UNITED STATES OF AMERICA BEFORE THE SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 41035 / February 10, 1999 ADMINISTRATIVE PROCEEDING File No. 3-9718 ______________________________ : In the Matter of : : ORDER MAKING FINDINGS AND JOSEPH W. PELLECHIA : IMPOSING REMEDIAL SANCTIONS : Respondent. : ______________________________: I. On September 24, 1998, the Securities and Exchange Commission ("Commission") instituted public administrative proceedings pursuant to Section 15(b)(6) of the Securities Exchange Act of 1934 ("Exchange Act") against Joseph W. Pellechia ("Pellechia") to determine whether he failed reasonably to supervise Sheldon Maschler ("Maschler") with a view to preventing violations of the federal securities laws by Maschler, and, if so, what remedial actions or sanctions, if any, were appropriate. In response to the institution of administrative proceedings, Respondent has submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceeding 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 jurisdiction of the Commission over him and the subject matter of the proceeding, which are admitted, Respondent Pellechia consents to the entry of this Order Making Findings and Imposing Remedial Sanctions ("Order"). II. On the basis of this Order and the Respondent’s Offer, the Commission makes the following findings[1]: 1. This matter involves Pellechia’s failure reasonably to supervise Maschler, who violated Sections 5(a) and (c) of the Securities Act of 1933 ("Securities Act") in connection with an unregistered distribution of the stock of Alter Sales Co., Inc. ("ASI"). A. Respondent 2. Joseph William Pellechia, age 35, was the branch manager of Datek Securities Corp.’s Staten Island branch office and Maschler’s supervisor during the relevant period. Pellechia was employed in the securities industry from 1982 until June 1998 as a registered representative and securities principal. Pellechia declined to testify in response to a subpoena issued to him in the Commission’s investigation in reliance on his Fifth Amendment privilege against self-incrimination. B. Other Relevant Entities and Persons 3. Datek Securities Corp. ("Datek"), at the relevant time, was registered with the Commission as a broker-dealer pursuant to Section 15(b) of the Exchange Act. Datek’s principal place of business was Brooklyn, New York, and it had branch offices in Staten Island and New York, New York. 4. Sheldon Maschler ("Maschler"), age 53, was a broker at Datek who opened an account in the name Martin Clainey and through which he sold shares in ASI. During the relevant period, Datek’s Staten Island branch office was located in the basement of Maschler’s residence. Maschler asserted his Fifth Amendment privilege against self-incrimination and refused to testify in the Commission’s investigation. 5. Alter Sales Co., Inc., incorporated in Florida in 1957, was engaged during the relevant period in the distribution of automotive parts and accessories. The company went public in 1991, trading on the NASDAQ SmallCap market. Before the distributions that are the subject of this Order, ASI had approximately 2 million total shares outstanding. 6. Martin Clainey ("Clainey"), age variously listed, was the name given to the fictitious foreign investor who was purported to have purchased 3,000,000 unregistered shares of ASI common stock in a series of Regulation S offerings approved by the company’s board between April and July 1993, all of which were resold within the United States by the end of October 1993. C. Summary 7. The predicate violation by Maschler in this failure to supervise case is related to the unregistered distribution of ASI stock through Datek in 1993. Maschler opened a new account in the name of a Martin Clainey, a fictitious individual, immediately began executing sell transactions in ASI stock creating a large short position in the account, took delivery of 1.4 million shares of ASI stock into that account, part of which covered the short positions, and delivered out the proceeds from the sales. In view of the red flags suggesting that he was participating in an unregistered distribution, Maschler violated Section 5 of the Securities Act by failing to discharge his duty to investigate the circumstances of those transactions. 8. Pellechia, a Datek branch manager and Maschler’s supervisor, failed to supervise Maschler with a view to preventing his Section 5 violations. At all relevant times, Pellechia was responsible for managing what Datek denominated its Staten Island branch office, which was located in the basement of Maschler’s residence. Pellechia, who approved the opening of the Clainey account, knew or reasonably should have known of the activity in the account that raised red flags concerning a possible unregistered distribution. Pellechia did not take reasonable steps to supervise Maschler in light of the suspicious facts that confronted him regarding the possible illegality of the large volume of sales of ASI stock through the brand-new Clainey account. Pellechia did not require Maschler to make any inquiry of the transactions. D. The Requirements of Section 5 of the Securities Act 9. Sections 5(a) and (c) of the Securities Act generally prohibit the use of the mails or interstate means to sell or offer to sell, directly or indirectly, any security unless a registration statement is in effect or has been filed with the Commission as to that security, or unless an exemption from the registration provisions applies. A showing of scienter is not necessary to prove a Section 5 violation. 10. Because of their positions as gatekeepers to the public markets, the Commission has imposed responsibilities on brokers to ascertain that they are not selling unregistered securities: "[A] dealer who offers to sell, or is asked to sell a substantial amount of securities must take whatever steps are necessary to be sure that this is a transaction not involving an issuer, person in a control relationship with an issuer or an underwriter. . . . [W]here the surrounding circumstances raise a question as to whether or not the ostensible sellers may be merely intermediaries for controlling persons or statutory underwriters, then searching inquiry is called for." Distribution By Broker- Dealers of Unregistered Securities, Exchange Act Release No. 4445, 27 Fed. Reg. 1251 (1962). 11. The courts have determined that "[b]rokers and securities salesmen are under a duty to investigate, and a violation of that duty brings them within the term ‘willful’ of the Securities Act," Quinn and Company, Inc. v. SEC, 452 F.2d 943, 947 (10th Cir. 1971), and that "willfulness can be found if a broker or dealer who is aware of several facts suggesting a suspicious transaction proceeds to facilitate the sale with reckless indifference to such facts, and ignores the obvious need for further inquiry and the duty to disclose all relevant information to his superiors." Owen V. Kane v. SEC, 842 F.2d 194, 200 (8th Cir. 1988) (citing Wasson v. SEC, 558 F.2d 879, 886 (8th Cir. 1977)). E. Maschler’s Violations of Sections 5(a) and (c) of the Securities Act 12. Between April 22 and July 27, 1993, three million unregistered shares of ASI common stock were issued in the name of Martin Clainey under the provisions of the Regulation S safe harbor. 13. Beginning in April 1993, accounts in the name of Clainey were opened at three U.S. brokerage firms. Approximately 2,775,000 of the Regulation S shares issued by ASI were delivered into the Clainey brokerage accounts. More than 2.4 of the 3.0 million shares were sold on the U.S. market within forty days of their original issuance, contrary to the explicit provisions of Regulation S, and all three million shares were sold by mid- October 1993. 14. One of the three Clainey accounts was opened at Datek in late July. In late July and early August 1993, Maschler executed a series of short sales of ASI stock in the newly-opened Datek Clainey account, for which he served as account executive. During this same period, more than 30 stock certificates in the name of Martin Clainey representing 1,400,000 shares of ASI were received by Datek for delivery into the Clainey account. The shares delivered into the account were used to cover the short positions. All but 36,000 of the 1,400,000 shares were sold within 40 days of the original issuance. The following chart reflects the activity in the Clainey account: Date Transaction Quantity Net Position principal/agency 7/27/93 Sale 236,000 short 236,000 principal 7/28/93 Sale 339,500 short 575,500 principal 7/30/93 Receipt 300,000 short 275,500 8/5/93 Receipt 150,000 Sale 75,000 short 200,500 agency 8/9/93 Receipt 700,000 Sale 495,000 long 4,500 agency 8/13/93 Sale 218,500 short 214,000 agency 8/16/93 Receipt 250,000 long 36,000 15. The $3.457 million in proceeds derived from these sales were removed quickly from the account. $1.32 million was wired out to two bank accounts -- one in the Isle of Jersey and one in the U.S. It is plain from the wire instructions delivered to Datek that the U.S. bank account was held jointly with Marc Osheroff, ASI’s CEO and president. The remaining shares and $2.137 million in cash were transferred to an account at one of the other broker-dealers where an account was maintained in Clainey’s name. 16. Maschler sold 1,364,000 shares of ASI stock on behalf of Clainey within three weeks of their delivery into Clainey’s new account at Datek. These shares represented, and Maschler is responsible for, distributions equivalent to 63 percent of the amount of ASI stock outstanding before the Clainey distributions commenced. In light of his failure to discharge his duty as a broker of conducting a searching inquiry of Clainey to determine whether these sales were part of an illegal unregistered distribution, Maschler violated Sections 5(a) and 5(c) of the Securities Act. F. Pellechia Failed Reasonably To Supervise Maschler 17. As branch manager of Datek’s Staten Island branch office during the relevant period, Pellechia had overall supervisory responsibility for all of the employees in the office, including Maschler. As branch manager, Pellechia’s responsibilities included approving the opening of new retail accounts by registered representatives, enforcing the "know your customer well" rule in effect at Datek, reviewing all order tickets generated by the branch, and reviewing all mail received by the branch. Pellechia also could obtain any information that he needed regarding any of the accounts in the Staten Island office. Pellechia was authorized to discipline Maschler and other employees of that office. 18. Pellechia was confronted with sufficient suspicious circumstances such that he should have taken steps at least to determine whether Maschler had complied with his duty to investigate the circumstances of these massive deposits and sales of ASI stock through the Clainey account at Datek. First, Pellechia reviewed and signed the account opening form to approve the establishment of the Clainey account at Datek. As such, he knew that Clainey was a new, unfamiliar customer. Moreover, he knew that the information required on the form was incomplete. Although the documents reflected that Clainey was a foreign person, and that he was self-employed and that he held the position of president, they included no further detail about his occupation. While there was an address in France listed for Clainey, there was no telephone number provided. No information was provided in response to the following items: age, number of dependents, marital status, estimated annual income, estimated net worth, estimated liquid net worth, statement of objectives, investment experience, and whether he was associated with a registered entity. Moreover, the document was not dated. 19. Because he was responsible for reviewing all order tickets, and had full access to all activity in all accounts in the Staten Island office, Pellechia knew or should have known of the series of short sales creating a large short position in the Clainey account, and that the short position was being covered through the delivery of a large amount of ASI stock into the account. The sales of 1,364,000 ASI shares, all of which occurred in less than a three week period and were the only securities transactions ever in the Clainey account, resulted in distributions equivalent to approximately 63 percent of the amount of ASI stock outstanding before this unregistered distribution commenced. Pellechia knew or should have known this because Datek’s Staten Island office made a market in ASI and maintained or should have maintained a due diligence file containing ASI’s most recent Form 10-K, which disclosed the number of ASI shares outstanding. As branch manager, Pellechia was responsible for the Staten Island office’s trading function, in addition to the retail area. 20. Pellechia did not enforce Datek’s "know your customer well" rule, which was the responsibility of the branch manager to enforce. The rule generally imposed on brokers the responsibility of carrying out due diligence to learn the essential facts concerning each customer prior to opening the account. The rule further imposed on a broker’s supervisor the responsibility of ensuring that the broker initially obtain, and periodically update, essential facts about the customer and his account. In addition, the rule required the broker to obtain information regarding special circumstances appropriate to any unusual transaction. 21. Pellechia is liable under Section 15(b)(6) of the Exchange Act for failing reasonably to supervise Maschler’s handling of the transactions in Clainey’s account at Datek. Section 15(b)(6) of the Exchange Act, incorporating by reference Section 15(b)(4)(E) of the Act, authorizes the Commission to sanction a person associated with a broker-dealer if the Commission finds that such sanction is in the public interest and that the person "has failed reasonably to supervise, with a view to preventing violations of the provisions" of the federal securities laws "another person who commits such a violation, if such other person is subject to his supervision." Section 15(b)(6) further provides that a person is not deemed to have failed to supervise if 1) there were established procedures, and a system for applying them, that reasonably would be expected to prevent and detect, insofar as practicable, any such violation by the other person, and 2) the person "has reasonably discharged the duties and obligations incumbent upon him by reason of such procedures and system without reasonable cause to believe that such procedures and system were not being complied with." As the statutory language makes clear, it is necessary to show only negligent, not willful, conduct to establish failure to supervise. See SEC v. Geon Industries, Inc., 531 F.2d 39, 53-54 (2nd Cir. 1976); Louis R. Trujillo, Administrative Proceeding File No. 3-6555, at 74 n.40 (April 23, 1987) (Init. Dec.), dismissed on other grounds, Exchange Act Release No. 26635, 43 S.E.C. 690 (March 16, 1989). 22. Pellechia had sufficient red flags regarding the transactions in Clainey’s account to warrant him taking further action to ensure that Maschler was complying with the federal securities laws. By failing to reasonably carry out his responsibilities as a branch manager, Pellechia failed reasonably to supervise Maschler, who was subject to his supervision, with a view toward preventing Maschler’s violations of Sections 5(a) and 5(c) of the Securities Act. III. Accordingly, IT IS ORDERED that Pellechia be and hereby is suspended from association with any broker or dealer in a supervisory capacity for a period of six months, beginning on the second Monday following entry of this Order. IT IS FURTHER ORDERED that Pellechia shall, within ten (10) days of the date of this Order, pay a civil penalty in the amount of $10,000 to the United States Treasury. Such payment 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) delivered to the Comptroller, Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop 0-3, Washington D.C. 20549; and (4) submitted under cover letter which identifies Pellechia 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 Erich T. Schwartz, Assistant Director, Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop 7-6, Washington, D.C. 20549. By the Commission. Jonathan G. Katz Secretary **FOOTNOTES** [1]: The findings in the Order are made pursuant to Pellechia’s Offer and are not binding on any other person or entity named as a respondent in this or any other proceedings.