UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
SECURITIES ACT OF 1933
SECURITIES EXCHANGE ACT OF 1934
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be instituted against iCapital Markets LLC ("iCapital"), successor to the broker-dealer registration of Datek Securities Corporation ("Datek Securities"), pursuant to Section 15(b)(4) of the Securities Exchange Act of 1934 ("Exchange Act").
In anticipation of these administrative proceedings, iCapital 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 to which the Commission is a party, and without admitting or denying the findings herein, except as to jurisdiction of the Commission over iCapital and over the subject matter of this proceeding, which iCapital admits, iCapital consents to the issuance of this Order Instituting Administrative Proceedings, Making Findings and Imposing Sanctions. Accordingly, IT IS ORDERED that proceedings, pursuant to Section 15(b)(4) of the Exchange Act, against iCapital be, and hereby are, instituted.
On the basis of this Order and the Offer submitted by iCapital, the Commission makes the following findings:1
1. iCapital Markets LLC (successor to Datek Securities Corporation)
iCapital Markets LLC ("iCapital") is a broker-dealer registered with the Commission pursuant to Section 15(b) of the Exchange Act and headquartered in Jersey City, New Jersey. iCapital was originally Datek Securities Corporation ("Datek Securities"). As a result of the following reorganizations and name changes, iCapital succeeded to the broker-dealer registration of Datek Securities. Datek Securities originally registered as a broker-dealer with the Commission pursuant to Section 15(b) of the Exchange Act in May 1979. In February 1998, Datek Securities reorganized under a holding company with six wholly-owned subsidiaries (the "Company"), including Datek Securities. As part of this corporate restructuring, Datek Securities changed its name to Datek Online Brokerage Services ("DOBS") on March 16, 1998. On March 30, 1998, Datek Securities sold the assets of its day-trading business to Heartland Securities Corp. for a promissory note of $3.5 million. Pursuant to the terms of the sales agreement, Heartland acquired these assets subject to liabilities relating to the day-trading business. After the sale, DOBS conducted and continued to develop an online brokerage business. Recently, DOBS was renamed iCapital Markets, which continues the firm's order execution and proprietary trading business, and will also provide other firms with order routing and execution services and connections to market centers.
In the years following the sale of the day-trading business, the Company hired new managers and other industry professionals without prior ties to Datek Securities. In addition, the Company undertook to eliminate control and reduce ownership of certain shareholders in the Company. In July 1999, two institutional investors invested $163 million to acquire a minority interest in the Company. In December 2000, a number of institutional investors completed an agreement to invest $700 million to acquire a controlling interest in the Company. The new investors in the Company were not involved in the conduct that is the subject of this proceeding.
B. Other Relevant Persons
1. Sheldon Maschler
Sheldon Maschler, 57, was registered as an employee of Datek Securities at its Manhattan office from July 1987 to February 1997, according to NASD records. During the relevant time period, 1993-March 1998, Maschler and Jeffrey Citron (identified below) controlled Datek Securities. Maschler joined the firm in 1987 and began Datek Securities' day-trading operations in the basement of his Staten Island home.
2. Jeffrey A. Citron
During the relevant time period, 1993-March 1998, Jeffrey A. Citron, age 31, along with Sheldon Maschler, controlled Datek Securities. According to NASD records, Citron was registered at Datek Securities from July 1, 1988 through August 1992. Citron was the Company's CEO from February 1998 until his resignation on October 6, 1999.
This proceeding involves a fraudulent scheme carried out by Datek Securities, under the control of Sheldon Maschler, Jeffrey Citron, and others, from at least 1993 through March 1998 involving its use of the Nasdaq Stock Market's Small Order Execution System ("SOES"). The SOES system was the only Nasdaq trading system that allowed for automatic execution, and offered faster execution than any other system. During the relevant time period, NASD rules restricted use of the SOES system to small retail customer orders and prohibited broker-dealers from using SOES to trade for their own accounts.2 By fraudulent means Datek Securities used the SOES system to execute millions of proprietary trades, resulting in tens of millions of dollars in illegal trading profits for the firm. As described in Section III.D.7. below, the great majority of these profits were paid to its undisclosed principals, Sheldon Maschler and Jeffrey Citron. The fraudulent scheme was carefully planned and orchestrated, and was accomplished by the use of sophisticated software, concealment of its conduct from regulators, fictitious books and records, and false reports filed with the Commission.
During the relevant time period, Datek Securities' New York City branch operated as a day-trading firm.3 Datek Securities' traders, like other day-traders, attempted to profit by executing numerous intra-day trades to take advantage of small price movements in stocks (e.g., 1/8 or 1/16 of a point per trade). As is typical with day-trading, positions were held for a very short time: seconds, minutes, or hours, seldom overnight, and positions were closed out for small profits. However, Datek Securities was different in two important respects. In the early 1990's a day-trading software known as "Watcher" was developed for Datek Securities. Watcher gave Datek Securities traders a significant advantage over traders at other firms. Second, unlike other day-trading firms that provide services for customers who trade for their own accounts, Datek Securities' traders traded for firm proprietary accounts.
Watcher was extraordinarily successful at identifying trading opportunities in a rapidly changing market by analyzing movements in quotations and highlighting trading opportunities. Combined with the sophisticated technology Datek Securities used, Watcher also gave Datek Securities traders a significant time advantage over other market participants, including day-trading firms, who used the traditional Nasdaq Workstation II.4 Watcher, in and of itself, was not illegal. However, Datek Securities, under the control of Maschler, Citron, and others, recognized that it could maximize profits from Watcher by using it to trade for the firm's accounts on a massive scale through the Nasdaq system that offered the fastest execution: the SOES system. Instead of using the SOES system for its intended and lawful purpose -- to place small orders for the accounts of customers -- Datek Securities used the system for millions of proprietary trades.
In order to hide its use of the SOES system for proprietary trading, Datek Securities set up nominee accounts and paid the nominees for use of their identities and complete discretionary trading authority. Initially, the nominees provided their own funds to set up the accounts. In turn Datek Securities promised to return the funds, and "guaranteed" a rate of return. Later, Maschler, Citron, and others, provided funds that were used to provide "loans" to nominees that were used to set up accounts for trading. The firm then guaranteed a rate of return from trading that was above the interest rate being charged on the loan. However, the loans were without recourse to the nominee. Again, Datek Securities had complete discretionary authority over each account. With respect to all of the nominee accounts, trades were allocated among the accounts and commissions adjusted so as to provide the promised rate of return. Whether the nominees provided their own funds, or whether the funds were borrowed, the nominees were never at risk for market losses. Thus, the payment to each nominee was in reality payment for the use of the nominee's identity and Datek Securities was the beneficial owner of the nominee accounts.
Datek Securities' traders, many of whom were unregistered, executed trades without regard to any particular account. The firm then used a complex allocation process to allocate trades to the nominee accounts in order to generate a fixed rate of return for the accounts. Initially, all of Datek Securities' trades were reviewed and assigned to accounts at the end of the day in order to create the appearance of compliance with SOES rules, margin requirements, and to generate the guaranteed rate of return for each account. This allocation process was done manually until 1994, at which time Datek Securities developed a computer program to perform this function. By 1995, the computer allocation program had been refined to the point where the trades were allocated to nominee accounts as they were made.
In mid-1997, Maschler, Citron, and one of Maschler's sons, among others, began funding nominee accounts with profits from the illegal SOES scheme. Between May 1997 and March 1998, Raft Investments, Inc., a corporate entity controlled by Maschler and Citron, made uncollateralized "loans" totaling at least $50 million to various individuals and entities for the purpose of opening over 125 nominee accounts at Datek Securities. These nominees were permitted to keep the difference between the guaranteed rate of return (usually 16 percent) and the interest due to Raft (usually 14 percent) as compensation for the use of their identities.
Datek Securities, under the control of Maschler, Citron, and others, created and maintained false books and records to hide its proprietary trading. In addition to the records concerning nominee accounts, these false and inaccurate records included trading records, blotters, ledgers, order tickets, and account statements. In addition, Datek Securities filed false reports with the Commission, including false FOCUS reports and false Forms BD that did not disclose Maschler and Citron as control persons. Datek Securities also falsified its books and records with respect to profit payments made to Maschler and Citron in 1995 and 1996 in an effort to conceal their control of the firm.
D. Fraudulent Scheme To Place Proprietary Trades Through SOES
1. Nasdaq and SOES
The National Association of Securities Dealers, Inc. ("NASD") established the Small Order Execution System ("SOES") in 1984.5 SOES was an automated trading system intended to benefit small investors by providing immediate execution of small orders entered into the Nasdaq system at the best available price. In 1988, NASD made participation in SOES mandatory for all Nasdaq market makers in Nasdaq National Market securities.
There were several restrictions on the use of the SOES system. Under NASD rules, "[o]nly agency orders no larger than the maximum order size, as defined herein, received from public customers may be entered by a SOES Order Entry Firm into SOES for execution against a SOES Market Maker."6 NASD rules define an "agency order" for purposes of the SOES system as "public customer orders" which are executed by a SOES-order entry firm "on an agency basis."7 Although NASD rules do not specifically define "public customer," they treat the term "public customer" as synonymous with individual retail, non-broker-dealer customers.8 Furthermore, the NASD has clarified that "SOES was designed exclusively for individual retail customer orders restricted to a maximum size," and "[t]he restriction in the SOES Rules that permits the system to be used for agency orders of public customers is intended to preclude use by firms for their proprietary trading or for similar types of activity by professionals trading for their own accounts."9
NASD rules also set a maximum order size for SOES trades. In 1993, the maximum was 500 shares. In 1995, the maximum was 1000 shares. In 1997, the maximum was 100 shares. NASD rules also prohibited the division of orders in excess of the maximum order size into smaller parts for purposes of complying with the maximum order size requirement. In addition, trades entered within any five-minute period for a single security were aggregated for determining compliance with the order size limits, and such trades that collectively exceeded the maximum size order would violate the so-called "five-minute rule."
Eligible firms wishing to participate in the SOES system, including Order Entry Firms,10 were required to register with the NASD by executing an "Application and Agreement for Small Order Execution System" ("Application"). Pursuant to the terms of this Application, each SOES Order Entry Firm agreed to strictly comply with the rules governing the use of the SOES system and that violations would subject the firm to censure, fine, suspension or revocation of its registration as a SOES Order Entry Firm or any other fitting penalty under NASD Rules. By virtue of the SOES rules, the SOES registration process, and the terms imposed on SOES participants, the NASD made clear that the identity of the purchaser as a public customer in SOES transactions was a material fact. Once registered as a SOES Order Entry Firm, a firm could enter the SOES system to execute trades by simply identifying itself as an Order Entry Firm.
2. Datek Securities' Knowledge of SOES Rules
Datek Securities registered as a SOES Order Entry Firm on August 4, 1987. By registering as a SOES Order Entry Firm, Datek Securities represented to the NASD and other SOES participants that it would abide by the rules governing the SOES system, including the rules prohibiting proprietary trading. Beyond that representation, Datek Securities was aware of the rules because of its involvement in an NASD disciplinary proceeding. In 1994, Maschler, Citron, Datek Securities and other individuals associated with Datek Securities were the subject of an administrative complaint by the NASD for violating SOES rules between November 1991 and February 1993. On or about December 31, 1996, the action was settled. Pursuant to the settlement, Datek Securities, Maschler, and Citron were censured and fined (Datek Securities, $10,000; Maschler $675,000; Citron $20,000). In addition, Maschler was suspended from association with any NASD member for one year and Citron was suspended for 20 days. Finally, Citron kept abreast of proposed NASD rule changes affecting SOES and coordinated Datek Securities' response, preparing comment letters for traders to sign and send to the NASD and the Commission.
3. The "Watcher" System
Watcher was developed for Datek Securities, with assistance from Maschler and Citron. Watcher was designed to run Nasdaq data through Datek Securities computers, which were far faster than a Nasdaq Workstation II. The Watcher system gave Datek Securities traders a significant time advantage because they received last sale and quotation update information before other market participants. The Watcher system also analyzed the data to highlight trading opportunities.11 These features enabled Datek Securities traders to react more quickly to market activity and to enter and receive execution on their orders more quickly than other market participants. While other means of executing securities transactions were available -- namely, the telephone or SelectNet -- only SOES offered automatic execution, increasing the timing advantage offered by Watcher.
Watcher's superior technology combined with SOES automatic execution gave Datek Securities traders an advantage. However, that advantage was limited by SOES rules: SOES could not be used for proprietary trading and there were limits on the number of shares per trade. To maximize profitability and comply with the SOES rules, Datek Securities traders would have had to execute a large number of trades in accounts held by numerous retail customers. Datek Securities would have collected only commissions on such trades. Instead, Citron, Maschler, and other Datek Securities senior managers engaged in the proprietary scheme described below.
4. Datek Securities' Trading Operations
From 1993 to 1998, Datek Securities' day-trading operation, the profit center for the entire firm, was headquartered at 50 Broad Street in Manhattan. Over time, Datek Securities increased the size of the operation from 20-30 traders in early 1994 to nearly 200 traders by late 1996. Most of Datek Securities' new traders were hired right out of college, with little or no securities industry experience; some were friends or family members of existing traders. Once hired, the new traders received no formal training. Rather, for a brief period of time (from approximately one week to one month), they observed a more experienced trader, who gave them verbal instructions about how to use Watcher. After this "training," and often before they had registered with the NASD, the new traders were allotted $300,000 to $400,000 with which to trade.12 In addition to employing unregistered traders, many of Datek Securities' supervisors failed to complete the required NASD examinations and obtain the required licenses to act as supervisors.13 During 1996 and 1997, a group of experienced traders had undisclosed supervisory authority at Datek Securities. They trained and supervised other traders, and some attended management meetings. These supervisors also received a percentage of the trading profits earned by their trainees.
Datek Securities' Manhattan office was spartan. The trading floor consisted of rows of computers. The traders watched their computer terminals and punched computer keys for hours on end, entering orders into the Watcher system. In theory the traders earned 10-15 percent of the trading profits they generated for Datek Securities. However, Datek Securities retained half of those promised profits.
5. Concealment of Proprietary Trading
Datek Securities executed millions of trades for its own account using the SOES system. In placing the trades through the SOES system, Datek Securities was making a representation that the transactions were on behalf of a public customer, in accordance with SOES rules. The volume of proprietary trading by Datek Securities was enormous. From 1995 through March 1998 Datek Securities executed approximately 12 million SOES trades, over 30 percent of all SOES trades. Not only did Datek Securities engage in proprietary trading, it routinely violated the five-minute rule. Datek Securities, under the control of Maschler, Citron, and others, concealed its use of SOES for proprietary trading in several ways, including the use of nominee accounts, cross trading with its proprietary account, the creation of false books and records, and the filing of false reports with the Commission.
a. Nominee accounts and allocation of trades
Datek Securities used numerous nominee accounts to hide its proprietary trading. Datek Securities recruited individuals to open accounts at the firm, including friends and family members of the undisclosed control persons. Datek Securities promised to pay the account holders quarterly payments at a fixed rate of return, typically 16 percent. In exchange, the account holders gave Datek Securities complete discretionary trading authority. None of the account holders directed the trading in their accounts and generally had no contact with the Datek Securities traders. Datek Securities used the nominee accounts to assign and allocate proprietary trades in an unlawful post-transaction process. Datek Securities made sure that each account achieved the guaranteed rate of return by several means, including the allocation of profitable trades to underperforming accounts and the manipulation of commission rates. Nominee accounts never made more than the guaranteed return -- if accounts made more, Datek Securities kept the excess by adjusting commission charges and reassigning trades to other accounts.
The post-trading allocation of trades was possible because the SOES system did not require an order entry firm to identify a particular account to enter an order. The order entry firm merely had to identify that it was an order entry firm that was placing the trade. Datek Securities' traders executed SOES trades without regard to any particular account and routinely violated the rules regarding maximum size orders. Traders did not create or fill out contemporaneous order tickets.
All of the trades were subsequently allocated among accounts after the close of the market. From 1993 to early 1994 this allocation process was carried out manually. After the close of the market, Datek Securities clerks reviewed a Nasdaq print-out of the day's trades and matched the closest chronological SOES buys and sells of the same security to free up the greatest amount of "buying power."14 After the trades had been matched, the clerks gave the list to back-office employees who decided which trades would be assigned to each account. Trades were allocated to particular accounts in a manner that gave the appearance of compliance with NASD rules governing SOES. Other factors in the allocation process included the margin requirement for the account and the rate of return guaranteed to the account. After the trades had been allocated, they were entered into a computer system and the resulting computer file was transferred to Datek Securities' Brooklyn office, where it was used to generate blotters, trial balances and customer account statements. The proprietary trades were unlawfully executed and falsely recorded as those of individual retail customers.
In early 1994 the allocation process was carried out by means of a computer program known as "Wire." Wire was run at the end of each trading day, and as it was refined, at different points during the day. When the Wire program could not identify an account with sufficient buying power, a Datek Securities clerk would enter a fictitious cross trade with a Datek Securities proprietary account in order to create sufficient buying power in an account. By 1995, software known as "Real Time Wire" had been developed, which, as its name suggests, allocated trades as they took place. In 1997, Datek Securities gradually began assigning specific traders to specific accounts, a practice referred to as "mapping." By the end of 1997 only one trader was assigned to each account and the trades associated with that trader were assigned to that account. However, Datek Securities continued to manipulate transactions and commission charges to ensure that accounts achieved the guaranteed rate of return. In some cases, Datek Securities employees swapped entire days' trades from one account to another as a way to achieve the guaranteed rates of returns. At the same time that Datek Securities was phasing out its real time allocation of trades, it was also beginning to open nominee accounts through the Raft loan program.
b. Cross trades to conceal proprietary trading
Datek Securities also hid its unlawful activity by the manner in which it carried out trades. From 1995 through early 1997 Datek Securities automatically generated a series of cross trades between nominee accounts and a proprietary trading account.15 In a typical sequence of trades, a nominee account would purchase a Nasdaq quoted stock through SOES. The position would then be sold to the Datek Securities proprietary account at a markdown. Within hours, the proprietary account would either sell the position through SelectNet or sell the shares back to a Datek Securities customer account (at a markup), which would then sell the position on SOES. This sequence, or its mirror image, repeated itself hundreds, sometimes thousands, of times each day. Each of these cross trades had been preprogrammed to occur automatically and each occurred without input or direction from any Datek Securities trader. Even though most of these trades individually resulted in only a small profit for the proprietary account, the huge volume of trades that went through the account each day allowed Datek Securities to profit enormously. By using this automated trading system, Datek Securities was able to earn substantial trading profits while hiding its use of SOES for proprietary trading.
6. The Raft Loan Program
In order to perpetuate the scheme, Maschler and Citron cycled a substantial portion of the trading profits back into Datek Securities through Raft Investments, Inc., a corporation formed in 1995, which was owned by Maschler and controlled by him and Citron.16 From October 1996 through May 1998, Maschler personally loaned Raft nearly $40 million. In addition, trusts established for three of Maschler's children also made loans to Raft, in the amounts of $12.9 million, $12.75 million, and $12.85 million, respectively.17 Citron and an entity under his control loaned Raft an additional $12.1 million: between October 3, 1996 and October 16, 1997, Citron individually loaned Raft $7.1 million, and, in January 1998, an offshore trust controlled by Citron loaned Raft $5 million.
Between May 1997 and March 1998, Raft channeled at least $50 million to various individuals to open over 125 nominee accounts at Datek Securities, having each nominee sign a "loan agreement" for the funds received. With few exceptions, these loans were for $400,000. The vast majority of nominee account holders did not have sufficient income or assets to qualify for such loans. The "loan agreements" did not obligate the nominees to repay the monies and the loans were not collateralized. Almost all of these nominee account holders did not have the financial ability to repay the loans.18 Raft generally charged the account holders 14 percent interest on the loans. Because the nominee account holders were generally guaranteed a 16 percent return on their accounts, the nominee account holders kept the 2 percent difference between the guaranteed return and interest. Thus, the account holders received payments from Datek Securities for the use of their identities.19 Once the nominee accounts were funded in the foregoing manner, Datek Securities used these accounts to carry out unlawful proprietary trading on the SOES system. Datek Securities' funding and use of the nominee accounts to carry out proprietary trading made Datek Securities the beneficial owner of the accounts. Datek Securities did not record accurately this beneficial ownership in its books and records.
7. Distribution of Profits to Maschler and Citron
In 1987, when Maschler began Datek Securities' day-trading operation, he entered into an agreement whereby Datek Securities agreed to pay him 90 percent of the profits generated by its day-trading operation. Citron, who controlled Datek Securities, also indirectly received a percentage of Datek Securities' profits. In 1995 Datek Securities paid Elm Management Co., a company owned by Maschler, approximately $60 million. In 1996, Datek Securities paid Elm approximately $127 million. Elm, in turn, paid approximately 40 percent of the funds it received from Datek Securities to Treasure Solutions, Inc., a company wholly owned by Citron. Datek Securities also paid $14 million directly to Treasure in 1996. Between January 1997 and March 1998, Datek Securities paid SmithWall Associates, LLC, a limited liability company owned and controlled by Citron, trusts for the benefit of three of Maschler's children, and others, approximately $76 million.
8. Hidden Control of Datek Securities
Maschler and Citron took extensive steps to conceal their control of Datek Securities from regulators. In 1995 and 1996 Datek Securities falsely classified the Elm and Treasure payments in its general ledger as "commission expenses." On December 30, 1996, Datek Securities reclassified the 1996 Elm and Treasure payments in its general ledger as "data processing" expenses. No such data processing work was ever performed by Elm or Treasure for Datek Securities.
In 1995, 1996, and 1997, Datek Securities also falsely classified the Elm and Treasure payments in reports filed with the Commission. In Datek Securities' 1995 audited financial statements, the payments were classified as "salary and commission" expenses. In Datek Securities' 1996 and 1997 audited financial statements, the payments were classified as "computer services" expenses. Datek Securities' FOCUS report for the fourth quarter of 1996 also reflected this reclassification. When the Commission staff requested documentation supporting the 1995 and 1996 payments, Datek Securities produced fictitious and backdated agreements, contracts, and invoices.
Datek Securities concealed and failed to disclose to the Commission that Maschler and Citron were control persons of Datek Securities. Datek Securities failed to disclose this fact in Forms BD filed with the Commission between 1995 and 1997 and failed to file amendments to the Forms BD to correct the inaccurate information. The Forms BD filed with the Commission were signed by either Datek Securities' president or Datek Securities' FINOP and Director of Compliance, both of whom were aware that Maschler and Citron were control persons of Datek Securities.
Between late 1995 and early 1997, Datek Securities filed at least eight Forms BD with the Commission that failed to disclose that Maschler and Citron had control over Datek Securities.20 Citron and Maschler were never listed as control persons on any portion of the Forms BD that required such information. Citron was never identified in Schedule A to any of Datek Securities' Forms BD filed during this period. Maschler was listed as a shareholder several times, but there was always a "no" next to his name under the column headed "control person." Moreover, Datek Securities responded "no" to Question 6.A. of the Forms BD, another part of the Form BD requiring identification of additional control persons, on at least eight occasions between late 1995 and early 1997.
A. Violations of the Antifraud Provisions
Section 17(a) of the Securities Act of 1933 ("Securities Act") proscribes fraud in the "offer or sale" of securities. Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit fraud in connection with the purchase or sale of a security. Rule 10b-5(1) makes it "unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange. . . to employ any device, scheme, or artifice to defraud. . . ." The antifraud provisions are construed broadly, and Section 10(b) is "a catchall' clause to enable the Commission to deal with new manipulative or cunning devices.'" Ernst & Ernst v. Hochfelder, 425 U.S. 185, 203 (1976); accord Herman & MacLean v. Huddleston, 459 U.S. 375, 386-87 (1983). To violate Section 17(a)(1) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, a defendant must act with scienter. Aaron v. SEC, 446 U.S. 680, 701-02 (1980). Several key Datek Securities managers and employees intentionally set up the elaborate SOES scheme, made numerous refinements over time to increase its profitability, and went to great lengths to conceal it from regulatory scrutiny. Datek Securities is chargeable with its employees' state of mind. See SEC v. Manor Care Nursing Ctrs., Inc., 458 F.2d 1082, 1089 n.3 (2d Cir. 1972).
From at least 1993 through March 1998, Datek Securities violated the antifraud provisions by devising and implementing a fraudulent scheme to gain access to and use the SOES system improperly for Datek Securities' proprietary trading. Datek Securities executed millions of unlawful trades resulting in substantial trading profits. Datek Securities' fraudulent scheme was carefully planned and orchestrated to avoid scrutiny by regulatory officials. Datek Securities directed its traders to place trades on the SOES system when it knew, by its explicit agreement with NASD and by applicable rules, that it was not permitted to use the system for proprietary trading. The trades, executed in complete disregard of SOES rules, constituted approximately 30 percent of all SOES transactions from 1995 through March 1998. After the trades were executed, Datek Securities concealed its misconduct by using nominee accounts, allocating trades by means of a sophisticated software program, fabricating trading and financial records, and filing false reports with the Commission.
For the foregoing reasons, Datek Securities willfully violated Section 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
B. Violations of the Broker-Dealer Reporting and Record-Keeping Provisions
1. Violations of Section 17(a)(1) of the Exchange Act and Rule 17a-3
Section 17(a)(1) of the Exchange Act and Rule 17a-3 thereunder require broker-dealers to make certain books and records. Information contained in a required record, filing or report must be accurate.U.S. v. Sloan, 389 F. Supp. 526, 528 (S.D.N.Y. 1975);Merrill Lynch, Pierce, Fenner & Smith, Inc., Exchange Act Release No. 33367 (Dec. 22, 1993), 55 SEC Docket 1970 (Jan. 11, 1994). The Commission has emphasized the importance of the records maintained by broker-dealers pursuant to the Exchange Act, describing them as the "keystone of the surveillance of brokers and dealers by our staff and by the securities industry's self-regulatory bodies."Edward J. Mawod & Co., 46 SEC 865, 873 n. 39 (1977), aff'd, 591 F.2d 588 (10th Cir. 1979).
Datek Securities willfully violated numerous books and records provisions by improperly recording the Elm and Treasure payments, allocating proprietary trades to nominee accounts, recording trades as customer trades, failing to prepare contemporaneous sales tickets, failing to reflect the true beneficial owner of the Raft nominee accounts, and failing to maintain accurate forms relating to its traders.
Books and records specifically required by Section 17(a) and Rule 17a-3, but which were falsified or inaccurate include the following:
(1) blotters containing an itemized daily record reflecting, among other things, all receipts and disbursements of cash and other debits and credits, and the account for which each such transaction was effected (17a-3(a)(1)) (these records were false and inaccurate as a result of the improper allocation of proprietary trades);
(2) ledgers reflecting all assets and liabilities, income and expense and capital accounts (17a-3(a)(2)) (these records were false and inaccurate as a result of the improper allocation of proprietary trades and the classification of the Elm and Treasure payments);
(3) ledger accounts itemizing separately as to each cash and margin account of every customer, among other things, all debits and credits to that account (17a-3(a)(3)) (these records were false and inaccurate as a result of the improper allocation of proprietary trades);
(4) sales tickets (17a-3(a)(7)) (no true and accurate sales tickets existed);
(5) records with respect to each cash and margin account indicating the name and address of the beneficial owner of such account (17a-3(a)(9)) (the records failed to reflect the true beneficial owners of the Raft nominee accounts); and
(6) executed employment applications and questionnaires for each "associated person" (17a-3(a)(12)) (Datek Securities failed to maintain current and accurate records relating to its traders).
2. Violations of Section 17(a)(1) of the Exchange Act
Section 17(a)(1) of the Exchange Act and Rule 17a-5(a) thereunder required Datek Securities periodically to file Part II of Form X-17A-5 ("FOCUS report") with the Commission. In addition, Rule 17a-5(d) required Datek Securities to file annual audited financial statements. A broker-dealer violates Rule 17a-5 by filing FOCUS reports and audited financial statements containing inaccurate financial information. See Nikko Secs. Co. Int'l, Exchange Act Release No. 32,331 (May 19, 1993). As a result of the systematic allocation of trades and the improper classification of the Elm/Treasure payments, Datek Securities filed inaccurate FOCUS reports and audited financial statements for 1995, 1996, and 1997 and therefore willfully violated Section 17(a)(1) of the Exchange Act and Rules 17a-5(a) and 17a-5(d).
3. Violations of Section 15(b) of the Exchange Act and Rule 15b3-1
Section 15(b) of the Exchange Act and Rule 15b3-1 thereunder require all brokers or dealers applying for registration with the Commission to file a Form BD with the Commission and, if any information contained therein, or in any amendments thereto, is or becomes inaccurate for any reason, the broker or dealer shall correct the inaccurate information. Schedule A of Form BD requires registered broker-dealers to disclose, in pertinent part, the names of the firm's officers and directors, as well as whether any of these individuals is a "control person." In addition, Question 6.A. of Form BD requires broker-dealers to disclose whether any person not identified on Schedule A exercises control, directly or indirectly, over the firm's management or policies, through agreement or otherwise.
Datek Securities concealed and failed to disclose to the Commission that Maschler and Citron were control persons of Datek Securities. Datek Securities failed to disclose this fact in Forms BD filed with the SEC between 1995 and 1997 and failed to file amendments to the Forms BD to correct the inaccurate information. The Forms BD filed with the Commission were signed by either the firm's president or the firm's FINOP and Director of Compliance, both of whom were aware that Maschler and Citron were control persons of Datek Securities.
4. Violations of Section 15(b) of the Exchange Act and Rule 15b7-1
Under Rule 15b7-1, no broker or dealer "shall effect any transaction in, or induce the purchase or sale of, any security unless any natural person associated with such broker or dealer who effects or is involved in effecting such transaction is registered or approved in accordance with the standards of training, experience, competence, and other qualification standards (including but not limited to submitting and maintaining all required forms, . . . and passing any required examinations) established by the rules of any national securities exchange or national securities association" of which such broker or dealer is a member. Datek Securities willfully violated Section 15(b) and Rule 15b7-1 thereunder by permitting unregistered salespersons to purchase and sell securities. In addition, many of Datek Securities' supervisors never passed the requisite supervisory examinations, and many continued to supervise even after they were no longer officially registered with Datek Securities.
As a result of the conduct described above, Datek Securities willfully violated Section 17(a) of the Securities Act and Sections 10(b), 15(b), and 17(a)(1) of the Exchange Act and Rules 10b-5, 15b3-1, 15b7-1, 17a-3(a)(1), 17a-3(a)(2), 17a-3(a)(3), 17a-3(a)(7), 17a-3(a)(9), 17a-3(a)(12), 17a-5(a), and 17a-5(d) thereunder.
In determining to accept the Offer of Settlement by iCapital, the Commission considered remedial acts undertaken by iCapital, and the Company's new management and investors, and cooperation afforded the Commission staff.
In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions specified in the Offer submitted by iCapital.
Accordingly, IT IS HEREBY ORDERED that:
By the Commission.