UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION Securities Exchange Act of 1934 Release No. 37673 / September 12, 1996 Administrative Proceeding File No. 3-9079 : In the Matter of : ORDER INSTITUTING A PROCEEDING : PURSUANT TO SECTIONS 15(b) AND LEHMAN BROTHERS INC., as : 21C OF THE SECURITIES EXCHANGE successor to SHEARSON LEHMAN : ACT OF 1934, MAKING FINDINGS, BROTHERS INC. : INSTITUTING A CEASE-AND- : DESIST ORDER, AND IMPOSING Respondent. : REMEDIAL SANCTIONS : I. The Commission deems it appropriate and in the public interest that a public administrative proceeding be, and hereby is, instituted against Lehman Brothers Inc. (Lehman Brothers), as the successor to Shearson Lehman Brothers Inc. (Shearson), pursuant to Sections 15(b) and 21C of the Securities Exchange Act of 1934 (Exchange Act). II. In anticipation of the institution of this proceeding, Lehman Brothers has submitted an offer of settlement, which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the findings contained in this order (except that Lehman Brothers admits that the Commission has jurisdiction over it and over the subject matter of this proceeding), Lehman Brothers consents to the entry of the findings, the institution of the cease-and-desist order, and the imposition of remedial sanctions as set forth below. ==========================================START OF PAGE 2====== III. The Commission finds-[1]- the following: A. FACTS 1. Respondent Lehman Brothers Inc. Lehman Brothers, a Delaware corporation, is a broker-dealer registered with the Commission pursuant to Section 15(b) of the Exchange Act. During the period relevant to this matter, Lehman Brothers, together with a system of retail branch offices, operated as Shearson. In 1993, most of Shearson's retail branch offices were sold to Smith Barney, Harris Upham & Co. However, Lehman Brothers, as the successor to Shearson, retained responsibility for any regulatory liability incurred by Shearson prior to the sale of Shearson's retail branch offices. 2. Summary This matter concerns Shearson's failure to reasonably supervise a registered representative, Stanley J. Feminella, who was subject to its supervision, with a view to preventing the charging of undisclosed, excessive markups in violation of Section 17(a) of the Securities Act of 1933 (Securities Act) and Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder.-[2]- Feminella caused two customers, Consumers Union of United States, Inc. (CU) and its employee pension fund, to pay excessive markups on the purchase of certain government- issued and -guaranteed securities.-[3]- ---------FOOTNOTES---------- -[1]- The findings herein are made pursuant to Lehman Brothers' offer of settlement and are not binding on any other person or entity in this or any other proceeding. -[2]- The Commission has filed a separate enforcement action related to some of the matters discussed herein. Securities and Exchange Commission v. Stanley J. Feminella and David W. Granston, No. 96-CIV-336 (AGS) (S.D.N.Y.), Litigation Release No. 14786 (Jan. 18, 1996); Litigation Release No. 14939 (June 7, 1996). -[3]- These securities were Government National Mortgage Association (GNMA) mortgage-backed securities, which are created by pooling and repackaging mortgage obligations into securities that pass interest and principal payments from the underlying mortgages, through intermediaries, to investors; and, in one instance, Separate Trading of Registered Interest and Principal Securities (STRIPS), which the United States Department of Treasury creates by separating the interest component from the principal component of selected Treasury notes and bonds. ==========================================START OF PAGE 3====== In late 1988, when Feminella transferred to Shearson from another national retail brokerage firm, Shearson agreed to allow him to charge a 3-point sales credit on every GNMA mortgage- backed security purchased by the CU accounts. The 3-point sales credit, when added to the spreads charged by the firm's retail trading desk, directly resulted in CU paying undisclosed, excessive markups.-[4]- From November 1988 through February 1991, while the accounts were at Shearson, CU and its pension fund purchased approximately $36 million in GNMA mortgage-backed securities in thirty-two transactions-[5]- and approximately $2.5 million of STRIPS in one transaction. On these transactions, ranging in amounts from approximately $107,000 to more than $3,000,000, the CU accounts were charged markups that ranged from 3.5 percent to 4.7 percent. The CU accounts paid a total of at least $1,390,000 in markups, of which Feminella received at least $904,000. Feminella's charging of large across-the-board sales credits in the context of these transactions negated the notion that the markups charged CU were based on the particular facts and circumstances of each securities transaction. This resulted in a situation where the CU accounts purchased securities at prices that bore no reasonable relationship to the prevailing market prices. Thus, Feminella caused the CU accounts to pay excessive markups. Shearson failed to reasonably supervise Feminella with a view toward preventing the excessive markups. Shearson lacked sufficient firm-wide policies and procedures reasonably designed to prevent and detect excessive markups, particularly on large retail transactions such as those at issue here. During the relevant period, Shearson had a computer system that disseminated ---------FOOTNOTES---------- -[4]- With respect to the transactions at issue in this matter, Feminella obtained the securities sold to the CU accounts from Shearson's retail trading desk, which, in turn, typically obtained the securities from either Shearson's institutional trading desk or an inter-dealer broker, which acts as an intermediary that arranges transactions between dealers. For purposes of this order, on each transaction the markup was calculated as the combination of the sales credit and the retail trading desk's spread. See infra at note 8 for further discussion. -[5]- CU's orders were filled with specific pools of GNMA mortgage-backed securities, and eighteen of the thirty-two transactions were for "seasoned" securities. During the relevant period, "seasoned" GNMA mortgage-backed securities referred to securities that originated before 1980 and/or ten or more years before the trade date. ==========================================START OF PAGE 4====== to its retail salesforce information (including recommended sales credits) on representative fixed-income securities in the retail trading desk's inventory. Because of the large size and type of CU's transactions and the limitations of the retail trading desk's inventory, CU never purchased securities shown on the computer system or held in the retail trading desk's inventory. For securities that were not shown on the computer system, such as the ones purchased by CU, Shearson relied on its personnel involved in the transactions to monitor those transactions. With respect to the markups charged, this practice was ineffective not only because no one at Shearson was required to determine the total markup charged a customer based on the prevailing market price, but also because the appropriate range of markups, the facts to be weighed, and the persons responsible for monitoring the markups were never clearly identified. In addition, Shearson sent to CU and its pension fund customer confirmations erroneously stating that Shearson had acted as agent for CU and the seller in agency-cross transactions. Because Shearson had instead acted as a principal on CU's GNMA mortgage-backed securities purchases, the confirmations violated Section 10(b) of the Exchange Act and Rule 10b-10 promulgated thereunder. Finally, Shearson failed to keep certain required books and records related to its business (including confirmations and memoranda of orders stating their time of entry or receipt), as required by and in violation of Section 17(a) of the Exchange Act and Rules 17a-3 and 17a-4 promulgated thereunder. 3. Background In approximately January 1983, CU hired a new chief financial officer, David W. Granston.-[6]- Among other duties, Granston managed and controlled the investment of funds for CU and its pension fund. As a policy, CU and its pension fund limited their investments to either federally insured certificates of deposit or securities issued, guaranteed, or both by the United States Government. In August 1983, Feminella began his employment with a small brokerage firm, having no professional experience in the securities industry. Shortly after joining this firm, Feminella asked Granston, whom he had known socially for years, if he could invest funds for CU. Granston responded by telling Feminella about CU's investment policy, and Feminella suggested that CU purchase GNMA and Federal National Mortgage Association mortgage- backed securities. From the beginning, according to Granston, he ---------FOOTNOTES---------- -[6]- CU is a New York non-profit, membership corporation, which publishes Consumer Reports magazine. ==========================================START OF PAGE 5====== placed substantial reliance on Feminella's self-proclaimed expertise in government securities. From March 1984 until February 1991, while he was employed at three different brokerage firms, Feminella continuously handled the securities transactions of CU and its pension fund. During this period, Feminella began secretly kicking back a portion of his compensation from CU's securities transactions to Granston in return for Feminella's receipt of CU's lucrative investment business. Granston and Feminella concealed these kickbacks from CU, its pension fund, and Shearson. After CU discovered evidence of the kickback scheme and the excessive markups, Shearson conducted an internal investigation that resulted in Feminella's termination and the firm's financial settlement with CU and its pension fund. 4. Markups Charged the CU Accounts a. Shearson allows Feminella to charge a 3-point sales credit on CU's purchases of GNMA mortgage-backed securities In November 1988, when the CU accounts were transferred to Shearson, they owned a total of approximately $40 million in securities. When Feminella joined Shearson, the firm agreed that Feminella could charge a 3-point sales credit on all purchases of GNMA mortgage-backed securities by CU and its pension fund. This across-the-board sales credit was to be charged regardless of the market conditions at the time of the transactions or the dollar amount or the complexity of any particular transaction. Shearson did not make any independent inquiry to determine the appropriateness of charging 3-point sales credits on CU's anticipated purchases of GNMA mortgage-backed securities, which historically usually exceeded $1 million per transaction. Rather, Shearson relied on Feminella's representations concerning his expertise in government securities and concerning the services he would perform for the CU accounts. Among other things, no one at Shearson ever considered whether the 3-point across-the-board sales credits, when added to trading desk spreads, would prevent the reasonable pricing of GNMA mortgage- backed securities purchased by CU in light of the specific facts and circumstances of each particular transaction. b. Markups charged CU on GNMA mortgage-backed securities and STRIPS At Shearson, the orders for the CU accounts were always executed on the retail trading desk. At the time, the retail trading desk's total inventory of mortgage-backed securities averaged from between approximately $200,000 to $2 million. The vast majority of orders filled by the retail trading desk were in amounts less than $100,000. Through Shearson's Financial ==========================================START OF PAGE 6====== Consultant Inquiry (FCI) computer system, the retail trading desk provided Shearson's retail salesforce with information on representative securities in its inventory and recommended sales credits on those securities. If a registered representative sought a sales credit that exceeded the recommendation on the FCI system, then an unwritten procedure called for the retail traders to consult with the registered representative and his or her branch manager to determine whether the credit was appropriate for the particular transaction. Because of their size and type, none of CU's orders were filled with GNMA mortgage-backed securities shown on the FCI system or already in the retail trading desk's inventory. Instead, the retail trading desk filled CU's orders primarily by purchasing GNMA mortgage-backed securities either from its institutional trading desk or from inter-dealer brokers. The retail trading desk had a practice of then adding to the price of the securities not only its own desk spread, but also a sales credit to compensate the registered representatives and their retail branch offices. Over a two-year period, in thirty-two transactions the CU accounts purchased seventy-two pools of GNMA mortgage-backed securities, for a total of approximately $36 million. For each purchase, the retail trading desk on the same day both acquired and resold to the CU accounts the GNMA mortgage-backed securities. On these riskless principal transactions, the markups charged the CU accounts ranged from 3.5 to 4.7 percent (or between $3,621 to $105,280) for transactions ranging in amounts from approximately $107,000 to $3,000,000. In addition to the GNMA mortgage-backed securities, CU also purchased in one transaction, approximately $2.5 million in STRIPS, on which it paid a markup of 3.5 percent (or $84,750). Because these were principal transactions, CU and its pension fund were never told the size or dollar amount of the markups that they were charged.-[7]- ---------FOOTNOTES---------- -[7]- Rule 10b-10, promulgated under Section 10(b) of the Exchange Act, does not require that in a principal transaction the customer confirmation disclose the size or dollar amount of the markup charged. However, when a markup is excessive, disclosure of that fact is required to avoid violating the anti-fraud provisions of the federal securities laws. In re Duker & Duker, 6 S.E.C. 386, 389 (1939); see Ettinger v. Merrill Lynch, Pierce, Fenner & Smith Inc., 835 F.2d 1031, 1036 (3d Cir. 1987)(compliance with the confirmation disclosure requirements of Rule 10b-10 does not, as a matter of law, prevent liability under Section 10(b) and Rule 10b-5 for failing to disclose excessive markups). ==========================================START OF PAGE 7====== In one representative transaction, CU purchased, for approximately $2.3 million, 2,475,177 in GNMA mortgage-backed securities, at $93 per bond. Feminella placed CU's order with Shearson's retail trading desk, which filled the order with six separate pools of GNMA mortgage-backed securities from two sources: Shearson's institutional trading desk and an inter- dealer broker. From the institutional trading desk, the retail desk acquired 1,763,824 in GNMA mortgage-backed securities, comprised of three pools. The institutional trading desk sold these securities at its offer (89 22/32 per bond) to the retail desk. The retail desk added to the price of these securities not only its own spread, but also Feminella's pre-designated 3-point sales credit, which because of the discount pricing of the securities translated into a 3.34 percent sales credit (or $53,262). On this portion of the transaction, CU paid a markup of 3.69 percent. The retail desk acquired the remaining 711,353 in GNMA mortgage-backed securities through an inter-dealer broker at 89 23/32 per bond. The retail desk added to the price of these securities its own spread and Feminella's sales credit of 3.34 percent (or $21,674). On this portion of the transaction, CU paid a markup of 3.65 percent. In total, CU paid $81,768 to purchase these securities. B. ANALYSIS 1. Feminella Caused the CU Accounts to Pay Excessive Markups The difference between the price charged a customer and the prevailing wholesale market price establishes the markup charged in a securities transaction. Zero-Coupon Securities, Exchange Act Release No. 24368 (Apr. 21, 1987), 38 SEC Dkt. 234, 235. The anti-fraud provisions of the federal securities laws prohibit a brokerage firm and its associated persons from charging their customers undisclosed, excessive markups. E.g., Charles Hughes & Co. v. SEC, 139 F.2d 434, 436-37 (2d Cir. 1943), cert. denied, 321 U.S. 786 (1944)(brokerage firm violated anti-fraud provisions by charging excessive markups); In re Alstead, Dempsey & Co., Exchange Act Release No. 20825 (Apr. 5, 1984), 30 SEC Dkt. 259, 260 and n. 3 (same)(quoting Duker & Duker, 6 S.E.C. at 388-89); In re Charles Michael West, Exchange Act Release No. 15454 (Jan. 2, 1979)(stockbroker violated anti-fraud provisions by charging customers excessive markups). Under the shingle theory, securities market professionals implicitly represent to the public that they will buy and sell securities to customers at prices reasonably related to the current wholesale market prices for the securities. Duker & Duker, 6 S.E.C. at 389 ("[A] dealer may not exploit the ignorance of his customer to exact unreasonable profits resulting from a price which bears no reasonable relation to the prevailing price."). When engaging in principal transactions, a brokerage firm and its associated persons can avoid committing fraud upon a customer only by ==========================================START OF PAGE 8====== either: (1) charging a price that bears a reasonable relationship to the prevailing market price-[8]- or (2) disclosing information sufficient for the customer to exercise an informed judgment on whether to engage in the transaction. Duker & Duker, 6 S.E.C. at 389; see SEC v. Hasho, 784 F. Supp. 1059, 1107 (S.D.N.Y. 1992)(stockbrokers owe special duties to their customers of fair dealing and full disclosure). Whether the markups charged CU violated the anti-fraud provisions of the federal securities laws depends on all the relevant facts and circumstances surrounding each particular transaction. Duker & Duker, 6 S.E.C. at 389 ("The reasonableness of the profit charged can be determined only on the basis of the individual facts of each case."). Generally, the Commission and the courts consider five categories of facts and circumstances when analyzing whether markups charged customers violate the anti-fraud provisions. The starting point in this analysis, and the one relevant to this matter, is the securities industry experience and practice regarding the range of appropriate markups on the particular securities or similar types of securities. See In re Sheldon, Reid, and Pattison, Exchange Act Release No. 31475 (Nov. 18, 1992), 52 SEC Dkt. 3,826, 3,862; F.B. Horner & Assocs. v. SEC, 994 F.2d 61, 63 (2d Cir. 1993), aff'g In re F.B. Horner & Assocs., Exchange Act Release No. 30884 (July 2, 1992), 51 SEC Dkt. 1749.-[9]- ---------FOOTNOTES---------- -[8]- The best evidence of the prevailing market price, absent countervailing evidence, is the dealer's "contemporaneous cost" for the securities, which means the dealer's purchase price from another dealer close in time to the sale to the customer. See, e.g., Orkin v. SEC, 31 F.3d 1056, 1060 (11th Cir. 1994)(citations omitted), aff'g In re Robert Bruce Orkin, Exchange Act Release No. 32035 (Mar. 23, 1993), 53 SEC Dkt. 2,903. Because on each transaction for the CU accounts the combination of the sales credit and retail trading desk's spread alone constituted an excessive markup, the Commission need not consider whether Shearson's institutional trading desk acted as a market maker on these transactions. See Alstead, Dempsey & Co., 30 SEC Dkt. at 261 (Generally, a market maker is entitled to calculate the markup charged a customer from its contemporaneous sale price to another dealer or market maker rather than its contemporaneous cost (i.e., the market marker is allowed to exclude its institutional spread in calculating the markup).). -[9]- The other factors have included: (1) the relative activity or inactivity of the market for the securities (In re NASD, 17 S.E.C. 459, 466-67 (1944)); (2) the total money involved in the transaction (Id. at 469); (3) the unit price for the securities (In re Ross Sec., 40 S.E.C. 1064, 1066 (1962)(applying NASD 5 percent policy to low-priced securities); and (4) the (continued...) ==========================================START OF PAGE 9====== The markups charged CU were excessive. In the release concerning zero-coupon securities, the Commission stated that the common industry practice at the time was to charge markups of between 1/32 percent to 3 1/2 percent on Treasury securities depending on the size of the transaction, the availability of the securities in the market, and the maturity of the securities. Zero-Coupon Securities, 38 SEC Dkt. at 235.-[10]- Because of the similar market, trading, and other characteristics of Treasury securities and GNMA mortgage-backed securities, both of which are issued and guaranteed by the federal government, Shearson should have recognized that the Zero-Coupon Securities Release indicated that markups of 3.5 percent or more on GNMA mortgage-backed securities and STRIPS may violate the anti-fraud provisions of the federal securities laws in certain circumstances. See generally In re Donald Sheldon, Administrative Proceeding File No. 3-6626 (Dec. 2, 1988), 1988 SEC LEXIS 2388, *117. In a case involving markups charged on GNMA mortgage-backed securities, the Commission noted that "even a four percent -- or smaller -- markup on government securities may be excessive." Sheldon, 52 SEC Dkt. at n. 99. Furthermore, in Sheldon, the Commission held that a broker-dealer's pricing policy of charging an across-the-board 5 point markup on all discounted government agency mortgage-backed securities inevitably produced markups in excess of 5 percent, while necessarily precluded pricing the securities based on the particular circumstances of each specific transaction or the conditions of the market generally. Id. at 3,862. Thus, the Commission concluded that as a result of the firm's markup policy the broker-dealer violated the anti-fraud provisions of the federal securities laws because its customers purchased securities at prices that bore no reasonable relationship to the prevailing market prices. Id. ---------FOOTNOTES---------- -[9]-(...continued) nature of the services that the brokerage firm or its associated persons have provided to the customer (F.B. Horner, 994 F.2d at 63). -[10]- The Commission has consistently held that on the sale of equity securities markups of more than 10 percent are fraudulent. Zero-Coupon Securities, 38 SEC Dkt. at 235; In re Powell & Assocs., 47 S.E.C. 746, 748 (1982). The 10 percent benchmark does not govern this case, however, because markups charged on the sale of government securities (like other debt securities) should be significantly lower than the markups charged on comparably-sized transactions for equity securities. Sheldon, 52 SEC Dkt. at 3,861-62 (quoting Zero-Coupon Securities at 235). ==========================================START OF PAGE 10====== Based on the particular facts and circumstances of each of the thirty-three purchases of STRIPS and GNMA mortgage-backed securities, Feminella caused the CU accounts to pay excessive markups (which ranged from 3.5 percent to 4.7 percent). During the relevant period, the securities industry had a practice of charging markup percentages on GNMA mortgage-backed securities and STRIPS in comparably-sized transactions that were substantially less than the markup percentages charged the CU accounts. On GNMA mortgage-backed securities, STRIPS, and similar types of securities, the securities industry also had a practice of charging progressively smaller markup percentages as the dollar amount of the transactions increased. The markup percentages charged the CU accounts were inconsistent with the generally accepted practices of the securities industry for these and similar types of securities based on all the relevant facts and circumstances for each transaction, particularly, the type of securities involved, the liquidity of the markets in which they traded, the riskless nature of the transactions (i.e., the purchase and immediate resale of the securities), the large dollar amount of the transactions, and the lack of any special or extraordinary services provided to the accounts by Feminella. In total, based on the particular facts and circumstances of each transaction, the CU accounts paid at least $1 million in excessive markups. In addition to being inconsistent with industry practices, the across-the-board 3-point sales credits (which constituted the vast proportion of the markups), when added to the spreads charged by Shearson's retail trading desk, caused CU to pay prices that bore no reasonable relationship to the market conditions, the services provided to CU, or any other facts or circumstances particular to the individual transactions. Therefore, as in Sheldon, on these large dollar securities transactions, the large and arbitrary across-the-board sales credits, when coupled with the retail trading desk's spreads, negated the notion that the markups charged the CU accounts bore any reasonable relationship to the prevailing market prices. A registered representative must have an understanding of securities pricing, and cannot merely rely on the brokerage firm's organizational structures as a means of discharging his responsibilities to his customers to ensure that the prices charged them are not excessive. In re Robert Bruce Orkin, 53 SEC Dkt. at 2,913-14, aff'd, Orkin v. SEC, 31 F.3d 1056; SEC v. Hasho, 784 F. Supp. at 1107 (stockbroker's special duties to his customers of fair dealing and full disclosure cannot be avoided by relying on his employer). Because Feminella was secretly paying a portion of the compensation he received from CU's securities transactions to Granston (the person at CU responsible for the investments), Feminella knew that Granston would not probe the reasonableness of the prices charged the accounts. Feminella knew, or was reckless in not knowing, that the markups ==========================================START OF PAGE 11====== charged CU invariably included a sales credit of 3 percent or more, to which Shearson's retail trading desk added spreads. Furthermore, Feminella knew, or was reckless in not knowing, that the markups charged CU were excessive for the size and type of securities purchased and bore no reasonable relationship to the prevailing market prices. Based on the foregoing, Feminella violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5. 2. Shearson's Failure Reasonably to Supervise Feminella "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 market." In re Smith Barney, Harris Upham & Co., Exchange Act Release No. 21813 (Mar. 5, 1985), 32 SEC Dkt. 999, 1010. Moreover, "in large organizations it is especially imperative that the system of internal control be adequate and effective and that those in authority exercise the utmost vigilance whenever even a remote indication of irregularity reaches their attention." In re Shearson, Hammill & Co., 42 S.E.C. 811, 843 (1965) (quoting In re Reynolds & Co., 39 S.E.C. 902, 916 (1960)). The Exchange Act empowers the Commission to censure a broker-dealer if the firm has "failed reasonably to supervise, with a view to preventing violations [of the federal securities laws], another person who commits such a violation, if such person is subject to [its] supervision." Section 15(b)(4)(E).-[11]- For large retail securities purchases such as CU's, Shearson relied on the professionals involved in the transactions to monitor the transactions. With respect to the markups charged, this practice was ineffective not only because no one at Shearson was required to determine the total markup charged a customer based on the prevailing market price, but also because the appropriate range of markups, the factors to be weighed, and the persons responsible for determining and monitoring the markups were never clearly identified. ---------FOOTNOTES---------- -[11]- Section 15(b)(4)(E) provides a safe harbor from failure to supervise sanctions if (1) a system of procedures was established and applied to reasonably prevent and detect the federal securities law violations by supervised individuals and (2) the supervisor reasonably applied the procedures and believed that the supervised individual was complying with the procedures. In this instance, the safe harbor does not apply to Shearson because it lacked sufficient firm-wide policies and procedures or systems in place reasonably designed to prevent and detect the markup violations. In re Goldman, Sachs & Co., Exchange Act Release No. 33576 (Feb. 3, 1994), 55 SEC Dkt. 3,208, 3,218. ==========================================START OF PAGE 12====== First, Shearson lacked sufficient policies or procedures to ensure that the prevailing market price was the starting point in the markup calculation. No one at Shearson ever ascertained the markup by comparing the price charged a customer with the prevailing inter-dealer market price. Second, Shearson never clearly identified who was responsible for determining and monitoring the markups charged customers. The retail branch personnel maintained that the responsibility for monitoring the markups rested with the retail trading desk, while the retail trading desk maintained that the branch managers held that responsibility for the sales credits. Third, Shearson lacked sufficient policies or procedures to ensure that the markups were reasonable in light of all relevant facts and circumstances. At the very least, the 3-point across-the-board sales credit was a red flag that should have alerted Shearson to a possible violation. Instead, Shearson never reconciled its approval of Feminella's across-the-board sales credits with the requirement that for each transaction the price charged a customer must be reasonably related to the prevailing market price based on all the relevant facts and circumstances. Brokerage firms are free to establish policies and procedures to prevent and detect excessive markups and to designate the persons internally responsible for implementing and monitoring compliance with such policies and procedures. However, at a minimum, a brokerage firm's policies and procedures must ensure and monitor the communication and integration of all relevant facts and circumstances necessary to determine the reasonableness of the markups charged customers. At Shearson, the firm failed to establish policies and procedures necessary to ensure: (1) that all the relevant facts and circumstances known by the responsible associated persons and their respective supervisors concerning the markups were communicated, integrated and appropriately weighed to assess the reasonableness of the markups; and (2) that responsibility was appropriately delegated for calculating and determining the reasonableness of the markups charged customers. Based on the foregoing, Shearson failed reasonably to supervise Feminella, who was subject to its supervision, with a view to preventing his violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5. 3. Shearson Sent Erroneous Customer Confirmations Pursuant to the Exchange Act, during the relevant period, Shearson was required to give or send customers written notification that it was acting as principal for its own account in transactions for GNMA mortgage-backed securities. Section 10(b) of the Exchange Act and Rule 10b-10(a)(1)(1991)(currently ==========================================START OF PAGE 13====== codified as Rule 10b-10(a)(2)(1996)). Over at least a two-year period, for GNMA mortgage-backed securities transactions, Shearson sent confirmations to CU and its pension fund that erroneously stated that the trades were executed in the "mutual fund" market and that Shearson "acted as agent for the buyer and the seller in a cross transaction." In fact, each transaction was executed through the Shearson retail desk's ledger with Shearson acting as principal. Based on the foregoing, Shearson violated Section 10(b) of the Exchange Act and Rule 10b-10. 4. Shearson Failed to Keep Required Books and Records for Prescribed Periods The Exchange Act requires broker-dealers to make and keep for three years copies of customer confirmations as well as memoranda of orders stating their time of entry or receipt. Section 17(a) of the Exchange Act and Rules 17a-3(a)(6) and (8) and 17a-4(b)(1). Shearson failed to keep order confirmations related to the CU purchases and certain memoranda of orders with the time of entry or receipt for customers trading close in time to the CU purchases. Based on the foregoing, Shearson violated Section 17(a) of the Exchange Act and Rules 17a-3 and 17a-4. IV. FINDINGS On the basis of this order and the offer of settlement submitted by Lehman Brothers, the Commission finds that: A. Shearson failed reasonably to supervise Feminella, an individual subject to its supervision, with a view to preventing his violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; and B. Shearson willfully violated Sections 10(b) and 17(a) of the Exchange Act and Rules 10b-10, 17a-3, and 17a-4 thereunder. V. ORDER In view of the foregoing, it is in the public interest to impose the sanctions specified in the offer of settlement. Accordingly, IT IS ORDERED that: A. Lehman Brothers be, and hereby is, censured; B. pursuant to Section 21C of the Exchange Act, Lehman Brothers shall cease and desist from committing or causing any violations, and committing or causing any future violations, of ==========================================START OF PAGE 14====== Sections 10(b) and 17(a) of the Exchange Act and Rules 10b-10, 17a-3, and 17a-4 thereunder; C. pursuant to Section 21B of the Exchange Act, Lehman Brothers shall, prior to the close of business within ten business days after the date of entry of this order, pay a civil money penalty in the amount of $50,000 to the United States Treasury. The 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. hand-delivered to the Comptroller, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549; and 4. submitted with a cover letter that identifies Lehman Brothers as Respondent in this proceeding and the file number of this proceeding, a copy of which cover letter and money order or check shall be sent to Kathleen M. Hamm, Branch Chief, Division of Enforcement, Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop 8-5, Washington, D.C. 20549. By the Commission. Jonathan G. Katz Secretary