UNITED STATES OF AMERICA
In the Matter of
|ORDER INSTITUTING ADMINISTRATIVE PROCEEDINGS PURSUANT TO SECTION 15(b) OF THE SECURITIES EXCHANGE ACT OF 1934, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS|
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be, and hereby are, instituted pursuant to Section 15(b) of the Securities Exchange Act of 1934 ("Exchange Act") against Prudential Securities, Incorporated ("PSI" or "Respondent").
In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement (the "Offer") 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 to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over it and the subject matter of these proceedings, which are admitted, Respondent consents to the entry of this Order Instituting Administrative Proceedings Pursuant to Section 15(b) of the Securities Exchange Act of 1934, Making Findings, and Imposing Remedial Sanctions ("Order"), as set forth below.
On the basis of this Order and Respondent's Offer, the Commission finds1 that:
1. Prudential Securities, Incorporated has been registered with the Commission as a broker-dealer since 1939. Its main office is located in New York, New York and, together with its affiliated companies, PSI has a total of 317 branches in 20 countries.
2. Robert J. Ostrowski, age 67, was a registered representative in PSI's Wilkes-Barre, Pennsylvania branch office for 41 years until he was permitted to resign in July 2001. At all relevant times, Ostrowski was a registered representative subject to PSI's supervision.
3. Rees T. Harris, age 71, was the branch office manager of PSI's Wilkes-Barre office from February 1997 through August 2000.
4. This matter involves PSI's failure reasonably to supervise Ostrowski with a view to preventing his violations of the federal securities laws. From 1998 through 2000, Ostrowski sold Class B shares in certain PSI proprietary mutual funds to his customers, without disclosing the existence of sales charge discounts for large purchases ("breakpoints") that would have made purchases of the funds' Class A shares lower cost investments for most of his customers. In so doing, Ostrowski increased his own compensation, generating excess commissions as a result of his improper Class B share sales practices.
5. During Ostrowski's fraudulent conduct, PSI had policies and procedures in effect concerning sales of mutual fund shares. However, PSI failed to adopt a sufficient system to determine whether the existing policies and procedures were followed above the branch office manager's level. As a result, when Harris, Ostrowski's branch office manager and direct supervisor, failed to follow and enforce PSI's policies and procedures related to the sale of mutual fund shares, PSI had inadequate means to detect that branch office manager's failure.
"Breakpoints" and Mutual Fund Shares
6. PSI funds offered several classes of shares representing interests in the same portfolio of investments. For each class of shares, a mutual fund uses a different method to collect sales charges from investors. Class A fund shares are subject to an initial sales charge ("front-end load"). Since the sales fee is paid up front, Class A shares incur smaller "rule 12b-1 fees," a fee the investor pays to the mutual fund specifically to compensate for distribution costs, including commissions paid to the broker-dealers and their registered representatives selling fund shares. Class B shares, by contrast, are not subject to an up-front sales charge. Instead, they become subject to a sales charge (a "contingent deferred sales charge" or "CDSC") only if, and when, they are redeemed before the end of a specified holding period (six years in this case). The amount of the CDSC declines as a percentage of the account's value over the six-year holding period specified in each fund's prospectus (5%, 4%, 3%, 2%, 1% and 1%). Class B shares usually automatically convert to Class A shares after a specified number of years (seven years in this case). Because Class B share investors only pay a CDSC, if any, at the time that they redeem their shares, the funds charge Class B share investors higher rule 12b-1 fees to defray distribution expenses associated with Class B shares.
7. Discounts on front-end loads are available for large purchases of Class A shares. The amount of the discount often increases at specified, increasing investment levels, or "breakpoints." (In this case, the first breakpoint is $50,000.) Investors may also qualify for breakpoint discounts pursuant to a "letter of intent," an agreement to make multiple purchases of Class A shares issued by PSI funds over a 13-month period which, when aggregated, equal an amount that qualifies for a breakpoint discount. Breakpoints are also available through "rights of accumulation," under which an investor, or an eligible group of related investors (e.g., the customer, the customer's spouse and minor children), may aggregate the value of their existing holdings of shares of PSI funds with the amount of the contemplated new investment to determine the reduced sales charge applicable to that purchase of Class A shares.
8. The lower rule 12b-1 fees and breakpoint discounts associated with Class A shares mean that the rate of return over time is generally higher with Class A shares than with Class B shares. Thus, an investor who qualifies for breakpoints or rights of accumulation may be financially better off investing in Class A shares. Breakpoint discounts are not available for purchases of Class B shares regardless of the size of the investment. Because Class B shares do not offer breakpoint discounts, brokers usually earn higher commissions on large Class B share investments than on Class A share purchases of the same amount.
Ostrowski's Fraudulent Sales Practices Concerning Class B Shares
9. From 1998 to 2000, Ostrowski recommended that certain customers purchase shares of certain PSI mutual funds. In doing so, he knowingly or recklessly concealed the salient characteristics of Class A and Class B shares that would have been important to any reasonable investor. In 42 out of 44 instances in which customers purchased (or accumulated in a short period) more than $100,000 worth of shares in PSI mutual funds - enough to earn breakpoint discounts if invested in Class A shares - Ostrowski placed customer funds in Class B shares. In doing so, Ostrowski failed to disclose the potential economic advantages of Class A shares for investments of that size.
10. Ostrowski obtained the customers' approval to purchase the particular fund, but he failed to provide the customers with a prospectus in advance of the sale, and to disclose the existence of multiple classes of shares, breakpoints, rights of accumulation and letters of intent. As a result, the affected customers did not understand that they were purchasing Class B shares. It was and is PSI's procedure to send a fund prospectus when there is an initial purchase of, or exchange into, any fund at the time the confirmation is sent. In addition, in several instances, Ostrowski made multiple purchases of Class B shares for the same account on the same day, or over a short period of time which, when aggregated, exceeded the $100,000 breakpoint threshold, thereby entitling the customer to breakpoints for Class A share purchases.
11. As a result of this conduct, Ostrowski received approximately $51,500 in excess commissions from the improper sale of Class B shares and generated approximately $63,000 in excess commissions for PSI.
PSI's Mutual Fund Policy and Harris' Failure to Enforce Compliance by Ostrowski
12. During the period of Ostrowski's misconduct, PSI had in place policies and procedures that specifically addressed sales of mutual fund shares. Pursuant to these policies and procedures, PSI directed that each registered representative "advise the client of the availability of the multiple classes and fully explain the terms of the different financing methods prior to purchase." Various factors to be considered in assessing which class was most suitable for the customer included the amount of the sales charge and whether the customer qualified for a reduction in the charge based upon breakpoints, rights of accumulation and/or letters of intent. PSI further required that the branch office manager approve all purchases greater than $100,000. Pursuant to PSI's policies and procedures, the branch office manager was charged with the responsibility of considering these factors in deciding whether to approve these transactions.
13. Harris was the branch office manager charged with implementing PSI's policies and procedures with respect to Ostrowski. However, despite his knowledge of these policies and procedures, Harris violated them by approving numerous trades by Ostrowski. Harris approved all 42 instances of Ostrowski's sales of Class B shares in amounts exceeding $100,000, while taking no steps to determine whether Ostrowski had disclosed required breakpoint information to customers.
PSI's Failure Reasonably to Supervise
14. PSI failed reasonably to supervise Ostrowski with regard to his improper sales of Class B shares to certain customers. Although PSI had policies and procedures prohibiting the type of sales practices that Ostrowski utilized, it did not have any systems in place to effectively monitor and enforce those policies and procedures.
15. During the relevant period, PSI's branch office managers were solely responsible for ensuring that registered representatives followed the firm's mutual fund policies and procedures. However, PSI failed to establish any system to effectively monitor actual compliance with its policies and procedures concerning sales of Class B shares, such as monitoring tools or reports.
16. PSI's supervisory lapses prevented it from detecting and preventing Ostrowski's fraudulent actions. When Harris failed to enforce compliance with PSI's policies and procedures, PSI did not have a system in place to monitor the performance of its branch managers with respect to the policies and procedures described in paragraph 12.
17. In July 2001, following completion of an internal review, PSI revised its mutual fund policies and procedures and implemented systems to monitor compliance with them. It now prohibits purchases of more than $100,000 in Class B shares by customers unless certain specific exceptions apply. It instituted a "hard block" in its computer system that prevents the execution of Class B share purchases in amounts over $100,000. The firm also developed new exception reports designed to detect Class B share transactions at just below the $100,000 limit or transactions aggregating more than $100,000 over a relatively short period of time.
18. As a result of the conduct described above, Ostrowski willfully violated Section 17(a) of the Securities Act of 1933 ("Securities Act"), Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which prohibit fraudulent conduct in the offer or sale of securities and in connection with the purchase or sale of securities.
19. As a result of the conduct described above, PSI failed reasonably to supervise Ostrowski, within the meaning of Section 15(b)(4)(E) of the Exchange Act, with a view to preventing Ostrowski's violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
PSI's Remedial Efforts
20. In determining to accept the Offer, the Commission considered the revised policies and procedures described in paragraph 17 that PSI adopted and cooperation afforded to the Commission staff.
21. PSI has undertaken to cooperate with the Commission staff in connection with this action or any related judicial or administrative proceeding or investigation commenced by the Commission or to which the Commission is a party, including but not limited to producing documents in its possession, custody or control, providing truthful testimony in any proceedings in which testimony may be requested by the Commission, and providing whatever other reasonable assistance is requested of it by the Commission. In determining whether to accept the Offer, the Commission has considered this undertaking.
In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions specified in Respondent PSI's Offer.
ACCORDINGLY, IT IS HEREBY ORDERED:
A. that PSI is hereby censured.
B. that Respondent shall, within ten days of the entry of this Order, pay disgorgement (representing the commissions referred to in paragraph 11 above) and prejudgment interest thereon in the total amount of $82,000, for future distribution to Prudential clients harmed by the conduct described above, and a civil penalty in the amount of $300,000, to the United States Treasury. Such payments shall be: (A) made by United States postal money orders, certified checks, bank cashier's checks or bank money orders; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Office of Financial Management, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (D) submitted under cover letter that identifies PSI as a Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money orders or checks shall be sent to Arthur S. Gabinet, District Administrator, Philadelphia District Office, Securities and Exchange Commission, The Curtis Center, Suite 1120E., 601 Walnut Street, Philadelphia, Pennsylvania 19106.
C. PSI shall comply with its undertakings to:
1) Maintain the revised policies, procedures and systems, as described above, that it implemented to enhance the supervision of Class B share sales.
2) Review, with the assistance of outside counsel, its procedures and systems regarding the sale of Class B shares for compliance with the federal securities laws and regulations, and the rules of the NASD and the New York Stock Exchange. Within 90 days of the issuance of this Order, unless otherwise extended by the staff of the Commission for good cause shown, PSI undertakes and agrees to inform the Commission in writing that it has completed its review and that, if necessary, it has established additional systems or procedures reasonably designed to achieve compliance with those laws, regulations, and rules concerning the sale of Class B shares
By the Commission.
Jonathan G. Katz
|1||The findings herein are made pursuant to Respondent's Offer of Settlement and are not binding on any other person or entity in this or any other proceeding.|
|Home | Previous Page||