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FILE COPYADMINIS'IRATNE PROCEEDINGSFILE NO. 3-5150UNITED STATES OF AMJ3UCABefore theSECURIT1%S AND EXCHANGE COMMISSIONIn the Matter ofFEVEmJ IYANA(3ElWNT CO*, INC.( 8-8021)AMERICAN FUND EZlI'VICES, LTD.ABIWT KUHNINITIAL DECISIONDecember 2, 1977Washington, D C .Ralph Hunter TracyAdminist r a t ive Law Judge
ADMINISTRATIVE PROCEEDINGSFILE NO. 3-5150UNITED STATES OF AMERICABefore t h eSECURITIES AND EXCHANGE COMMISSIONI n t h e Matter ofREVERE MANAGEMENT CO., INC., (8-8021)AMERICAN FUND SERVICES, LTD.:INITIAL DECISIONWILLIAM N. HESSALBERT KUHNAPPEARANCES:John R. Kiefner and Lynda L. Coleof t h e Washington Regional Officef o r t h e Mvision of EnforcementWilliam T. Hangley of Goodman &Ewlng f o r Revere Managemnt Co.,Inc.Daniel B. Pierson of Pierson, Jones &Nelson f o r William M. HessBEFORE:Ralph Hunter TracyAdministrative Law Judge
This i s a public proceeding i n s t i t u t e d by Comnission order(order) dated January 5, 1977, pursuant t o Sections 15(b) and 19 (h)of the Securities Exchange Act of 1934 (E changeAct) and Section 9(b)of the Investment Company Act of 1940 (Investment Company Act), t odetermine whether the above-named respondents,L/ comnittedvariouscharged violations of the Exchange Act and regulations thereunder, asalleged by the Division of Enforcement (Division), and the r e m d i a laction, i f any, t h a t might be appropriate i n the public i n t e r e s t .The Order alleges, i n substance, t h a t the remaining respondentsin t h i s proceeding, William M. Hess (Hess) and Revere Management Co., Inc.,(Managemnt) willf'ully violated and willf'ully aided and abetted violati'ons' of Section 10(b) of the Exchange Act and Rule lob-5 thereunder.Respondents Hess and Management were represented by counselthmughout the procee-.Proposed findings of f a c t and conclusionsof l a w and supporting b r i e f s were B l e d on behalf of Hess, Managemnt'and the Division.Tfie findings and conclusions herein are based upon clear andconvincing evidence as determined fYom the record and upon observation.-of the witnesses 2/VPrior t o the hearing the Division was unable t o obtain serviceof the Order on respondents Albert Kuhn (Kuhn) o r American FundService, Ltd. and they did not appear nor were they representedduring the proceeding.The Comnission has traditionally enployed t h e "preponderance of theevidence" standard of proof. However, i n its recent decision i nCollins Securities Corporation v. S.E.C., C.A.D.C.,August 12, 1977,the Court held t h a t , at l e a s t i n cases involving alleged fraud andpotentially severe sanctions, the higher "clear and convincing evidence" standard must be met. I n the instant case, where there areno factual disputes of substance, the application of e i t h e r standardyields the same results.
The findings herein a r e applicable only t o Hess and Managementand are not binding on any of the other respondents named i n the Order.FINDINGS OF FACT AND LAWRespondentsRevere Management Co . , Inc ., (Management ) , a Pennsylvania corporation with i t s principal offices a t 123 South Broad S t r e e t , Philadelphia,Pennsylvania, has been registered with t h i s Conmission as a brokerdealer pursuant t o Section 1 5 ( b ) ( l ) of the Exchange Act since November10, 1959, and i s a member of the National Association of SecuritiesDealers (NASD).Since 1959 Management has been the exclusive underwriterand has provided conplete admbistratjve services t o Revere Fund, Inc.(Revere), a Delaware corporation which has been registered with thisComnission since 1959, as a management, open-end, diversified investment conpany, pursuant t o Section 8 ( a ) of t h e Investmnt Company Act.William Hess (Hess) received a BS degree f r o m t h e Wharton Schoolof t h e University of Pennsylvania in 1941.Following military servicehe entered the s e c u r i t i e s business i n 1946 and is Chairman, Treasurerand 36% shareholder of Hess, Grant and Frazier, Inc. (formerly Hess,.Grant & Remington, Inc ) a New York Stock Exchange merber firm, Hessi s President and C h a i m of Revere.He i s also Chalrman and Treasurerof Philadelphia Financial Management Company (Financial), a wholly-ownedsubsidiary of Hess, Grant and Frazier, Inc.Financial is registeredwith the Conmission as an investment adviser pursuant t o Section 203
of the Investment Advisers Act of 1940, and has provided advisory services t o Management since 1971. When Revere E g i s t e dwith theCornmission i n 1959, Hess was a director and President of Managemntand Revere, and a l l of Managerrent's directors were directors andstockholders of Hess, Grant & Remington, Inc.During 1972 and 1973rnembers of the Hess family held 27.9% of the outstanding shares ofManagement; members of the family of Richard 0 . Smith, a director ofRevere, held 36.7% of the outstanding shares of Management; the wife ofJames G r a n t , a shareholder and director of Hess, Grant & F h z i e r , Inc.,held 16.2% of the shares of Management and Howard Sanders who wasPresident, Treasurer and a d i r e c t o r of Management fmm October 1966u n t i l June 1, 1972, held a 12.2% i n t e r e s t i n Managemnt.Albert Kuhn (Kuhn) i s a G e m national who was a mutual funddealer with h i s principal o f f i c e at Charlotten Strasse 32, Dusseldorf,Gemmy.He w a s assisted by his wife Sylvia and at one time had asmany as 25 salesmen working f o r him i n West Germany, Belgian and otherEuropean countries.He xepresented Management f h m 1966 u n t i l early1974American Fund Services, Ltd. ( A S ) was fomded by Kuhn onMay 5, 1969, as a Bahamian corporakion.It never had an o f f i c e o rpersonnel i n the Bahamas but maintained a Post Office Box i n Nassau.A Nassau attorney forwarded the unopened mail t o Kuhn's Dusseldorfaddress.m rnCIPALSHoward Sanders (Sanders) received a BS degree fram Temple Univerersity in 1962 and a Master of Accounting degree f b m Ohio StateUniversity i n 1966.He worked with the public accounting firm of
Price Waterhouse & Co. from February 1962 t o September 1965.InFebruary 1966, he was hired as Treasurer of Management and i n October1966 was elected President and a director as well.Treasurer of Revere a t the same time.He w a s also electedHe was in charge of sales pro-motion and was responsible f o r obtaining dealers f o r Management.Hewas also, an a s s i s t a n t professor of accounting at Temple University.He resigned from Management i n June 1972, and since then has been operat i n g Sanders Financial Managemnt Inc. i n Fort Lauderdale, Florida.James Michael McFadden (McFadden) received aEconoKcs flmn Villanova University in 1966.degree i nHe i s a CPA and w a s employedby the public accounting firm of H a s k i n s & S e l l s from May 1966 t o November1968 when he joined Management as Vice-President and Secretary.I n June1972, he also,.became Secretary-Treasurer of Revere and i n February 1973,becam Executive Vice-President, Secretary-Treasurer and a d i r e c t o r ofManagement.He resigned i n January 1974, because Hess suggested he lookf o r another job as Management could no longer afford h i s salary.Edwin K. Daly (Daly) is an attorney who was counsel t o RevereFund and Management from about 1966 t o about June 1974.During t h i s tiroehe was i n private practice but p r i o r t o 1966 he was associated with thePhiladelphia l a w firm of Stradley, Ronon, Stevens & Young, which representedFund and Managemnt at t h a t time.retained him as t h e i r counsel.When he l e f t the firm Fund and ManagementHe was consulted on an almost daily basis,when necessary, by McFadden concerning problems which arose at Management,p a r t i c u l a r l y those concerning Kuhn.with Hess concerning these matters.He also, had frequent discussions
Richard May (May) has a BS degree i n Industrial Managementfrom LaSalle College and spent 2-1/2 years i n the U.S. Army which hel e f t i n 1967 with the rank of Captain.In 1968 he joined F i r s t PennsylvaniaCorporation (Penco) an a f f i l i a t e of F i r s t Pennsylvania Bank.He con-tinued with Fund Plan Services (FPS), a subsidiary of Penco, and i nDecen-ber 1974, he became an assistant vice president of FPS.FPS wasthe transfer agent f o r s o m 40 different mutual f'unds and i n February1969, became transfer agent and shareholder record keeper for RevereFund.FPS processed all r e d q t i o n requests f o r Revere shareholdersfrom early 1972 u n t i l early 1974.ViolationsThe Order charges that k.om on or about June 30, 1972, t o on o rabout December 3, 1973, Management, Hess, Kuhn and AFS willf'ully viol a t e d and willf'ully aided and abetted violations of Section 10(b)3'of the Exchange Act and Rule lob-5 thereunder i n redeeming and effectingtransactions in the s h m s of Revere, and in connection therarith, directly3/Section 10(b) as here pertinent mkes i t unlawf'ul f o r any person t ouse o r employ in connection with the purchase o r s a l e of a securityany manipulative device o r contrivance i n contravention of rulesand regulations bf the Comnission prescribed thereunder. Rule lob-5defines manipulative o r deceptive devices by making it unlawf'ul f o rany persons i n such connection: "(1)t o employ any device, scheme,o r a r t i f i c e t o def'raud, (2) t o make any untrue statement of a m t e r i a lfact o r t o omit t o s t a t e a material fact necessary i n order t o makethe statements made, i n the l i g h t of the circumstances under whichthey were made, not misleading, o r (3) t o engage i n any a c t , practice,o r course of business which operates o r would operate as a fraud o rdeceit upon any person."
and indirectly, made untrue s t a t e m n t s of material f a c t s and omittedt o s t a t e material f a c t s necessary i n order t o rrake the statements made,i n l i g h t of the circumstances under which they were made, not misleading,and engaged in transactions, a c t s , practices and a course of conduct whichoperated as a fraud and deceit upon the s e l l e r s of such shares.A s partof this conduct respondents made f a l s e and misleading statements of materialf a c t s and omitted t o s t a t e material f a c t s concerning:the redenption procedures employed by Revere;the f a i l u r e of shareholders t o receive redemtionproceeds and the disposition of such proceeds;the unauthorized affixing on redemption checks ofsignatures which were purported t o be those of redeemingshareholders;the purported existence of an investigation by theCornmission i n t o t h e a c t i v i t i e s of Revere;Kuhn's purported r o l e a s director of Revere;the processing of inproperly guaranteed redenptionrequests; and,statements and omissions of similar purport and object.The allegations s e t f o r t h in the Order involving Managment andHess m s e hm t h e i r enployment of Kuhn. .Management is the exclusiveunderwriter of Revere, of which Hess i s pmsident, and it has distributedf'und shares through NASD dealers.I n 1966, Howard Sanders (Sanders), whowas then president and t r e a s m r of Management, met Kuhn through a memberof the NASD and although Kuhn w a s not an NASD merrber he sigged him up asa dealer i n Germany.Kuhn proved t o be a successfbl s a l e s m and at onetime operated as an exclusive d i s t r i b u t o r of the Revere shares i n Germanypursuant t o a contract with Management.From October 28,1966, the date of h i s f i r s t contact with m m e n t ,u n t i l Noverrber 1, 1969, when the West German g o v e m n t r e s t r i c t e d thes a l e s of foreign securities, Kuhn and h i s salesrrian sold approximately
3 million dollarsworthof Revere shares.Following the action of theGerman government s a l e s by Kuhn were non existent except f o r the continuance of contract plans.Moreover, G e m investors began t o redeemt h e i r shares, mostly through Kuhn, and i n 1972 and 1973, these redemptionst o t a l e d over a quarter of a million dollars.In 1974, following complaintsby Revere shareholders t o the G e m authorities, Kuhn was arrested andbro@tt o trial i n Dusseldorf f o r having enbezzled approximtely 235,000from Revere shareholders.He w a s convicted and i s now serving a 5 y e a rsentence i n a German prison.I n support of i t s charges i n the Order the Division maintainst h a t Management and Hess ignored a s e r i e s of "red flags" ralsed by Kuhnlsa c t i v i t i e s ; t h a t these "red flags" should have put Hess and Managementon notice t h a t something w a s wrong; t h a t they had a duty t o control o rc u r t a i l Kuhnls a c t i v i t i e s ; and t h a t t h i s duty, i f properly carried out,would have prevented t h e en&ezzlement of German shareholders by Kuhn.?he f a c t t h a t Management and Hess did nothing t o control Kuhn and hisa c t i v i t i e s made them participants i n Kuhnls scheme t o def'raud investors.Respondents, on the other hand, argue t h a t Kuhn independentlyperformed a f'raud on many of his German customers and t h a t Management andHess had no knowledge of and did not p a r t i c i p a t e in Kuhnts fraudulentactivities.That t h e actions taken by Hess and Management i n t h e i rdealings with Kuhn in l i g h t of t h e circumstances as they existed p r i o rt o Kuhnls conviction, without the benefit of hindsigtnt, did not v i o l a t et h e anti-fraud provisions of the Exchange Act.
The f a c t s herein are not seriously disputed.The p a r t i e s submitteda s t i p u l a t i o n of f a c t s and agreed t o the authenticity of some 318 premarked Division exhibits a t t h e comnencernent of the proceedings.Theadmissibility, relevancy and materiality of the exhibits were ruled onduring the course of t h e hearing.Therefore, t h e issues t o be resolveda r i s e fm the i n t e r p r e t a t i o n of the s t a t u t e and rule, which respondentsare charged with violating, i n l i g h t of the applicable f a c t s .bm October 28, 1966, u n t i l September 24, 1969, Kuhn was a veryactive salesman f o r the Fund.He r e t a i l e d a l o t of shares and during thel a t e r p a r t of the period he was an exclusive d i s t r i b u t o r f o r Revere Fundshares i n G e m y pursuant t o an agreement with Management which wasthe underwriter f o r the Fund.On September 24, 1969, t h e exclusive agencyagreemnt w a s terminated.On October 28, 1966, Management contracted with Kuhn t o be ad i s t r i b u t o r of Fund shares.Somtime i n 1967 at Kuhn's request, asecond contract was entered i n t o between Managemnt and Kuhn designatinghim as Management's exclusive d i s t r i b u t o r i n Gemany.This exclusived i s t r i b u t o r contract w a s cancelled on September 24, 1969.Once he became a Fund d i s t r i b u t o r Kuhn had the Fund prospectustranslated i n t o German f o r d i s t r i b u t i o n t o prospective investors.Also,sornetime between October 1966 and October 1969, Kuhn published and dist r i b u t e d i n Germany a magazine e n t i t l e d Investment Fund Analysis, aand advertisementspublication featuring s t o r i e s , performancer e l a t i n g primarily t o American mutual f'unds.Kuhn sent copies t o Sandersand everyone at Management, including Hess, saw t h e magazine.The magazinec a r r i e d advertisements f o r Revere, and one such advertisement included
pictures of Hess and Sanders and referred t o Kuhn as Revere 'sexclusive d i s t r i b u t o r .From 1967 t o 1970 lvlanagement experienced d i f f i c u l t i e s withKuhn and American Fund Services (AE-S) concerning l a t e payrnents f o r Fundshares sold i n Germany.The payments made by the German investors t oKuhn were not received by Revere, Management o r Fund Plan Services, Inc.(FPS)within seven days of the reported and effective sales ofRevere shares as required by Regulation T.51On September 5, 1968, the Revere directors discussed the signifi-cant l y l a t e p w n t s f o r ( K u h n ' s customers ) purchases accompanied byan increasing r a t e of sales.In view of the lateness of the payments,it was determined by the board t o ref'use further sales t o Kuhn u n t i lthe unpaid orders were resolved.A conardttee of 2 directors w a s appointedt o review the s i t u a t i o n before resuming business with Kuhn on a creditbasis.A t t h e November 1968 director's meeting it was reported that saleswith Kuhn had been resumed and t h a t Kuhnls payments were on a currentbas is.However, subsequent t o sales being resumed with K u h n therewere M h e r d i f f i c u l t i e s and f r o m Novenber 1, 1968 through October6, 1969, payments f o r 20 of Kuhnls transactions were more than 10 daysa/-5/-A wholly owned subsidiary of F i r s t Pennsylvania Banking & TrustCompany (Penco) which has served as Revere1s transfer and dividendd i s b m i n g agent and custodian f o r a l l of Revere's securities.F'PS w a s delegated the f'unction of processing Revere's redemptionsm u n d April 1972. Neither Penco nor FPS had any p a r t in Revere'smanagement o r policy decisions.Regulation T, promulgated by the Federal Reserve Board pursuant t oSection 7 of t h e Exchange Act, provldes, among other things nothere pertinent, that purchases of securities be paid for within7 days*
l a t e and a t some time during t h i s period Daly found it necessary t odiscuss the l a t e payment problem with the NASD.An NASD Report ofExamination of Management, dated October 9, 1969, stated under comnents:"Inadequate customer ledger and f a i l u r e t o notify NASD on l a t e paymentsby r e t a i l e r t o underwriter."was Management.The r e t a i l e r was Kuhn and the underwriterOn March 26, 1970, the NASD addressed a l e t t e r t o Sanderss e t t i n g forth the r e s u l t s of i t s examination which stated:"Firm not preparing o r maintaining an adequate customers1 ledgeri n accordance with provisions of SEC Rule 17a-3 and 4 as foundbeginning on page 4021 of the Associationls Manual."The NASD l e t t e r stated, also, t h a t during the period fYom at leastNovenber 1, 1968 tkrough October 1969 the firm had not notified theNASD D i s t r i c t Office of l a t e payments received f o r shares of investmentcompanies purchased by the members.Meanwhile, on November 5, 1969, theRevere directors had ordered t h a t future business with Kuhn must be ona cash only basis.Also, on March 19, 1969, Haskins & S e l l s , Management l s auditors,sent a material inadequacy l e t t e r t o Management concerning Management'sFinancial Report on Form X-17A-5,f i l e d with the Conmission.f o r the year ended Decenber 31, 1968,The l e t t e r and report called attention t omaterial inadequacies i n the accounting system, internal accounting controland procedures f o r safeguarding s e c u r i t i e s .It w a s noted t h a t the custodianbank f o r Revere had encountered d i f f i c u l t i e s i n handling the volume oftransactions occuring i n 1968, which resulted i n individual inaccuracies i nManagementls f a i l and cash balances.Moreover, Haskins & S e l l s stated t h a t"a European bank accomt, established t o f a c i l i t a t e t r a n s f e r of funds rel a t i n g t o foreign sales of Fund shares by an independent foreign dealer(Kuhn) , w a s not incorporated i n t o the Ccanpany l s accounting systemnor was the account effectively reconciled during the period due t o in-
adequate infornation supplied by the dealer."On Riarch 26,1969, Haskinsand c o m n d a t i o n st o Management.& S e l l s submitted a l e t t e r of corrrnentsUnder a section e n t i t l e d ForeignSales, it was noted t h a t the German bank account had not been incorporated i n t o Management's accounting system o r effectively reconciledduring the year and t h a t the current method f o r the collections on s a l e sin West Germmy i s not effective.It w a s recormended t h a t the practiceof paying Kuhnls salesmen f r o m m d s in the German accounts be stoppedinmediately and t h a t all correspondence from AFS (which w a s i n G e m )be translated i n t o English.It w a s f'urther suggested, i n view ofSEC Investment Company Act Release No. 5618, t h a t management and counselinmediately review Management's position as related t o s a l e s t o foreignnationalsasf'it appears t h a t adoption of these proposals w i l l e n t a i l manychanges in your contracts and procedures. "On February 5, 1970, Haskins & S e l l s , sent Management anothermaterial inadequacy l e t t e r concerning i t s Financial Report on Form X17A-5 f o r the year ended Decenber 31, 1969.This l e t t e r containedcom-ments on many of t h e deficiencies previously noted, including the f a i l u r et o reconcile t h e G e m bank account, but noted t h a t the former custodianbank agreement had been terminated and a new custodian bank (Penco)employed on April 7, 1969.Haskins & S e l l s s t a t e s t h a t the performanceof Managanent since t r a n s f e r t o the new custodian bank indicated theproblems in handling t h e volume of transactions experienced during 1968,had been solved.
The European bank account referred t o by Haskins & S e l l s w a s anaccount opened by Management a t the Dresdner Bank inDusseldorf, Germany,in 1967, as a conduit f o r f a c i l i t a t i n g collections and transfer offunds on s a l e s of Revere shares by Kuhn.Actually there were 2 accounts,one f o r deutsche marks and one f o r dollars and t h e only signatories(two had t o sign) were Hess, Sanders and Smith.Deposits f r o m sharepurchasers would be made i h t o the deutsche mark account and Kuhn wouldtransfer them i n t o the d o l l a r account.Every week o r two Managanentwould t r a n s f e r t h e accumulated deposits t o Penco and the shareholders1accounts would be credited by Management i n accordance with investrwntlists flunished by Kuhn o r h i s wife Sylvia.In 1969, at Kuhnls suggestion, h i s son, Hagen Kuhn, w a s hiredby Management t o "monitor German problem" and handle the G e mHagen would furmish lists of investors t o FPS which indicatedaccounts.t o whose account m n i e s deposited i n the Dresdner Bank were t o be credited.Frequently, theamountson the lists did not correspond t o t h e amount ofthe checks.When discrepancies occurred, Hagen Kuhn would make erasureson t h e lists, adding and eliminating names "to make the whole thingsettle."Richard M a y (May) a s s i s t a n t vice-president of FPS, believedt h a t Hagen Kuhn w a s not investing the shareholders1 m n i e s in a timelyfashion and reported this b e l i e f t o McFadden who "somewhat dismissed"h i s suspicion t h a t Hagen Kuhn was "accumdating mnies."May believedt h a t Hagen Kuhn w a s an employee of AF'S, inasmuch as he had indicated t oM a y t h a t he was a representative f o r Albert and Sylvia Kuhn.
Sometim i n 1969 Hagen Kuhn fraudulently endorsed, convertedand cashed approximately 3,400 i n conrmission checks payable t o Kuhno r AFS which Management had entrusted t o Hagen Kuhn f o r forwardingt o Germmy.The conversion w a s acconplished without the knowledgeo r authorization of Kuhn o r Management although both soon learned ofit. Sanders advised Hess of Hagen Kuhnls conversion of the comnissionchecks.By l e t t e r dated Septenber 23, 1969, Hess and Sanders directedt h e Dresdner Bank t o close the accounts but the German investors werenot advised of t h i s action and they continued t o make, and the DresdnerBank continued t o accept, investors1 deposits.On Decemer 3, 1969,the Dresdner Bank w a s again instructed t o close the accounts and t oaccept no f'urther deposits.In addition t o the l a t e payment and the Dresdner Bank problem,Management, around 1969, was having other problems with Kuhn caused byhis d e m d s f o r c o s s i o n sand expenses which Management believed t obe excessive, and h i s threats t o cause R e v e l sGerman shareholders,whom he referred to as "his i n e s t o r s ' t ,o redeem t h e i r Revere accounts.On September 24, 1969, Management and Kuhn entered into anagreemnt, signed by Sanders and Kuhn and witnessed by Hess, terminatingthe "exclusive agency agreement" between Management and Kuhn.'Ihis tmination agreement was written by Daly and w a s intended t o resolve thequestion of commissions claimed by Kuhn, t o enforce h i s corrpliance withthe NASD Rules of Fair Practice, and t o prevent h i s encouraging Revereshareholders t o redeem.In order t o s e t t l e the comnission dispute,Managemnt paid Kuhn 9,934 when the exclusive agreement was terminatede
and agreed t o pay another 2,000.On November 3, 1969, Sanders sent; al e t t e r t o Sylvia Kuhn enclosing a check f o r 2,000 and s t a t i n g t h a t"It should be noted t h a t t h e 2,000 payment received by you includes a l lpast problems of overpayments and commissions. "On July 28, 1969, the German government pmmulgated a law concerning t h e Distribution of Foreign Shares and the Taxation of Revenues f'rom Foreign Shares (ForInvestLaw) which became e f f e c t i v e onNovenber 1, 1969.This e f f e c t i v e l y prevented f W h e r d i s t r i b u t i o nof Revere shares in Germany.6/Therefore,Kuhn was retained a s adealer pursuant t o this t h i r d contract not in anticipation t h a t hewas going t o s e l l mre Revere shares, but t h a t he would continue t ohave the rigtnt t o receive "trail commissions", commissions which areaccrued by t h e payment of installments on Investment plans.However,Management did not advise e i t h e r t h e German shareholders o r FPS t h a tt h e exclusive distributorship agreement with Kuhn had been terminated.Although t h e 1969 termination contract was designed t o end allproblems with Kuhn it did not.In May 1970 Hess received a l e t t e rfmm Albert Kuhn and on August 4, 1970, Management received a letterf'mm Albert and Sylvia Kuhn i n which they demanded more comnissions,alleged t h a t many of t h e deposits made in the Dresdner Bank accountshad not been invested f o r shareholders and accused Management of embezzling m n i e s owed t o t h e Kuhns and German shareholders.6/The KuhnsThe new German law required f o r i g nbased mutual funds t or e a s t e r and t o m e t c e r t a i n requirements which Revere chosenot t o do.
wanted Management t o invest f o r o r return t o various shareholdersapproximately 3,400 and t o pay t o AFS 3,300 as settlement on 7,000 claimed t o be due AES i n comissions.A t Dalyls suggestionMcFadden reconciled t h e Dresdner Bank accounts and reviewed andanalyzed the sharvholder investment accounts and t h e Kuhn conanissionaccount.McFadden established t h a t Management may have owed custanersapproximately 1,100.However, h i s analysis led him t o suspect t h a thad been withdrawn from the deutsche mark accounta p r o x w t e 1500l at the Dresdner Bank without being deposited i n t o t h e U.S. dollaraccount.McFadden found that t h e monies Kuhn wanted invested f o rcustomers had been deposited i n t h e Dresdner Bank account p r i o r t oSeptember 1969.Since he found t h a t i n September 1969 Managemnt hadmade all investments i n accordance with t h e investment lists rumished byHagen Kuhn he assumed t h a t the monies Kuhn now wanted invested w e r em n i e s which had not been properly credited t o customers p r i o r t oS e p t e d e r 1969 but had instead been "used f o r other purposes."Thef a c t s showed t h a t payments being requested w e r e one nunber higher than thenunber of payments invested f o r 32 of 140 accounts l i s t e d on Hagen KuhnlsSeptember 1969 list.This led McFadden t o suspect the llpossdbility of7/a lapping operation." 7/Lapping w a s described a s a device t o i l l e g a l l y increase cashflow t h e f i r s t (A) account payment i s pocketed, or diverted,t h e second (B) account payment i s used t o cover the A account,t h e C t o cover the B, e t c . s o t h a t the f i r s t account and then thesucceeding accounts do not become past due and arouse suspicion.-
- 16 McFadden prepared a lengthy mmrandum e n t i t l e d Review oft h e German Matter containing certain findings and asswnptions basedon the f a c t s developed by h i s detailed examination of the situation.The memrandum w a s transmitted t o Sanders and Daly on September 30,1970.McFadden noted i n his memrandum t h a t the 3,400 claimed byKuhn t o be due t o custmers was the same amount that Hagen Kuhn hadconverted i n comission checks due t o Kuhn and he was "sure" thatKuhn would make up this 3,400 i n some manner.McFadden believedt h a t Kuhn would attempt t o obtain the 3,400 (1) f r o m Hagen Kuhn,( 2 ) d i r e c t l y f'rom Management, (3) frm Revere's custodian bank, o r(4) indirectly k o m Managemnt by "diverting c u s t m e r deposits givent o him o r Dresdner Bank."The fourth alternative w a s the one McFaddenw a s "mst sure was taken."McFadden t e s t i f i e d t h a t he spent at least100 hours reconciling the Dresdner Bank accounts and preparing the1970 m r a n d u m .Following a thorn@discussion of all the issues involvingManagpnent, Kuhn, the Dresdner Bank accounts and the German shareholders, McFadden suggests t h a t s o w s o r t of a settlement with Kuhnshould be considered i n order t o avoid an investigation involvingthe SEC o r the NASD. He says:"If my conclusions are correct as t oour l i a b i l i t i e s we should make an immediate settlement t o avoid anyunnecessary involvement with regulatory bodies.***Remember, theGerman Bank Account was t h e subject of a lmaterial inadequacy1 lettert o the SEC i n 1968 a s the r e s u l t of t h e Haskhs & S e l l s audit.***The SEC sent a representative t o our office and he w a s assured we
had the matter under control.I f they are made aware t h a t such i snot the case then we can only be put i n a bad l i m t .The SEC isnot concerned whether o r not a dealer o r management company losesmoney.Their primary concern is f o r the shareholders welfare.Ifa shareholder i s hurt it i s no excuse that w e had no way of knowing,we remain responsible.We must eliminate the p o s s i b i l i t y of
Albert Kuhn (Kuhn) is a Gem national who was a mutual fund . James Michael McFadden (McFadden) received a degree in . EconoKcs flmn Villanova University in 1966. He is a CPA and was employed by the public accounting firm of Haskins & Sells from May 1966 to November 1968 when he joined Management as Vice-President and Secretary. In June 1972 .
