UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION Securities Act of 1933 Release No. 7334 / September 23, 1996 Securities Exchange Act of 1934 Release No. 37712 / September 23, 1996 Investment Company Act of 1940 Release No. 22237 / September 23, 1996 Administrative Proceeding File No. 3-9092 --------------------------- : In the Matter of : ORDER INSTITUTING PUBLIC : PROCEEDINGS PURSUANT TO MONNESS, CRESPI, : SECTION 8A OF THE SECURITIES HARDT & CO., INC., and : ACT OF 1933, SECTIONS 15(b)(4), NEIL CRESPI, : 15(b)(6), AND 21C OF THE : SECURITIES EXCHANGE ACT OF : 1934, AND SECTION 9(f) Respondents. : OF THE INVESTMENT COMPANY ACT : OF 1940, AND FINDINGS, CEASE AND : DESIST ORDER, AND ORDER IMPOSING : SANCTIONS ---------------------------- I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest to institute public administrative proceedings pursuant to Section 8A of the Securities Act of 1933 ("Securities Act"), Sections 15(b)(4), 15(b)(6), and 21C of the Securities Exchange Act of 1934 ("Exchange Act"), and Section 9(f) of the Investment Company Act of 1940 ("Investment Company Act") against Monness, Crespi, Hardt & Co., Inc. ("MCH"), a broker-dealer registered with the Commission, and Neil Crespi ("Crespi"), President of MCH (collectively, "Respondents"). II. In anticipation of the institution of these proceedings, MCH and Crespi have submitted Offers of Settlement ("Offers") to the Commission, 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 in which the Commission is a party, and without admitting or denying the findings contained herein, MCH and Crespi consent to the issuance of this Order Instituting Public Proceedings, and Findings, Cease and Desist Order, and Order Imposing Sanctions ("Order") and to the entry of the findings and the imposition of the remedial sanctions set forth below. Accordingly, IT IS ORDERED that proceedings pursuant to Section 8A of the Securities Act, Sections 15(b)(4), 15(b)(6), and 21C of the Exchange Act, and Section 9(f) of the Investment Company Act be, and hereby are, instituted against MCH and Crespi. III. On the basis of this Order and Respondents' Offers, the Commission makes the following findings: A. Respondents 1. MCH has been registered with the Commission as a broker-dealer since February 11, 1977. MCH's principal place of business is in New York City. 2. Crespi is one of three principals of MCH and serves as the firm's president and head of trading. B. Summary 1. This case involves violations of certain antifraud provisions of the Securities Act, Exchange Act, and Investment Company Act resulting from undisclosed mark-ups and mark-downs on over-the-counter ("OTC") securities trades executed by MCH and Crespi. Respondents obtained a total of $2,022,363 in undisclosed mark-ups and mark-downs in 343 OTC trades executed by MCH as a riskless principal from February 1989 through July 1991. C. Facts 1. Shearson Advisors was an investment advisory division of Shearson Lehman Brothers Inc., which was registered with the Commission as both an investment adviser and a broker-dealer. 2. During February 1989 through July 1991, Shearson Advisors served as investment adviser to Shearson Lehman Brothers Investment Portfolios - Growth Portfolio, Shearson Lehman Brothers Investment Portfolios - Special Equities Portfolio ("Special Equities Portfolio"), and Shearson VIP Fund - Equity Series (together, the "Funds"). Each Fund was a registered investment company. 3. From in or about February 1989 to in or about July 1991, Shearson Advisors used MCH to execute certain of the Funds' OTC transactions. MCH did not make a market in any OTC securities. 4. Of the 343 OTC transactions at issue in this proceeding (the "Transactions"), 268 involved 10,000 or more shares, and 25 Transactions involved 100,000 or more shares. Crespi was MCH's trader on substantially all of the Transactions. He received the orders from Shearson Advisors, executed the trades with market- makers and informed Shearson Advisors of the price that would be paid or received by the Funds. 5. Shearson Advisors understood that MCH's compensation on OTC trades was to be six cents per share, with the exception of trades for the Special Equities Portfolio, for which MCH's compensation was to be seven cents per share. Crespi knew that Shearson Advisors understood MCH's compensation to be limited on these terms. 6. In 299 of the 343 Transactions, MCH provided to Shearson Advisors written confirmations stating that MCH had acted as agent. In the remaining 44 Transactions, MCH provided to Shearson Advisors written confirmations stating that MCH had acted as principal. 7. In fact, in each of the 343 Transactions, MCH acted as a "riskless principal" -- temporarily acquiring the securities into its own proprietary account, where MCH would add a mark-up or a mark-down (depending on whether the Fund was purchasing or selling the securities) in addition to the six or seven cent per share compensation to which MCH was entitled. These undisclosed mark-ups and mark-downs ranged from one half cent to 66 cents per share, and averaged 14 cents per share in excess of the agreed six or seven cents. 8. As a result of this riskless principal trading, MCH obtained profits of at least $2,022,363 in excess of the six or seven cents per share to which it was entitled.1 9. MCH and Crespi never disclosed to Shearson Advisors or the Funds that, when executing the Transactions, MCH was acting 1 Subsequent to the events described herein, the assets of Shearson Advisors were acquired by Smith Barney, Harris Upham & Co. Incorporated, later renamed Smith Barney Shearson Inc. ("SBS"). SBS and Lehman Brothers Inc. ("LB") have made payments to the Funds to compensate the Funds, inter alia, for losses incurred by the Funds on the Transactions with MCH. SBS and LB have received reimbursement from ICI Mutual Insurance Company ("ICI Mutual") for certain payments to the Funds, pursuant to an ICI Mutual insurance policy which named the Funds as insureds. ICI is subrogated to the rights of SBS and LB to obtain recovery from MCH for, inter alia, these payments made by SBS and LB to the Funds. ==========================================START OF PAGE 3====== as a riskless principal and receiving a mark-up or mark-down in addition to the agreed six or seven cents. 10. None of MCH's trade confirmations for the Transactions disclosed the mark-ups or mark-downs by MCH. All trade information appearing on the confirms was inputted into a computer system by MCH personnel and electronically transmitted to MCH's clearing agent for printing. Crespi was the ultimate source of this information. Crespi failed to take any steps to cause the confirms to disclose MCH's true compensation. In addition, Crespi failed to take any steps to cause the confirms for most of the Transactions to disclose accurately MCH's capacity. D. Legal Analysis 1. Violations of Section 17(a) of the Securities Act and Sections 10(b) and 15(c) of the Exchange Act and Rules 10b-3(a), 10b-5 and 15c1-2 Thereunder a. Section 17(a) of the Securities Act prohibits, in the offer or sale of securities, (1) devices, schemes, or artifices to defraud, (2) misrepresentations or omissions of material facts, or (3) transactions, practices, or courses of business that would operate as a fraud. Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit devices, schemes, and artifices to defraud in connection with the purchase or sale of securities. Scienter is a required element to prove violations of Section 17(a)(1), Section 10(b) and Rule 10b-5. Aaron v. SEC, 446 U.S. 680, 701-02 (1980); Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976). Section 15(c) of the Exchange Act, and Rules 10b-3(a) and 15c1-2 thereunder prohibit any broker or dealer from employing any manipulative, deceptive, or otherwise fraudulent device or contrivance when effecting any transaction in any security otherwise than on a national securities exchange. b. MCH violated Section 17(a) of the Securities Act, Sections 10(b) and 15(c) of the Exchange Act and Rules 10b-3(a), 10b-5, and 15c1-2 thereunder. Specifically, (i) MCH failed to disclose to the Funds that it was interpositioning its own proprietary account and acting as a riskless principal when executing the Transactions; and (ii) MCH charged the Funds undisclosed mark-ups and mark-downs totaling $2,022,363. See, e.g., SEC v. Ridenour, 913 F.2d 515 (8th Cir. 1990); Sinclair v. SEC, 444 F.2d 399, 400-01 (2d Cir. 1971). c. Crespi, who received the orders for substantially all of the Transactions from Shearson Advisors, executed the trades and informed Shearson Advisors of the price to be paid or received by the Funds, violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. ==========================================START OF PAGE 4====== d. Crespi also aided and abetted MCH's violations of Section 15(c) of the Exchange Act and Rules 10b-3(a) and 15c1-2 thereunder. Section 15(b)(6)(A)(i) of the Exchange Act, in conjunction with Section 15(b)(4)(E), authorizes the Commission to take administrative enforcement action against a person associated with a broker or dealer who aids or abets violations of the Exchange Act. The elements of aiding and abetting liability are: (1) a securities violation by a primary party other than the alleged aider and abettor; (2) knowledge or reckless disregard by the aider and abettor of the primary violation; and (3) substantial assistance rendered by the aider and abettor in the commission of the primary violation. IIT v. Cornfeld, 619 F.2d 909, 922 (2d Cir. 1980). MCH committed its violations largely through the acts and omissions of Crespi. Thus, Crespi was aware of and substantially assisted in the commission of the acts constituting MCH's violations. Crespi was also a "cause" of MCH's violations within the meaning of Section 8A of the Securities Act, Section 21C of the Exchange Act and Section 9(f) of the Investment Company Act, because he committed acts and omissions that he knew or should have known would contribute to the foregoing violations by MCH. 2. Violations of Section 37 of the Investment Company Act a. The Commission has authority to bring an administrative action for violation of Section 37 of the Investment Company Act against a respondent who converts assets of a registered investment company. In the Matter of International Research & Management Corp., Investment Advisers Act Release No. 617, Investment Company Act Rel. No. 10150 (Mar. 6, 1978). b. MCH and Crespi violated Section 37 by obtaining undisclosed mark-ups and mark-downs from the Funds, which were registered investment companies. See In the Matter of Chandler Management Corp., Exchange Act Rel. No. 9735, Investment Company Act Release No. 7331 (Aug. 17, 1972). 3. Violations of Exchange Act Rule 10b-10 a. Rule 10b-10(a)(1) requires brokers to provide their customers with written notification at or before completion of each transaction specifying the capacity in which the broker is acting when executing the transaction.2 Rule 10b-10(a)(8) prescribes that when a broker or dealer acts as a riskless 2 At the time of Respondents' conduct, this requirement was contained in Rule 10b-10(a)(1). Pursuant to a later amendment, the requirement was restated in Rule 10b- 10(a)(2). See Confirmation of Transactions, Exchange Act Release No. 34962, 57 S.E.C. Docket No. 2674 (Nov. 10, 1994). ==========================================START OF PAGE 5====== principal, and is not a market maker in the subject security, the broker or dealer must provide the customer with written confirmation at or before completion of the transaction displaying "the amount of any mark-up, mark-down, or similar remuneration received in [the] equity security."3 b. MCH violated Rule 10b-10 by providing confirms to Shearson Advisors for 299 of the 343 Transactions which falsely indicated that MCH was acting as an agent in executing the Transactions, when MCH was in fact acting as a riskless principal. MCH violated Rule 10b-10 by issuing confirms to the Funds for each of the Transactions which failed to disclose the difference between the price to the Funds and MCH's own contemporaneous purchase or sale price. For the reasons set forth in Section III.D.1.d. above, Crespi aided and abetted and caused MCH's violations of Rule 10b-10. IV. A. While engaged in the conduct described above, MCH and Crespi, directly and indirectly, used the means or instrumentalities of interstate commerce, or of the mails. B. Based on the foregoing, the Commission finds that: 1. MCH willfully violated Section 17(a) of the Securities Act, Sections 10(b) and 15(c)(1) of the Exchange Act and Rules 10b-3(a), 10b-5, 10b-10 and 15c1-2 thereunder, and Section 37 of the Investment Company Act; and 2. Crespi willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Section 37 of the Investment Company Act, and aided and abetted and caused MCH's violations of Section 15(c)(1) of the Exchange Act and Rules 10b-3(a), 10b-10, and 15c1-2 thereunder. V. In view of the foregoing, it is in the public interest to impose the sanctions specified in the Offers. Accordingly, IT IS HEREBY ORDERED that: 3 At the time of Respondents' conduct, Rule 10b-10(a)(8) was in effect. Pursuant to the later amendment, this requirement was restated in Rule 10b-10(a)(2)(ii)(A). See Confirmation of Transactions, Exchange Act Release No. 34962, 57 S.E.C. Docket No. 2674 (Nov. 10, 1994). ==========================================START OF PAGE 6====== A. MCH shall, effective immediately, cease and desist from committing or causing any violation, and from committing or causing any future violation, of Section 17(a) of the Securities Act, Sections 10(b) and 15(c)(1) of the Exchange Act and Rules 10b-3(a), 10b-5, 10b-10 and 15c1-2 thereunder, and Section 37 of the Investment Company Act; B. Crespi shall, effective immediately, cease and desist from committing or causing any violation, and committing or causing any future violation, of Section 17(a) of the Securities Act, Sections 10(b) and 15(c)(1) of the Exchange Act and Rules 10b-3(a), 10b-5, 10b-10 and 15c1-2 thereunder, and Section 37 of the Investment Company Act; C. Respondents MCH and Crespi be, and hereby are, censured; D. MCH pay, within ten business days of the date of this Order, disgorgement of $1,521,906.53. Such payment shall be made directly to ICI Mutual Insurance Company, under cover letter which identifies MCH as a Respondent in these proceedings and the file number of these proceedings. A copy of the cover letter and payment shall be simultaneously transmitted to Wayne M. Carlin, Assistant Regional Director, Northeast Regional Office, Securities and Exchange Commission, 7 World Trade Center, 13th Floor, New York, NY 10048; E. MCH pay, within ten business days of the date of this Order, to the United States Treasury a civil penalty in the amount of $500,000 pursuant to Section 21B(a)(4) of the Exchange Act. Such payment shall be: (1) made by United States postal money order, certified check, bank cashier's check or bank money order; (2) made payable to the Securities and Exchange Commission; (3) delivered to the Comptroller, Securities and Exchange Commission, 450 5th Street, N.W., Washington, DC 20549; and (4) submitted under cover letter which identifies MCH as a Respondent in these proceedings and the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Wayne M. Carlin, Assistant Regional Director, Northeast Regional Office, Securities and Exchange Commission, 7 World Trade Center, 13th Floor, New York, NY 10048; F. Crespi pay, within ten business days of the date of this Order, to the United States Treasury a civil penalty in the amount of $100,000 pursuant to Section 21B(a)(4) of the Exchange Act. Such payment shall be: (1) made by United States postal money order, certified check, bank cashier's check or bank money order; (2) made payable to the Securities and Exchange Commission; (3) delivered to the Comptroller, Securities and Exchange Commission, 450 5th Street, N.W., Washington, DC 20549; and (4) submitted under cover letter which identifies Crespi as a Respondent in these proceedings and the file number of these ==========================================START OF PAGE 7====== proceedings, a copy of which cover letter and money order or check shall be sent to Wayne M. Carlin, Assistant Regional Director, Northeast Regional Office, Securities and Exchange Commission, 7 World Trade Center, 13th Floor, New York, NY 10048; G. MCH shall comply with its undertakings, as specified in its Offer of Settlement: 1. MCH shall retain an outside consultant ("Consultant"), not unacceptable to the Commission's staff, at MCH's expense, to conduct a review of MCH's policies, practices, and procedures to determine the adequacy of such policies, practices, and procedures to reasonably detect and prevent the violations of the federal securities laws that gave rise to this proceeding. The Consultant shall make recommendations as to the adoption and implementation of any new and/or revised policies, practices, and procedures deemed necessary or appropriate in light of the violations of the federal securities laws that gave rise to this proceeding. 2. MCH shall adopt, implement, and maintain all policies, practices, and procedures recommended by the Consultant within the period of time prescribed in Paragraph V.G.3. below; provided, however, that as to any recommendation of the Consultant which MCH determines is, in whole or in part, unduly burdensome, MCH may suggest an alternative procedure designed to achieve the same objective or purpose as that of the recommendation of the Consultant. MCH shall set forth in an affidavit to be submitted to the Consultant pursuant to this Paragraph such alternative procedure, and a description of how such alternative procedure achieves the same objective or purpose as the Consultant's original recommendation. The Consultant shall evaluate the alternative procedure proposed by MCH and MCH will abide by the Consultant's determination with regard thereto and adopt those recommendations which the Consultant shall ultimately determine are appropriate. 3. Within 90 days of the issuance of this Order, MCH shall file an affidavit with the Commission's staff, setting forth the details of MCH's implementation of the Consultant's recommendations pursuant to Paragraph V.G.2. above. MCH may apply to the staff of the Commission for an extension of this deadline, and upon a showing of good cause by ==========================================START OF PAGE 8====== MCH, the Commission's staff may grant such extensions for whatever time period it deems appropriate, but in no event shall the affidavit be delivered to the staff more than 120 days from the date of this Order; H. MCH shall provide notice disclosing the material terms of this Order, in a form acceptable to the staff of the Commission, to all of its current customers, within thirty (30) days from the date of this Order. Within forty-five (45) days of the date of this Order, MCH shall submit an affidavit to the staff of the Commission certifying MCH's compliance with this Paragraph V.H. I. MCH shall provide notice disclosing the material terms of this Order, for a period of one (1) year from the date of this Order, in a form acceptable to the staff of the Commission, to all of its prospective customers, not less than twenty-four (24) hours prior to executing any orders for the purchase or sale of securities on behalf of the prospective customers. Within one (1) year from the date of this Order, MCH shall submit an affidavit to the staff of the Commission certifying MCH's compliance with this Paragraph V.I. By the Commission. Jonathan G. Katz Secretary ==========================================START OF PAGE 11======