==========================================START OF PAGE 1====== UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 37707 / September 23, 1996 ADMINISTRATIVE PROCEEDING File No. 3-9088 ------------------------------ : In the Matter of : ORDER INSTITUTING PROCEEDINGS : PURSUANT TO SECTIONS 15(b), HOWE BARNES INVESTMENTS, INC. : 19(h) AND 21C OF THE : SECURITIES Respondent : EXCHANGE ACT OF 1934, MAKING : FINDINGS AND IMPOSING REMEDIAL : SANCTIONS ----------------------------- : I. The Securities and Exchange Commission (Commission) deems it appropriate and in the public interest that public administrative and cease and desist proceedings be instituted pursuant to Sections 15(b), 19(h) and 21C of the Securities Exchange Act of 1934 (Exchange Act) against Howe Barnes Investments, Inc. (Howe Barnes). In anticipation of the institution of these administrative proceedings, Howe Barnes has submitted an Offer of Settlement which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, the Respondent, by the Offer of Settlement, consents to the entry of this Order Instituting Proceedings, Making Findings and Imposing Remedial Sanctions without admitting or denying the findings herein, except for those contained in paragraphs II.A.1. and 2., B. and C. below, which are admitted. II. Accordingly, it is ordered that proceedings pursuant to Sections 15(b), 19(h) and 21C of the Exchange Act, and hereby are, instituted. On the basis of this Order and the Respondent's Offer of Settlement, the Commission makes the following findings-[1]-: A. The Commission's public files disclose that: 1. Howe Barnes has been registered with the Commission as a broker-dealer pursuant to Section 15(b)(1) of the Exchange Act since February 2, 1968. Howe Barnes has its principal place of business in Chicago, Illinois; 2. From October 1977 until September 1993, John L. Fauls III (Fauls) was employed by Howe Barnes. During this time, Fauls served as, among other things, a Senior Vice President and Director and held between 10% and 25% ownership interest in the broker-dealer; B. On May 3, 1994, Fauls was found guilty of mail fraud, securities fraud, pension fund bribery and racketeering by a jury sitting before the United States District Court for the Northern District of Illinois. United States v. Robert Burstein and John L. Fauls III, No. 93 CR 80 (N.D. Ill., filed August 31, 1993). On October 24, 1994, Fauls was sentenced to 57 months incarceration and ordered to pay $3.32 million in restitution and to forfeit $3.32 million; C. On November 20, 1995, the United States District Court for the Northern District of Illinois entered an Order of Permanent Injunction and Other Equitable Relief (injunction), by consent, against Fauls which permanently restrains and enjoins Fauls from violating Section 17(a) of the Securities Act of 1933 (Securities Act) and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; D. The conduct that was the basis of Fauls' criminal conviction and permanent injunction stemmed from a fraudulent scheme that Fauls engaged in between 1987 and 1990, along with Robert Burstein (Burstein), who was associated with an investment ---------FOOTNOTES---------- -[1]- The findings herein are made pursuant to Howe Barnes' Offer of Settlement and are not binding on any other person or entity named as a respondent in this or any other proceeding. adviser to the Union Carbide Pension Fund.-[2]- Fauls and Burstein effected a series of prearranged trades between the pension fund and a midwestern bank (Bank) that was also a customer of Fauls.-[3]- The scheme violated, among other things, the antifraud provisions of the Securities Act and the Exchange Act. In furtherance of their scheme, Fauls and Burstein traded United States treasury securities in a prearranged pattern which insulated the Bank from market conditions by guaranteeing against a loss. The scheme worked by interpositioning the Bank between the pension fund and the market. When the market price was moving up on a given day, the Bank would buy United States treasury securities from the pension fund and in turn sell them on the same day in the open market. The price of the sale from the pension fund to the Bank would be set lower than the open market trade, but within the day's trading range. When the market price was moving down on a given day, the Bank would purchase United States treasury securities at a price lower than the market high and then would sell those securities to the pension fund at or near the day's market high, thus generating a profit for the Bank. The price of the sale from the Bank to the pension fund was set higher than the open market trade, but within the day's trading range. As a second part of the scheme, Fauls made purchases of United States treasury securities in the early part of a trading day and sold those same securities near the end of a trading day without identifying the original purchaser, a trade allocation scheme. If the transaction was profitable, the Bank was always identified as the original purchaser while if the transaction resulted in a loss, the pension fund would be identified as the original purchaser; ---------FOOTNOTES---------- -[2]- The United States District Court for the Northern District of Illinois entered an Order of Permanent Injunction and Other Equitable Relief, by consent, against Burstein which permanently restrains and enjoins him from violating Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and Section 206 of the Investment Advisers Act of 1940. -[3]- Burstein also served on the Board of Directors of the Bank. He was responsible for the Bank's securities trading, although he and Fauls conspired to keep that information from Howe Barnes. He also received 10% of all profits generated from the Bank's securities trading and received payments from Fauls, including a boat, for directing the pension fund's business to Fauls at Howe Barnes. Burstein's financial interest in the Bank's trading and the payments made by Fauls were also not disclosed by Fauls and Burstein. ==========================================START OF PAGE 3====== E. Fauls, in addition to serving as head of Howe Barnes' Fixed Income Department, had the dual responsibility of acting as a registered representative for his own customers, the largest and most active traders of which were institutional investors, and performing trading functions in certain fixed income securities for Howe Barnes clients. Fauls' responsibilities included trading in United States treasury securities for Howe Barnes customers, although on occasion others in the department, all of whom were supervised by Fauls, performed certain tasks or transactions, either at his direction or on their own initiative. Fauls was responsible for all phases of a customer transaction in United States treasury securities, such as locating securities available for purchase by a customer and purchasers for securities to be sold by a customer, and obtaining price quotations.-[4]- Fauls employed a personal record keeping system in which he wrote price and source quotations in a spiral notebook. Fauls was also responsible for preparing the order tickets for customer transactions that he executed in fixed income securities. With the information in the notebook Fauls prepared order tickets. In executing the interpositioned trades, Fauls predetermined the profit to the Bank and did not prepare order tickets at the same time that he obtained the execution prices. In executing the trade allocation portion of the scheme, Fauls would purchase the security and not identify the buyer until after the close of the market. The order tickets Fauls prepared in connection with his trading scheme contained numerous irregularities. For example, Fauls prepared order tickets bearing time stamps after the close of the day's market; order tickets without any indication of time of entry or execution; and order tickets with strikeovers and corrections in the customer, security or buy/sell section of the order ticket form such that this information was unclear. As a department head, member of the Executive Committee,-[5]- and principal of the firm, Fauls occupied a senior position in Howe Barnes' management. In addition, at the ---------FOOTNOTES---------- -[4]- There was no independent historical data base or computer record available to the industry to obtain price quotations for United States treasury securities during the period between 1987 to 1990. Instead, Fauls and/or his assistants called brokers trading in the securities and obtained bid and ask quotes directly from the dealers. -[5]- At the time of Fauls' conduct, the Executive Committee was comprised of four officers of the firm, including Fauls, all of whom also served on the firm's Board of Directors. The Executive Committee was responsible for setting firm policy. The Executive Committee reported to the Board of Directors, which had no outside members and met only quarterly. ==========================================START OF PAGE 4====== time of his violative conduct, Fauls generated significant commissions for the firm from his sales activities. There was no person or position directly responsible for supervising Fauls, in part as a result of his role as a senior manager who also routinely performed the dual responsibilities of trader and sales person. An officer of the firm spent a portion of his time reviewing Howe Barnes' records, such as commission runs, trade blotters and monthly statements. The purpose of these reviews was to monitor business matters, such as firm performance and profitability and to identify compliance issues. The officer did not review order tickets as part of his regular reviews. The officer, in his discretion, would refer compliance matters to Howe Barnes' president. The two, in turn, would determine whether to bring matters to the attention of the Executive Committee. In the Summer of 1988, during his regular review of Howe Barnes' trading records, the officer found an apparent pattern of same day cross-trades in United States treasury securities between the Bank and the pension fund. In response to questions from the officer and the president regarding the Bank's and the pension fund's trading, Fauls said that Burstein had a planned trading strategy for the pension fund to lengthen the maturities of the United States treasury securities held in the pension fund's portfolio. Fauls then explained that he had contacted the Bank and informed bank officials of the availability of the securities and that the Bank wanted to purchase them. Fauls did not inform Howe Barnes officials that Burstein was the Bank representative he contacted or that Burstein was responsible for the Bank's trading decisions. Howe Barnes made no further inquiries of Fauls in the Summer of 1988. In December 1988, during another regular review of Howe Barnes' trading records, the officer noticed that the pattern of cross-trading between the Bank and the pension fund had apparently continued. He also noticed that the Bank garnered a profit in every cross-trade. The matter was referred to the Executive Committee, which, without Fauls' knowledge or participation, reviewed the records and decided to retain outside counsel. The officer prepared a summary of the suspicious trading. Howe Barnes' president retained outside counsel, which was provided with a summary of the suspicious trades, to conduct an investigation. When interviewed by outside counsel, Fauls gave the same explanation he had given to his colleagues at Howe Barnes. At the conclusion of their review, outside counsel provided an opinion that the cross-trading did not present any legal problem. At the end of 1988 and beginning of 1989, Howe Barnes officers took two additional steps: (1) they required Fauls to cease the same day cross-trades between the pension fund and the ==========================================START OF PAGE 5====== Bank;-[6]- and (2) the president placed several telephone calls to both a Bank official and Burstein to inquire about their trading at Howe Barnes. After Fauls had become aware that Howe Barnes retained outside counsel to review the trades, he and Burstein informed a Bank official of the investigation. They requested that the official, should he be contacted by either Howe Barnes or its outside counsel, state that he was responsible for the Bank's securities trading. The official complied, and when contacted by Howe Barnes' president, maintained that he, not Burstein, was responsible for the Bank's securities trading. Because of this deception, and Fauls' other efforts to conceal his scheme, Howe Barnes had no further indications that Fauls was involved in improper activities after the Winter of 1988-89. Fauls' business activities at Howe Barnes were not altered or curtailed until September 1992 when he was placed on an unpaid leave of absence after the Office of the United States Attorney for the Northern District of Illinois notified Howe Barnes that Fauls was under investigation for, among other things, securities fraud in connection with his trading for the Bank and the pension fund. Fauls remained on unpaid leave and, shortly after the United States Attorney issued an indictment against him on August 31, 1993, he was formally terminated by Howe Barnes. Howe Barnes failed reasonably to supervise Fauls with a view toward preventing violations of the antifraud provisions of the Securities Act and the Exchange Act. Howe Barnes failed to establish procedures, and a system for applying such procedures, which would reasonably be expected to prevent and detect, insofar as practicable, Fauls' fraudulent trading schemes. There was no clear delineation of supervisory responsibilities over Fauls' activities designed to guard against potential abuses of Fauls' position. For example, there were no procedures in place providing for the review of order tickets Fauls prepared. As stated above, many of the order tickets he prepared in connection with the scheme contained irregularities. Howe Barnes was required to have in place reasonable procedures to supervise Fauls notwithstanding his senior position at the firm. Moreover, it was not appropriate for the firm to structure its supervision of Fauls in reliance, in part, on the expectation that, because ---------FOOTNOTES---------- -[6]- While Fauls and Burstein ceased conducting all portions of the interpositioning trading scheme through Howe Barnes in December 1988, they continued to execute the scheme for nearly two more years, until October 1990. They executed portions of the interpositioned series of trades through another broker/dealer, directed that broker/dealer to deliver the securities to the appropriate Howe Barnes account and then executed the remainder of the transaction through Howe Barnes. In all, between 1987 and 1990, they executed 76 sets of transactions. ==========================================START OF PAGE 6====== most of Fauls' sales and trading activities were for institutional or other large and presumably sophisticated customers, his customers would themselves be more alert to improper sale practices than unsophisticated retail customers. III. Based on the foregoing, the Commission finds that Howe Barnes failed reasonably to supervise Fauls with a view towards preventing violations of the antifraud provisions of the Securities Act and the Exchange Act and that Howe Barnes willfully violated Section 17(a) of the Exchange Act and Rule 17a-3(a)(6) promulgated thereunder by failing to make order tickets with accurate time stamps indicating when an order was entered and executed and making order tickets containing irregularities in the customer identification, security name and buy/sell instruction portion of the order tickets. The Commission further finds that it is in the public interest to impose the sanctions specified in this Order. Accordingly, IT IS ORDERED THAT: 1. Howe Barnes is censured; 2. Howe Barnes 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(a)(6) promulgated thereunder; 3. Howe Barnes shall undertake to appoint an independent consultant not unacceptable to the Commission staff in the Midwest Regional Office, to conduct reviews of Howe Barnes' compliance procedures, make recommendations, when necessary and appropriate, for structural or other changes to the firm's compliance procedures and prepare a yearly report, to be presented to the firm's Board of Directors, on all compliance matters addressed by Howe Barnes during each of the two years following the issuance of this Order. Howe Barnes shall bear the cost of the services of the independent consultant. A copy of each report prepared by the independent consultant shall be delivered to the Regional Director, Midwest Regional Office, 500 West Madison, Suite 1400, Chicago, Illinois 60661 within 14 days of its issuance to the Board of Directors. Any recommendations regarding organizational or other changes to the compliance procedures made by the independent consultant shall be implemented by Howe Barnes within 90 days from the date of the final recommendation or as soon as is practical, not to exceed 120 days from the date of the final recommendation. The Regional Director of the Midwest Regional Office, may, in her discretion, after a showing, by the President and Chairman of the Board of Howe Barnes, of best efforts to comply with this deadline and reasonable business factors making the deadline impractical, grant such extension to the deadline as is reasonable in light of ==========================================START OF PAGE 7====== the reasons for Howe Barnes' inability to meet the 120 day deadline included in this item; 4. Howe Barnes shall undertake to appoint an outside member to its Board of Directors and shall maintain at all times during its existence at least one outside director on its Board. This undertaking was implemented by Howe Barnes on October 24, 1995 and shall be maintained. The Board shall undertake to establish a sub-committee specifically charged with responsibility for oversight of compliance matters at Howe Barnes and shall at all times have as one of its members an outside director; 5. Howe Barnes shall undertake to make structural and procedural changes to its management responsible for compliance matters in order to: (i) improve the firm's supervisory procedures and internal compliance reporting procedures, (ii) establish clear lines of authority for compliance oversight amongst the pertinent managers, and (iii) establish comprehensive policies regarding the distribution of written materials describing the supervisory and compliance procedures to all employees with customer contact; 6. Howe Barnes shall submit a written, sworn affidavit by the President of the firm and the Chairman of the Board specifically explaining each and every modification made pursuant to the undertaking describe in item 5. above and certifying that each and every modification is completed. Such affidavit shall be submitted to the Regional Director, Midwest Regional Office, 500 West Madison, Suite 1400, Chicago, Illinois 60661 within 90 days of the issuance of the Order. The Regional Director may, in her discretion, after a showing, by the President and Chairman of the Board of Howe Barnes, of good cause and best efforts to comply with this deadline grant a 90 day extension to the deadline for submission of the affidavit attesting to completion of the undertakings described in item 5. above. By the Commission. Jonathan G. Katz Secretary ==========================================START OF PAGE 8======