UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 38775 / June 25, 1997 ADMINISTRATIVE PROCEEDING File No. 3-9342 In the Matter of FIRST MONTAUK SECURITIES CORP., Respondent ORDER INSTITUTING ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS PURSUANT TO SECTIONS 15(b), 19(h) and 21C OF THE SECURITIES EXCHANGE ACT OF 1934, MAKING FINDINGS AND IMPOSING REMEDIAL SANCTIONS AND A CEASE-AND-DESIST ORDER I. The Securities and Exchange Commission ( Commission ) deems it appropriate and in the public interest to institute public administrative and cease- and-desist proceedings pursuant to Sections 15(b), 19(h) and 21C of the Securities Exchange Act of 1934 ( Exchange Act ) against Respondent First Montauk Securities Corp. ( First Montauk or Respondent ). II. In anticipation of the institution of these proceedings, Respondent First Montauk has submitted an Offer of Settlement ( Offer ) to the Commission, 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 herein, except as to the jurisdiction of the Commission over Respondent and over the subject matter of this proceeding and except as to Section III.A. below, which is admitted, Respondent First Montauk, by its Offer, consents to the entry of findings, remedial sanctions and cease-and-desist order set forth below. Accordingly, IT IS ORDERED that proceedings pursuant to Sections 15(b), 19(h) and 21C of the Exchange Act be, and, they hereby are, instituted. ======END OF PAGE 1====== III. On the basis of this Order and the Offer submitted by Respondent First Montauk, the Commission finds<(1)> that: A.First Montauk is, and at all relevant times was, a broker-dealer registered with the Commission, with approximately 125 branch offices and 75 offices of supervisory jurisdiction. B. First Montauk employed at all relevant times, a registered principal in its main office in Red Bank, New Jersey ("the Supervisor"). C. First Montauk's Houston office was opened by certain individuals with prior experience trading government securities (hereafter the Houston traders ) in October 1990. The Houston office was established to sell fixed-income products, primarily REMICs and other mortgage-backed securities, to institutional clients. Prior to the opening of the Houston office, fixed-income products were a minor part of the First Montauk s business, and the firm had relatively few institutional clients. By opening the Houston branch to sell REMICs and other mortgage-backed securities, First Montauk was expanding into an area in which the firm previously had very limited experience. The Houston office was one of only three First Montauk branches that was allowed to execute its own trades. This distinct trading activity required stringent home office supervision, but First Montauk did not have procedures in place to review the Houston office s trading activity. D. First Montauk did not effectively designate any one individual in the Houston office to supervise sales practices on a day to day basis. Among other things, the firm failed to require the Houston office to assign an individual with responsibility for supervising daily sales practices. The Supervisor, at all relevant times a principal in First Montauk's main office in New Jersey, by reason of his greater experience in mortgage- backed securities, was delegated responsibility for supervising certain of the Houston office's operations, including the branch's trading activity. E. At all relevant times, the Houston office had the authority to execute riskless principal transactions. The procedure required the Houston traders, who directed the Houston office s activities, to arrange and confirm both sides of each transaction, and then call the details directly in to the Supervisor in New Jersey. The Supervisor then would write an order ticket for each transaction and provide that information to First Montauk's clearing firm. Parking, Excessive Markups and Net Capital and Books and Records Violations <(1)> The findings herein are made pursuant to Respondent First Montauk's Offer and are not binding on any other person or entity named as a Respondent in this or any other proceeding. ======END OF PAGE 2====== F. First Montauk did not allow the Houston office to hold positions in securities unless it received approval from the main office. In order to circumvent First Montauk's restriction on holding positions, the Houston traders engaged in a parking scheme which enabled them to purchase bonds and secretly hold them "off their books," while still maintaining control of the securities. From October 1992 through March 1994, the Houston traders parked government agency securities on at least seventeen occasions, including every month from March 1993 through March 1994. G. The parking scheme was conceived and carried out by the Houston traders in the following manner. Whenever the Houston traders wanted to park securities, they entered into an arrangement with two other broker dealers (Dealers One and Two) whereby First Montauk would sell the bonds to Dealer One for settlement that month. Dealer One would then sell the bonds to Dealer Two for a fraction higher than it had purchased them from First Montauk. The Houston traders then caused First Montauk to repurchase the bonds from Dealer Two for settlement the next month, with Dealer Two earning a small profit on the transaction. The Houston traders used the time between settlement dates to find a customer for the bonds. The parking scheme essentially allowed the Houston traders an extra month to find a customer for securities over which they maintained control. H. Each time the Houston traders executed a parking transaction, they filled out tickets for the sale and the repurchase from the other dealers. These trades were then called in to the Supervisor in New Jersey, who wrote tickets for processing by First Montauk s clearing agent. the Supervisor never saw the order tickets which were prepared in the Houston office. For each of the parking transactions, however, one or more of the order tickets written by the Supervisor contained trade dates different than the trade dates on the Houston tickets. These order tickets depicted each of the parking transactions as two separate riskless principal trades, thereby enabling the scheme to go undetected. I. On at least seven occasions, the Houston traders used the parking scheme to manipulate the price of certain government agency securities and conceal from First Montauk and others undisclosed excessive markups charged to First Montauk customers. The excessive markups on the seven transactions alone amounted to approximately $1.85 million, of which approximately $1.66 million was paid directly to the Houston traders, while the remainder, less clearing fees, was retained by First Montauk. J. In those instances, the Houston traders purchased bonds and marked them up significantly on the sale to Dealer One. Dealer One then marked up the securities another 1/32 or 2/32 when selling them to Dealer Two. The Houston traders would then mark up the securities another 4% - 5% when selling them to First Montauk customers. K. In response to regulatory inquiries in April 1994, the firm undertook an investigation of trading activity in the Houston office. After that date, there were no further trades in furtherance of the parking scheme described above. ======END OF PAGE 3====== L. As a result of the parking scheme carried out by the Houston traders, First Montauk failed to maintain accurate books and records, insofar as, among other things, the firm's books and records did not reflect the liabilities arising from the Houston traders' commitments to repurchase the securities involved, and contained incorrect valuations of the firm's positions. This conduct also caused the firm to compute its net capital inaccurately. M. Proper recordation by the Houston traders of these transactions on First Montauk's books and records would have adversely affected Respondent First Montauk's computation of net capital and, in some instances, resulted in undisclosed net capital deficiencies. N. The parking scheme of the Houston traders also caused First Montauk to file inaccurate FOCUS reports with the National Association of Securities Dealers, Inc., thereby presenting to regulators a misleading picture of the firm's net worth. Furthermore, the Houston trader s scheme caused First Montauk to fail to disclose to the Commission that the firm was in net capital violation on numerous occasions. Misrepresentations to Escambia County, Florida O. Escambia County (the "county") began doing business with the Houston office of First Montauk and one of the office s registered representatives ("RR") in December 1990. In connection with the offer and sale of certain complex mortgage-backed derivative securities known as REMICs, the RR misrepresented information regarding the risks of these securities. The RR also made misrepresentations regarding, among other things, the returns that the county would receive. ======END OF PAGE 4====== First Montauk's Failure to Supervise P. First Montauk's compliance procedures were inadequate to detect the parking scheme. There was no system of follow up and review to determine if the supervisory responsibilities delegated to the Supervisor were being diligently exercised. There also was no specific procedure for anyone to review the activity in the proprietary trading account or the trade blotter for the Houston office. Such a review, on either a monthly or quarterly basis, might well have alerted the firm to the Houston office s parking scheme, its books and records violations and its net capital deficiencies. Q. Additionally, First Montauk had inadequate procedures for conducting compliance audits. No guidance is given in First Montauk's compliance manual as to how to perform audits, nor was the Supervisor given any training. There was no specific procedure to review the branch's trade blotter, or even to determine if the branch kept one, despite the fact that the firm's compliance manual requires that every office maintain a blotter. There also were no procedures for the examiner to review any of the Houston office's records (i.e. broker's books or trade tickets). Proper procedures would have alerted the Supervisor to the parking scheme being carried out in the Houston office and the resulting excessive markups. R. In addition to having inadequate compliance and review procedures as detailed above, First Montauk failed to effectively designate a supervisor for the Houston branch office, allowing inadequate supervision of the office's daily sales practices. Among other things, the firm failed to require the Houston office to assign an individual with responsibility for supervising daily sales practices. Violations S. As a result of the conduct described above, First Montauk willfully violated Sections 15(c) and 17(a) of the Exchange Act and Rules 15c3-1, 17a-3, 17a-5 and 17a-11. T. As a result of the conduct described above, First Montauk failed reasonably to supervise one or more individuals subject to its supervision within the meaning of Section 15(b) of the Exchange Act. IV. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer submitted by First Montauk and impose the sanctions specified therein. Accordingly, IT IS ORDERED that: A. Pursuant to Section 21C of the Exchange Act, First Montauk is ordered to cease and desist from committing and/or causing to commit any violation or future violation of Section 15(c) and 17(a) of the Exchange Act and Rules 15c3-1, 17a-3, 17a-5, and 17a-11; ======END OF PAGE 5====== B. First Montauk shall be, and hereby is, censured; C. First Montauk shall comply with the undertakings described below: 1. First Montauk undertakes that, within thirty (30) days of the entry of the Order, First Montauk will supplement its compliance and supervisory policies and procedures to address those deficiencies raised in sections III.P. - III.R. above, relating to the firm's affiliate program and the supervision of the firm's branch offices by the main office. 2. First Montauk undertakes to maintain the modified supervisory and compliance policies and procedures, as well as existing supervisory and compliance policies and procedures, except as they may be inconsistent with, or superseded by, any new policies or procedures adopted in accordance with Paragraph B.3. below; 3. First Montauk undertakes to retain, within sixty (60) days of the date of the Order, at First Montauk's expense, an Independent Consultant ("Consultant"), not unacceptable to the Commission's staff, to conduct a review of, and to report and make recommendations as to First Montauk's supervisory and compliance policies and procedures, particularly those subject matters and areas of First Montauk's operations discussed in sections III.P. - III.R. above, relating to the firm's affiliate program and the supervision of the firm's branch offices by the main office. 4. First Montauk undertakes to cooperate fully with the Consultant in this review, including making such non-privileged records available, as the Consultant may reasonably request; and by permitting and requiring First Montauk's employees and agents to supply such non- privileged information as the Consultant may request for the Consultant's review. 5. At the conclusion of such review, which in no event shall be more than 120 days after the date of the retention of the Consultant, the Consultant shall submit to First Montauk a draft report ("Draft Report") which shall address the adequacy of First Montauk s policies and procedures to detect and prevent federal ======END OF PAGE 6====== securities laws violations of the nature involved in this matter and shall include the Consultant s recommendations therein. 6. Within forty-five (45) days of transmittal of the Consultant's Draft Report, First Montauk shall in writing advise the Consultant of any recommendation which First Montauk has determined to accept and of any recommendation which First Montauk has determined to reject. With respect to any recommendation of the Consultant which First Montauk has rejected, First Montauk will select and set forth an alternative policy or procedure designed to achieve the same objective or purpose. With respect to the latter, First Montauk and the Consultant shall then attempt in good faith to reach agreement on any policy or procedure as to which there is a dispute. 7. Within ninety (90) days after transmittal of the Consultant's Draft Report, First Montauk shall in writing advise the Consultant of any recommendation which First Montauk and the Consultant have agreed upon and which First Montauk has determined to accept. In the event the Consultant and First Montauk are unable to agree on an alternative proposal, First Montauk shall abide by the recommendation of the Consultant. 8. The Consultant shall complete the aforementioned reviews and submit a written final report ("Final Report") thereon to First Montauk and to the Commission's staff within 330 days after the date of the Order. The Final Report shall describe the efforts undertaken by the Consultant to review First Montauk's supervisory and compliance policies and procedures, shall set forth the Consultant's recommendations, and shall specify those recommendations which have been accepted by First Montauk and those recommendations as to which there has been agreement as to an alternative policy or procedure. The Final Report shall set forth the alternative policy or procedure selected by First Montauk and agreed to by the Consultant. 9. Within sixty (60) days of transmittal of the Consultant's Final Report, First Montauk undertakes to adopt and implement all of the Consultant's recommendations or alternative policies or procedures which have been agreed upon in the Final Report. 10. Within ninety (90) days of transmittal of the Consultant's Final Report, First Montauk shall submit to the Commission's staff an Affidavit of Compliance setting forth the details of its implementation of the recommendations and accepted alternative policies or procedures contained in the Consultant's Final Report and all other undertakings set forth in Section IV. herein. For good cause shown, the Commission's staff may extend any of the procedural dates set forth above, provided that the Affidavit of Compliance is received within eighteen (18) months from the date of entry of the Order. 11. To ensure the independence of the Consultant, First Montauk: (i) shall not have the authority to terminate the Consultant, without the prior written approval of the staff of the Southeast Regional Office; (ii) ======END OF PAGE 7====== shall compensate the Consultant, and persons engaged to assist the Consultant, for services rendered pursuant to this Order at their reasonable and customary rates; (iii) shall not, without prior written consent of the staff of the Southeast Regional Office, enter into any legal, business, or other financial relationship with the Consultant, any firm with which he or she is affiliated or of which he or she is a member, or any person engaged to assist the Consultant in the performance of his or her duties under this Order, during the period of their engagements and for a period of two years following the completion of their duties described in this Order; and (iv) shall not be in and shall not have an attorney-client relationship with the Consultant and shall not seek to invoke the attorney- client or any other doctrine or privilege to prevent the Consultant from transmitting any information, reports, or documents to the Commission or its staff. D. First Montauk shall pay to the Commission, within 30 business days after the entry of the Order, (i) disgorgement in the amount of $175,458; (ii) prejudgment interest in the amount of $51,584; and (iii) a civil money penalty in the amount of $50,000. Such payment 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) mailed to the Comptroller, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, Mail Stop 0-3; and (d) submitted under cover letter which identifies First Montauk as a respondent in this proceeding, the file number of this proceeding, a copy of which cover letter and money order or check shall be sent to David Nelson, Southeast Regional Office, Securities and Exchange Commission, 1401 Brickell Avenue, Suite 200, Miami, FL 33131. By the Commission. Jonathan G. Katz Secretary ======END OF PAGE 8======