UNITED STATES OF AMERICA
In the Matter of
Lehman Brothers, Inc.,
|ORDER INSTITUTING ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS AND A CEASE-AND-DESIST ORDER PURSUANT TO SECTIONS 15(b) AND 21C OF THE SECURITIES EXCHANGE ACT OF 1934|
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative and cease-and-desist proceedings be, and hereby are, instituted pursuant to Sections 15(b) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Lehman Brothers, Inc. ("Respondent" or "Lehman Brothers").
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 Respondent and the subject matter of these proceedings, Respondent consents to the entry of this Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order Pursuant to Sections 15(b) and 21C of the Securities Exchange Act of 1934 ("Order"), as set forth below.
On the basis of this Order and Respondent's Offer, the Commission finds that:1
1. Respondent failed reasonably to supervise Frank D. Gruttadauria ("Gruttadauria") with a view to preventing and detecting his violations of the federal securities laws during the 15-month period that it employed him from October 2000 to January 2002. From 1987 to January 2002, while employed at a series of five different registered broker-dealers, Gruttadauria defrauded over 60 customers by lying about purchases and sales of securities, misappropriating funds and securities, and sending falsified account documents. By the time that Gruttadauria confessed generally to his fraudulent conduct in a letter to the Federal Bureau of Investigation on January 11, 2002, he had misappropriated over $115 million from customers over a period of 15 years - transferring most of the money to other customers to cover withdrawal requests - and overstated account values by more than $280 million.
2. Respondent Lehman Brothers, Inc., a direct subsidiary of Lehman Brothers Holdings, Inc., is a Delaware corporation registered with the Commission as a broker-dealer pursuant to Section 15(b) of the Exchange Act. Lehman Brothers has its principal place of business in New York, New York and maintains approximately 52 branch offices throughout the United States and worldwide.
3. Frank D. Gruttadauria, 45, was the manager of Lehman Brothers' Cleveland, Ohio branch office from October 2000 through January 2002. Gruttadauria was also a registered representative of Lehman Brothers throughout this period. Gruttadauria became an associated person of Lehman Brothers upon Lehman Brothers' acquisition of certain assets of the retail brokerage business of SG Cowen Securities Corporation ("SGC") in October 2000. From January 1984 through October 2000, Gruttadauria was employed as a registered representative at several other broker-dealers, including SGC from July 1998 through October 2000, and SGC's predecessor beginning in 1989. From 1990 through October 2000, Gruttadauria was also the branch manager for the Cleveland branch of SGC and its predecessor.
4. On August 29, 2002, Gruttadauria pled guilty to, among other things, federal charges of securities and mail fraud in connection with his fraudulent conduct. On November 14, 2002, Gruttadauria was sentenced to seven years of confinement.
5. In October 2000, Lehman Brothers acquired certain assets of SGC's retail brokerage business. Among the assets of that brokerage business was the branch office in Cleveland, Ohio, of which Gruttadauria was the branch office manager ("BOM"). Gruttadauria had also been among the top-producing brokers at SGC nationwide.
6. Since 1987, Gruttadauria had been defrauding dozens of customers through various means. He lied to some of those customers about purchases and sales of securities in their accounts and the performance of those accounts, often telling these customers that their accounts contained a wide variety of holdings worth millions of dollars when, in fact, the accounts contained only a few thousand dollars. He falsely told some customers that he used the funds that they deposited into their accounts to buy securities when, in fact, he misappropriated those funds. In a few instances, Gruttadauria induced customers to give him funds to open an account and simply misappropriated the funds. Gruttadauria also told a number of customers from whom he did not misappropriate funds or securities that their accounts were more valuable than the accounts actually were. When those customers sought to withdraw the inflated amounts, Gruttadauria misappropriated funds from other customer accounts to satisfy those withdrawal requests.
7. Gruttadauria used most of the misappropriated funds to conceal and perpetuate the fraudulent acts in which he was engaging. In most instances, he transferred funds or securities deposited by some customers for investment purposes to other customers or their designees, either directly or through an intermediary brokerage or bank account. Virtually all of these transfers were used to satisfy withdrawal requests made by customers to whom Gruttadauria falsely represented that they had sufficient funds to make the transfers out of their own accounts, but whose accounts had been depleted or had fewer assets than Gruttadauria had reported.
8. To further conceal his false representations and misappropriations, Gruttadauria created and sent many of the defrauded customers falsified account statements and other documents that vastly overstated the actual value of the accounts, reflected holdings that did not exist, reflected purchases or sales of securities that had never occurred, and failed to disclose unauthorized withdrawals from the accounts. Gruttadauria caused the actual brokerage statements for some of these customers to be mailed, without the knowledge or authorization of these clients, to entities or post office boxes under his control. The account address information Lehman Brothers received from SGC included these unauthorized mailing addresses.
9. By the time that Lehman Brothers employed Gruttadauria in October 2000, he had misappropriated at least $94 million from over 40 customers. He had led the customers to whom he had been sending falsified account statements and other documents to believe that they had over $294 million in their accounts when, in fact, they had less than $30 million in those accounts.
10. During his employment with Lehman Brothers, Gruttadauria misappropriated in total approximately $21.5 million from the accounts of seven customers, with about $19 million coming from one customer and about $2 million from another customer.2 Gruttadauria transferred over $19 million of the misappropriated funds to a bank account under his control and disbursed the money to other customers who had made requests for withdrawals out of their depleted accounts. In over ten instances, Gruttadauria transferred monies from a customer's brokerage account at Lehman Brothers to another customer or that customer's designee without using the intermediary bank account.
11. During this period, Gruttadauria also sent falsified account statements to approximately 40 clients representing almost 60 accounts. Gruttadauria had already misappropriated all or most of the funds from the majority of these accounts before Lehman Brothers employed him. Of the clients receiving falsified account statements, over 30 also received funds that Gruttadauria had misappropriated from other accounts. Gruttadauria transferred misappropriated funds to about 18 other customers who did not receive falsified account statements.
12. On January 11, 2002, Gruttadauria disappeared, leaving a letter with the Federal Bureau of Investigation in which he confessed to the general outlines of his fraudulent conduct. At that time, the last falsified account statements that Gruttadauria had sent to clients showed that their accounts were worth over $285 million, when the actual Lehman Brothers statements for those accounts showed an aggregate balance of less than $2 million. About a month later, Gruttadauria surrendered to the Federal Bureau of Investigation.
13. As a result of the conduct described above, Gruttadauria, during the period that Lehman Brothers employed him, violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which prohibit fraudulent conduct in connection with the offer, purchase or sale of securities.
14. The failure of Lehman Brothers reasonably to supervise Gruttadauria occurred in a context that itself created an inherent risk that Gruttadauria would not be adequately supervised. Gruttadauria was a producing BOM, which means that he was responsible both for the overall supervision of the Cleveland branch and for his own retail brokerage customers. The procedures Lehman Brothers had in place at the Cleveland branch when it employed Gruttadauria required the firm to assign a person with a Series 8 registration to oversee all of the retail brokerage activity in the Cleveland branch, including activity for those customers serviced by Gruttadauria. Lehman Brothers assigned two persons within the Cleveland branch to those responsibilities. It assigned the administrative manager to oversee day-to-day sales activity and the operations manager to review and approve requests for third-party disbursements.3 Although these individuals interacted periodically with others outside of the Cleveland branch, by choosing persons in the Cleveland branch subordinate to Gruttadauria to oversee his daily retail brokerage activity, Lehman Brothers structured its supervisory and compliance functions in a manner that created an inherent risk that Gruttadauria would not be adequately supervised. As BOM, Gruttadauria had input within the Cleveland branch relating to personnel matters, such as salaries, bonuses, and continued employment of the branch staff, including that of the two persons assigned to oversee his activities as a broker. This type of authority can lead to conflicts of interest that, in turn, can compromise the ability of those subordinate to the BOM to oversee adequately the BOM's activity.4 This structure may have been a contributing factor in the supervisory failures described below.
15. Lehman Brothers failed reasonably to supervise Gruttadauria's conduct as a producing BOM. Although Lehman Brothers had procedures addressing the review of outgoing and incoming correspondence, Gruttadauria was able to evade that review because Lehman Brothers did not have an adequate system for applying these procedures to Gruttadauria, who as a producing BOM had access to a facsimile machine and the office's postage meter.5 Gruttadauria's facsimile machine, which only he and his sales assistants were authorized to use, was located outside of his office. Gruttadauria represented to the compliance staff that he used this machine only for transmitting and receiving confidential internal administrative correspondence such as performance evaluations. However, Gruttadauria also used this facsimile machine to evade the review of outgoing and incoming correspondence, by using it to send and receive correspondence in furtherance of his fraudulent activity. Additionally, because he was the BOM, Gruttadauria also had a key to the otherwise secure area, known as the cage, which contained the branch office's postage meter. Gruttadauria used this key to evade the review of his outgoing correspondence that contained falsified account statements by, on a monthly basis, entering the cage after working hours, and placing a stack of sealed envelopes containing the falsified statements directly on top of the postage meter for mailing. These unreviewed statements were mailed out the next morning with Lehman Brothers' official envelopes and postage markings.
1. Failures Related to the Monitoring and Use of Personal Computers
16. Lehman Brothers did not have supervisory procedures expressly for monitoring the use of personal computers that were separate from the firm's company-wide computer system.6 Unlike the company-wide system, such personal computers do not have built-in safeguards against creating false account data. At SGC and throughout the period that Lehman Brothers employed him, Gruttadauria had a personal computer that was networked to similar computers used by his two sales assistants, but not to the company-wide system. Gruttadauria ostensibly used this computer system as an electronic posting book, into which he had his sales assistants enter trading data and out of which he generated reports reflecting a client's holdings and year-end profit and loss statements for tax preparation purposes. However, Gruttadauria also used this computer system to generate the falsified account statements that he mailed to many of his defrauded customers. Thus, Lehman Brothers did not have procedures reasonably designed to prevent and detect Gruttadauria's generation of falsified account statements on personal computers.
2. Failures Related to Third-Party Transfers
17. A crucial component of Gruttadauria's fraudulent conduct was misappropriating funds and securities out of customer accounts and then transferring them into an intermediary bank account or directly to other customers or their designees. This type of transfer is known as a third-party transfer because the assets at issue change ownership. Under certain circumstances pertinent here, Lehman Brothers' procedures for third-party disbursements required a Series 8 manager, other than the initiating broker, to confirm such transfers directly with the client out of whose account the disbursement was to occur. However, Lehman Brothers did not have an adequate system for applying its procedures for the processing and approval of third-party transfers. Lehman Brothers failed to detect or prevent Gruttadauria from making over $21 million in unauthorized third-party transfers, a number of them over $1 million.
3. Failures Related to Account Documentation
18. A brokerage firm is responsible for the accuracy of the account documentation that it maintains for its customers. The addresses on the account documentation that Lehman Brothers received from SGC for certain of the defrauded customers of Gruttadauria had been falsified by him prior to the time that he joined Lehman Brothers. Although Lehman Brothers endeavored to convert the former SGC accounts to its own accounts by re-opening them using Lehman Brothers' documentation procedures, which included procedures to confirm customer addresses, Lehman Brothers lacked an adequate system for ensuring that these procedures were applied to these accounts in a timely fashion.
19. In addition, Lehman Brothers lacked an adequate system for applying its procedures for generating exception reports concerning accounts with post office box and "care of" mailing addresses and following-up on these reports. >Lehman Brothers' procedures required its examiners to generate reports reflecting the accounts each broker had with "care of" addresses or post office box addresses and review those reports with a view towards identifying patterns and conducting appropriate follow-up. Gruttadauria diverted account statements for at least 16 accounts to the same post office box in the name of an accounting firm that did not exist. Of those 16 accounts, at least 11 were captioned as "care of" accounts. Lehman Brothers did not implement its procedures in a fashion that ensured that these accounts of Gruttadauria's were identified and appropriate follow-up conducted.
20. Section 15(b)(4)(e) of the Exchange Act requires broker-dealers to supervise reasonably persons subject to their supervision, with a view toward preventing violations of the federal securities laws. See e.g., Smith Barney, Harris Upham & Co., Exchange Act Rel. No. 21813, 32 SEC Docket 999, 1004 (March 5, 1985). This section also provides an affirmative defense to broker-dealers which can show that they have "established procedures and a system for applying such procedures" that could reasonably be expected to prevent and detect such violations. The Commission has emphasized that the "responsibility of broker-dealers to supervise their employees by means of effective, established procedures is a critical component in the federal investor protection scheme regulating the securities markets." Id.
21. For the reasons stated in paragraphs 1-19, Lehman Brothers failed reasonably to supervise Gruttadauria with a view to preventing or detecting his violations of the federal securities laws.
22. Section 17(a) of the Exchange Act and Rule 17a-3 thereunder require that registered brokers and dealers make and keep current certain specified books and records relating to their business. Implicit in the Commission's recordkeeping rules is the requirement that information contained in a required book or record be accurate. In re Merrill Lynch, Pierce, Fenner & Smith Inc., Exchange Act Rel. No. 33367 (Dec. 22, 1993).
23. Lehman Brothers violated Section 17(a) of the Exchange Act and Rule 17a-3 thereunder because it failed to maintain complete and accurate books and records as required by those provisions. For example, Lehman Brothers' addresses for certain of Gruttadauria's defrauded clients were incorrect. Lehman Brothers also failed to maintain complete and accurate books and records for customer ledger accounts, journal entries, memoranda of customer orders, and transfers of funds as a result of Gruttadauria's fraudulent acts.
Respondent undertakes to participate in a special arbitration process for potential victims of Gruttadauria's fraudulent acts as further set forth in Appendix A. 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 Lehman Brothers' Offer.
ACCORDINGLY, IT IS HEREBY ORDERED:
A. That Lehman Brothers be, and hereby is, censured.
B. Pursuant to Section 21C of the Exchange Act, that Lehman Brothers cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Exchange Act and Rule 17a-3 thereunder.
C. That Lehman Brothers shall, within ten days of the entry of this Order, pay the amount of $2.5 million. Lehman Brothers shall make payments as follows: (i) pursuant to Section 21B of the Exchange Act, Lehman Brothers shall pay a civil monetary penalty of $1,250,000 to the United States Treasury; and (ii) pursuant to Lehman Brothers' agreement with the New York Stock Exchange in related proceedings, Lehman Brothers shall pay a fine in the amount of $1,250,000 to the New York Stock Exchange. Such payment to the United States Treasury 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 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 Lehman Brothers, Inc. 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 Lawrence A. West, Division of Enforcement, Securities and Exchange Commission, 450 5th Street N.W., Washington, D.C. 20549-0801.
By the Commission.
|Jonathan G. Katz
This Appendix A sets forth terms and conditions of a special arbitration process that Lehman Brothers, Inc. ("Lehman") and SG Cowen Securities Corp. ("SG Cowen") (the "Firm" or "Firms") have agreed to make available to qualifying former customers of Frank Gruttadauria. This process is completely voluntary on the part of qualifying former customers, and does not preclude former customers who elect not to participate in this process from pursuing other remedies in any forum.
Qualifying Customers. Persons eligible to participate in this process are former customers of Frank Gruttadauria from whom Gruttadauria misappropriated funds or securities (including unauthorized transfers) and/or who received falsified account documents from or at the direction of Gruttadauria (whether or not they also received genuine account documents) during the period that Gruttadauria was employed at Cowen & Co. or the Firms ("Qualifying Customers"). A customer who has previously released his or her claims against either Firm in connection with a settlement of such claims is not a Qualifying Customer with respect to that Firm. All disputes, claims, or controversies ("Claims") of Qualifying Customers relating to any accounts or purported accounts for which Gruttadauria was or purported to be the account representative may be brought in this process. The arbitrator(s) assigned to hear a Claim shall also decide any disputes as to whether the person submitting that Claim is a Qualifying Customer. The arbitrator(s) shall render any such decision promptly and before proceeding with any other aspects of this special arbitration process. Qualifying Customers may only name as a Respondent in these proceedings those Firms at which Gruttadauria was employed when he misappropriated from the Qualifying Customer any funds or securities (including unauthorized transfers) and/or provided any falsified account documents to the Qualifying Customer. SG Cowen will pay all awards made for conduct during the period from May 12, 1989 to October 13, 2000 (the "SG Cowen Time Period"). Lehman will pay all awards made for conduct during the period from October 16, 2000 to January 18, 2002 (the "Lehman Time Period"). The arbitrator(s) will determine liability for conduct that occurred on October 14 or 15, 2000.
Arbitration Rules. Subject to paragraph 6, the Firms will make this special arbitration process available to Qualifying Customers at the New York Stock Exchange ("NYSE") pursuant to the NYSE Arbitration Rules. At the election of the customer, certain timeframes and deadlines may be modified as set forth in paragraph 3 below. However, nothing in this Appendix A is intended to preclude the parties in a particular case from agreeing, in consultation with the arbitrator(s) or the NYSE Director of Arbitration as appropriate, to resolving Claims under any other procedures or rules. A Qualifying Customer may elect to proceed under the Random List Selection or Enhanced List Selection alternatives contained in the NYSE Voluntary Supplemental Procedures for Selecting Arbitrators, and the Firms will not object to any such election. The Firms will also make mediation available to Qualifying Customers pursuant to NYSE Rule 638 or, if an arbitration proceeding is already in progress at the National Association of Securities Dealers ("NASD"), pursuant to NASD Code of Arbitration Procedure 10400.
Modified Timeframes and Deadlines. In order to expedite the hearing of Claims, customers may elect to proceed as set forth below. All other terms of this special arbitration process will apply whether or not customers elect to proceed in this manner.
The time period set forth in Rule 612(c)(1) shall be 20 calendar days.
Parties may serve requests under Rule 619(b) immediately upon service of the Statement of Claim. The time for satisfying or objecting to requests under Rule 619(b)(2) shall be twenty-five (25) calendar days.
Subject to other determination by the NYSE Director of Arbitration, a discovery conference to resolve discovery issues will be held within twenty (20) calendar days of the receipt of a written request by a party under Rule 619(b)(4).
Subject to other determination by the NYSE Director of Arbitration, the hearing will be held within 180 days from the date that the Statement of Claim is filed, and a decision or award will be rendered within thirty (30) days of the conclusion of the hearing.
The time period set forth in Rule 627(g) shall be twenty (20) calendar days.
Within ten (10) days of the date of the Commission's orders and the New York Stock Exchange Hearing Panel Decisions in these proceedings (collectively, "the Orders"), the Firms will send the following to the last known address of, or, if known, to counsel for, all persons whom they have reason to believe are or may be Qualifying Customers:
Copies of the Orders and the Commission's press release;
To the extent located by each Firm as of the date of the Orders, and not previously produced to the Qualifying Customer, with respect to any account or purported account of the customer from which Gruttadauria misappropriated funds or securities (including unauthorized transfers) and/or with respect to which a customer received falsified account documents from or at the direction of Gruttadauria (a "Qualifying Account"), all genuine account statements issued by the Firm during its Time Period for any Qualifying Account of the customer, and all falsified account statements and other falsified documents pertaining to the Qualifying Account.
The notice in paragraph 4.a. will also provide that the Qualifying Customer may request from the Firm sending the notice any of the following documents during the respective Firms' Time Periods with respect to transactions for which the Qualifying Customer seeks additional information:
(i) copies of checks, wire transfers, journals, or other transfers of cash or securities out of the Qualifying Account and letters of authorization relating to same;
(ii) copies of receipts for checks, cash, or securities received by the Firm from the Qualifying Customer and documents sufficient to show whether those checks, cash, or securities were actually deposited into the Qualifying Account;
(iii) documents sufficient to identify any checks, cash, or securities received by or for the benefit of the Qualifying Customer from a source other than his or her account; and
(iv) all account opening documents, all margin agreements for any customer's Qualifying Accounts at the respective Firms.
The Firm will respond to such a request by providing such documents or information to the extent located by each Firm as of the date of the Orders, and not previously produced to the Qualifying Customer. If a Firm seeks to satisfy such a request by reference to a prior production to the Qualifying Customer, the Firm must identify each responsive, previously produced document by Bates number. The Firms shall provide such documents or information within fourteen (14) days of receiving the request.
If at any time within 180 days of the date of this Order, the Firms learn of other persons whom they have reason to believe are or may be Qualifying Customers, the Firms will provide the notice described in paragraph 4.a. within seven (7) days of the date that they learn of such persons.
Initiation of Process.
Qualifying Customers who receive notice under paragraph 4.a. must file their Submission Agreement and Statement of Claim with the Director of Arbitration (as required by Rule 612 of the NYSE Arbitration Rules) along with a statement clearly setting forth their intention to take part in this process, whether the Qualifying Customer elects to proceed under any of the arbitrator selection options referred to in paragraph 2, and the bases for their status as Qualifying Customers, within 90 days of the date of mailing of such notice. Former customers of Gruttadauria who believe that they are Qualifying Customers but did not receive notice pursuant to paragraph 4.a must submit these materials within 180 days of the date of the Order. Any Qualifying Customer who elects to proceed under the modified timeframes and deadlines set forth in this Appendix A, must clearly state the election at the time of submission of the Claim.
As an alternative to refiling their Claim pursuant to paragraph 5.a Qualifying Customers with Claims pending against either of the Firms at the NYSE Department of Arbitration as of the date of the Order may elect to bring their existing proceeding under the terms and conditions of this special arbitration process by giving written notice to the Firms and the NYSE Director of Arbitration as described in paragraph 5.a. All of the terms and conditions of this Appendix A will apply, except that the provisions of paragraphs 2 and 3 above will apply only as determined to be practicable by the Director of Arbitration or arbitrator(s), as appropriate, given the stage of the existing proceedings.
Existing Arbitration Proceeding. Any Qualifying Customer who, at the time of the Orders, has an arbitration proceeding pending against either or both of the Firms at any forum other than the NYSE Department of Arbitration may elect to continue that proceeding under the principles set forth in this Appendix A. All of the terms and conditions of this Appendix A will apply, except that the provisions of paragraphs 2 and 3 above will apply only as determined to be practicable by the forum's Director of Arbitration or arbitrator(s), as appropriate, given the stage of the existing proceedings. The Firms will give all consents necessary to achieve this result.
Other Proceedings. Qualifying Customers who elect to take part in this process must unconditionally stay any other actions or proceedings seeking legal or equitable redress arising out of the same facts and circumstances described in the Statement of Claim, and dismiss with prejudice any such action or proceeding after a decision or award is rendered by the arbitrator and, if necessary, satisfied by the Firm(s). However, if the arbitrator(s) decide(s) that a person who elected to take part in this process is not a Qualifying Customer, that person's obligation under this paragraph 7 to stay or dismiss other actions or proceedings terminates upon issuance of that decision. Qualifying Customers who elect only to pursue arbitration of a matter referred to in paragraph 13(b) are not required to comply with this paragraph 7.
Fees and Expenses. All filing fees, forum fees, and fees and expenses of mediators and arbitrators, including reasonable travel expenses, shall be paid by the Firms and allocated among them pursuant to their agreement, or, if no agreement is reached, the decision of the arbitrator(s). The arbitrator(s) may otherwise determine the allocation of costs as provided for in the NYSE Arbitration Rules.
Certain Defenses. Solely for the purposes of this special arbitration process, and in consideration of the Qualifying Customers' agreements to submit their disputes for resolution hereunder, the Firms will not assert statutes of limitation or statutes of repose, and no other time bar principles, such as the claims eligibility requirements set forth in NYSE Rule 603, will apply, as to (a) Claims arising out of Gruttadauria's misappropriation of funds or securities (including unauthorized transfers), the receipt of falsified account documents from or at the direction of Gruttadauria, the unauthorized changing of the mailing address for the Qualifying Customer's account, or the Firm's conduct in relation to same, and/or (b) any other Claim permitted to be brought pursuant to this special arbitration process and which did not arise out of Gruttadauria's misappropriation of funds or securities (including unauthorized transfers), or the receipt of falsified account documents from or at the direction of Gruttadauria, or the Firm's conduct in relation to same, but for which the Qualifying Customer was not aware of the basis for such Claim because such customer received falsified account documents from or at the direction of Gruttadauria.
No Contest of Liability. Solely for the purposes of this special arbitration process, and in consideration of the Qualifying Customer's agreement to submit his or her disputes for resolution hereunder:
The Firm shall not contest its liability for (i) Gruttadauria's misappropriation of funds or securities (including unauthorized transfers) from the Qualifying Customer's account, (ii) the Qualifying Customer's receipt of falsified account documents sent by or at the direction of Gruttadauria, (iii) the unauthorized changing of the mailing address for the Qualifying Customer's account (collectively, (i), (ii), and (iii), "Unauthorized Act(s)"), and/or (iv) the Firm's conduct, as described in the Order, in relation to any such Unauthorized Act(s).
Except as set forth above and in Paragraphs 9 and 11, the Firm may contest claims alleging churning, unsuitable trading, or any other misconduct alleged by the Qualifying Customer to have been committed in the Qualifying Customer's account by or at the direction of Gruttadauria ("Additional Claims"). However, as to any Additional Claim(s) based on misconduct that allegedly occurred after the date of the first Unauthorized Act at the Firm in connection with the Qualifying Customer's account, the Firm will be liable to the Qualifying Customer for any such Additional Claim(s) based upon such misconduct of Gruttadauria, provided that the misconduct is established, except to the extent that the Firm can establish the defenses of waiver, estoppel and/or ratification based upon the Qualifying Customer's conduct.
Notwithstanding anything in subparagraphs (a) and (b) above, the Firm may contest the amount claimed by the Qualifying Customer, including contesting, to the extent relevant, the Qualifying Customer's claimed reliance on any misrepresentations or other unlawful conduct of Gruttadauria, the reasonableness of any such reliance, and the Qualifying Customer's factual proof supporting damages. Moreover, nothing contained herein precludes the Firm from contesting on any basis any claim that is brought in any judicial or arbitration forum outside of this process.
Counterclaims. Solely for the purposes of this special arbitration process, and in consideration of the Qualifying Customers' agreements to submit their disputes for resolution hereunder, any claims by the Firms against Qualifying Customers who proceed in this forum may be brought only in this forum and not in any other forum. Further, the only claims that the Firms may assert in this forum against Qualifying Customers are claims based on the Qualifying Customer's knowing participation in Gruttadauria's unlawful conduct.
Punitive Damages. Punitive, exemplary, treble, or other multiple damages will not be awardable.
Accelerated Payment Dispute.
A Qualifying Customer who elects to pursue a Claim under this special arbitration process and who also disputes the application of the Accelerated Payment formula to the facts and circumstances of their account in connection with a payment pursuant to Appendix B of the Orders against SG Cowen ("Appendix B"), may pursue both Claims under this special arbitration process.
In the event that a Qualifying Customer disputes under this process only the application of the Accelerated Payment formula to the facts and circumstances of their account in connection with a payment pursuant to Appendix B the Qualifying Customer may submit a Claim to have that issue alone resolved pursuant to, at the election of the Qualifying Customer, the special arbitration process set forth in this appendix, or the NYSE Rules governing Simplified Arbitration, within 45 days of SG Cowen's written explanation and response pursuant to a customer objection referred to in paragraph II.B.2 of Appendix B, without waiving any right to otherwise proceed against the Firms in any other proceedings. In the event that a Qualifying Customer elects to proceed pursuant to the Simplified Arbitration rules, the dollar amount limitation pertaining to such claims shall not apply, and the applicable fees to be paid by SG Cowen shall be determined by the arbitrator. All other provisions of this Appendix A shall apply.
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.
2 Prior to the date of this Order, Lehman Brothers voluntarily repaid all of these misappropriated amounts to the affected customers.
3 At SGC, the administrative manager had the title "assistant branch manager." The administrative manager had a Series 8 registration, but the operations manager did not.
4 From the outset of Gruttadauria's employment with Lehman Brothers, the administrative manager and the operations manager reported directly to someone outside of the Cleveland branch at a level higher than Gruttadauria. In May 2001, Lehman Brothers devised certain other procedural safeguards designed specifically to address the supervision of a producing BOM. The preface to these safeguards observed that offices supervised by a producing manager "require careful supervision to ensure that client accounts handled by the producing manager receive independent review. In order to prevent any potential conflicts of interest, the following procedures must be followed with respect to producing managers." These safeguards required, among other things, that the regional manager conduct comprehensive semi-annual book reviews of Gruttadauria's retail client accounts, those book reviews having an emphasis on active accounts. Further, the procedures required the regional manager to visit the branch every three months to ensure the effectiveness of the supervision being done by the administrative manager. However, Lehman Brothers did not fully implement these procedures until nearly the end of 2001, shortly before Gruttadauria confessed to his fraud.
5 Respondent's procedures required the review by the branch administrative manager of all incoming correspondence before distribution to the registered representatives and an after-the-fact review each month of a random sample of outgoing correspondence, with each registered representative's correspondence subject to a review at least annually. The practice in the Cleveland branch was that the administrative manager actually reviewed outgoing correspondence before it was sent out. Once the administrative manager approved the correspondence, the broker or his or her assistant would place the correspondence in an unsealed envelope in a mail bin to be picked up by the mailroom staff, who would later seal the envelope and affix the postage using a machine.
6 To the extent that a broker or sales assistant used a personal computer to generate client correspondence, that correspondence was subject to the review procedures described in footnote 5.
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