United States of America
In the Matter of
SPEAR, LEEDS &
|ORDER INSTITUTING ADMINISTRATIVE PROCEEDINGS, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS PURSUANT TO SECTION 15(b) OF THE SECURITIES EXCHANGE ACT OF 1934|
The Securities and Exchange Commission (the "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 Spear, Leeds & Kellogg, L.P. ("Respondent" or "SLK").
In anticipation of the institution of these administrative proceedings, SLK 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, SLK consents to the entry of this Order Instituting Administrative Proceedings, Making Findings, and Imposing Remedial Sanctions Pursuant to Section 15(b) of the Securities Exchange Act of 1934 ("Order"), as set forth below.
On the basis of this Order and SLK's Offer, the Commission finds that:
A. SLK failed reasonably to supervise certain employees with a view to preventing them from aiding and abetting a Direct Access client in unlawful "marking the close" trades on the floor of the New York Stock Exchange ("NYSE") in 1999. "Marking the close" refers to the manipulative practice of attempting to influence the closing price of a stock by executing purchase or sale orders at or near the close of the market. During the relevant period, SLK lacked adequate procedures specifically to detect and prevent marking the close. For example, SLK did not conduct a periodic review of trades at and near the end of the day to detect patterns of marking the close by its clients. Instead, SLK's procedures merely contained a proscription against marking the close and required employees to notify SLK's compliance department of suspicious trading at or near the close. SLK's procedures for supervision of its business on the NYSE floor were also circular because the supervisor responsible for reviewing order tickets and daily activity reports was also one of the floor brokers executing certain of the client's orders.
B. SLK is a member of the NYSE and has been registered with the Commission as a broker-dealer since 1948. SLK is based in New York, New York.
C. The NYSE permits its member firms to conduct business in Exchange-listed securities with customers, including non-member broker-dealers, by telephone directly from the NYSE trading floor, provided that the member firm complies with Commission and NYSE requirements, including requirements concerning supervision. The practice of placing and accepting orders in this manner is referred to as Direct Access business. One of SLK's Direct Access clients, Baron Capital, Inc. ("Baron Capital"), is a broker-dealer registered with the Commission since 1982. Baron Capital comprised nearly half of SLK's Direct Access business during the relevant time period.
D. Southern Union Company is a utilities company whose common stock was, at all relevant times, traded on the NYSE under the symbol "SUG." Pursuant to a merger agreement entered into in June 1999, SUG would acquire Pennsylvania Enterprises ("PNT") for a combination of cash and SUG stock to be determined by the average closing price of SUG stock during a ten-day period which began on October 19 and ended on November 1, 1999 (the "pricing period"). The higher the average closing price of SUG, the less cash SUG would pay. If the average closing price of SUG was less than $17.30, PNT had the right to terminate the merger. On the morning of October 18, 1999, SUG stock hit a six-month low of $17.625 per share.
E. Baron Capital is a broker-dealer for several of its affiliated investment advisory firms ("Baron affiliates"). As of October 15, 1999, client accounts managed by the Baron affiliates owned more than 10% of SUG's outstanding shares. During the merger pricing period, Baron Capital marked the close of SUG by effecting purchases of SUG stock at or near the close of trading in order to raise and maintain the price of SUG stock. As a result of this conduct, Baron Capital violated Section 15(c)(1) of the Exchange Act. See In the Matter of Baron Capital, Inc., et al., Admin. Proc. File No. 3-11096 (April 29, 2003). The purchase orders were executed by SLK as described below.
F. SLK order clerks on the trading floor received the purchase orders from Baron Capital and conveyed the order to SLK floor brokers for execution pursuant to Baron Capital's instructions. Recorded telephone conversations between Baron Capital traders and two SLK order clerks ("Clerk A" and "Clerk B"), and other evidence, indicate that the two SLK order clerks were aware, or were reckless in disregarding, that Baron Capital was entering a series of purchase orders to be executed at the close of the market in order to raise or maintain SUG's stock price, and that the SLK order clerks assisted Baron Capital in marking the close.
G. For example, on October 18, 1999, Baron Capital placed an order to buy 25,000 shares of SUG at a maximum price of $18¾ near the close of trading. While the order was outstanding, Clerk A telephoned the Baron Capital trading desk and asked, "on that SUG, now given the opportunity you would ... drive the price up a little bit...." The Baron Capital trader responded, "Yes I would." A few minutes later, the Baron Capital trader called Clerk A and instructed him to "keep taking it up on the SUG," and increased the maximum price to $19. In the last 5 minutes of trading on October 18, 1999, SLK made purchases of SUG stock for Baron Capital totaling 20,900 shares on successive plus ticks at the offer, with the effect of raising the price from $18 ½ to close at $19.
H. On October 20, 1999, a Baron Capital trader placed an order near the close of trading with Clerk B, who was the SLK head order clerk, to "buy 24,000 SUG with a $20 limit." Clerk B asked, "You want me to take it right up there and mark it there?" The Baron Capital trader responded affirmatively. Later that day, Clerk B called the Baron Capital trader to report that he (the clerk) was "going to save some ammo until the end of the day. So we don't buy it and then they sell it through us. So they'll mark it at 20." The Baron Capital trader responded, "That is what I want to do." On October 20, 1999, SUG stock closed at $20. SLK's purchase for Baron Capital of 20,000 shares at the offer of $20, up 4/16 from the prior trade, was the closing trade.
I. On October 21, 1999, Clerk B telephoned the Baron Capital trading desk to report that he was "showing [their] bid," and "making the world believe that there's a rally happening in the stock." The Baron Capital trader laughed and said, "Okay." On October 21, 1999, SLK's purchases of SUG stock for Baron Capital totaled 67,000 shares of the day's total volume of 68,700 shares. Later that day, Clerk B called back, stating, "Sugar, we're trying to get it closed the right way.... I told him [an SLK floor broker], get it, try to get it up there the right way." On October 21, 1999, SUG stock closed at $20. SLK's purchase for Baron Capital of 40,500 SUG shares at the offer of $20, up 2/16 from the prior trade, was the closing trade.
J. On October 22, 1999, at approximately 3:40 pm, in placing an order to buy SUG, a Baron Capital trader instructed Clerk A, "by the end of the day, buy 34,600 up to 20½." Clerk A responded, "You want to take it up to 20½?" The Baron Capital trader then said "Yup," and noted moments later that "I had trouble yesterday when it didn't close where I wanted it to close so make sure it closes. . . ." Clerk A asked, "Where do you want [it], where would you like it to close ultimately?" The Baron Capital trader replied, "20 and ½." Clerk A confirmed, "You would like it to close up there, OK." A few minutes later, Clerk B called the Baron Capital trader back to verify the plan, stating, "I heard the instructions that we should close it at ½." Later that day, near the close of the market, Clerk B telephoned the Baron Capital trading desk to ask, "Do you want it to be shown a [sic] close at a half or do you want it shown a half bid close." The Baron Capital trader responded, referring to Baron Capital 's chief executive officer, "I think he wants it to close at a half." Clerk B repeated, "Close at a half. The last sale a half. So I can leave it at a quarter [bid] and 5/8 [ask]." The Baron Capital trader then confirmed, "Yes, he'd be alright with that." When late day selling threatened their plan, Clerk B telephoned the Baron Capital trader again, saying, "Give me some more Sugar to buy. Somebody came in through the system with 16,000." The Baron Capital trader immediately provided the SLK head clerk with the authority to buy an additional 10,000 shares of SUG to close the stock at the target price of $20 ½. On October 22, 1999, SUG stock closed at $20 ½. SLK's purchase for Baron Capital of 15,000 SUG shares at the offer of $20 1/2 was the closing trade.
K. On October 26, 1999, near the close, Clerk B called the Baron Capital trader to report that someone had placed an order to sell SUG at 20 7/16 and that it prevented him from closing SUG at 20 ½. Clerk B said, "with the overlay in the Sugar, I can't seem to get it up to a half, 7 teenies is the close, I have to do it that." The Baron Capital trader responded, "That's fine." On October 26, 1999, SUG stock closed at $20 7/16. SLK's purchase for Baron Capital of 30,200 SUG shares at $20 7/16, up 3/16 from the prior trade, was the closing trade.
L. SLK executed Baron Capital's purchase orders of SUG stock pursuant to the client's instructions and without regard for executing purchases at the lowest or best price available. Virtually all of the purchases of SUG executed by SLK on behalf of Baron Capital were made at the offer and were executed on a plus or zero plus tick. This should have raised concerns by SLK that Baron Capital was seeking to mark the closing price of SUG stock.
M. For example, as shown below, on October 22, 1999 from 3:40 pm to the close of trading, SLK executed all of Baron Capital's orders to purchase a total of 49,600 SUG shares on plus ticks ranging from a zero plus tick to +4/16 and all but one were executed at the offer:
|Time of Trade On
October 22, 1999
|Quote||Executed Price||Limit||# Shares||Change & Tick||At or Below Offer|
|3:43:05 pm||19 12/16 20||20||20 1/2||3400||+2/16||at offer|
|3:44:34 pm||19 12/16 20 2/16||20 2/16||20 1/2||5000||+2/16||at offer|
|3:45:25 pm||20 20 4/16||20 2/16||20 1/2||3900||0+||2/16 below offer|
|3:50:32 pm||20 20 4/16||20 4/16||20 1/2||7000||+2/16||at offer|
|3:50:38 pm||20 20 4/16||20 4/16||20 1/2||300||0+||at offer|
|3:53:09 pm||20 20 8/16||20 8/16||20 1/2||15,000||+1/4||at offer|
|4:01:01 pm||20 4/16 20 8/16||20 1/2||20 1/2||15,000||0+||at offer|
N. During the five business days beginning on October 20, the largest single purchase of SUG by Baron Capital for each and every business day was either ordered or executed at 3:59 or 4:00 p.m., when the NYSE closes. Baron Capital, through SLK's executions, was the closing trade for seven of the ten days of the pricing period. On the three other days during the pricing period, the closing trade was either the same as or higher than Baron Capital's last purchase of SUG as executed by SLK.
O. SUG's average daily trading volume during the two weeks preceding the pricing period was 19,350 shares per day, and during the pricing period it was 70,230 shares per day. Baron Capital's purchases, all of which were executed through SLK, made up approximately 78% of SUG's trading volume during the pricing period.
P. The average closing price of SUG during the pricing period was $20 1/8 per share. In contrast, the average closing price of SUG during the ten business days immediately prior to the pricing period was $18 1/2 per share.
Q. SLK failed reasonably to supervise its employees with a view to detecting or preventing its employees from aiding and abetting marking the close.
R. During the relevant period, while SLK had adopted written policies and procedures designed to promote general compliance with regulations governing order execution, SLK lacked adequate procedures to monitor for marking the close. For example, SLK did not conduct a periodic review of trades at and near the end of the day to detect patterns of marking the close by its Direct Access customers. Instead, according to its compliance manual in effect at the relevant time, SLK relied upon a system under which, in the event an employee became aware of any suspicious trades or pattern of trading at or near the close, the employee was required to notify SLK's compliance department.
S. Under SLK's written procedures during the relevant period, the compliance manual required the Floor supervisor to "spot check" order tickets on a periodic basis to ensure that they were complete and to conduct a daily review of the previous day's activity sheets to check client transactions. SLK's procedures for supervision of its Direct Access business on the Floor during the relevant period were circular. During the relevant period, the SLK Floor supervisor responsible for reviewing order tickets and daily activity reports was one of the Floor brokers executing certain of Baron Capital's orders to purchase SUG stock at or near the close. Under SLK's supervision at the time, the Floor supervisor reviewed, among other things, his own order tickets and daily trading reports. Thus, during the relevant period, the Floor supervisor was, in effect, supervising himself with respect to the trades he executed.
T. SLK's Floor supervisor was also responsible for supervising the activities of SLK's Floor clerks. During the relevant period, in the Floor supervisor's absence, supervision of SLK's Floor clerks was delegated to the head clerk, who, as described above, was accepting Baron Capital's orders and was aware or was reckless in disregarding that the orders were for the purpose of marking the closing price of SUG stock. Thus, under SLK's system of supervision during the relevant period, the head clerk, who was aiding and abetting Baron Capital's violative conduct, was, in effect, permitted to supervise himself in the Floor supervisor's absence.
U. No SLK employee reported any trading irregularities or suspicious patterns of trading in SUG stock to SLK during the relevant period.
V. In April 2001, the Firm took corrective steps which included instituting a review of trades executed at or near the end of the day to detect patterns of marking the close by its Direct Access customers.
W. Section 15(c)(1)(A) of the Exchange Act prohibits brokers and dealers from using "any manipulative, deceptive, or other fraudulent device or contrivance" in connection with securities transactions. 15 U.S.C. § 78o(c). "`Marking the close' is the practice of attempting to influence the closing price of a stock by executing purchase or sale orders at or near the close of the market." In the Matter of the Application of Thomas C. Kocherans, 60 S.E.C. Docket 2210 (1995). Marking the close is a manipulative practice within the meaning of the federal securities laws. Id. Baron Capital violated Section 15(c)(1)(A) of the Exchange Act by marking the close of SUG.
X. "The three elements necessary to find aiding and abetting [liability] are:
(1) securities law violations by another party; (2) substantial assistance by the aider and abettor in the conduct constituting those violations and (3) general awareness or knowledge by the aider and abettor that his actions were part of a course of conduct that is illegal or improper." In the Matter of Richard D. Chema, 68 S.E.C. Docket 1911 (November 30, 1998). "Knowledge or recklessness is sufficient to satisfy th[e] general awareness requirement." In the Matter of Howard R. Perles, 77 S.E.C. Docket 744 (April 4, 2002) (quoting Graham v. SEC, 222 F.3d 994, 1004 (D.C. Cir. 2000)). The conversations between Baron Capital's traders and SLK's order clerks demonstrate that the SLK clerks knew, or were reckless in disregarding, that Baron Capital was effecting purchases of SUG stock for the purpose of raising its closing price. SLK order clerks substantially assisted marking the close by accepting and executing Baron Capital's improper orders at or near the end of the day at the prices specified by Baron Capital. By virtue of this conduct, the SLK order clerks aided and abetted Baron Capital's violations of Section 15(c)(1)(A) of the Exchange Act.
Y. Section 15(b)(4) of the Exchange Act requires broker-dealers to supervise reasonably, with a view to preventing violations of the federal securities laws, persons subject to their supervision. SLK was responsible for supervising the SLK order clerks who aided and abetted Baron Capital's violation.
Z. "The Commission has repeatedly emphasized that the duty to supervise is a critical component of the federal regulatory scheme." In the Matter of Oechsle International Advisors, L.L.C., Admin. Proc. File No. 3-10554, 5 (August 10, 2001). Section 15(b)(4) provides that a broker-dealer may discharge this responsibility by having "established procedures, and a system for applying such procedures, which would reasonably be expected to prevent and detect" such violations.
AA. 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 (May 8, 1968) ("Although it was registrant's stated policy . . . it failed to establish an adequate system of internal control to insure compliance with such policy."). In large organizations in particular, it is imperative that the system of internal control be adequate and effective. A firm's failure to establish such procedures is symptomatic of a failure to supervise reasonably.
BB. Although SLK had a policy against marking the close, SLK failed to establish or to implement adequate measures to monitor compliance with procedures reasonably designed to ensure that its policy against marking the close was followed by employees. The procedure that SLK established (having a supervisor involved in the order execution process review purchase orders for general purposes) was not systematic or effective for the purpose of preventing and detecting marking the close. See In re ABN AMRO Inc., Admin. Proc. File No. 3-10552 (Aug. 10, 2001) (broker-dealer sanctioned for failure to supervise senior trader who participated in marking the close scheme because his trading was not "effectively reviewed periodically to ensure compliance with [firm policies] and to ensure adherence to the securities laws") (settled action).
CC. "Where there has been an underlying violation of the federal securities laws, the failure to have or follow compliance procedures has frequently been found to evidence a failure reasonably to supervise the primary violator." In the Matter of William V. Giordano, Admin. Proc. File No. 3-8933 (January 19, 1996). Because the SLK order clerks aided and abetted Baron Capital's violation, and SLK failed to have or to follow compliance procedures reasonably designed to detect or prevent such violation, SLK failed reasonably to supervise its employees for purposes of Section 15(b)(4) of the Exchange Act.
DD. Based on the foregoing, the Commission finds that SLK failed reasonably to supervise employees with a view to preventing the employees from aiding and abetting the violation of Section 15(c)(1)(A) of the Exchange Act.
In determining whether to accept the Offer, the Commission has considered the following: (1) In 2001, SLK implemented certain new procedures intended to detect and prevent marking the close and (2) contemporaneously with this Order, SLK has consented to a "Stipulation of Facts and Consent of Penalty" with the NYSE requiring, among other things, that SLK pay a penalty to the NYSE as set forth in Section V. B. (ii), below.
In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions specified in the Offer.
ACCORDINGLY, IT IS HEREBY ORDERED that:
A. Pursuant to Section 15(b)(4) of the Exchange Act, Respondent SLK is censured.
B. Respondent SLK shall, within 20 days of the entry of this Order, pay the amount of $450,000. Respondent shall make payment as follows: (i) a civil money penalty in the amount of $225,000 to the United States Treasury; and (ii) pursuant to Respondent's agreement with the NYSE in related proceedings, Respondent shall pay a fine of $225,000 to the NYSE. Payment to the United States Treasury 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 Office of Financial Management, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (4) submitted under cover letter that identifies Spear, Leeds & Kellogg L.P. 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 Caren Nelson Pennington, Assistant Regional Director, Division of Enforcement, Securities and Exchange Commission, Northeast Regional Office, 233 Broadway, New York, N.Y. 10279.
C. SLK shall comply with the following undertakings:
1. Within 30 days of the date of this Order, SLK shall employ an independent consultant ("Independent Consultant") acceptable to the Commission staff and knowledgeable in all aspects of broker-dealer operations, including, but not limited to, the order execution rules promulgated under the Exchange Act, to conduct a comprehensive review of and make findings regarding SLK's internal controls, policies, practices, and procedures designed to detect and prevent marking the close. Such Independent Consultant will also recommend any revised or additional internal controls, policies, or procedures which the Independent Consultant believes are necessary to provide reasonable assurance that SLK will be in compliance with the above mentioned requirements related to preventing and detecting marking the close.
2. SLK shall require the Independent Consultant to enter into an agreement that provides that for the period of the engagement and for a period of two (2) years from the completion of the engagement, the Independent Consultant shall not enter into any employment, consultant, attorney-client, auditing or other professional relationship with SLK, or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity as such. Any firm with which the Independent Consultant is affiliated or of which he or she is a member, and any person engaged to assist the Independent Consultant in the performance of his or her duties under the Order shall not, without prior written consent of the Commission's staff, enter into any employment, consultant, attorney-client, auditing or other professional relationship with SLK, or any of its present or former affiliates, directors, officers, employees, or agents in their capacity as such for the period of the engagement and for a period of two (2) years after the engagement.
3. SLK shall promptly provide the Independent Consultant with any and all requested documents and other information pertaining to SLK's order execution process, and permit the Independent Consultant to meet with and interview any officer, agent, and employee of SLK.
4. No later than three months from the date that SLK employs the Independent Consultant, the Independent Consultant will submit, in writing, to SLK, with a copy to the staff of the Commission, his or her report detailing his or her findings regarding SLK's internal controls, policies, practices, and procedures for detecting and preventing marking the close, and his or her recommendations, if any, for revised or additional measures designed to detect and prevent marking the close.
5. Upon good cause being shown, the staff of Commission may grant the Independent Consultant such additional time as the staff deems necessary to submit his or her report regarding SLK's internal controls, policies, practices, and procedures, and his or her recommendations, if any, for revised or additional measures designed to detect and prevent marking the close.
6. Within 30 days after the date of the issuance of the Independent Consultant's report, SLK shall remedy any deficiencies in its internal controls, policies, practices, or procedures identified by the Independent Consultant and adopt, implement, and maintain any revised or additional measures recommended by the Independent Consultant, or alternatives recommended in writing by SLK and accepted in writing by the Independent Consultant or the staff of the Commission.
7. No later than 30 days from the date of the issuance of the Independent Consultant's report, SLK, through an officer, shall submit an affidavit to the staff of Commission stating that SLK has remedied any deficiencies in its internal controls, policies, practices, and procedures identified by the Independent Consultant (stating the means by which such remedy has been accomplished), and stating further that SLK has adopted, implemented, and will maintain any revised or additional internal controls, policies, practices, or procedures recommended in the Independent Consultant's report, or alternatives acceptable to the Independent Consultant or the staff of Commission. Upon written request and good cause being shown, the staff of the Commission may grant SLK such additional time as the staff deems necessary to submit such affidavit.
8. If, after 30 days from the date of the issuance of the Independent Consultant's report, or such additional time as allowed by the staff in writing, SLK fails to remedy the deficiencies in its internal controls, policies, practices, and procedures identified by the Independent Consultant, or such alternatives recommended in writing by SLK and accepted in writing by the Independent Consultant or the staff of the Commission, the Commission may vacate this Order and restore this proceeding to its active docket.
By the Commission.
Jonathan G. Katz
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