On July 3, 2003, registered representative Douglas J. Toth was named as one of several defendants by the New Jersey Attorney General and the New Jersey Bureau of Securities in a securities fraud civil action that alleged, in part, that he had made materially false and misleading statements to investors. When a Uniform Application for Securities Industry Registration (“U4”) was submitted by an NASD member on Toth's behalf on August 13, 2003, the answer of “no” was checked off for Question 14H(2) of Form U4:
Are you named in any pending investment-related civil action that could result in a yes answer to any part of [Question] 14H(1)?
Question 14H(1) of Form U4, in pertinent part, asks: “Has any domestic or foreign court ever: (a) enjoined you in connection with any investment-related activity? (b) found that you were involved in a violation of any investment-related statute(s) or regulation(s)?”
In September 2003, the New Jersey Bureau of Securities contacted Toth's member firm seeking an explanation for the non-disclosure of its pending case. Toth resigned in October 2003. In July 2005, the action by the State of New Jersey against Toth was dismissed. You may smile and think, “No harm, no foul.” Think again!
The Devil In The Detail
In 2006, an NASD Hearing Panel found that, by failing to disclose to his former firm the pending state civil action against him, Toth had willfully caused his firm to file an inaccurate U4 on his behalf or amend it. He was suspended for one year in all capacities. Toth later appealed to the Securities and Exchange Commission (SEC), which sustained the NASD findings and sanction. In the Matter of the Application of Douglas J. Toth (Securities Exchange Act Rel. No. 58074/July 1, 2008) the SEC's opinion restates the maxim that:
Form U4 is used by NASD and other self-regulatory organizations to determine the fitness of applicants for registration as securities professionals. Consequently, the candor and forthrightness of applicants is critical to the effectiveness of the screening process. Misrepresentations on Form U4, in addition to violating Membership Rule IM-1000-1, violate the standard of just and equitable principles of trade to which every person associated with an NASD member is held. (Footnotes omitted)
The SEC noted that Toth “emphasizes repeatedly that he never saw the Form U4 before he met with NASD in October 2004 and has never signed it.” However, the SEC found that Toth knew of the firm's intent to register him and the need to file a U4 to effectuate that and rejected Toth's attempt to blame the firm: “As we have stated previously, primary responsibility for maintaining the accuracy of a Form U4 lies with the registered representative.”
No Laughing Matter
The operative word in all of this is “willful.” A willful violation of the securities laws means merely that the person knew what he was doing — there is no requirement that the actor also be aware that he is violating a securities rule or regulation. Under the Securities Exchange Act, willfully filing a materially inaccurate U4 results in statutory disqualification.
Further, under Article III, Section 3(b) of NASD's By-Laws, a “statutorily disqualified” person cannot become, or remain associated with, an NASD member unless the disqualified person's member firm applies for relief from the statutory disqualification under Article III, Section 3(d) of the By-Laws. So the seemingly mild one-year suspension actually became a bar. That's the weird twist to this case and the most important lesson for you to learn. If Toth had simply answered “yes,” from day one, none of this would have happened. Regardless of the certainty of his job prospects, this was a costly gambit — and the house took all of Toth's chips.
Scratching your head over this one? Well, that's good. Perhaps you will be more careful when confronted with a similar situation. At least now you understand the danger of that one word: Willful. Also, keep in mind the SEC's telling warning that the “fact that the New Jersey Complaint was subsequently dismissed two years after the events at issue does not diminish the importance of its timely disclosure.”