UNITED STATES OF AMERICA
|In the Matter of
Prospera Financial Services, Inc.
|ORDER INSTITUTING PROCEEDINGS, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS|
The Securities and Exchange Commission ("Commission") deems it appropriate in the public interest and for the protection of investors that public administrative proceedings be, and hereby are, instituted pursuant to Sections 15(b) and 19(h) of the Securities Exchange Act of 1934 ("Exchange Act") against Prospera Financial Services, Inc. (formerly known as Addison Securities, Inc., hereinafter referred to as "Addison") and Jonathan D. Stein ("Stein").
In anticipation of the institution of these proceedings, Addison and Stein have submitted an Offer of Settlement ("Offer") to the Commission, which the Commission has determined to accept.
Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or in which the Commission is a party, and without admitting or denying the findings contained herein, except those contained in paragraph II.A. and the jurisdiction of the Commission over Respondents and the subject matter of these proceedings, Addison and Stein consent to the issuance of this Order Instituting Proceedings, Making Findings and Imposing Remedial Sanctions, and to the entry of the findings set forth below.
On the basis of this Order and the Offer submitted by Addison and Stein, the Commission finds that:
A. THE RESPONDENTS
Addison is a broker-dealer that has been registered with the Commission since 1982 (File No. 8-28164). Addison is based in Dallas, Texas and maintains 9 "branch offices" in Texas, Virginia, Kansas and California. Addison employs approximately 95 registered representatives, approximately 39 of whom work in off-site offices, all of which are separate and apart from the firm's home office location or branch office locations. Twenty-four of these off-site offices are one-person offices. Beginning in July 1994, Stein was Addison's president, as well as a minority shareholder of the firm. Stein was also the person responsible for Addison's supervisory policies and procedures.
This matter arises from Addison's and Stein's failure reasonably to supervise two registered representatives - a registered representative in a one-person, off-site office in Pittsburgh, Pennsylvania, and a registered representative in the home office of Addison located in Dallas, Texas - with a view to preventing violations of Section 17(a) of the Securities Act of 1933 ("Securities Act"), and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. When hired by Addison, both representatives had histories of customer complaints arising during their prior employments. Further, during their employment by Addison, each was sanctioned by a self-regulatory organization for the sales practices that triggered the customer complaints during their prior employments. Despite their histories of customer complaints and sanctions, Addison failed to place the representatives under any heightened supervision.
The registered representative in Pittsburgh misappropriated approximately $324,000 over a two and one-half year period from funds customers and other investors entrusted to him for specific investments. This registered representative then expended these funds, a portion of which was lost in speculative options transactions in his personal trading account at Addison. The registered representative in Addison's home office engaged in unauthorized transactions and unsuitable recommendations, including speculative options trading, and misappropriated at least $100,000 in customer funds over approximately two and one-half years.
Addison lacked adequate supervisory and compliance procedures and failed adequately to implement procedures that were in place. Addison's procedures failed adequately to provide for: delineation of supervisory responsibilities; heightened supervision of registered representatives who had a history of sales practice related complaints; monitoring of the off-site offices of registered representatives; monitoring of outside business activities of registered representatives; and, a system of follow-up and review to ensure that supervision was being diligently exercised. As a result, Addison and Stein failed adequately to supervise the two registered representatives referenced herein.
C. THE REGISTERED REPRESENTATIVES' VIOLATIONS
1. Pittsburgh, Pennsylvania Office
In 1991, Addison hired a registered representative who had a history of customer complaints alleging unsuitable recommendations and unauthorized transactions, including options transactions. In connection with state licensing requirements, the Pennsylvania State Securities Commission required Addison to affirm it was aware of the registered representative's complaint history and that it would maintain procedures adequate to insure he was under "diligent supervision," as required by Pennsylvania law. Moreover, in August 1993, the New York Stock Exchange imposed a 90 day suspension on this registered representative, based upon its determination that, while associated with another firm, he exercised discretionary trading authority without first obtaining written authorization from customers.
While associated with Addison, this registered representative operated an off-site, one-person, office out of his home in Pittsburgh, where he pursued other business interests in addition to his brokerage business. No supervisor or other person associated with Addison, however, ever personally met the representative or conducted an on-site inspection of his office.
Between May 1994 and November 1996, various investors, including at least seven Addison customers, entrusted $448,900 to this representative for specific investments. Instead, he misappropriated their funds for various purposes, including to engage in numerous unprofitable options transactions in his personal brokerage account at Addison. To hide his diversion of their funds, this registered representative provided several customers with false account statements on Addison masthead which reflected various profitable, but fictitious, investments.
By January 1995, losses in this representative's personal account exceeded his earnings from Addison, and by January 1996, the losses had exhausted the value remaining in his account. Subsequently, the representative left Addison. In April 1998, the representative sent investors a letter acknowledging that he had misappropriated their funds.
2. Dallas-Based Registered Representative
In May 1991, Addison hired a registered representative at its home office who was the subject of customer complaints alleging unsuitable recommendations and fraudulent transactions during a prior employment. Shortly after being hired by Addison, arbitration proceedings were initiated to resolve these complaints. Additionally, in October 1991, the National Association of Securities Dealers, Inc. ("NASD") notified Addison that it was investigating certain of these complaints, and in August 1993, it notified Addison that it had initiated formal proceedings against the registered representative. To settle these proceedings, in June 1995 the registered representative agreed to a NASD censure, a $22,500 fine, and a five day suspension. The registered representative discharged the NASD suspension while associated with Addison.
Between April 1994 and August 1996, while associated with Addison, the registered representative misappropriated customer funds and engaged in a series of unauthorized transactions and unsuitable recommendations. The registered representative submitted to Addison false account documentation to justify the speculative margin and options transactions she effected in customer accounts. The registered representative concealed these activities from some customers by sending them written reports, on Addison masthead, of fictitious holdings and profits. The registered representative also intercepted a $100,000 check issued by one customer for investment purposes, altered it for deposit into a brokerage account she controlled away from Addison, and then used the proceeds for personal transactions. In addition, she used a forged letter of authorization to make an unauthorized transfer of $26,000 held for investment into the account she controlled away from Addison. These funds were also lost in options transactions.
D. ADDISON'S AND STEIN'S FAILURE TO SUPERVISE
As set out below, Addison, under Stein's direction, failed to adopt, implement and follow adequate supervisory and compliance procedures. As such, both Addison and Stein, failed reasonably to supervise the above-described Pittsburgh and home office registered representatives with a view toward preventing their violations of the federal securities laws.
1. Inadequate Delineation of Supervisory Responsibilities and System of Follow-up and Review
Addison's written supervisory procedures provided that non-supervisory personnel in the compliance department and designated supervisors shared the responsibility of supervising the firm's registered representatives. These procedures designating supervisory responsibility were ineffective, however, because they failed adequately to assign specific supervisory duties among the parties. As a result, in this matter the several parties with supervisory responsibilities did not carry out all of the supervisory functions that the firm's supervisory manual described. Further, Addison's written supervisory procedures were also ineffective because they failed adequately to provide for a system of follow-up and review to ensure supervision was being diligently exercised. Accordingly, Addison failed to detect and prevent the violations that were committed by the Pittsburgh representative and the home office representative described herein.
2. Heightened Supervision of Registered Representatives with Known Disciplinary Histories
Both of the registered representatives described above were the subjects of customer complaints arising from prior employment at the time they were hired by Addison. In addition, both thereafter became the subject of separate investigations and were each sanctioned, for activity they engaged in at prior firms, by a self-regulatory organization during the course of their employment with Addison. Despite choosing to associate representatives with such backgrounds, Addison had neither procedures, nor a system, under which these representatives would be placed under increased supervision. Heightened supervision of these two representatives might have detected and prevented the violations committed while they were associated with Addison.
3. Examinations of Off-Site Offices
Addison's procedures did not require an on-site examination of the offices of off-site registered representatives. Such on-site examinations might have enabled supervisors to review the customer files maintained by the representative, including any fictitious account statements, confirmations, correspondence and checks to and from customers. On-site examinations also might have enabled supervisors to observe and review records and activities related to other business activities conducted by the representative. Between 1991 and 1996, the entire period that the Pittsburgh representative was associated with the firm, no supervisor or other person at Addison ever met the Pittsburgh representative or conducted an on-site examination of his office. Accordingly, Addison's procedures were inadequate to detect and prevent the violations by the Pittsburgh registered representative.
4. Monitoring and Review of Outside Business Activities of Registered Representatives
The Pittsburgh representative was pursuing other business interests from the same office in which he conducted brokerage activity through Addison, and Addison's supervisory and compliance personnel, including Stein, were aware that he conducted outside business activities. Subsequently the firm and Stein became aware that the representative's trading losses in his personal account exceeded the amount of commission income he generated through Addison. When questioned about his trading losses, the representative responded by claiming that the funds were obtained from an inheritance and from insurance commissions that he was earning, in addition to his brokerage commissions.
In response to this red flag, Addison and Stein accepted the representative's explanation at face value verifying only his affiliation with the insurance company. Addison did not verify his sources or amount of income, such as by requesting written documentation of his inheritance or his insurance commissions. Given the representative's disciplinary history and need for "diligent supervision," and the fact that Addison had nothing to substantiate his purported inheritance or insurance commissions, it would have been prudent to make further inquiry about his business activities. Regardless, at that time, no one from Addison personally met with the representative about these concerns, or examined his office and reviewed his files. Further, Addison did not have any procedures to request that information under these or similar circumstances.
Had any of these actions been taken, particularly file reviews, Addison might have determined that the representative's explanation for the losses in his personal account were false, that he was creating bogus account statements and that he was raising and stealing money from investors under another business name. Instead, because Addison did not have adequate procedures and because Addison and Stein failed reasonably to respond to this red flag, the representative continued his fraudulent practices undeterred.
Section 15(b)(4) of the Exchange Act provides for the imposition of a sanction against a broker or dealer who "has failed reasonably to supervise, with a view to preventing violations of such statutes, rules, and regulations, another person who commits such a violation, if such other person is subject to his supervision." See Smith Barney, Harris Upham & Co., Inc., Exchange Act Release No. 21813, 32 SEC Docket 999, 1004 (March 5, 1985). Section 15(b)(6) parallels Section 15(b)(4) and provides for the imposition of sanctions against persons associated with a broker or dealer. These sections also provide an affirmative defense for supervisors who can show that (1) there have been established procedures, and a system for applying such procedures, which would reasonably be expected to prevent and detect, insofar as practicable, any such violation by such other person, and (2) such person has reasonably discharged the duties and obligations incumbent upon him by reason of such procedures and system without reasonable cause to believe that such procedures and system were not being complied with.
Supervision is an essential function of the broker-dealer. The Commission has long held that responsibility for the supervisory function of a registered broker-dealer is incumbent upon the most senior members of management. Frederick H. Joseph, Exchange Act Rel. No. 32340, 54 SEC Docket 283, 290 (May 20, 1993). "It is critical for investor protection that a broker establish and enforce effective procedures to supervise its employees." Donald T. Sheldon, Exchange Act Release No. 31475, 52 SEC Docket 3826, 3855 (November 18, 1992), aff'd 45 F.3rd 1515 (11th Cir. 1995). Establishment of policies and procedures alone is not sufficient to discharge supervisory responsibility. It also is necessary to implement measures to monitor compliance with those policies and procedures. Thomson & McKinnon, Exchange Act Release No. 8310, 43 S.E.C. 785, 788 (1968) ("Although it was registrant's stated policy . . . it failed to establish an adequate system of internal control to insure compliance with such policy."); Sutro Brothers & Co., Exchange Act Release No. 7052, 41 S.E.C. 443, 464 (1963) ("registrant did not expand its supervisory procedures to keep pace with the rapid expansion of its operations").
Further, broker-dealers must not only adopt effective procedures for supervision, but must also "provide effective staffing, sufficient resources and a system of follow up and review to determine that any responsibility to supervise delegated to compliance officers, branch managers and other personnel is being diligently exercised." Mabon, Nugent & Co., Exchange Act Release No. 19424, 26 SEC Docket 1846, 1852 (January 13, 1983). The system must provide sufficient checks "to insure that the first line of compliance, the branch manager, [is] functioning adequately." Shearson Lehman Brothers, Inc., Exchange Act Release No. 23640, 36 SEC Docket 1075, 1083 (September 24, 1986). Moreover, "[t]he need for central control increases, not decreases, as branch offices become more numerous, dispersed and distant." Shearson, Hamill & Co., Exchange Act Release No. 7743, 42 S.E.C. 811, 843 (November 12, 1965).
The Commission has repeatedly emphasized the need for heightened supervision when a firm employs a broker with known regulatory problems or customer complaints. See James Thornton, Exchange Act Release No. 41007, 69 SEC Docket 49, 55 (February 1, 1999) (firm failed reasonably to supervise when "supervisory policies made no provision for heightened supervision of a registered representative with a disciplinary history"); Consolidated Investment Services, Exchange Act Release No. 36687, 61 SEC Docket 20, 30 (Jan. 5, 1996) ("registered representative who has previously evidenced misconduct can be retained only if he subsequently is subjected to a commensurately higher level of supervision" (citing Dan A. Druz, Exchange Act Release No. 35203, 58 SEC Docket 1621, 1627 (January 9, 1995)); Frank J. Custable, Jr., Exchange Act Release No. 33324, 51 SEC Docket 855, 860 (December 10, 1993); Donald T. Sheldon, 51 SEC Docket at 82. Extraordinary supervision of a registered representative with a disciplinary past is particularly appropriate when that representative operates out of a one-person office, a substantial distance away from supervisory or compliance personnel. Houston A. Goddard, Exchange Act Release No. 32839, 54 SEC Docket 2431, 2439 (September 2, 1993).
In this matter, each of the representatives whose conduct is described above had a history of customer complaints when hired by Addison. Further, an SRO subsequently sanctioned each representative. Heightened supervision might have detected and prevented some, if not all, of their violations committed while they were associated with Addison.
The Commission has determined that broker-dealers which conduct business through off-site offices have not adequately discharged their supervisory obligations where there are no inspections of those offices. Consolidated Investment Services, 61 SEC Docket at 26 (broker-dealer's supervision of small office run by a single registered representative inadequate without inspections); Royal Alliance Associates, Inc., Exchange Act Release No. 38174, 63 SEC Docket 1843 (January 15, 1997). In this matter, Addison did not have procedures that required inspections of its one and two person off-site offices. The lack of inspections was particularly unreasonable given that the firm employed registered representatives in off-site offices. NYLife Securities, Inc., Exchange Act Release No. 40459, 68 SEC Docket 158 (September 23, 1998) (broker-dealer supervision of off-site representatives inadequate without examinations of such personnel). If Addison's procedures had included such inspections, the firm might have detected the Pittsburg representative's violations.
Further, allowing a registered representative to engage in outside business activities involves the risk that the representative will use his outside business to carry out or conceal violations of the securities laws. Addison did require that representatives obtain permission before engaging in outside business activities, but nothing in the written procedures guided supervisory inquiries when "red flags" indicated the possibility of illegitimate business activities. In this matter, Addison observed that the Pittsburgh representative, who maintained an off-site office, was suffering trading losses in his personal account that exceeded his Addison commission income. Rather than adequately investigate this red flag, however, Addison relied upon the representative's unverified assertions regarding the propriety of his outside activities and the source and amount of his other income. In this regard, Addison's procedures were deficient for failing to require inspections of off-site offices or to require independent verification of such matters as the nature and extent of outside business activities and a representative's outside sources of income. See PFS Investments, Inc., Exchange Act Release No. 40269, 67 SEC Docket 2032, 2038 (July 28, 1998).
Addison's procedures and compliance system were also deficient because there were no procedures in place to assure the thorough investigation of customer complaints, suitability issues or other matters raised by the firm's compliance reviews. For example, no procedure required, in the investigation of complaints, verification of information provided by the registered representative by contacting the complainant. PFS Investments, 67 SEC Docket at 2038. Nor was supervision intensified after these complaints, even though the representative in question had previously evidenced misconduct. Dan A. Druz, 58 SEC Docket at 1627.
Addison's procedures were also inadequate because they did not adequately delineate responsibility among the various positions charged with supervisory responsibility. Had the firm clearly assigned supervisory responsibility, intermediate managers and compliance officers might have detected the violations of the registered representatives described above. In addition, there was no system of follow up and review to determine that supervision was being diligently exercised.
In view of the foregoing, the Commission deems it appropriate in the public interest and for the protection of investors to impose the sanctions that are set forth in the Offer submitted by Prospera (f\k\a Addison) and Stein.
Accordingly, IT IS ORDERED that:
A.Prospera (f\k\a Addison) is hereby censured.
B.Prospera (f\k\a Addison) shall, within 90 days of the issuance of this Order, pay a civil money penalty in the amount of $40,000 to the United States Treasury. Such payment shall be: 1) made by United States postal money order, certified check, bank cashier's check or bank money order; 2) made payable to the Securities and Exchange Commission; 3) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and 4) submitted under a cover letter that identifies Prospera (f\k\a Addison) as a respondent in these proceedings and states the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Harold F. Degenhardt, District Director, Fort Worth District Office, 801 Cherry Street, 19th Floor, Ft. Worth, TX 76102.
C. Prospera (f\k\a Addison) undertakes to:
1. Retain, within 30 days of the date of this Order, at its expense, an Independent Consultant not unacceptable to the Commission's staff. The Independent Consultant shall conduct a review of Prospera's (f\k\a Addison) supervisory, compliance, and other policies and procedures designed to prevent and detect federal securities law violations of the nature involved in this matter. Prospera (f\k\a Addison) shall cooperate fully with the Independent Consultant and shall provide the Independent Consultant with access to its files, books, records, and personnel as reasonably requested for the review.
2. At the conclusion of that review, which in no event shall be more than 120 days after the date of the Independent Consultant's retention, the Independent Consultant shall submit to Prospera (f\k\a Addison) and to the Commission an Initial Report. The Initial Report shall address the adequacy of Prospera's (f\k\a Addison) policies and procedures to detect and prevent federal securities law violations of the nature involved in this matter, and shall include the Independent Consultant's recommendations thereon.
3. Within 30 days of transmittal of the Independent Consultant's Initial Report, Prospera (f\k\a Addison) shall in writing advise the Independent Consultant of the recommendations that it has determined to accept and the recommendations that it considers to be unduly burdensome. With respect to any recommendation that Prospera (f\k\a Addison) deems unduly burdensome, Prospera (f\k\a Addison) may propose an alternative policy or procedure designed to achieve the same objective or purpose.
4. With respect to any recommendation or proposal with which Prospera (f\k\a Addison) and the Independent Consultant do not agree, Prospera (f\k\a Addison) and the Independent Consultant shall attempt in good faith to reach an agreement. In the event the Independent Consultant and Prospera (f\k\a Addison) are unable to agree on an alternative proposal, Prospera (f\k\a Addison) shall abide by the recommendation of the Independent Consultant.
5. Within 60 days of transmittal of the Independent Consultant's Initial Report, Prospera (f\k\a Addison) shall in writing advise the Independent Consultant and the Commission of the recommendations and proposals that it is adopting.
6. The Independent Consultant shall complete the aforementioned review and submit a written Final Report thereon to Prospera (f\k\a Addison) and to the Commission's staff within 270 days after the date of this Order. The Final Report shall recite the efforts the Independent Consultant undertook to review Prospera's (f\k\a Addison) supervisory functions, compliance mechanisms, and other policies and procedures, set forth the Independent Consultant's recommendations and Prospera's (f\k\a Addison) proposals, and describe how Prospera (f\k\a Addison) is implementing those recommendations and proposals.
7.Prospera (f\k\a Addison) shall take all necessary and appropriate steps to adopt and implement all recommendations contained in the Independent Consultant's Final Report.
8. No later than one year after the date of this Order, unless extended pursuant to paragraph 9, below, Prospera (f\k\a Addison) shall submit to the Commission's staff an Affidavit setting forth the details of its efforts to implement the recommendations contained in the Independent Consultant's Final Report and stating whether it has achieved compliance.
9. For good cause shown, and upon receipt of a timely application from the Independent Consultant or Prospera (f\k\a Addison), the Commission's staff may extend any of the procedural dates set forth above.
10. To ensure the independence of the Independent Consultant, Prospera (f\k\a Addison): (i) shall not have the authority to terminate the Independent Consultant, without the prior written approval of the Commission's staff; (ii) shall compensate the Independent Consultant, and persons engaged to assist the Independent Consultant, for services rendered pursuant to this Order at their reasonable and customary rates; (iii) shall not be in and shall not have an attorney-client relationship with the Independent Consultant and shall not seek to invoke the attorney-client or any other doctrine or privilege to prevent the Independent Consultant from transmitting any information, reports, or documents to the Commission or its staff.
11. To further ensure the independence of the Independent Consultant, for the period of the engagement and for a period of two years from completion of the engagement, the Independent Consultant shall not enter into any employment, consultant, attorney-client, auditing or other professional relationship with Prospera (f\k\a Addison), or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity. Any firm with which the Independent Consultant is affiliated in performance of his/her duties under this Order shall not, without prior written consent of the Fort Worth District Office of the Commission, enter into any employment, consultant, attorney-client, auditing or other professional relationship with Prospera (f\k\a Addison), or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity as such for the period of the engagement and for a period of two years after the engagement.
D. Stein shall, within 90 days of the issuance of this Order, pay a civil money penalty in the amount of $10,000 to the United States Treasury. Such payment shall be: 1) made by United States postal money order, certified check, bank cashier's check or bank money order; 2) made payable to the Securities and Exchange Commission; 3) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and 4) submitted under a cover letter that identifies Stein as a respondent in these proceedings and states the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Harold F. Degenhardt, District Director, Fort Worth District Office, 801 Cherry Street, 19th Floor, Ft. Worth, TX 76102.
E. Stein is hereby suspended from association with any broker or dealer in any supervisory or proprietary capacity for a period of six months.
By the Commission.
Jonathan G. Katz
|Home | Previous Page||