S.E.C. v. Slocum, Gordon & Co.

• Decision Date: 28 September 2004
• Docket Number: C.A. No. 02-367L.
• Citation: 334 F.Supp.2d 144
• Court: U.S. District Court — District of Rhode Island
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. SLOCUM, GORDON, & CO.; John J. Slocum, Jr.; and Jeffrey L. Gordon, Defendants.

Page 144

334 F.Supp.2d 144

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. SLOCUM, GORDON, & CO.; John J. Slocum, Jr.; and Jeffrey L. Gordon, Defendants.

C.A. No. 02-367L.

United States District Court, D. Rhode Island.

September 28, 2004.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Luke T. Cadigan, Esq., Dawn A. Edick, Esq., Frank Huntington, Esq., Beth Lehman,

Esq., Ian D. Roffman, Esq., Boston, MA, for Plaintiff.

Deming E. Sherman, Esq., Patricia A. Sullivan, Esq., Annemarie M. Carney, Edwards & Angell, Providence, RI, for Defendants.

DECISION AND ORDER

LAGUEUX, Senior District Judge.

The Plaintiff in this case, the Securities and Exchange Commission ("SEC" or "Commission") brought a civil suit against the investment firm of Slocum, Gordon, & Co. ("SG & C") and its two founding partners, John J. Slocum, Jr. ("Slocum") and Jeffrey L. Gordon ("Gordon"). The Commission's chief allegation against these Defendants is that they defrauded both the SEC and their clients between the years 1996 and 2000 through a practice commonly called "cherry picking," whereby certain stocks were initially purchased for clients and later re-allocated to the SG & C firm account if the stocks went up in value prior to the settlement date.

In addition to the Commission's cherry picking allegations, the SEC claims that Defendants engaged in fraudulent or deceptive conduct by a registered investment advisor by improperly commingling client funds and securities with firm funds and securities, breaching its record-keeping requirements, and making material misrepresentations and omissions, both in interactions with clients and in filings with the SEC. According to the Commission, Defendants' conduct and office practices resulted in violations of federal securities laws. The SEC also asserts separate claims against Defendants Slocum and Gordon, alleging that they individually aided and abetted all securities violations committed by their firm.¹

These various claims make up an eight count complaint filed by the Commission, alleging violations of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77q(a), the Securities Exchange Act of 1934 ("Exchange Act") 15 U.S.C. § 78j(b), and the Investment Advisers Act of 1940 ("Advisers Act"), 15 U.S.C. §§ 80b-4, 80b-6(1)-(4), and 80b-7. The SEC also alleges violations of certain regulations promulgated under these statutory provisions. See 17 C.F.R. §§ 240.10b-5; 275.204-2(a)(3); and 275.206(4)-2(a)(2).²

Although plead generically in the Commission's complaint, it is helpful for this writer to further categorize these different counts as they relate to the various forms of fraud alleged against Defendants. Counts 1 and 2 are counts under the anti-fraud sections of the Securities Act and the Exchange Act, and relate only to the SEC's allegations of securities fraud by way of cherry picking favorable securities for the firm's benefit. Counts 3, 4, 5, and 6 are brought under the Advisers Act, and are technical counts regarding organizational structure of the firm's account system, its operation practices during the relevant time period, and the Defendants' obligation as fiduciaries to disclose material facts to their clients and the SEC. Counts 7 and 8 are aiding and abetting counts, and, as such, only apply if liability is found under one or more of the other claims in the Commission's complaint.

After conducting a trial in this case without a jury, and then reviewing the trial testimony, exhibits, and the parties' post-trial submissions, the Court now renders a decision in this case. As to Counts 1, 2, 5, 6, 7, and 8, the Court finds that the Commission failed to meet its burden of proof, and renders a decision on these counts in favor of Defendants. However, for the reasons articulated herein, the Court finds in favor of the Commission on Count 4 and in part on Count 3. Based on the evidence submitted, the Court concludes that Defendants did improperly commingle client funds and securities with firm funds and securities, in violation of Section 206(4) of the Advisers Act and Rule 206(4)-2(a)(2) thereunder. See 15 U.S.C. § 80b-6(4); 17 C.F.R. § 275.206(4)-2(a)(2). Although this technical violation was not willful, the Court finds that the commingling of client and firm assets created a potential conflict of interest, which Defendants, as fiduciaries, were required to disclose to their clients regardless of their lack of intent to defraud. See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 196-97, 84 S.Ct. 275, 11 L.Ed.2d 237(1963). As a result, the Court finds that Defendants engaged in a course of business which "operated as a fraud" upon their clients, in violation of Section 206(2) of the Advisers Act. 15 U.S.C. § 80b-6(2).

I. Bench Trial Standard

Following a bench trial, "the court shall find the facts specifically and state separately its conclusions of law thereon," before proceeding to enter judgment. Fed.R.Civ.P. 52(a); see also Cafe La France, Inc. v. Schneider Securities, Inc., 281 F.Supp.2d 361, 363 (D.R.I.2003). In making its factual findings, it is appropriate for the Court to weigh the credibility of the witnesses presented. Fed.R.Civ.P. 52(a); see also Gautieri v. U.S., 167 F.Supp.2d 207, 209 (D.R.I.2001). Having thus articulated the legal standard, the Court proceeds to make its findings of fact and conclusions of law based on the evidence presented.

II. Findings of Fact

Due to its importance to the facts in this case, this writer deems it necessary to explain the company infrastructure in place at SG & C between 1996 and 2000 with great detail and specificity. As a result, the Court's findings of fact are bifurcated into two sections. In Part One, the Court will find facts relating to the establishment, operation, and account structure of SG & C during the relevant time period. This section will provide the necessary background for understanding the technical issues in this case. In Part Two, the Court will find facts relating to the SEC's examination, investigation, and the specific transactions before the Court for scrutiny.

PART ONE: BACKGROUND

A. The Firm Profile

SG & C is a small investment advising firm registered under the federal Advisers Act, 15 U.S.C. § 80a-1 et seq., as amended. The firm's only office is located at 39 Mill Street, Newport, Rhode Island. Slocum and Gordon, the firm's two founders, and Defendants in this cause of action, established the investment company in late 1978 and registered it with the Commission in January 1979. From its inception, SG & C was a small-scale, old-fashioned investment firm, seeking to provide personalized investment services to the "middle market," or mid-sized, investment accounts.

Over its years of operation, SG & C managed investment accounts for individual clients, families, and charitable organizations in the Newport area. The company also handled personal trades for firm partners, former partners, and their close family members. SG & C offered their clients many different types of investment services, ranging from placing trades to paying bills. In some cases, SG & C even prepared their clients' tax returns. By offering customized services to meet their individual client's needs, and largely by word-of-mouth advertising, SG & C was able to attract and retain a large client base in the Newport area. Approximately 75 to 80 percent of the firm's revenue came from providing portfolio management and other services to clients.

In addition to these various client accounts, SG & C maintained a firm trading account ("trading account"), which provided the remaining 25 to 20 percent of the firm's annual revenue. The trading account benefitted the firm, and, in turn, the partners, who each received a percentage of the firm's annual profits. In addition, profits gleaned from the trading account were used to offset errors made in client trades. Although all investment advisers working at SG & C had the opportunity to make trades for the firm trading account, only Slocum and Gordon actually engaged in firm trades.

B. Partners and Employees

At the time of trial, SG & C was comprised of three partners, Slocum, Gordon, and Barclay Douglas, Jr. ("Douglas"). A fourth partner, Jane Lippincott ("Lippincott"), was also affiliated with SG & C during part of the time period at issue; however, she left SG & C to open her own investment firm on January 2, 2000. In addition to these partners, SG & C maintained two office employees between 1996 and 2000: LuAnn Shoemaker ("Shoemaker"), the firm's Operations Manager, and Kimberly Stahm ("Stahm"), a secretary/receptionist.

1. Investment Advising and Portfolio Management

Although SG & C's partners and employees described themselves as wearing many different hats in the course of their daily firm activities, each person working for SG & C had his or her own individual responsibilities. Slocum and Gordon acted as investment portfolio managers for the majority of the firm's client base between 1996 and 2000, and were also responsible for trades done for the firm's benefit in its trading account. In addition to these duties, Gordon was the firm's managing partner, and was responsible for overseeing the firm's budget, dealing with financial issues, and overseeing the firm's tax preparation on an annual basis. Gordon was also responsible for insuring SEC compliance by updating and filing the required ADV Form with the SEC annually.

During this time period, Lippincott also acted as an investment portfolio manager for approximately ten percent of SG & C's client accounts. In addition to her work on these accounts, Lippincott assisted Slocum in managing about a quarter of his client accounts, prepared individual tax returns for clients, and worked on creating a computer database of corporate research information coming into the firm. Lippincott did not engage in any securities trades for the firm during her tenure as a partner, and confined her trading activities...