The opinion of the court was delivered by: Judge Pellegrini
Submitted: January 2, 2009
BEFORE: HONORABLE DAN PELLEGRINI, Judge, HONORABLE ROBERT SIMPSON, Judge, HONORABLE JOSEPH F. McCLOSKEY, Senior Judge.
Joseph S. Schwalm (Schwalm) appeals pro se an order of the Pennsylvania Securities Commission (Commission) finding that he violated Section 301(b) of the Pennsylvania Securities Act (Act),*fn1 70 P.S. §301(b), by selling unregistered securities in Pennsylvania. As a result, the Commission barred him from working as a securities representative in Pennsylvania and imposed a $140,000 administrative assessment and a $35,195.96 assessment for investigative and legal costs that the Commission incurred. On appeal, Schwalm contends that his due process rights were violated and that constitutional violations occurred because the Commission applied laws ex post facto.
This matter involves Schwalm's sale of viatical settlement contracts*fn2 and universal leases*fn3 that he sold, and the following facts are not in dispute: between June 1997 and September 1998, on behalf of Mutual Benefits Corporation (Mutual), Schwalm offered and sold viatical settlement contracts to at least 13 Pennsylvania residents for a total amount of at least $345,812. From December 1998 to May 1999, Schwalm worked for Beneficial Assistance, Inc. (Beneficial) selling viatical settlement contracts. He sold two contracts to two Pennsylvania residents for a total of $49,910. He received $25,601 in commissions. During the time Schwalm was selling the viatical settlement contracts, he was a registered agent with Hackett Associates, Inc. and Cantella & Co., Inc.
Beginning in May 2001, Schwalm began selling universal leases offered by Yucatan Resorts, S.A. de C.V. (Yucatan) located in Cancun, Mexico. Investors had three options when purchasing the time share: (1) they could use the property for the allotted time each year; (2) they could rent the time share out to third parties; or (3) they could hire a management company to rent the property on behalf of the client and then pay the client an annual return on the lease of between 9% and 11%. If an investor chose the third option, a related company called Majestic Travel acted as the management company. Through 2002, Schwalm sold 17 Pennsylvania residents time shares under option three for an aggregate sum of $1.1 million, and received a sales commission of $103,000.*fn4
On September 15, 2005, the Commission issued an order to show cause to Schwalm, alleging that he had violated Sections 201, 301 and 401(b) of the Pennsylvania Securities Act of 1972 (Act)*fn5 by engaging in the sale of non-registered, non-exempt securities, transacting business as an agent of a broker-dealer or issuer while unregistered or while affiliated with another broker-dealer, and making untrue statements of material fact and/or omitting to state material facts in connection with the offer and sale of the securities. Schwalm responded pro se to the order to show cause, maintaining that he had not been selling securities. A hearing was held before a Commission hearing officer (Hearing Officer) in May 2006 and by that time, Schwalm had obtained counsel and was represented at the hearing.
At the hearing, Commission securities examiner Zachary Ortenzio (Examiner Ortenzio) testified that under the National Association of Securities Dealers (NASD) Rule 3040,*fn6 an agent who wished to engage in private securities transactions had to request in writing permission from his current brokerage firm. Once the request was made, the firm had to respond in writing, and if the request was granted, the firm had to carry the transactions on its books and records. Examiner Ortenzio stated that Schwalm had never made a request to either Hackett Associates, Inc. or Cantella & Co., Inc, and neither broker-dealer's records reflected the viatical settlement contract transactions. Regarding the universal leases, Richard Kiehl (Examiner Kiehl), a Commission securities examiner, testified that Schwalm told him that his sales tactic was to offer only option three.
Four individuals who purchased viatical contracts testified that they had purchased viatical settlement contracts and were told that the rate of return was guaranteed at either 21% or 24% for 18 months. They also testified that Schwalm did not explain the risks of the investment -- that the viator might surpass his or her life expectancy, that they might be liable for life insurance premiums should the viator surpass his or her life expectancy, or that the insurer or viatical settlement company could become insolvent.
Two individuals who purchased the universal leases testified that they had sought to obtain better returns on their investments and were guaranteed a 9% or 11% annual return on their investment. They stated that they chose to have the management company rent out the time share because that was the only option with which they were presented by Schwalm. Both testified that through Commission action, they had secured the return of their investment.
Schwalm testified that he had worked as an insurance agent since 1975 and that he had worked with securities as a registered representative since 1984. Schwalm stated that he did not think the viatical settlement contracts were securities at the time he was selling them, and that when he checked in Pennsylvania, he discovered that the Commonwealth had never addressed the issue of whether the viatical settlement contracts were securities. Therefore, Schwalm believed that they were not securities and were not regulated by the Commission. He testified that he stopped selling the viatical settlement contracts in 1998 because they were not maturing in the way Schwalm believed they would mature.
Regarding the universal leases, Schwalm testified that he began selling them in 2001 and that he viewed them as a time share product. Schwalm testified that he actually travelled to Cancun to inspect the properties before he began selling the universal leases. He stated that he had discussed all three options with prospective clients before making a sale, but that all of his clients chose to buy option three. Schwalm further testified that he had sought an advisory opinion from a lawyer at Baker & McKenzie as to whether the universal leases would be considered securities. The advisory opinion informed Schwalm that the universal leases would not be considered a security, and, therefore, Schwalm did not believe they needed to be registered. The advisory opinion was also admitted into evidence. Schwalm admitted that his authority to sell the universal leases was revoked and that he told clients that the returns on both products were guaranteed.
Following the hearing, the Hearing Officer found as fact that Schwalm had been engaged in the sale of viatical settlement contracts from June 1997 through September 1998 and from December 1998 through May 1999, and that they were securities under Pennsylvania law. Further, Schwalm had been involved in the sale of universal leases from May 2001 through May 2003, and that these instruments were securities. The Hearing Officer further found that Schwalm had not registered either the viatical settlement contracts or the universal leases as required by the Act, and that he had failed to disclose the risks of these investments to his clients and had explained that they were risk free. The Hearing Officer concluded that as a matter of law, the instruments were securities under the Act, that Schwalm had violated Section 201 of the Act, 70 P.S. §1-201, that Schwalm was not registered under Section 301 of the Act, 70 P.S. §1-301, and that Schwalm had made misleading statements to clients in willful violation of Section 401(b) of the Act, 70 P.S. §1-401(b).
The Hearing Officer recommended that the Commission bar Schwalm for six months from acting as a broker-dealer, agent or investor, and that Schwalm pay $10,000 to the Commonwealth as an ...