SG Cowen and Lehman Brothers Settle Enforcement Actions with SEC and NYSE for Supervisory Failures in Frank Gruttadauria Case


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SEC Contact: Brian A. Ochs
Ph.: (202) 942-4740

NYSE Contact: Diana DeSocio
Ph.: (212) 656-5448

Washington, D.C., Aug. 14, 2003 -- The Securities and Exchange Commission and the New York Stock Exchange today announced joint actions against SG Cowen Securities Corporation and Lehman Brothers, Inc. for failing to supervise Frank D. Gruttadauria, a former branch office manager and broker. Beginning in 1987, while employed at a series of broker- dealers, Gruttadauria misappropriated over $115 million from his customers. He stole approximately $47 million of this total during the 27-month period that SG Cowen employed him and $21.5 million during the 15-month period that Lehman Brothers employed him. Gruttadauria also sent his victims falsified account statements that vastly inflated the holdings in their accounts, and diverted the genuine statements for most of these victims. When Gruttadauria surrendered to authorities in February 2002, these statements showed that the accounts of Gruttadauria's victims had a total of over $285 million, when they actually had less than $2 million. Gruttadauria is serving a seven-year jail term.

As part of the joint actions, SG Cowen will pay penalties of $5 million and Lehman Brothers will pay $2.5 million, split equally between the SEC and the NYSE. In connection with the settlement, SG Cowen has also agreed to make immediate payments of out-of-pocket losses suffered prior to the time the accounts were transferred to Lehman Brothers to former customers from whom Gruttadauria stole cash or securities and who have not already been paid through settlements with the firm. This process has largely been completed. Last year, Lehman Brothers voluntarily paid back to customers the net amount that Gruttadauria took from their accounts during the period that Lehman Brothers employed him. Customers also will have an opportunity to pursue claims for additional monies beyond these losses through a special arbitration process to which the firms have agreed as part of the settlements.

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In commenting on the joint enforcement actions, Stephen M. Cutler, Director of the SEC Division of Enforcement, observed:

"At both SG Cowen and Lehman Brothers, the primary responsibility for overseeing Gruttadauria's daily retail brokerage activity was entrusted to Gruttadauria's own subordinates. We have grave doubts that such a structure — absent frequent and meaningful involvement by independent supervisors — could ever be effective."

Regarding the joint actions, David P. Doherty, Executive Vice President, Enforcement at the NYSE, said:

"The decisions announced today by both the NYSE and SEC against SG Cowen and Lehman put an end to one of the most egregious examples of misconduct in the securities industry. This matter highlights the importance of strong supervision and internal controls and the degree to which member firms will be held accountable for misconduct within their firms when they fail to fulfill those responsibilities. The NYSE has proposed new rules that specifically impose additional requirements that address these supervision and internal control concerns."

Summary of the Violations Found and the Relief Ordered

Without admitting or denying the findings of the SEC and the NYSE, SG Cowen and Lehman Brothers consented to findings that they separately:

  • violated Section 15(b)(4) of the Securities Exchange Act of 1934 and NYSE Rules 342 and 405 and engaged in conduct inconsistent with the NYSE's just and equitable principles of trade by failing to have and implement adequate systems to supervise Gruttadauria; and
  • violated Section 17(a) of the Exchange Act, Rule 17a-3 under the Exchange Act and NYSE Rule 440 by failing to maintain complete and accurate books and records.

The NYSE decision separately found that SG Cowen engaged in conduct inconsistent with the NYSE's just and equitable principles of trade by failing fully to implement policies and procedures to which it had committed pursuant to an undertaking imposed in an earlier NYSE enforcement action.

In addition to participating in the special arbitration process, SG Cowen will pay up front to former customers from whom Gruttadauria stole funds and who have not already resolved their claims against the firm the difference between amounts they invested and amounts they withdrew or transferred to Lehman Brothers pursuant to a method set forth in the SEC order and the NYSE decision against SG Cowen.

Any former client of Gruttadauria's from May 1989 through January 2002 who received falsified account documents or had assets misappropriated by Gruttadauria is eligible to participate in the special arbitration process. The firms cannot argue that claims are too old and will accept liability for Gruttadauria's misappropriations and his sending of falsified account documents. Other claims of those customers may also be brought in this process, and, with limited exceptions, the firms will also be liable for those once Gruttadauria's misconduct is established. SG Cowen will pay all awards for the time period that SG Cowen's predecessor, Cowen & Company, employed Gruttadauria. The process will be made available at the NYSE: former customers with ongoing litigation may opt into the process, and persons with ongoing arbitrations at either the NYSE or the NASD may elect to convert those proceedings into a special proceeding. The firms will pay all filing fees, forum fees, and the fees and expenses of mediators and arbitrators. Clients who participate cannot receive punitive or treble damages.

Both firms agreed, pursuant to the SEC order and NYSE decision, to a censure based on their failures reasonably to supervise Gruttadauria. Further, both firms agreed, pursuant to the SEC's order, to cease and desist from any further violations of the books and records provisions of the federal securities laws. Both firms also agreed, pursuant to the NYSE decision, to have consultants conduct a review — designed to prevent a recurrence of Gruttadauria's violations — of their respective policies and procedures related to the use of personal computers, accounts with post office and "care of" mailing addresses, and third-party disbursements.

Summary of the SEC and NYSE Findings

The SEC and the NYSE found the following failures at SG Cowen and Lehman Brothers with respect to their supervision of Gruttadauria.

  • Gruttadauria was a producing branch office manager, which means that he was responsible both for the overall supervision of the Cleveland branch and for his own retail brokerage clients. Both firms had persons subordinate to Gruttadauria bear the primary responsibility for overseeing his daily retail-brokerage activity. By structuring their supervisory and compliance functions in this manner, SG Cowen and Lehman Brothers created an inherent risk that Gruttadauria would not be adequately supervised. In that regard, a previous enforcement action by the NYSE against SG Cowen's predecessor had identified salient weaknesses in this aspect of what became SG Cowen's supervisory structure and, later, Lehman Brothers'.
  • Further, SG Cowen and Lehman Brothers failed reasonably to supervise Gruttadauria, with a view to detecting and preventing his fraudulent conduct, in the following ways:
    • Both firms failed adequately to handle the accounts transferred to them when acquiring the Cleveland branch, which allowed Gruttadauria to continue diverting the real account statements for many of his victims.
    • Neither firm had an adequate system for applying its respective procedures for the review of Gruttadauria's incoming and outgoing correspondence, because Gruttadauria, as a producing branch office manager, had access to a facsimile machine, the mailroom, and the firms' postage meter. Gruttadauria used this access to, among other things, evade the firms' correspondence review procedures when sending falsified account statements to his victims in the firms' envelopes and with the firms' postage markings.
    • Both firms lacked procedures for monitoring Gruttadauria's use of the personal computer system that he used to create falsified account statements and other account documents.
    • Both firms lacked an adequate system for applying its procedures for detecting and preventing unauthorized third-party transfers.
    • SG Cowen separately failed to have adequate procedures to prevent Gruttadauria, as a producing branch office manager, from authorizing third-party disbursement requests for his own clients and deviating from the firm's cashiering and related procedures in processing such requests.
    • SG Cowen separately failed to have adequate procedures for a supervisor not subordinate to Gruttadauria to follow up on critical missing account documentation involving the accounts of some of Gruttadauria's victims. As a result, after an SG Cowen examiner discovered in 1999 that 30 of Gruttadauria's customer accounts had inadequate documentation to permit the use of a post office box or "care of" mailing address, Gruttadauria was able to follow up himself by forging the necessary documents.
    • SG Cowen separately failed to have an adequate system for applying its procedures related to the periodic review of client account statements with an eye to identifying unusual transfers of funds and reviewing the underlying documentation, including the verification of customer signatures.
    • SG Cowen separately failed to comply with its responsibility regarding the undertaking imposed in the NYSE enforcement action against Cowen, including aspects of the undertaking relating to producing branch office managers.
    • Lehman Brothers separately failed to have an adequate system for applying its procedures concerning accounts with post office box and "care of" mailing addresses during the period that it employed Gruttadauria.
  • Both firms violated the books and records provisions of the federal securities laws because of inaccurate client mailing addresses and inaccuracies in client account records arising out of Gruttadauria's misappropriation of funds and securities.

The SEC and the NYSE acknowledge the assistance and cooperation of both the NYSE Arbitration Division and NASD Dispute Resolutionwith regard to the special arbitration process that the firms will implement as part of the SEC orders and NYSE decisions.

The SEC's and NYSE's investigations are continuing.

See Also:  Administrative Proceeding Release No. 34-48335Administrative Proceeding Release No. 34-48336
Last modified: 8/14/2003