UNITED STATES OF AMERICA
In the Matter of
JOSEPHTHAL & CO., INC.
|ORDER INSTITUTING PROCEEDINGS, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS|
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public proceedings be, and hereby are, instituted pursuant to Section 15(b) of the Securities Exchange Act of 1934 ("Exchange Act") against Josephthal & Co., Inc. ("Josephthal").
In anticipation of the institution of these proceedings, Josephthal has submitted an Offer of Settlement to the Commission, which the Commission has determined to accept. Solely for the purposes of this proceeding and any other proceeding 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 paragraphs II. A. and B., the jurisdiction of the Commission over Respondent and the subject matter of these proceedings, which are admitted, Josephthal consents to the issuance of this Order Instituting Proceedings, Making Findings, and Imposing Remedial Sanctions, and to the entry of the findings and the Order set forth below.
On the basis of this Order and the Offer submitted by Josephthal, the Commission finds that:1
A. Josephthal (File No. 8-5651), a New York corporation based in New York City, New York, has been registered with the Commission as a broker-dealer since March 1, 1957. Until October 1997, Josephthal operated under the name Josephthal, Lyon & Ross, Inc. Josephthal filed a Form BDW with the Commission on April 25, 2002 to withdraw its broker-dealer registration.
B. On March 26, 1997, the New York Stock Exchange ("NYSE") censured and fined Josephthal, and ordered it to comply with an undertaking to retain an independent consultant to prepare recommendations for additional or different systems, policies and procedures reasonably designed to ensure compliance with the federal securities laws and NYSE rules. The NYSE found that Josephthal failed reasonably to supervise and provide appropriate procedures of supervision and control over numerous activities, including failing to conduct, and to make a written record of, annual branch office inspections.2
INDEPENDENT CONSULTANT'S RECOMMENDATION
AND JOSEPTHAL'S RESPONSE
C. The independent consultant noted that Josephthal did not appear to have any mechanism in place to periodically monitor the supervisory efforts of its branch office managers. The independent consultant recommended, among other things, that Josephthal develop and distribute separate policies and procedures manuals for individuals, including brokers, branch office managers and divisional/regional managers.
D. Josephthal never developed a separate policies and procedures manual for divisional/regional managers. However, in October 1998, as part of its undertaking, and approved by the independent consultant, Josephthal distributed its "Branch Office Manager's Guide to Supervision" ("BOM DRAFT Guide") to each branch office manager, including the manager of the firm's Addison, Texas branch office. Each page of the BOM DRAFT Guide was stamped "DRAFT," and the firm never distributed a BOM DRAFT Guide without this draft designation.
E. The BOM DRAFT Guide contained specific procedures regarding wire transfers of money from customer accounts. Josephthal's previous compliance manual had no procedures governing wire transfers. The BOM DRAFT Guide required all wire transfer requests to be in writing and approved by the branch office manager. Before approving any wire transfer request, the branch office manager was required to confirm the written request by contacting the customer and verifying the bank account number to which the funds were to be wired. Additionally, the BOM DRAFT Guide required the branch office manager to maintain a record of this customer contact.
F. From time to time, Josephthal distributed updates revising provisions of the BOM DRAFT Guide. However, the section governing wire transfers never changed.
SUBSEQUENT SUPERVISORY LAPSES
G. From approximately June 2000 through March 23, 2001, a registered representative employed at Josephthal's Addison branch office willfully violated Section 17(a) of the Securities Act of 1933, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder when he misappropriated at least $1.3 million from his customers' accounts. The registered representative wire transferred his customers' funds from their accounts to his personal bank account or to bank accounts maintained by Las Vegas casinos, and used their funds to gamble on various sporting events.3
H. Although the BOM DRAFT Guide required that all wire transfer requests be in writing and the branch office manager to approve and verify each request, the registered representative simply by-passed the branch office manager and requested the operations department to wire transfer funds from his customers' accounts to a bank account he designated. The operations department initiated the wire transfers based upon the information provided by the registered representative. The branch office manager never confirmed or approved any of the wire transfers prior to their execution.
I. Had the branch office manager and the operations department followed the BOM DRAFT Guide procedures relating to wire transfers, specifically, by contacting the customers, almost certainly the registered representative's misappropriation of funds via wire transfer activities might have been detected earlier. By contacting them, the customers would have alerted the branch office manager that they had not authorized the wire transfers. Further, a review of the record maintained by the branch office manager of these customer confirmations would have revealed that the same registered representative initiated a large number of wire transfers from many different customers, most of which were directed to a single account. Minimal follow up would have revealed that this account belonged to the registered representative. Similar follow up might have revealed that the registered representative was also wire transferring customer funds into bank accounts, which were later determined to belong to casinos to fund his gambling activities.
J. Significantly, despite the recommendation of the independent consultant, Josephthal never developed a separate policies and procedures manual for divisional/regional managers and failed to institute procedures to monitor whether its branch office managers were adequately discharging their supervisory duties.
K. Thus, Josephthal failed reasonably to supervise with a view to preventing violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, by the registered representative of its Addison branch office because the firm failed to establish a system to monitor whether the branch office manager was implementing the wire transfer procedures required by the BOM DRAFT Guide.
L. Substantially all the outstanding shares of Josephthal & Co., Inc. have been acquired by another broker-dealer and, on December 31, 2001, Josephthal permanently ceased its broker-dealer operations. Josephthal filed a Form BDW on April 25, 2002 with the Commission to withdraw its broker-dealer registration. Currently, Josephthal's only business consists of winding down its business affairs.
JOSEPTHAL'S REMEDIAL EFFORTS
M. In determining to accept Josephthal's offer, the Commission considered remedial efforts undertaken by the firm, including compensatory payments made by the firm to the registered representative's customers, as well as the firm's deregistration with the Commission.
Section 15(b)(4)(E) 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 the provisions 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). Supervision is an essential function of the broker-dealer. "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 and facilities to keep pace with the rapid expansion of its operations").
"The Commission has long recognized that it is not sufficient for a broker-dealer to establish a system of supervisory procedures which rely solely on supervision by branch managers." Prudential-Bache Securities, Inc., Exchange Act Release No. 22755, 48 S.E.C. 372, 400 (1986). 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).
Josephthal's procedures and compliance system were deficient because they did not adequately implement effective wire transfer procedures. The Commission has repeatedly found that brokerage firms fail in their duty reasonably to supervise if they fail to effectively implement adequate procedures regarding wire and other transfers of customer funds. See Titan/Value Equities Group, Inc. Exchange Act Release No. 32939, 55 SEC Docket 0090, 0093 (September 22, 1993); Fahnestock & Co., Inc., Exchange Act Release No. 43054, 72 SEC Docket 2684, 2686 (July 19, 2000); Janney Montgomery Scott, LLC, Exchange Act Release No. 43050, 72 SEC Docket 2663, 2665 (July 18, 2000); Thomas F. White and Thomas F. White and Co, Inc., Exchange Act Release No. 30471, 50 SEC Docket 2159, 2160 (March 12, 1992).
Josephthal's procedures were also deficient because they failed to provide a system of follow up and review to determine that the responsibility to supervise delegated to the branch officer manager was being diligently exercised. "The Commission has long recognized that it is not sufficient for a broker-dealer to establish a system of supervisory procedures which rely solely on supervision by branch managers. See Shearson, Hamill & Co., 42 S.E.C. 811 (1965). In Shearson, Hammill, the Commission found that the firm abdicated its responsibility of supervision over its organization by excessive reliance on branch managers ..." Prudential-Bache, 48 S.E.C at 400. As noted, had the branch office manager properly implemented the BOM DRAFT Guide wire transfer procedures, the misappropriation of customer funds by the registered representative probably would have been detected and deterred. Josephthal's failure to clearly assign to an intermediate supervisor the supervisory responsibility of ensuring that branch office managers effectively implemented the BOM DRAFT Guide, in turn, allowed the failure of the branch office manager to implement its wire transfer procedures to go undetected. This supervisory deficiency is of particular concern given that Josephthal failed to implement the earlier recommendation of the independent consultant that the firm develop and distribute a separate policies and procedures manual for divisional/regional managers, the firm's intermediate supervisors.
In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions that are set forth in the Offer submitted by Josephthal.
Accordingly, IT IS ORDERED that:
A. Josephthal be, and hereby is, censured.
B. Josephthal shall, within 21 days of the entry of this Order, pay a civil money penalty in the amount of $75,000 to the United States Treasury. Such payment shall be: (A) made by United States postal money order, certified check, bank cashier's check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (D) submitted under cover letter that identifies Josephthal as a Respondent in these proceedings, 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 Administrator, Securities and Exchange Commission, Fort Worth District Office, 801 Cherry Street, Unit 18, Fort Worth, Texas 76102.
By the Commission.
Jonathan G. Katz
|1||The findings herein are made pursuant to the Respondent's Offer of Settlement and are not binding on any other person or entity in this or any other proceeding.|
|2||New York Stock Exchange, Inc. v. Josephthal Lyon & Ross, Inc., Exchange Hearing Panel Decision 97-33 (March 26, 1997).|
|3||On April 6, 2001, the Commission obtained Ex Parte Orders Freezing Assets, Directing the Repatriation of Funds and Surrender of Passport, Requiring an Accounting, Requiring Preservation of Documents and Authorizing Expedited Discovery against this registered representative. The Commission's complaint also sought preliminary and permanent injunctions, disgorgement with prejudgment interest and a civil money penalty. (Lit. Rel. No. 16954). On October 31, 2001, in a related criminal proceeding, this registered representative was sentenced to serve 46 months in federal prison and three years of supervised release, and ordered to pay restitution of more than $1.6 million, based on his guilty plea to one count of securities fraud. (Lit. Rel. No. 17214).|
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