In these trying times, many reps feel a financial pinch. For some, the simplest route is to max out their credit cards; others take a second job. However, many will turn to family and friends for a loan. Unfortunately, many a “friend” is also a “customer,” and borrowing money from a client poses problems. Surprisingly, it's legal to borrow from your clients (though prohibited by some firms), but it sure can cause a whole lot of trouble if it's not done just right.
Take the case of James Davenport, for example. In 1987, Davenport joined NASD member firm J.J.B. Hilliard, W.L. Lyons. While there, he started trading OEX puts and calls in his personal account. He lost as much as $125,000 a day. The losses started mounting.
However, he remained a solid rep. He had an $83 million book of business and was grossing nearly $664,000 per year. But because of the OEX losses, he had borrowed more than $1.5 million from 26 customers pursuant to promissory notes bearing fair market-rate interest.
Here's the catch, though. The firm's compliance manual prohibited employees from borrowing money from a customer and the firm annually distributed a “Prohibited Activities List” form, which specifically asked about customer loans. Worse, in returning a signed copy of the form for 1997, 1998 and 1999, Davenport did not disclose the loans.
In 1999, Davenport was offered a $278,000 signing bonus by Dean Witter Reynolds. Great, he thought. The loans could be repaid. He gave his secretary $5,000, his church $10,000 and applied the remaining $263,000 plus $105,000 from his IRA account toward the loans. Davenport ceased further personal speculative options trading at Dean Witter. Unfortunately, in January 2000, an anonymous letter was sent to Dean Witter, NASD and the SEC, complaining that Davenport had taken a personal loan from the sender's mother, also disclosing further loans from other customers. The NASDR Department of Enforcement did not accept the bona fides of the anonymous letter and theorized that it was from a “disgruntled co-worker or someone who had some axe to grind with Davenport.”
When Dean Witter confronted Davenport with the anonymous letter, he admitted the full extent of the loans. Nonetheless, Dean Witter fired him and NASDR commenced an investigation. Davenport presently holds a $60,000-per-year sales job with a veterinary supplies company owned by one of his former customers. Davenport apparently never missed an installment payment until Dean Witter fired him, at which time he renegotiated payment terms and continued to meet his obligations on the $400,000 in remaining debt.
NASDR charged Davenport with violating NASD Conduct Rule 2110, which imposes “high standards of commercial honor and just and equitable principles of trade.” Essentially, Davenport was charged with submitting false certifications about the loans to his former employer. Davenport represented himself during the proceedings and admitted the allegations against him. He conceded that he submitted the false reports in order to avoid being fired. However, to his credit, he did not attempt to justify nor excuse his conduct. Davenport asked for a hearing for the limited purpose of contesting sanctions. He argued that as of the date of the hearing, he had already been out of the industry for nearly two years and that any further suspension would be unwarranted.
In crafting the sanctions to be imposed, the NASDR hearing panel noted that it was not considering the legality of the loans but merely Davenport's misconduct in covering up their existence. The panel gave some weight to the fact that neither of the two employers nor any customer lost any money, and that Davenport was “forthright and honest” when confronted. Further, the panel noted that Davenport had dealt with his OEX options' problem before his discharge and his motivation in accepting the signing bonus was to accelerate repayment of the loans. Finally, the panel took notice of Davenport's remorse and his representation that if he were allowed to re-enter the industry he would be able to undertake repayment of the loans sooner than anticipated.
This panel suspended Davenport for nine months, but gave him full credit for the two years he had already been out of the industry (effectively, the imposed suspension is deemed served). Second, although Davenport was fined $10,000, that fine was payable in accordance with an installment plan that took into account his ongoing satisfaction of his loan repayments. Any default would permit the balance of the fine to be accelerated. Finally, Davenport was prohibited from leveraged trading in his own account until he has repaid the customer loans and the fine.
I suspect that the NASDR will attract some heat for this decision. Some will say it is too lenient. I find it refreshing. Sure, they could have barred Davenport and fined him a million dollars — wouldn't be the first time such heavy-handed justice was meted out. But ultimately, who benefits? At least this way the customers who lent Davenport money have a chance to get repayment. Is Davenport entitled to such consideration? Was the panel suckered in by feigned remorse? Only time will tell, but, still, it's nice to see that despite justice being blind, she's not always heartless. Jim, don't let us down.
Bill Singer is a partner with the law firm of Gusrae, Kaplan & Bruno. rrbdlawyer.com