June 30, 1993
TO: COMPLIANCE COMMITTEE NO. 13-93
INVESTMENT ADVISERS COMMITTEE NO. 20-93
SEC RULES COMMITTEE NO. 57-93
RE: SEC FURTHER CLARIFIES ROLE OF SUPERVISORS
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As you may know, in administrative proceedings last year against three
senior officials of a major broker-dealer firm, the Securities and Exchange
Commission amplified its views on who is a supervisor for purposes of the federal
securities laws and the responsibilities that this role entails. The Commission
has further clarified its views in a recent administrative proceeding against the
chief executive officer of a broker-dealer firm.
In the order, the Commission found that the officer failed reasonably to
supervise the manager of the firm's high yield and convertible bond department
(the "HYBD"), with a view to preventing two unrelated schemes to violate the
securities laws. In the first scheme, entities controlled by the HYBD manager
(the "Partnerships") allegedly purchased securities that were being underwritten
by the firm and (after the HYBD had made a market in the securities) sold their
holdings back to the HYBD at a premium to the offering price. The Commission
found that the HYBD manager thereby violated Section 17(a) of the Securities Act
and Section 10(b) of the Securities Exchange Act and Rules 10b-5 and 10b-6
thereunder. The Commission also found that the HYBD manager told the chief
executive officer that the Partnerships were willing to purchase unsubscribed
portions of the offerings, and found that the chief executive officer approved
the Partnership purchases.
The second scheme involved an off-shore fund organized by the securities
firm. The firm paid trailing commissions to the its salespersons who sold the
fund shares and charged the HYBD a fee to recoup the trailing commissions. In
order to recover the charge, the HYBD manager required the fund manager to
designate the securities firm to receive selling concessions on the purchase of
newly issued securities by the fund and other clients of the fund manager. The
fund manager also adjusted the prices of trades made for the fund and the fund
manager's other clients, in favor of the securities firm. Neither the
designation of selling concessions nor the adjustment of trading prices was
disclosed to the fund investors or the fund manager's other clients. The
Commission found that the HYBD manager thereby violated Exchange Act Section
10(b) and Rule 10b-5, and aided and abetted the fund manager's violation of
Section 206 of the Investment Advisers Act. The Commission also found that the
HYBD manager had told the chief executive officer about the selling concession
designations and "sales credits on trades."
The Commission's order states that "reasonable supervision [under the
federal securities laws] requires 'strict adherence' to internal company
procedures" and that the federal securities laws "impose on supervisors the
obligation to respond vigorously even to indications of possible wrongdoing."
The order continues:
Red flags and suggestions of irregularities demand
inquiry as well as adequate follow-up and review. When
indications of impropriety reach the attention of those
in authority, they must act decisively to detect and
prevent violations of the federal securities laws.
The Commission found that, at a minimum, the chief executive officer should
have brought the Partnership purchases to the attention of those persons in the
firm primarily responsible for legal and compliance matters, and should have
followed-up to ensure that appropriate action was being taken. The Commission
also found that the chief executive officer should have acted to prevent the HYBD
manager's recovery of the internal fee by means of the selling concession
designations. The Commission found that, when the HYBD manager told the chief
executive officer that h was recouping a portion of the fee with "sales credits
on trades," the officer should have halted the practice if he understood this
terminology or, if he did not understand it, "should have recognized it as a red
flag and inquired to determine what this method of recouping the fee entailed."
The Commission found that the chief executive officer took no action with respect
to either scheme (and failed to inquire as to the sales credits), and that he
failed reasonably to supervise the HYBD manager with a view to preventing the
securities law violations.
Without admitting or denying the Commission's findings, the chief executive
officer consented to an order barring him from association in a supervisory
capacity with any broker-dealer, investment adviser, investment company, or
municipal securities dealer, with a three-year right to reapply to become so
associated except as chairman, chief executive officer, or president. A copy of
the order is attached.
Thomas M. Selman
Assistant Counsel
Attachment