UNITED STATES OF AMERICA
|In the Matter of
ORDER INSTITUTING PUBLIC
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be instituted against Dean Witter Reynolds Inc. ("Dean Witter") pursuant to Sections 15(b) and 19(h) of the Securities Exchange Act of 1934 ("Exchange Act"). In anticipation of the institution of these administrative proceedings, Dean Witter 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 prior to a hearing pursuant to the Commission's Rules of Practice, 17 C.F.R. § 201.100 et seq., Dean Witter, by its Offer of Settlement, admits the jurisdiction of the Commission over it and the subject matter of these administrative proceedings and consents to the entry of this Order Instituting Public Administrative Proceedings, Making Findings, and Imposing Remedial Sanctions and Monetary Penalties without admitting or denying the Commission's findings except for those contained in Section III.A., which are admitted.
Accordingly, IT IS HEREBY ORDERED that proceedings pursuant to Sections 15(b) and 19(h) of the Exchange Act be, and hereby are, instituted.
On the Basis of this Order and Dean Witter's Offer of Settlement, the Commission finds1 the following:
Dean Witter, at all times relevant to this proceeding, has been a broker-dealer registered with the Commission, a member of the New York Stock Exchange, the National Association of Securities Dealers, and all other major exchanges and associations and has been engaged in a nationwide securities business.2 The firm's main office is in New York, New York and it has 444 branch offices throughout the United States.
B. MUTUAL FUND SWITCHING VIOLATIONS
Mutual fund switching involves "liquidat[ing] holdings of investment company shares and us[ing]the proceeds to purchase shares of various other investment companies." Charles E. Marland & Co., Inc., 45 S.E.C. 632, 634 n.6 (1974). Mutual fund switching violates the antifraud provisions of the federal securities laws when registered representatives, in order to increase their compensation, induce investors to incur the costs associated with redeeming shares of one mutual fund and purchasing the shares of another fund and the benefit to the customer does not justify those costs. See Russell L. Irish, 42 S.E.C. 735, 736-40 (1965), aff'd, Irish v. SEC, 367 F.2d 637 (9th Cir. 1966), cert. denied, 386 U.S. 911 (1967).
From at least March 1994 through November 1996, a former registered representative ("RR") of Dean Witter's Atlanta, Georgia branch office ("Atlanta Branch"), engaged in at least 48 violative switch transactions in seven different accounts. Although Dean Witter policies purportedly were designed to discourage short term trading of mutual funds, the average time that the RR's customers held the funds that she switched was only eight months; some funds were held for only two months before being switched. By switching from a mutual fund in one family of funds to a fund in another mutual fund family, the RR increased the commissions she and Dean Witter received. The vast majority of these switches were between funds with identical or very similar investment objectives. If she had advised those customers to transfer their investments to a different fund in the same family of mutual funds, the RR and Dean Witter would have received little or no compensation.
Several of these switch transactions exhibit a circular switching pattern, where the RR's customers engaged in a series of mutual fund switches and, after generating thousands of dollars in commissions for the RR and Dean Witter and incurring thousands of dollars of contingent deferred sales charges ("CDSC")3 and front-end load fees4 for the customers, ended up buying back into the same mutual funds that they sold in the first instance. In one example of this circularity, the RR convinced one customer to switch, within a two and a half year period, from fund A to fund B, redeem more shares of fund A to buy fund C, then switch from fund C to fund B, redeem the shares of fund B to switch back to fund A, switch next to fund D, then to fund E, back to fund D, and finally switch back to fund A again.
These violative mutual fund switch transactions were processed without the Atlanta Branch manager's prior approval. Moreover, the RR did not obtain switch letters for half of the transactions. For those transactions for which there were switch letters, the letters were frequently obtained from, and indeed at times initially sent to, customers months after switch transactions were executed. The letters, filled out by the RR without any oversight, often contained materially misleading or false statements. A majority of the false statements involved the RR's material understatement, sometimes by as much as $5,000 per switch transaction, of the CDSCs incurred by her customers. In a few instances, the switch letters, prepared by the RR, incorrectly stated that the customers incurred front-end sales charges when they purchased the funds when, in fact, they incurred CDSCs on sales of the funds. Furthermore, the RR falsely represented that several customers' mutual fund switches were motivated by tax reasons. This was not true, as tax considerations played no role in these customers being convinced by the RR to follow her switch recommendations.
As a result of such violative conduct, the RR's customers unnecessarily paid approximately $157,000 in CDSCs and front-end load fees.
C. DEAN WITTER'S SYSTEMS DID NOT PREVENT OR DETECT VIOLATIVE MUTUAL FUND SWITCHING
While Dean Witter had written supervisory procedures in effect during the violative period, it did not have a system in place to effectively implement these written procedures. Dean Witter's written supervisory procedures in effect from at least 1994 through at least 1998 stated that "[a]ll mutual fund switches between different mutual fund groups require prior manager approval." Furthermore, its written procedures provided that "[a] mutual fund switch letter should be obtained from the client before the [switch] transaction occurs," and that among other things, "[i]n approving a switch, the manager should review the request to ensure that: a switch letter from the client is on file, the change is appropriate based on current market conditions and the client's investment objectives, [and] the [registered representative] has a valid reason" for the switch.
Dean Witter's systems as designed were inadequate to prevent and detect mutual fund switching. Although all switches purportedly required managerial pre-approval, there was no system in place to alert the branch manager prior to the execution of the transaction that a switch was involved. If the representative chose not to seek prior manager approval, the transaction would be processed without pre-approval.
In addition, while Dean Witter's written policies required that a switch letter be obtained from the client before the trade involving the switch be processed, they were not enforced. Moreover, the policies were flawed in that they relied upon the registered representative to prepare the letter with the requisite information (including the reason for the switch and the amount of sales charges incurred) and to mail it to the client. Dean Witter received such letters from clients, if at all, after switch transactions had been executed. There were few, if any, consequences for failing to obtain switch letters.
Consequently, what review and approval of mutual fund switches that did take place usually occurred after the switch transaction had been executed. Such review was often accomplished by the branch manager or a delegate looking at the monthly switch report5 and/or at the mutual fund switch letters returned by customers. As previously noted, no one took any steps to verify the accuracy of the representations in the letters.
D. DEAN WITTER'S FAILURE TO SUPERVISE
Section 15(b)(4)(E) of the Exchange Act requires broker-dealers to supervise reasonably, with a view to preventing violations of the federal securities laws, persons subject to their supervision. Section 15(b)(4)(E) provides a defense to broker-dealers who can show that they have "established procedures and a system for applying such procedures" which would reasonably be expected to prevent and detect such violations. The Commission has emphasized that the "responsibility of broker-dealers to supervise their employees by means of effective, established procedures is a critical component in the federal investor protection scheme regulating the securities markets." Smith Barney, Harris Upham & Co., Exchange Act Rel. No. 21813, 32 SEC Docket 999, 1010 (Mar. 5, 1985). Here, Dean Witter failed to fulfill this responsibility.
Dean Witter's system regarding mutual fund switching was deficient and could not reasonably be expected to prevent and detect violative mutual fund switching. As discussed above, although Dean Witter written policy required managerial pre-approval of mutual fund switches, the firm had no system to alert the branch manager that a mutual fund trade involved a switch. The pre-approval requirement was entirely dependent upon the registered representative bringing the switch to the manager's attention. Dean Witter's written procedures also provided that a switch letter be obtained from the client before the switch transaction would be executed. Once again, the system for implementing this written procedure was deficient in that the client's registered representative had sole responsibility for providing all of the requisite information in the letter as well as mailing it; Dean Witter had no system for verifying the information and had no way to ensure that such letters were mailed on a timely basis and returned prior to the switch transaction.
Dean Witter did not have a system for applying its procedures which would reasonably be expected to prevent and detect, insofar as practicable, violative mutual fund switching.
On the basis of this Order and Dean Witter's Offer of Settlement, the Commission finds that the RR's mutual fund switches and misrepresentations and omissions discussed above violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and Section 17(a) of the Securities Act of 1933 ("Securities Act").
On the basis of this Order and Dean Witter's Offer of Settlement, the Commission finds that, within the meaning of Section 15(b)(4)(E) of the Exchange Act, Dean Witter failed reasonably to supervise the RR with a view to preventing her violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and Section 17(a) of the Securities Act.
ACCORDINGLY, IT IS ORDERED that:
1. Dean Witter be, and hereby is, censured pursuant to Section 15(b)(4) of the Exchange Act;
2. Dean Witter shall, within 10 days of the date of this Order, remit to certain customers a total of $276,702 representing charges and other expenses plus interest in a manner and subject to conditions acceptable to the Commission's staff, and within 20 days of this payment submit to the Commission's staff an affidavit stating that it has complied with this undertaking to remit funds to these certain customers;
3. Dean Witter shall, within 10 days of the date of this Order, pay a civil penalty in the amount of $200,000 to the United States Treasury. 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) hand delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (d) submitted under cover letter that identifies Dean Witter as a respondent in these proceedings, the file number of these proceedings, a copy of such cover letter and money order or check shall be sent to Richard P. Wessel, District Administrator, Securities and Exchange Commission, Atlanta District Office, 3475 Lenox Road, N.E., Suite 1000, Atlanta, Georgia 30326;
4. Dean Witter comply with its undertakings to:
a. maintain its existing procedures, including but not limited to procedures that: (i) require branch manager approval of all open-end mutual fund switch transactions in an account prior to their execution, where in such transactions the proceeds from the sale of shares of one open-end mutual fund are used to purchase shares of another open-end mutual fund within 60 days and for which the broker receives transaction-based compensation for execution; (ii) provide information to the branch manager regarding whether the switch was solicited, the reason for the switch, current account and mutual fund trading activity, and mutual fund switch reports; and (iii) provide for the generation of mutual fund switch letters to be sent to customers contemporaneously with their switches;
b. retain, within 60 days of the date of this Order, at Dean Witter's expense, an Independent Review Person ("Review Person"), acceptable to the Commission's staff, to conduct a comprehensive review of Dean Witter's mutual fund switching procedures, including those set forth above. The Review Person is to review whether such procedures have been effectively implemented, maintained, and followed. The Review Person shall also recommend such other procedures (or amendments to existing procedures), if any, as are necessary and appropriate reasonably to prevent and detect violative mutual fund switching. The Review Person will prepare a written report ("Report") of his or her findings and recommendations within 120 days of the date of this Order. Dean Witter will be provided a reasonable opportunity to comment on the Review Person's report;
c. adopt and implement, within 30 days after receipt of the Report, at Dean Witter's expense, such procedures as recommended by the Review Person as provided in Section V.4.b.; provided, however, that as to any of the Review Person's recommendations that Dean Witter determines is unduly burdensome, Dean Witter may propose an alternative procedure reasonably designed to accomplish the same objectives. The Review Person shall reasonably evaluate such alternative procedure and, if appropriate, either approve the alternative procedure or amend his or her recommendation. If the Review Person does approve the alternative procedure or amends a recommendation, the Review Person shall, within 14 days of such decision, prepare a written report which identifies such alternative procedure or amended recommendation, sets forth the Review Person's reasons for his or her decision, and sets the time period within which Dean Witter shall adopt and implement the alternative procedure or amended recommendation ("Supplemental Report"). Dean Witter shall abide by the decision of the Review Person;
d. authorize the Review Person to provide copies of the Report to the Commission's Atlanta District Office within 120 days of the date of this Order;
e. authorize the Review Person to provide copies of the Supplemental Report, if any, to the Commission's Atlanta District Office within 7 days of the date of the Supplemental Report's preparation;
f. cooperate fully with the Review Person and cause its affiliates to cooperate fully with the Review Person, including obtaining the cooperation of Dean Witter employees or other persons under its control; and
g. require the Review Person to enter into an agreement, providing that (1) for the period of engagement and for a period of two (2) years from the completion of the engagement, the Review Person shall not enter into any employment, consultant, attorney-client, auditing, or other professional relationship with Dean Witter, or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity as such; and (2) any firm with which the Review Person is affiliated or with which he or she is a member, and any person engaged to assist the Review Person in performance of his or her duties under this Order shall not, without prior written consent of the Commission, enter into any employment, consultant, attorney-client, auditing, or other professional relationship with Dean Witter, or any of its present or former affiliates, directors, officers, employees, or agents in their capacity as such for the period of the engagement and for a period of two (2) years after the engagement;
5. Nothing herein shall prevent Dean Witter from adopting additional policies and procedures or improving upon the policies and procedures adopted pursuant to its undertakings; and
6. For good cause shown, and upon receipt of a timely application from the Review Person or Dean Witter, the Atlanta District Office may extend any of the procedural dates set forth above.
By the Commission.
Jonathan G. Katz
|The findings herein are made pursuant to Dean Witter's Offer of Settlement and are not binding on any other person or entity in this or any other proceeding.|
|Dean Witter is a subsidiary of Morgan Stanley Dean Witter & Co.|
|"B" class shares of a mutual fund are sold to investors without a front-end load fee; however, an investor generally must pay a CDSC if he or she redeems the shares within five years. CDSCs are usually incurred at the rate of 5% of the dollar value of shares redeemed within one year of purchase and decline one percentage point each year thereafter. The CDSC is retained by the mutual fund to offset the commission paid to the broker when the fund was sold.|
|Front-end load fees are sales charges applied upon the purchase of a load mutual fund. A broker's commission is paid out of the front-end load fee.|
|The monthly switch report, created by Dean Witter, lists any account that has a sale and purchase of a mutual fund within the month.|
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