Settlement Agreement: In the Matter of Norman Frydrych
R.S.O. 1990 c.S.5 AS AMENDED
AND
IN THE MATTER OF
NORMAN FRYDRYCH
SETTLEMENT AGREEMENT
I. INTRODUCTION
1. By notice of notice of hearing dated August 2,1996 (the "Notice of Hearing"), the Ontario Securities Commission (the "Commission") announced that itproposed to hold a hearing (the "Hearing") to consider:
(a) whether, pursuant to paragraph 1 of subsection 127(1) of the Securities Act R.S.O. 1990 c.S.3 as amended (the "Act"), it is in the public interest to order,that the registrations of Marchment & Mackay Limited, Amit James Sofer, Charles Lorne Ornstein, Jerry Murray Saltsman, Norman Frydrych, Gregory CharlesOsborne, and Fraser John Edward Plant (collectively, the "Respondents") should be suspended, terminated, restricted or be made subject to conditions;
(b) whether, pursuant to paragraph 3 of subsection 127(1) of the Act, it is in the public interest to order that the exemptions contained in Ontario securities lawdo not apply to the Respondents;
(c) whether, pursuant to subsection 37(1) of the Act, it is in the public interest to suspend, cancel, restrict or impose terms and conditions upon the right of theRespondents to call at or telephone to any residence in Ontario for the purpose of trading in any security or in any class of securities; and
(d) such further and other order as the Commission considers appropriate.
II. JOINT SETTLEMENT RECOMMENDATION
2. (a) The staff of the Commission ("Staff") agree to recommend the settlement of the Hearing initiated in respect of Norman Frydrych ("Frydrych") by theNotice of Hearing in accordance with the terms and conditions set out below. Frydrych consents to the making of the order against him on the basis of the factsas agreed to hereinafter.
(b) Staff and Frydrych agree that- only if, as and when the settlement is approved by the Commission, this settlement agreement and the schedules attachedhereto (the "Settlement Agreement") will be released to the public.
III. STATEMENT OF FACTS
Acknowledgement
3. Frydrych agrees with the facts set out in Schedule "A" of the Settlement Agreement.
Conduct Contrary to the Public Interest
4. Frydrych failed to deal fairly, honestly, and in good faith with Marchment & Mackay Limited ("Marchment") clients by engaging in the course of conduct asdescribed in Schedule "A".
IV. TERMS OF SETTLEMENT
5. Frydrych has not been employed, as a salesperson with a registered dealer under the Act since March 20, 1997, when he terminated his employment withMarchment. Frydrych applied for registration with the Commission as a salesperson at another registered dealer, after leaving the employment of Marchment. OnMay 3, 1997, staff in the registration division of the Commission advised Frydrych that his application for registration had been declined on the basis of theallegations made in the Hearing. Frydrych's registration under the Act shall be suspended for a period of ninety (90) days, and such suspension will commence onMay 3, 1997, the date his application for registration was originally declined.
6. Upon completion of his suspension and coincident with his employment as a salesperson with a registered dealer, the following terms and conditions shall beimposed on Frydrych's registration under the Act and shall continue in effect for a period of two years:
(a) no transaction shall occur in a new account until the full and correct documentation is in place as confirmed by a senior officer of the registrant;
(b) all client accounts shall be reviewed by a senior officer on a monthly basis to determine the continuing suitability of the investments in the account; and
(c) written acknowledgement is filed by Frydrych's employer on a quarterly basis with the Manager of the Compliance section of the Commission, or such otherperson as may be designated by Staff, confirming that the foregoing terms and conditions will be complied with.
7. Frydrych agrees that within the period described in paragraph 6 above, he will complete the Conduct and Practices Course offered by the Canadian SecuritiesInstitute.
8. If the Hearing against Frydrych is settled hereby, Frydrych will cooperate and be available to give evidence at the Hearing concerning the other Respondentsand any other proceeding or prosecution in respect of conduct alleged to be contrary to the public interest or breaches of the Act.
V. CONSENT
9. Frydrych hereby consents to an order of the Commission incorporating the provisions of paragraphs 3, 6 and 7 above in the form attached hereto as Schedule"B".
VI. STAFF COMMITMENT
10. If this settlement is approved by the Commission, Staff will not initiate any complaint to the Commission or request the Commission to hold a hearing orissue any order in respect of any conduct or alleged conduct of Frydrych in relation to the facts set out in Schedule "A" of the Settlement Agreement.
11. If this settlement is approved by the Commission, Staff will not initiate any prosecutions or other proceedings against Frydrych in respect of breaches of theAct in relation to the facts set out in Schedule "A" of the Settlement Agreement.
VII. PROCEDURE FOR APPROVAL OF SETTLEMENT
12. The approval of the settlement as set out in the Settlement Agreement shall be sought at the public hearing of the Commission on such date as agreed to byStaff and Frydrych, and in any event, by no later than July 31, 1997, in accordance with the procedures described herein, and such further procedures which maybe agreed upon between Staff and Frydrych.
13. Staff and Frydrych agree that if the Settlement Agreement is approved by the Commission, it will constitute the entirety of the evidence to be submittedrespecting Frydrych in this matter, and Frydrych agrees to waive his rights to a full hearing and appeal of the matter under the Act.
14. Staff and Frydrych agree that if the Settlement Agreement is approved by the Commission, they will not make public statements that are inconsistent with theSettlement Agreement.
15. If, for any reason whatsoever, the settlement is not approved by the Commission or the order set forth in Schedule "B" is not made by the Commission:
(a) Staff and Frydrych will each be entitled to all available remedies and challenges, including, proceeding to a hearing of the allegations in the Notice of Hearingand related Statement of Allegations, unaffected by this Settlement Agreement or the settlement negotiations;
(b) The terms of the Settlement Agreement will not be raised in any other proceeding or disclosed to any person except with the written consent of the Frydrychand Staff or as may be otherwise required by law; and
(c) Frydrych further agrees that he will not raise in any proceeding the Settlement Agreement or the negotiation or process of approval thereof as the basis forany attack on the Commission's jurisdiction, alleged bias, appearance of bias, alleged unfairness or any other remedies or challenges that may otherwise beavailable.
17. If, prior to the approval of this settlement by the Commission, there are new facts or issues of substantial concern, in the view of Staff, regarding Frydrych orthe facts set out in Schedule "A" of the Settlement Agreement, Staff will be at liberty to withdraw from the Settlement Agreement. Notice of such intention towithdraw will be provided to Frydrych in writing. In the event of such notice being given, the provisions of paragraph 13 will apply as if the SettlementAgreement had not been approved in accordance with the procedures set out herein.
VII. DISCLOSURE OF SETTLEMENT AGREEMENT
18. The terms of the Settlement Agreement will be treated as confidential by all parties hereto until approved by the Commission, and forever if, for any reasonwhatsoever, the Settlement Agreement is not approved by the Commission.
19. Any obligations as to confidentiality shall terminate upon the approval of the Settlement Agreement by the Commission.
VIII. EXECUTION OF SETTLEMENT AGREEMENT
20. The Settlement Agreement may be signed in one or more counterparts which shall constitute a binding agreement.
DATED as of the 10th day of July, 1997.
SIGNED IN THE PRESENCE OF:
"Rima Pilipavicius" "Norman Frydrych"
"Jeffrey Meade" "Larry Waite"
per Brenda Eprile
SCHEDULE "A"
Statement of: Norman Frydrych
Date: 10 July 1997
Background
1. Until March 20, 1997, I was employed as a senior salesperson at Marchment & MacKay Limited. I first became an employee of Marchment as a juniorsalesperson entitled to retain my accounts on April 7, 1987. I became a senior salesperson in about 1989. Prior to April 7, 1987, I was employed as a juniorsalesperson at Gordon-Daly Grenadier Securities Limited. I joined Gordon-Daly on October 19, 1983.
2. Prior to 1983, I was employed by two chartered accounting firms where I was in the articling programme. I have a Bachelor of Arts degree from theUniversity of Toronto. I graduated from the University of Toronto in 1979. 1 am married and have three minor children.
Trading Structure of Marchment & MacKay Limited
3. Throughout my employment at Marchment, it had the same basic structure for dealing with its clients. Marchment employed qualifiers, junior salespeople(known as openers) and senior salespeople (known as loaders). In addition there were intermediate salespeople who would act as openers and loaders for theirown accounts.
4. At the time that I left Marchment, there were approximately 25 qualifiers. These qualifiers worked in a separate "bull pen" area at Marchment's premises.Qualifiers cold-called individuals listed in telephone or other directories, asked individuals if they wished to receive marketing information from Marchment. Ifthe answer was positive, they wrote the name and address of the individual on a lead card. I believe that qualifiers are required to complete about 15-20 leadcards each day.
5. The lead cards are given to clerical staff who input the information contained on the cards into the computer system at Marchment. The information relating tothe individuals is given to the junior salespeople who are allocated 75-100 leads each day.
6. It was the function of the junior salespeople to open accounts by making calls to the leads and getting them interested in opening an account with Marchmentby acquiring 500-5000 shares of the securities that Marchment was promoting at the time. The junior salespeople (like all Marchment employees) primarily soldthe securities that Marchment promoted from its own inventory.
7. Although the junior salespeople were encouraged to sell mostly stock from Marchment's inventory increasingly, it was Marchment's strategy to augment theamount of "agency" trades that it transacted as opposed to "principal" trades. I believe that this was not done for profit but as "window dressing" so that it wouldappear to regulators that Marchment was not solely in the business of selling out its principal positions in over-the-counter stock which was its bread and butter.
8. To encourage agency trades, certain junior employees were paid seventy percent of the total commission charged to the client on agency trades.
9. In sales of principal stock (which is where Marchment made its money) the role of the junior salesperson was to close a sale of securities from Marchment'sinventory at a price that they were advised of by Marchment and to complete a new client application form for the client. Clients were led to believe by this salespresentation that the junior salesperson would have a continuing relationship with the client.
10. Although the junior salespeople represented to clients that they intend to establish a long relationship with them, in reality they only held the accounts forabout 2 to 4 month period.
Sales By Senior Salespeople
11. In my experience, in the two months after initial sale by the junior salesperson, the trading price of the securities that Marchment offers steadily increases.Then, the accounts of the junior salespeople are collected by management and distributed to senior sales people.
12. It was my experience that the price of the securities that Marchment offered from its inventory would always increase during the period described inparagraph 11. As salespeople we were advised by management as to the price of the shares that we promoted.
13. The client having perceived that he had made an unrealized gain on his initial purchase of securities was more receptive than he otherwise would have been tothe sales presentation of the senior sales person. This made it easier for me as a senior salesperson to sell the customer more stock.
14. Although I was always provided with information regarding the securities that we sold to customers and more recently, like all salespeople, was required tosign a document stating that I had read the materials, in reality, I had no discretion as to the principal stock that I was permitted to sell to clients from time totime. I was able through the selling technique to load a client with securities based on the price increase of the stock from the time that it was initially purchasedand by soliciting the customer's trust. It was not necessary for me to say very much about the securities themselves. Many customers relied on myrecommendation to buy more securities.
15. The trading price of every stock that I sold at Marchment (with one or two exceptions out of the approximately forty securities that I sold) declined in valueto 20 cents or less within about a year of their initial sale by the senior salesperson. As a senior salesperson I did not have any faith in the recommendation that Iwas making because I knew that in the vast majority of cases, the client would lose money.
16. In fact, if a security that Marchment sold was revitalized by a reverse takeover transaction in the years that followed Marchment's selling campaign and anindependent active market was established for the securities, it was our practice to contact the client, advise him of the value of the shares and then "lift" thesesecurities from the customer. We achieved this by selling their shares into the market as their agent and then using the proceeds to sell them the Marchmentprincipal stock that it was promoting at the time. The practice of "lifting" maximized the chances of clients losing money dealing with Marchment.
17. Between the time that the accounts were opened and passed to the senior salespeople, it was the practice of Marchment to send a questionnaire to thecustomers. Given the good performance of the securities up to the point that their accounts were passed to the senior salesperson, Marchment could in mostcases count on positive responses to the questionnaires. Marchment started sending the questionnaires in response to the Ontario Securities Commission practiceof sending questionnaires to clients. The purpose of the Marchment questionnaires was to establish a record for use in any hearing relating to the sale ofsecurities to the customer.
Discouragement of Sales of Securities
18. As senior salespeople we were only able to keep our commission if the customer held on to the stock that he purchased for 90 days because Marchmentwould lose money if it were required to repurchase shares at the price that it sold the stock to its customers. As senior salespeople we never told clients that wewould lose our commission if we executed a sell trade of the securities within this period.
19. We were also required as senior salespeople at Marchment to discourage customers from selling securities even beyond the 90 day period within which welost our commission if a client sold the securities that they acquired. Our ability to prevent customers from "selling out" was reflected on our performanceevaluation by management. We were instructed to do everything that we could to encourage customers to hold on to their stock. This practice was called"holding the client in".
20. As part of our sales presentation to customers, we always told them that we would contact them if it was a good time to sell the stock. This was done tomake the customer think that he would be looked after by the salesperson and that they could rely on us. In reality, we never contacted clients to sell stock unlesswe were lifting the stock. In fact, we knew that the stock would decline but never told the customers to sell (except where the stock was to be lifted as describedabove). If we did so, we stood to either lose our commission or displease our employer. We were warned that if we had a large number of "sell outs" we couldreceive fewer accounts to trade.
21. The only occasion on which we would make sell recommendations were cases in which the shares actually increased in value for the reasons described inparagraph 16 above. In such cases, we were encouraged to "lift" the stock from the customer and replace it with other securities from Marchment's inventory.
22. As a senior salesperson, I would continue to call a customer who purchased securities from me to acquire other securities that Marchment was promoting assoon as I received notification that the customer had paid for the previous stock. The strategy was to call the customer as soon as possible before the first stockdeclined in value. All the securities that I sold were in substance the same (principal stock from Marchment's inventory).
23. I continued to sell stock to the customer until either the customer became disenchanted or the sale was beyond his stated suitability or objectives on the newclient application form.
The Dead Box
24. Periodically, management would ask me whether I had any clients that no longer wished to purchase securities. These customers were placed in what wasknown as the "dead box" Almost all clients would end up in the dead box except for "spot" clients who continually buy securities.
25. Clients in the "dead box" would either be passed to other senior salespeople for further loading. If the clients in the "dead box" had already been loaded withMarchment principal stock up to their suitability limits, the accounts might be passed to the three or four salespeople who sold agency stock and mutual funds. Ibelieve that this was to create the appearance that the firm does not trade exclusively in principal stock with its customers.
Confirmation Slips
26. Marchment customers were given confirmation slips after each trade of securities. On the bottom of the slips, the remuneration received by the registeredrepresentative was indicated by a code explained on the reverse of the slip. I was responsible for at least 15,000 clients. Only a handful of these ever asked meabout the codes on the slips. I believe that the great majority of Marchment customers pay no attention to the codes on the confirmation slips.
Principal Trading
27. As a matter of practice, we were instructed to advise customers verbally that were acting as "principal" on the trade. Of the thousands of customers that Iwas responsible for only a handful ever asked me about principal trading by Marchment.
Clippers
28. In my experience, the individuals who asked me about Marchment's average acquisition cost and whether it was selling or buying as principal were what wasknown at Marchment as "clippers". Clippers were individuals who understood the Marchment selling technique and sought to sell securities back to Marchmentin the midst of a promotion for profit. Marchment lost money dealing with clippers but normally acquired their stock so that the promotion could be perpetuated.Buying back the stock of clippers was regarded as a cost of doing business by Marchment.
Losses By Clients
29. In my experience with Marchment, of the thousands of customers that I dealt with all of them (except for clippers and others who insisted on selling theshares that they acquired contrary to our recommendation) lost virtually all of the money that they invested with the company. This is primarily because the pricefor the stock almost always fell to less than 20 cents when Marchment's selling campaign was over. As I have said, even if a stock performed well or a market forthe stock developed independent of Marchment, the stock was "lifted" from the customer. The customer was always left with more Marchment principal stock atthe end of the day.
Speculative Trading
30. At Marchment, I was careful to ensure that I advised customers that the trades in principal stock that we did were speculative and as a matter of practice, Isold speculative stock within the boundaries of the objectives listed on the new client application form. In reality, however, customers only achieved gains inunusual situations for the reasons described above. Therefore I now acknowledge that whether I advised them that the investments were speculative or not didnot really matter.
Use of New Client Application Form at Marchment
31. I understand that the "know your client" obligations of a broker and the new client application form are meant to assist the broker in making appropriaterecommendations to the client regarding the sale of securities. At Marchment, new client application forms were completed accurately but were used to load theclient with as much principal stock as possible. While Marchment complied technically with "know your client" rules, the spirit of the concept to makeappropriate recommendations to clients was ignored.
Why I Left Marchment
32. I have decided that I am no longer interested in selling securities to clients in circumstances where they have no chance of making money. I have thereforesought to become involved with a broker that engages primarily in "agency" trades in listed securities and in sales of mutual funds.
33. As a salesperson at Marchment, I thought that I complied with my obligations to my clients simply by not lying to them and not processing trades that did notconform with their new client application forms. I now realize that as a professional, I have a duty to ensure that I have faith in the investments that I recommendto clients and that I should act in their best interests. For that reason I have severed my ties with Marchment. I am certain that I will be able to act in the bestinterests of my clients in my new employment.
July 10, 1997
"Norman Frydrych"
ORDER
THEREFORE IT IS HEREBY ORDERED, pursuant to subsection 127 (1) of the Securities Act (the "Act") that:
1. Frydrych's registration under the Act shall be suspended for a period of ninety (90) days commencing on May 3, 1997,
2. Upon completion of Frydrych's suspension and coincident with his employment as a salesperson with a registered dealer, the following terms and conditionsshall be imposed on his registration under the Act and shall continue in effect for a period of two years:
(a) no transaction shall occur in a new account until the full and correct documentation is in place as confirmed by a senior officer of the registrant;
(b) all client accounts shall be reviewed by a senior officer on a monthly basis to determine the continuing suitability of the investments in the account; and
(c) written acknowledgement is filed by Frydrych's employer on a quarterly basis with the Manager of the Compliance section of the Commission, or such otherperson as may be designated by Staff, confirming that the foregoing terms and conditions will be complied with.
3. Frydrych shall, within the period described in paragraph two above, complete the Conduct and Practices Course offered by the Canadian Securities Institute.