UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 34-40912 / January 11, 1999 INVESTMENT ADVISERS ACT OF 1940 Release No. IA-1781 ADMINISTRATIVE PROCEEDING File No. 3-9803 ___________________________________ : In the Matter of : ORDER INSTITUTING : PROCEEDINGS PURSUANT TO CERTAIN MARKET MAKING : SECTION 203(k) OF THE ACTIVITIES ON NASDAQ : INVESTMENT ADVISERS ACT : OF 1940 AND MAKING FINDINGS : AND IMPOSING SANCTIONS AS : TO LEGG MASON WOOD : WALKER, INCORPORATED ___________________________________: I. In the accompanying Order Instituting Proceedings Pursuant to Sections 15(b) and 21C of the Securities Exchange Act of 1934 and Findings of the Commission ("Order Instituting Proceedings"), the Securities and Exchange Commission ("Commission") instituted these public administrative proceedings against Legg Mason Wood Walker, Incorporated, and other firms and individuals. In addition, the Commission deems it appropriate and in the public interest that these public administrative proceedings be, and they hereby are, instituted pursuant to Section 203(k) of the Investment Advisers Act of 1940 ("Advisers Act") against Legg Mason Wood Walker, Incorporated. Contemporaneously, Legg Mason Wood Walker, Incorporated ("Respondent" or "Legg Mason") has submitted an Offer of Settlement ("Offer") in anticipation of the institution of these proceedings, which the Commission has determined to accept. In its Offer, Respondent, solely for the purposes of these proceedings and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, prior to a hearing pursuant to the Commission’s Rules of Practice, and without admitting or denying the findings herein, except for the findings of Section II.A., which are admitted, has consented to the entry of the Order Instituting Proceedings and this Order Instituting Proceedings Pursuant to Section 203(k) of the Investment Advisers Act of 1940 and Making Findings and Imposing Sanctions as to Legg Mason Wood Walker, Incorporated (which are hereinafter referred to as the "Orders"). The Commission has determined that it is appropriate and in the public interest to accept the Respondent’s Offer and accordingly is issuing this Order. II. On the basis of the Orders and Respondent’s Offer, the Commission finds[1] the following: A. Respondent Legg Mason Wood Walker, Incorporated, a Maryland corporation, is registered with the Commission as a broker- dealer pursuant to Section 15(b) of the Securities Exchange Act of 1934 ("Exchange Act") and as an investment adviser pursuant to Section 203 of the Advisers Act. At all relevant times, Legg Mason made markets in a number of securities traded in the Nasdaq market. The principal place of business of Legg Mason during the relevant time period was Baltimore, Maryland, and its Nasdaq trading operations were based in New York, New York. Legg Mason traded Nasdaq stocks for its own accounts and for the accounts of institutional and retail investors. At all times relevant herein, Legg Mason was a member of the National Association of Securities Dealers, Inc. ("NASD"), a national securities association registered with the Commission under Section 15A of the Exchange Act. B. Factual Summary In connection with its activities as a Nasdaq market maker, Legg Mason engaged in the following activities, as more fully described in the applicable sections of the accompanying Order Instituting Proceedings, in the following securities and on the following dates. 1. Undisclosed Arrangements to Coordinate Quotations Legg Mason entered, or caused to be entered, in the Nasdaq market fictitious quotations in one or more respects described in Section II.C.2. of the Order Instituting Proceedings in violation of Section 15(c)(2) of the Exchange Act and Rule 15c2-7 thereunder, in a market making transaction or related series of market making transactions in: a. the stock of Ground Round Restaurants, Inc. (Nasdaq symbol "GRXR") on July 11, 1994; b. the stock of First Southern Bancorp, Inc. (Nasdaq symbol "FSOU") on June 30, 1994; and c. the stock of Magna Bancorp, Inc. (Nasdaq symbol "MGNL") on June 14, 1994. 2. Failure to Honor Quotations Legg Mason failed to honor its quotations in one or more of the respects described in Section II.C.6. of the Order Instituting Proceedings in violation of Section 11A(c) of the Exchange Act and Rule 11Ac1-1 thereunder, in a market making transaction or related series of market making transactions in: a. the stock of Dell Computer Corp. (Nasdaq symbol "DELL") on June 22, 1994. 3. Principal Trading with Advisory Clients Section 206(3) of the Advisers Act prohibits an investment adviser from, directly or indirectly, acting as a principal in transactions with its advisory clients, ". . . without disclosing to such client in writing before the completion of such transaction the capacity in which he is acting and obtaining the consent of the client to such transaction."[2] The purpose of the rule is to ensure that the adviser "serve[s] the interests of his client with undivided loyalty."[3] In the instances specified below, Legg Mason arranged to indirectly transact as a principal in transactions with its advisory clients, without the required disclosure and consent of the client. On such occasions, an order to buy stock for the account of an advisory client was entered with the Legg Mason trading desk. A Legg Mason trader transmitted the order to another market maker for execution, purportedly on an agency basis. Without disclosure to, and consent of, the client, however, Legg Mason simultaneously arranged to sell an identical amount of the stock to the second market maker. The second market maker in turn sold the same amount of stock to Legg Mason, in order to fill the order of the Legg Mason advisory client. This arrangement gave Legg Mason the potential to make a trading profit from the orders of advisory clients, or to dispose of an unwanted inventory position.[4] The customer confirmation inaccurately indicated that Legg Mason acted in an agency capacity in the transaction. The purpose and effect of this series of transactions was to allow Legg Mason to indirectly trade as principal with its advisory clients. Such undisclosed arrangements created a conflict of interest between Legg Mason’s duties to its advisory clients and its desire to make trading profits. The avoidance of such conflicts is precisely the reason for the prohibition on undisclosed and unconsented-to principal transactions with advisory clients. Legg Mason acted as a principal in transactions with its advisory clients in the manner described above, in violation of Section 206(3) of the Advisers Act, in a market making transaction or related series of market making transactions in: a. the stock of DSC Communications Co. (Nasdaq symbol "DIGI") on July 8, 1994; and b. the stock of Figgie International Holdings Class A (Nasdaq symbol "FIGIA") on July 8, 1994. 4. Principal Trading with Discretionary Customers Commission decisions have long established that a firm may not trade over-the-counter securities as principal with a customer with which it has an agency relationship, without disclosure to and consent of the customer.[5] Discretionary authority over a customer account is an agency relationship.[6] In a number of instances, Legg Mason arranged to indirectly transact as a principal in transactions with its discretionary customers, without disclosure to its customers. Legg Mason employed the same method to accomplish this goal as in its transactions with advisory accounts described in Section II.B.3., supra. Legg Mason acted as a principal in transactions with its discretionary customers in that manner, in violation of Section 15(c)(1) of the Exchange Act and Rule 15c1-2 thereunder, in a market making transaction or related series of market making transactions in: a. the stock of Figgie International Holdings Class A (Nasdaq symbol "FIGIA") on July 7, 1994; b. the stock of Figgie International Holdings Class A (Nasdaq symbol "FIGIA") on July 6, 1994; c. the stock of DSC Communications Co. (Nasdaq symbol "DIGI") on July 6, 1994; and d. the stock of Somatix Therapy Corp. (Nasdaq symbol "SOMA") on July 1, 1994. 5. Failure to Keep Accurate Books and Records Legg Mason failed to keep and maintain accurate books and records in one or more of the respects described in Section II.C.7. of the Order Instituting Proceedings in violation of Section 17(a) of the Exchange Act and Rule 17a- 3 thereunder, in a market making transaction or related series of market making transactions in: a. the stock of Skolnicks Inc. (Nasdaq symbol "SKNS") on June 14, 1994; b. the stock of American Power Corp. (Nasdaq symbol "APCC") on June 21, 1994 in two violations; c. the stock of P X R E Corp. (Nasdaq symbol "PXRE") on June 22, 1994 in two violations; d. the stock of Ohio Casualty Corp. (Nasdaq symbol "OCAS") on June 22, 1994 in two violations; e. the stock of Aldila Inc. (Nasdaq symbol "ALDA") on June 30, 1994; f. the stock of Somatix Therapy Corp. (Nasdaq symbol "SOMA") on July 1, 1994; g. the stock of Figgie International Holdings Class A (Nasdaq symbol "FIGIA") on July 6, 1994; h. the stock of Figgie International Holdings Class A (Nasdaq symbol "FIGIA") on July 7, 1994; and i. the stock of DSC Communications Co. (Nasdaq symbol "DIGI") on July 8, 1994. 6. Failure to Reasonably Supervise Nasdaq Trading Legg Mason failed reasonably to supervise its Nasdaq market making activities with a view to preventing future violations within the meaning of Section 15(b)(4)(E) of the Exchange Act, in one or more of the respects described in Section II.C.8.a. and b. of the Order Instituting Proceedings, and in the other following respects: a. In 1994, Respondent Legg Mason failed to promulgate, maintain and enforce adequate policies and procedures to prevent violations of the Commission’s firm quote rule, 17 C.F.R. § 240.11Ac1-1. Legg Mason did not have any written policy explaining to its traders their obligations under the firm quote rule and had inadequate procedures to monitor for compliance with the firm quote rule; and b. In 1994, Respondent Legg Mason failed to promulgate, maintain and enforce adequate policies and procedures to prevent violations of the Commission’s prohibitions on principal trading with advisory and discretionary accounts. While Legg Mason had a written policy forbidding direct principal trading with advisory and discretionary accounts, it had no written or unwritten policies prohibiting indirect principal transactions with such accounts. Legg Mason had no procedures to monitor for indirect principal transactions with advisory and discretionary accounts. 7. Unlawful Profits and Other Gains While engaged in certain of the improper activities described above, Legg Mason obtained unlawful profits and gains, which, together with interest, total $2,305. III. By reason of the foregoing, Legg Mason willfully violated Section 206(3) of the Advisers Act and Sections 11A(c), 15(c)(1) and (2), and 17(a) of the Exchange Act, and Rules 11Ac1-1, 15c1-2, 15c2-7, and 17a-3 thereunder, and failed reasonably to supervise its Nasdaq trading personnel within the meaning of Section 15(b)(4)(E) of the Exchange Act. IV. In view of the foregoing and Respondents’ Offer, IT IS HEREBY ORDERED, pursuant to Sections 15(b) and 21C of the Exchange Act, and Section 203(k) of the Advisers Act that: 1. Legg Mason shall cease and desist from committing or causing any violation of, and committing or causing any future violation of Section 206(3) of the Advisers Act and Sections 11A(c), 15(c)(1) and (2), and 17(a) of the Exchange Act, and Rules 11Ac1-1, 15c1-2, 15c2-7, and 17a-3 thereunder; 2. Legg Mason shall, within 10 business days of the entry of this Order, pay a civil penalty in the amount of $425,000 by wire transfer in accordance with instructions furnished by the Commission staff, or by U.S. Postal money order, certified check, bank cashier’s check, or bank money order, made payable to the Securities and Exchange Commission, which shall be hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Mail Stop O-3, Alexandria, VA 22312, under cover of a letter that identifies Legg Mason as a Respondent in these proceedings and provides the caption and file number for these proceedings; with (a) written confirmation of payment by such wire transfer, or (b) a copy of such cover letter and money order or check, to be sent to Leonard W. Wang, Division of Enforcement, Securities and Exchange Commission, 450 5th Street, N.W., Mail Stop 7-1, Washington, D.C. 20549; 3. Legg Mason shall, within 10 business days of written notice from the Commission staff or the Independent Consultant (as defined below), pay disgorgement in the amount of $2,305 pursuant to Section 21C(e) of the Exchange Act; and 4. Legg Mason shall, within 90 days of the date of the entry of this Order, provide to the independent consultant appointed by the Commission in connection with these proceedings (the "Independent Consultant") a description of its policies, procedures and practices relating to prevention or detection of the types of improper conduct involving Legg Mason described in Section II of this Order. Within such time as the Commission directs, the Independent Consultant shall review such policies, procedures and practices with a view to determining if they would reasonably be expected to prevent and detect, insofar as practicable, any of the types of improper conduct involving Legg Mason described in Section II of this Order. Legg Mason shall cooperate with the Independent Consultant’s review of Legg Mason’s policies, procedures and practices, and shall, among other things, provide such further information as the Independent Consultant reasonably requests or that Legg Mason deems relevant to the Independent Consultant’s review, provided, however, that Legg Mason need not provide any information to which it asserts a valid claim of the attorney-client privilege. The Independent Consultant shall maintain the confidentiality of all materials provided by Legg Mason and shall not provide the materials to any person, provided, however, that such materials may be provided to the Commission or its staff. If the Independent Consultant concludes that Legg Mason’s policies, procedures and practices, as presented, would reasonably be expected to prevent and detect, insofar as practicable, any of the types of improper conduct involving Legg Mason described in Section II of this Order, the Independent Consultant shall inform Legg Mason of this conclusion in writing, and his or her responsibilities with respect to Legg Mason shall conclude. If the Independent Consultant cannot conclude that Legg Mason’s policies, procedures and practices meet the aforesaid standard, he or she may recommend changes in or additions to Legg Mason’s policies, procedures or practices for the purpose of improving their ability to meet the aforesaid standard. Legg Mason shall implement all such recommended changes or additions in a timely manner, but in any event no later than three months after receiving the recommendations of the Independent Consultant or such other reasonable time as determined by the Independent Consultant; provided, however, if Legg Mason believes that a change or addition to its policies, procedures and practices recommended by the Independent Consultant is unduly burdensome or unreasonable, it may: (a) propose an equally effective alternative to the Independent Consultant, and, with the Independent Consultant’s approval, implement that alternative in lieu of the Independent Consultant’s recommended change or addition; or (b) petition the Commission, with notice to the Independent Consultant and the Division of Enforcement, for relief from the recommendation of the Independent Consultant. Within three months of receiving recommendations of the Independent Consultant for changes in or additions to its policies, procedures and practices, Legg Mason shall report in writing to the Independent Consultant with respect to the implementation of the recommendations and/or any equally effective alternatives approved by the Independent Consultant. If Legg Mason’s report on implementation is without qualification and states that said recommendations and/or alternatives have been fully and effectively implemented, the Independent Consultant’s responsibilities with respect to Legg Mason shall conclude. If Legg Mason’s report on implementation is qualified, or in any respect indicates that implementation is not full and effective, Legg Mason shall cooperate with all further efforts of the Independent Consultant to ensure that said recommendations and/or alternatives are fully and effectively implemented. When the Independent Consultant concludes that Legg Mason has fully and effectively implemented said recommendations and/or alternatives, he or she shall inform Legg Mason in writing of this conclusion and his or her responsibilities with respect to Legg Mason shall conclude. The fees and expenses of the Independent Consultant arising from his or her review of the policies, procedures and practices of Legg Mason and the other respondent firms subject to the Independent Consultant’s review shall be prorated evenly among such firms, and in such prorated amounts, be paid by each such firm, provided however, that if the Independent Consultant recommends changes or additions to Legg Mason’s policies, procedures or practices, the fees and expenses of the Independent Consultant relating to the making and implementation of those recommendations and/or any alternatives approved by the Independent Consultant, and any disagreements relating thereto, shall be paid by Legg Mason. By the Commission. Jonathan G. Katz Secretary **FOOTNOTES** [1]: The findings herein are solely for the purpose of these proceedings, and are not binding on any person not a respondent in these proceedings. [2]: 15 U.S.C. § 80b-6(3). [3]: Opinion of Director of Trading and Exchange Division, Investment Advisers Rel. No. 40 (Feb. 5, 1945). [4]: In most instances, Legg Mason either purchased in the market an amount of securities equivalent to the size of the client’s order, or had a long position in its inventory account sufficient to cover the order. [5]: See, Allender Co., Inc., 9 S.E.C. 1043 (1941); William J. Stelmack Corp., 11 S.E.C. 601 (1942); Walter S. Grubbs, Exchange Act Rel. No. 34-4138 (Aug. 2, 1948); Herbert R. May and Russell H. Phinney, 27 S.E.C. 814 (1948). Such conduct violates theantifraud provisions of Section 15(c)(1) of the Exchange Act and Rule 15c1-2thereunder. [6]: McAdam v. Dean Witter Reynolds, Inc., 896 F.2d 750 (3d Cir. 1990); Lowenbraun v. L.F. Rothschild, 685 F. Supp. 336 (S.D.N.Y. 1988).