make certain adjustments to the adjusted net capital that FCFG reported in its 1-FRs or showed on its monthly capital computations. (Div. Exh. Nos. 1-2; FCFG Exh. No. 89.) According to the adjustments made by Maksymec, FCFG fell below its early warning threshold in June 1993 and operated below the required minimum net capital for twelve consecutive months, from September 1993 through August 31, 1994. Based on Maksymec's calculations, the amounts below excess early warning ranged from $294,394 to $3,267,890 during this time. The amounts below net capital ranged from $83,479 to $2,630,286. Id.
Rehn testified that he has a law degree, a CPA license and a bachelor's degree in accounting. (Tr. at 30.) He supervised FCFG's financial and compliance activities during 1993 and 1994. (Id.) Prior to Rehn's tenure as FCFG's president in 1993, the FCM had a history of losing money and required repeated capital infusions from its investors. (Tr. at 10, 177-179.)
Hermanson testified that he headed First Trading Group ("First Trading"), a guaranteed introducing broker that in 1991 became a subdivision of FCFG. (Tr. at 368-369; 388.) According to Hermanson, First Trading and FCFG had an understanding that, after First Trading deducted its clearance fee to FCFG, expenses and revenues were to be divided equally between them. (Tr. at 744.) During his employment as an AP at FCFG, Hermanson contributed substantially to FCFG's overall profits. (Tr. at 195-196, 793, 836.)
Hermanson testified that he saw his relationship with Mark Rehn as an informal joint venture: "[I do] him a favor, he [does] me a favor, whatever. It was a partnership." (Tr. at 370-373.) Hermanson admitted to having a pattern, beginning in 1992, of taking large "advances" from FCFG that remained unpaid for several months. (Tr. at 392-395; Div. App. Br. at 6.) Hermanson argued that these advances were offset against his commissions and that it was not entirely clear whether he had unpaid debts to FCFG or FCFG owed him money. (Tr. at 372-373; 390.)
Rehn testified that he acted on FCFG's behalf and extended several loans to Hermanson because he was under pressure at FCFG to retain a "large producer" such as Hermanson. (Tr. at 46; Resp. App. Br. at 10.) Rehn admitted that at one point he executed a letter to Hermanson's debtors guaranteeing that FCFG would repay Hermanson's debt in the event of the latter's default. (Div. Exh. No. 123;Tr. at 53.)
In June 1993, Rehn asked Mike Rohlfs, FCFG's managing director, for a capital infusion of $1,000,000 to avoid a violation of the "early warning" requirement caused by the NFA's reclassification of two of FCFG's loans from current to non-current status. (Div. Exh. No. 121; FCFG Exh. No. 89.) Rehn received only $300,000 from Rohlfs. (Tr. at 41.) FCFG then notified the Commission that it fell below the early warning threshold. (Div. Exh. No. 95; FCFG Exh. No. 89.)
a. The Month-End Transactions. At this time Rehn and Hermanson began a pattern of transactions that continued through December 1993. On or about the last business day of each month, from June 1993 to December 1993, Hermanson would write large checks to FCFG drawn on accounts under his control, with amounts ranging from $275,000 to $1,300,0000. (Div. Exh. No. 2; Tr. at 48-50; 64-66; 200-209.) These month-end checks were written against insufficient funds. (Div. Exh. Nos. 8, 16, 25; Tr. at 204-206; 355-361.)
FCFG deposited the checks in its operating bank account, thereby increasing its operating bank account balance and decreasing Hermanson's loan receivable. (Tr. at 141.) FCFG admitted that it classified the monthly balance in its operating bank account as a current asset and the remainder of Hermanson's alleged unpaid debt as a non-current asset.7 (Div. Exh. No. 1 (w/ attached Maksymec Test. at 9); Tr. at 141.) Accordingly, the effect of these notations was to increase FCFG's adjusted net capital by the amount of the Hermanson checks received at month end. (Id.; Tr. at 59-60; 637, 639-640.)
On the first business day of the following month, FCFG would wire the same amount of funds back to Hermanson. (Div. Exh. Nos. 1-2; Tr. at 47-50.) These transfers from FCFG prevented Hermanson's checks from being returned for insufficient funds. When FCFG transferred the funds back to Hermanson's accounts it decreased its operating bank account balance and increased Hermanson's alleged loan receivable. (Tr. at 141.) However, FCFG included Hermanson's checks in computing its adjusted net capital on its 1-FRs and its monthly capital computations, thereby representing to the Commission that it was operating above the early warning threshold and the regulatory capital requirements during these months. (Div. Exh. No. 1 ( Maksymec Test. at 9); (Tr. at 60; 141-142, 144-146.)8
Rehn and Hermanson gave conflicting testimony concerning these transactions. Rehn testified that Hermanson's checks were intended as payments on his alleged loan receivable and that they occurred at the end of the month by Hermanson's choice. (Tr. at 63-66.) According to Rehn, Hermanson always approached FCFG on the first of the following month claiming he had insufficient funds in his accounts to cover the checks and requesting that FCFG transfer the funds back to his accounts. Id. Rehn testified that, even though FCFG returned the funds to Hermanson at the beginning of the next month, Rehn believed FCFG could include the checks in its current assets as short-term loan receivables for that month because Hermanson promised to repay FCFG by the end of the month. (Tr. at 59.) However, at one point Rehn admitted that the month-end transactions "didn't look too good" from the standpoint of FCFG's auditors. (Tr. at 804.)
Hermanson testified that the month-end checks were loans that he made to FCFG at Rehn's request and that FCFG's wire transfers at the beginning of each month represented its repayments of the loans to him. (Tr. at 375-378.)
b. The Burling Bank Loan. On July 30, 1993, FCFG and Hermanson signed a promissory note for $650,000 with Burling Bank.9Hermanson signed the note as "borrower," while Rehn signed the note as FCFG's president and "co-signer." (Div. Exh. No. 92.) Hermanson instructed Burling Bank to disburse the loan proceeds to FCFG, which subsequently deposited the proceeds into its operating bank account. (Div. Exh. No. 119; FCFG. Exh. No. 5.)
FCFG did not count the loan as a liability in its capital computations or in its 1-FRs. If FCFG had treated the Burling Bank loan as a liability and excluded Hermanson's month-end checks from its calculation of current assets, then its net capital computations would have revealed that it was in early warning status for the periods ending July 31, 1993, and August 31, 1993, and was undercapitalized for the periods ending September 30, 1993, through December 31, 1993. (Div. Exh. No. 1.)
Rehn and Hermanson again gave conflicting testimony regarding the Burling Bank loan. Rehn testified that Hermanson owed approximately $650,000 to FCFG by July 1993 and therefore gave FCFG the Burling Bank loan proceeds as a repayment on his debts to FCFG. (Tr. at 753, 757-758, 763.) Rehn also testified that he believed that FCFG was a guarantor--not a joint obligor--on the loan. Therefore, according to Rehn, FCFG had no liability on the loan "whatsoever" because loan payments made by FCFG to Burling Bank would be derived from Hermanson's commission income. (Tr. at 84, 86-87, 754-757.) FCFG paid approximately $225,000 on the loan, including certain payments after Hermanson had left FCFG. (Div. Exh. No. 1 (Maksymec Test. at 14); Tr. at 572.) Burling Bank treated FCFG as a joint obligor. In December 1994, Burling Bank seized $40,000 from a FCFG account at the bank and applied that sum toward the remaining balance of the loan. (Tr. at 573, 652.)
Hermanson, on the other hand, testified that he signed the note as another "favor" to Rehn because FCFG needed money for its legal bills and could not obtain a loan in its own name. (Tr. at 371-373.)
c. The Hermanson and Schillaci Unsecured Notes. In January 1994, Hermanson signed a blank promissory note and a stock pledge agreement by which he purportedly agreed to pay FCFG $1,300,000 and pledge his interest in a Chicago fast food restaurant to secure the note. (Tr. at 150, 154-155; 249-251.) The date and amount on the promissory note allegedly were filled in later by someone at FCFG. (Div. Exh. No. 99; Div. Exh. 122; Tr. at 150-151, 249.) At the time Hermanson signed the promissory note, FCFG learned that the stock was not available and therefore could not be delivered. The stock was not listed on any exchange.10 (Tr. at 501, 723.) FCFG never attempted to obtain control of the stock or perfected an interest in it. (Tr. at 155; 249.) FCFG admitted that it improperly treated Hermanson's note as a secured loan receivable--i.e., a current asset--in its net capital computations and the 1-FRs. (Tr. at 155.) FCFG also admitted that the promissory note signed by Hermanson replaced the month-end checks. (Tr. at 151-152.)
In February 1994, FCFG loaned Robert Schillaci $250,000, for which Schillaci used his seat on the Chicago Mercantile Exchange as collateral.11 FCFG treated the loan as a secured receivable and thus a current asset, despite the fact that Commission Regulation 1.17 and instructions on the 1-FR specifically provide that FCMs should not treat exchange seats as current assets. (Div. Exh. No. 132 containing 1-FR instructions at 2-4; Tr. at 493-494). See also Commission Rule 1.17(c)(2)(x).
FCFG retained the accounting firm of Deloitte & Touche ("Deloitte") to prepare a financial audit for the time period ending December 31, 1993. On March 28, 1994, Deloitte issued its report, noting under the heading "subsequent event" that FCFG "extended unsecured demand loans to [Hermanson and Schilacci] totaling $1,615,000." (Div. Exh. Nos. 102, 115.) Rehn realized that, if the notes were treated as unsecured loan receivables and thus excluded from its current assets computation, then FCFG was undercapitalized for the "as of" periods ending January 31, 1994 through March 31, 1994. (Tr. at 91-92, 788-789.) Nevertheless, FCFG continued to reflect the notes as current assets in its 1-FRs until April 1994 when the NFA ordered it to reclassify the notes as non-current assets. (Tr. at 92-93; 157.)
d. The Dearborn Loan. In April 1994, following the reclassification of the Hermanson and Schillaci notes, Rehn notified the Commission and the NFA that FCFG fell approximately $964,000 below the minimum net capital requirements. (Div. Exh. No. 96.) Dearborn, a shareholder of FCFG, transferred stock and cash to FCFG's operating account. (Div. Exh. No. 105.) FCFG represented to the Commission and NFA and in its 1-FRs that the infusion was additional paid-in capital. (Div. Exh. Nos. 106-107.) NFA repeatedly demanded that FCFG submit supporting documents to certify that the infusion was permanent capital and not a loan from Dearborn. (Div. Exh. Nos 106, 109; Tr. at 423-426.) Three months later, at the end of July 1994, FCFG delivered draft subordination agreements to the NFA to certify that the infusion was indeed a loan and not permanent capital.12 (Div. Exh. No. 108; Tr. at 427-427.) The loan subordination agreements did not conform with NFA rules and were not approved by the NFA until September 1994. (Div. Exh. No. 111.) The NFA, however, found that these agreements contained conditions that excluded them from being considered as secured loan receivables or current assets in FCFG's capital computation. Id.
If FCFG had accounted properly for the Dearborn loan, its net capital computations would have revealed that it was undercapitalized for the "as of" periods ending April 30, 1994, through August 31, 1994. (Div. Exh. No. 1.)
III. The Initial Decision
In October 1997, the ALJ issued an initial decision concluding that the Division had proven by sufficient evidence that respondents violated net capital and reporting requirements substantially as alleged in the Complaint.13 The ALJ also found that respondents' conduct was conscious, willful and tantamount to "a fraud on the investing public." (I.D. at 45-48.) In addition, the ALJ characterized FCFG's and Rehn's testimony variously as "revisionist," "feeble," "foolhardy" and "lacking in good faith," noting that FCFG's and Rehn's conduct at the hearing exhibited little appreciation for the gravity of their actions. (I.D. at 37-38, 48.) The ALJ imposed registration revocations and cease and desist orders on all three respondents. (I.D. at 50-51.) He imposed $200,000 in civil monetary penalties on each of FCFG and Rehn and $50,000 on Hermanson.
IV. The Appeals
In November 1997, the Division, Rehn and Hermanson filed timely notices of appeal. FCFG filed a tardy notice of appeal beyond the 15-day rule prescribed by Commission Regulation 10.102(a), 17 C.F.R. § 10.102(a) (1998). The Division filed a motion to dismiss FCFG's appeal for failure to show excusable neglect, and in December 1997, the Commission granted the Division's motion on that ground. The Division and Rehn subsequently filed appeal briefs. Hermanson did not file a brief and therefore failed to perfect his appeal.
On appeal, Rehn challenges the ALJ's findings and conclusions with respect to the various transactions and contends that he acted reasonably and in good faith at all times. Rehn argues that FCFG's and his alleged violations, if any, were technical in nature and were committed in good faith or were caused largely by Hermanson's conduct. (Rehn App. Br. at 40-45.) In addition, he argues that he was not the controlling person with respect to the capital contribution provided to FCFG in April 1994 by its owners and played no part in structuring the transaction. (Id. at 45-47.) Finally, Rehn contends that the sanctions imposed were too severe because any misconduct that occurred did not cause "a remote threat of harm to the public" or result in customer losses. (Id. at 48-50.)
The Division, in its appeal, argues that the ALJ's sanctions analysis is flawed to the extent it is based on theories of customer loss. The Division contends that, as with trade practice cases and speculative position limit cases, respondents' violations are sufficiently grave to warrant severe sanctions in the absence of significant customer loss, because these kinds of misconduct put customer funds at risk, undermine consumer confidence, and undercut market integrity. (Div. App. Br. at 23.) The Division seeks a civil penalty of $3,800,000 against FCFG, a $533,000 civil penalty against Rehn, and a $200,000 civil penalty against Hermanson for his role as an aider and abettor. (Div. App. Br. at 27-28.)14 Rehn and FCFG oppose d the Division's appeal.
Rehn's Appeal. In seeking appellate relief, Rehn reiterates the version of events that he presented before the ALJ and the ALJ rejected. Our review of the record and the parties' appellate submissions establish that the findings and conclusions of the ALJ with respect to Rehn's liability are supported by the weight of the evidence; we therefore adopt them and affirm his findings as to Rehn's misconduct without extended discussion.
The Division's Appeal. The sole issue raised by the Division is the proper assessment of civil money penalties against the respondents. Section 6(c) of the Act, 7 U.S.C.§ 9, provides in pertinent part that the Commission may assess civil penalties of "not more than the higher of $100,000 or triple the money gain" of violators "for each . . . violation." In assessing monetary penalties, we are not bound by the ALJ's previous assessments but instead review de novo "the total 'facts and circumstances' of each case" as they relate to the gravity of a respondent's particular misconduct. In re Grossfeld, [1996-1998 Transfer Binder], Comm. Fut. L. Rep. (CCH) ¶ 26,921 at 44,467 (CFTC Dec. 10, 1996). Factors we have considered relevant to the gravity of particular misconduct include: (1) the relationship of the violation at issue to the regulatory purposes of the Act; (2) respondent's state of mind; (3) the consequences flowing from the violative conduct; and (4) respondent's post-violation conduct. Grossfeld, ¶ 26,921 at 44,467-68. We also have held that civil money penalties should be sufficiently high to deter future violations, that is, to "make it beneficial financially [for a respondent] to comply with the requirements of the Act and Commission regulations rather than risk violations." Id. at 44,468 (quoting In re Premex, [1987-1990 Transfer Binder], Comm. Fut. L. Rep. (CCH) ¶ 24,165 at 34,892-93 (CFTC Feb. 17, 1988)).
Our independent assessment of the record establishes that significant civil money penalties are warranted for respondents FCFG, Rehn and Hermanson. We find that respondents' misconduct posed a grave danger to customers and the market and, as the ALJ stated, was "tantamount to a fraud on the investing public." The ALJ's civil penalties--$200,000 each for FCFG and Rehn and $50,000 for Hermanson--do not fully reflect the gravity of their violations.
As the record shows, respondents' net capital and reporting violations are part of a calculated, long-term scheme to evade Commission regulatory requirements. While net capital and reporting requirements are designed to avert harm, they represent critical check points in the Commission's maintenance of safety and soundness of customer funds and the market. In the past, we have raised the dual concerns of customer protection and market integrity, finding that "minimum capital requirements are of central importance because they are the primary financial protection for public customers . . . . If customers cannot commit their funds to the market with confidence, the liquidity of the market will be irreparably harmed." Premex, ¶ 24, 165 at 34,891. Accordingly, we have held that "the general gravity of this type of violation is very severe." Id.; see also In re Incomco, Inc. [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,198 at 38,536 (CFTC Dec. 30, 1991) ("we have . . . recognized as quite serious . . . violations [that include] deliberate conduct intended to circumvent Commission reporting requirements . . . [such as] filing inaccurate financial reports and assisting an FCM to continue operations while undercapitalized") (citations and footnotes omitted). In this case, for eight consecutive months, from September 1993 to April 1994, FCFG actively concealed from the Commission that it failed to meet the Commission's minimum capital requirements by substantial deficits ranging from over $83,000 to $2,630,000.
State of mind is another crucial factor in assessing the gravity of a respondent's violative conduct. Grossfeld, ¶ 26,921 at 44,467; In re Rousso [Current Transfer Binder], Comm. Fut. L. Rep. (CCH) ¶ 27,133 at 45,310 (CFTC Aug. 20, 1997). This factor addresses "the context of violations, specifically the intentional or willful nature of a violation." See A Study of CFTC and Futures Self-Regulatory Organization Penalties, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,264 at 42,220 (CFTC November 1994) ("Penalty Study"). As we have held in Grossfeld, "[a] respondent who makes a mistake in the face of an ambiguous statutory duty is less culpable than a respondent who knowingly and repeatedly violates the same statutory provision in an effort to gain a competitive advantage." Grossfeld, ¶ 26,921 at 44,467 n.29. This is not a case of statutory ambiguity. Respondents' improper intent is apparent from incriminating evidence in this case and from the utter implausibility of their explanations. For example, in an effort to explain away the pattern of the month-end transactions, FCFG and Rehn offered a variety of strained, often ludicrous explanations of how Hermanson's "loan payments" were properly classified as current assets and therefore appropriately treated as part of FCFG's capital. Respondents would have us believe that in a six-month period 31 matching wire transfer and check receipt sequences occurred between FCFG's and Hermanson's bank accounts as a matter of happenstance and coincidence.
Nor did the month-end transactions take place in isolation. FCFG's accounting treatments of the Burling loan, the Hermanson and Schillaci notes and the Dearborn loan, seen in the aggregate with the month-end transactions, demonstrate a systematic scheme to deceive the Commission and the NFA. Such deceit practiced upon the entities charged with oversight of the futures industry poses a grave threat to the integrity and effectiveness of the regulatory scheme put in place by Congress.
The third factor that bears on the gravity of respondents' misconduct is the "consequences flowing from the violative conduct." Rousso, ¶ 27,133 at 45,310. In his initial decision, the ALJ noted that FCFG and Rehn's conduct "did not have disastrous consequences" in that FCFG's customers "did not lose any funds." I.D. at 49-50. However, as noted in the Penalty Study in a similar context, we have held that, "even in the absence of fraud, deceit or direct injury to customers, trade practice violations are more than `mere technicalities' and have been determined by Congress to be `malum in se.'" Penalty Study, ¶ 26,264 at 42,220. Similarly, in this case, respondents' misconduct constitutes a serious threat to the security of customer funds and the financial stability of the market regardless of whether customer loss occurred. As discussed above, respondents' net capital and reporting violations are sufficiently grave to warrant severe penalties because such violations put customer funds at risk, undermine public confidence, and undercut market integrity.
Despite telling evidence that demonstrates the deliberate nature of their misconduct, respondents FCFG and Rehn have shown little or no appreciation for the gravity of their actions, either claiming that their multiple violations were the results of Hermanson's attempt to defraud FCFG or maintaining that accounting errors were created through "good faith" carelessness. (Rehn App. Br. at 40-45; FCFG Ans. Br. at 61-62.) Their attitude constitutes an aggravating factor. At the hearing, Hermanson, while admitting that he was doing "something wrong" with the series of month-end transactions, stated that he does not know exactly what was wrong "in doing a favor for somebody." (Tr. at 375-76, 379.) Hermanson's token admission of the wrongfulness of his action does not constitute mitigating evidence.
Accordingly, to reflect properly the gravity of respondents' misconduct, we conclude that FCFG and Rehn each should be individually assessed a civil penalty of $400,000. Hermanson is assessed a civil penalty of $200,000.
We affirm the ALJ's imposition of cease and desist orders against respondents and the revocation of their registrations and impose civil monetary penalties in the amounts set forth herein.
IT IS SO ORDERED.15
By the Commission (Chairperson BORN and Commissioners HOLUM, SPEARS, and NEWSOME).
Jean A. Webb
Secretary of the Commission
Commodity Futures Trading Commission
Dated: May 20, 1999
1 Commission regulations cited herein are codified at 17 C.F.R. Part 1 (1998). When a rule has been amended recently, the text of the opinion summarizes the substantive provisions of the rule in force at the relevant time.
2 FCFG had transferred all of its customer accounts to other FCMs at the end of 1994 and is currently inactive. (Tr. at 857.)
3 An FCM's adjusted net capital is calculated in two steps: first, by deducting total liabilities from total current assets to arrive at net capital and then by deducting certain charges as a cushion against potential decreases in market value to arrive at adjusted net capital. See Commission Regulation 1.17(c)(1)(i)-(iv).
Commission Rule 170.15 requires all entities registered as FCMs to become and remain members of a self regulatory organization, in this case the National Futures Association ("NFA"). At the time of the violations, Commission Regulation 1.17(a) established $50,000 as the minimum dollar amount of adjusted net capital for all registered FCMs. The NFA, since December 1990, has established $250,000 as the minimum dollar amount of adjusted net capital for member FCMs who carry customer funds. In 1996 the Commission revised Regulation 1.17 to increase the amount from $50,000 to $250,000 for all registered FCMs to harmonize its minimum financial requirements with the prevailing standards established by the NFA.
At the time of the violations, Commission Regulation 1.10(b) required an FCM to file quarterly unaudited financial reports with the Commission on a Form 1-FR-FCM ("1-FR") by no later than 45 days after the "as of" date (i.e., the date for which the report is made) and to file an audited report, certified by an independent public accountant, within 90 days after the close of its fiscal year.
5 At the time of the violations, Commission Regulation 1.12(a) required an FCM to give telegraphic notice to the Commission within 24 hours of the FCM's determination that its adjusted net capital is less than the minimum required by the Commission, followed by the filing of a statement of financial condition and other financial reports.
6 Commission Regulation 1.12(b) requires a written notice to the Commission and the NFA within five days of the FCM's determination that its adjusted net capital has fallen below the early warning level, i.e., when its adjusted net capital is less than the greater of (a) 150% of the minimum amount specified in Commission Regulation 1.17(a)(1)(i) or (b) 6% of customer funds required to be held in segregated accounts.
7 FCFG's accounting treatment of the month-end transactions, in effect, circumvented the requirements of Commission Regulation 1.17. Commission Regulation 1.17(c)(2) defines current assets to include cash and other resources commonly identified as those which are reasonably expected to be realized in cash or sold during the next 12 months, excluding all unsecured receivables, advances and loans.
8 The amounts of checks written by Hermanson and deposited into FCFG's account totaled $650,000 for June 1993. This amount, plus the $300,000 capital infusion that FCFG received from Rohlfs, brought it into compliance with the Commission's net capital requirements for June 1993.
9 The July 30, 1993 note had a maturity date of September 30, 1993. On that date, Hermanson signed a second promissory note for $685,000 with a maturity date of June 30, 1994. Rehn did not sign the second promissory note until February 1994. As with the first note, Hermanson was listed as the "borrower" and Rehn as the "co-signer." (Div. Exh. No. 93; Tr. at 759-761.) On June 30, 1994, Hermanson signed a third promissory note in the amount of $510,000 with a maturity date of March 1995. Although the designation "Co-signer: First Commercial Group, Inc." is typed at the bottom of the document, Rehn did not sign the third promissory note. (Div. Exh. No. 94.)
10 Commission Regulation 1.17 expressly incorporates the definition of "readily marketable" found in SEC Rule 240.15c3-1(c)(11). A "ready market" includes a "recognized established securities market in which there exist independent bona-fide offers to buy and sell." See Commission Regulation 1.17(c)(2)(iv)(B). Hermanson's stock pledge agreement offers collateral that is not readily marketable and therefore cannot be treated as a secured loan receivable--i.e., a current asset--pursuant to Commission Rule 1.17.
11 When Schillaci pledged his CME seat as collateral for the FCFG loan, the seat already was encumbered by a prior loan. In June 1993, Schillaci had pledged it as a security for a $300,000 loan from Burling Bank to Schillaci and Hermanson. (Div. Exh. No. 110; Tr. at 80-84; 665.)
12 Commission Regulations 1.17(c)(4)(i) and 1.17(h)(3)(vi) provide that an FCM may exclude a loan from its liabilities computation if the loan is subordinated to the claims of its general creditors--i.e., if the loan is secondary to all other loans listed on its books--and if the subordination agreement is approved by the NFA. A subordination agreement may be in the form of a secured demand note agreement. If it is a proper secured demand note agreement, then it can be treated as a current asset in an FCM's net capital computation.
13 The ALJ in effect incorporated the Division's allegations into his initial decision, except for two "technical" findings that do not change respondents' overall liability as alleged in the four-count Complaint. Under Count I, the ALJ found that Hermanson was liable as an aider and abettor for FCFG's violations under Section 4f(b) of the Act and Commission Regulation 1.17(a)(4) (operating while undercapitalized), but not for FCFG's violations under Commission Regulation 1.17(a)(1) (falling below the minimum capital requirements). (I.D. at 44.) Under Count IV, the ALJ found that FCFG violated Commission Rule 1.12(b), and that Rehn was liable as a controlling person, for failing to notify the Commission of FCFG's early warning position in two instances only, in July and August 1993, instead of 14 instances--monthly from July 1993 to August 1994--as alleged by the Division's complaint and demonstrated by Maksymec's testimony. (I.D. at 46; Div. Exh. 1.)
14 The Division calculated its penalty request against FCFG as follows: under Count I, FCFG was found liable for operating while undercapitalized during 12 months, giving rise to 12 violations of the Act and Commission rules; under Count II, FCFG filed 13 false and misleading 1-FRs with the Commission, giving rise to 13 violations; under Court III, FCFG failed to provide the Commission with notice of its undercapitalization on 11 occasions, giving rise to 11 violations; and under Court IV, FCFG failed to provide the Commission with notice of its early warning position in each of the two months when such notice was required. The Division asks the Commission to impose a $100,000 penalty for each of the foregoing 38 violations.
With respect to Rehn, the Division asks the Commission to impose a $100,000 penalty for allowing FCFG to operate while undercapitalized plus $433,000 for signing false 1-FRs on 13 separate occasions. FCFG filed only 13 1-FRs for the "as of" periods ending June 1993 through August 1994, omitting the October and November 1993 filings. Generally, an FCM is required to file quarterly 1-FRs with the Commission unless its adjusted net capital falls below the early warning threshold during a given month, at which time the FCM is required to file a monthly 1-FR at the end of that month and each month thereafter until three successive months have elapsed during which the FCM's adjusted net capital has been shown to equal or exceed the early warning level. (Commission Rule 1.12(b); see also I.D. at 5-6.) FCFG notified the Commission of its early warning position in June 1993. (FCFG Exh. No. 89.) It filed monthly 1-FRs for the "as of" periods ending June 30, 1993, through September 30, 1993. FCFG did not file 1-FRs for the "as of" periods ending October 30, 1993, through November 30, 1993, representing that its adjusted net capital was above the early warning level. FCFG subsequently filed a quarterly 1-FR for December 1993.
15 A motion to stay the effect of the decision pending reconsideration by the Commission or notice of appeal seeking review by the relevant United States Court of Appeals must be filed within 15 days of the date this order is served. See Section 6(c) of the Act, 7 U.S.C. § 9 (1994) and Commission Regulation 10.106, 17 C.F.R. §10.106 (1998).