UNITED STATES OF AMERICA
In the Matter of
NORWEST INVESTMENT SERVICES, INC., now known as Wells Fargo Brokerage Services, LLC, successor by merger,
|ORDER INSTITUTING ADMINISTRATIVE PROCEEDINGS PURSUANT TO SECTION 15(b) OF THE SECURITIES EXCHANGE ACT OF 1934, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS AND MONETARY PENALTIES|
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be, and hereby are, instituted pursuant to Section 15(b) of the Securities Exchange Act of 1934 ("Exchange Act") to determine whether Norwest Investment Services, Inc., now known as Wells Fargo Brokerage Services, LLC, successor by merger (hereinafter "Respondent"), violated the federal securities laws and, if so, what remedial actions or sanctions are appropriate under the circumstances of this case.
In anticipation of the institution of these administrative proceedings, Respondent has submitted an Offer of Settlement ("Offer"), 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 herein, except that Respondent, by its Offer of Settlement, admits the Commission's jurisdiction over it and over the subject matter of these proceedings, Respondent has consented to the entry of the findings and the imposition of the remedial sanctions and monetary penalties as set forth below.
On the basis of this Order and the Offer submitted by Respondent, the Commission finds1 that:
Respondent, at all times relevant to this proceeding, was a bank affiliated broker-dealer registered with the Commission and a member of the National Association of Securities Dealers, and was engaged in a nationwide securities business.2 Respondent's main office was in Minneapolis, Minnesota. Currently, Respondent is a bank affiliated broker-dealer registered with the Commission and a member of the National Association of Securities Dealers and its principal place of business is in Minneapolis, Minnesota.
From February 1999 to August 1999, a former registered representative ("RR") of Respondent's Aurora, Colorado branch office, engaged in various sales practice violations, including fraudulent mutual fund switching in at least seven customer accounts. Respondent failed reasonably to supervise the RR to prevent or detect the RR's mutual fund switching violations. During the violative period, Respondent had inadequate mutual fund switching procedures to prevent or detect the RR's misconduct. Further, Respondent did not have a system in place to communicate, implement, and enforce effectively the switching policies and procedures it did have.
C. Mutual Fund Switching Violations
1. Mutual fund switching involves "liquidating holdings of investment company shares and using the proceeds to purchase shares of various other investment companies." Charles E. Marland & Co., 45 SEC 632, 634 n.6 (1974). Mutual fund switching violates the antifraud provisions of the federal securities laws when a registered representative, in order to increase his compensation, induces investors to incur the costs associated with redeeming shares of one mutual fund and purchasing shares of another and the benefit to the customer does not justify the costs. See, e.g., In the Matter of Dean Witter Reynolds, Inc., Exchange Act Rel. No. 43215, 2000 SEC LEXIS 1772, at *3 (August 28, 2000).
2. From February through August 1999, on at least seven occasions, the RR engaged in improper mutual fund switching. He induced customers, most of whom were elderly and unsophisticated, to sell shares of one mutual fund and to use the proceeds to buy shares of another mutual fund from a different fund family. He did not inform these customers that they could have exchanged their current funds for different funds within the same fund family and thereby substantially reduced or eliminated any sales load. If they had done this, the RR and Respondent would have received little or no compensation for the fund exchange. He often solicited customers to purchase shares of mutual funds having nearly identical investment objectives to the funds being sold.
3. These transactions provided no economic benefit to the customers; however, they increased the commissions the RR and Respondent received.
4. The violative mutual fund switch transactions occurred without the prior approval of the RR's branch manager. Although the RR obtained a letter from these customers indicating the customers' authorization of the transaction (a "switch letter"),3 he never forwarded the switch letters to his branch manager for approval prior to the execution of the switch. In fact, several of the switch letters were obtained from his customers after the switch transaction had been executed.
D. Respondent's Systems Did Not Prevent or Detect Violative Mutual Fund Switching
1. Although Respondent had written procedures relating to mutual fund switching in effect during the violative period, the procedures were not reasonably designed to prevent and detect inappropriate mutual fund switching. In addition, the procedures were not effectively communicated to branch managers and there were few, if any, consequences for failing to follow the required procedures. As a consequence, Respondent registered representatives were allowed to switch their customers from one mutual fund to another without review or pre-approval.
2. First, Respondent's procedures in 1999 required both the registered representative and the client to sign a switch letter, which evidenced the particulars of the switch, before the execution of the trade. See n.3. These procedures were inadequate because the registered representatives had sole responsibility for completing the switch letter and for obtaining the customer's signature before the transaction. Respondent did not have a system in place to ensure that the switch letters contained accurate information and were signed by the customer before the trade. Moreover, no consequences existed for failing to obtain switch letters prior to the trade.
3. Second, under the Respondent's procedures in 1999, the branch manager was required to review the transaction before the trade, indicate his or her approval by signing or initialing the switch letter, and maintain a copy of all switch letters in a designated file. Respondent failed both to communicate effectively these procedures to branch managers and to enforce them. Respondent's branch managers were unaware of or confused about their pre-approval and record keeping responsibilities. During the relevant period, the procedures did not appear in Respondent's policy manual for branch managers and branch managers did not receive any other written notice of the procedures. In addition, there was no signature block on the switch letter form indicating that branch manager approval was needed. Moreover, Respondent had no mechanism to alert the branch manager of switching prior to the execution of the transaction. Respondent also failed to enforce its pre-approval and record keeping requirements. Switch transactions were routinely processed without any managerial review or pre-approval. In addition, Respondent's audit procedures did not require the compliance analyst to determine whether the branch manager had reviewed mutual fund switches prior to execution or whether the branch manager maintained switch files.
4. Third, Respondent's procedures in 1999 provided for a second review of switches by Respondent's compliance department through its analysis of a mutual fund switch exception report, commonly referred to as the switch blotter.4 Again, this review was inadequate to prevent and detect inappropriate mutual fund switching. The review consisted of little more than a request by the analyst to the registered representative for a copy of the switch letter for any switch that appeared in the switch blotter. If a switch letter did not exist, the registered representative was asked to obtain one after the fact. If a registered representative failed to forward a switch letter, there were no consequences. Moreover, there was no analysis of whether the switch met the customer's investment objectives or of the accuracy of the representations in the switch letter (including the reason for the switch).
E. Respondent's Failure to Supervise
1. Section 15(b)(4)(E) of the Exchange Act requires broker-dealers to supervise reasonably, with a view toward preventing violations of the federal securities laws, persons subject to their supervision. This section also provides a defense to broker-dealers who can show that they have "established procedures and a system for applying such procedures" which would be expected reasonably to prevent and detect such violations.
2. 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." See, e.g., Smith Barney, Harris Upham & Co., Exchange Act Rel. No. 21813, 1985 SEC LEXIS 2051, at *22 (March 5, 1985). In 1999, Respondent failed to meet its responsibility.
3. Respondent's procedures regarding mutual fund switching were deficient and could not reasonably be expected to prevent and detect violative mutual fund switching. The firm failed to communicate effectively to branch managers or enforce its requirement for managerial pre-approval of mutual fund switches and did not have a system to alert the branch manager that a mutual fund trade involved a switch. The registered representative had sole responsibility for completing all of the requisite information in the switch letter and Respondent had no system for verifying the information or ensuring that such letters were signed by the customer prior to the switch transaction. Respondent's procedures required an analytical review by the compliance department of the switches identified in the switch blotter; however, no such review took place.
The RR's mutual fund switches discussed above violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Based on the foregoing, Respondent failed to supervise reasonably the RR, a registered representative subject to its supervision, with a view to preventing violations of Section 10(b) of the Exchange Act and Rules 10b-5 thereunder, within the meaning of Section 15(b)(4)(E) of the Exchange Act.
In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer submitted by Respondent and to impose the sanctions specified therein.
Accordingly, IT IS ORDERED that:
A. Respondent be, and hereby is, censured pursuant to Section 15(b)(4) of the Exchange Act.
B. Respondent shall pay, within 30 days of the entry of the Order, disgorgement and prejudgment interest in the total amount of $3,245.19 and pay a civil money penalty of $150,000 to the United States Treasury. 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) hand-delivered or mailed to the Office of the Comptroller, U.S. Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (4) submitted under cover letter which clearly identifies the Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Katherine S. Addleman, Assistant Regional Director, Securities and Exchange Commission, Denver Regional Office, 1801 California Street, Suite 4800, Denver, Colorado 80202.
C. Respondent shall comply with its undertakings to:
1. Maintain the revised procedures it implemented in 2000 relating to mutual fund switching, including but not limited to procedures that require: (a) mutual fund switch letters to be presented to customers for signature prior to execution of the transaction; (b) written branch manager approval on the switch letter of all open-end mutual fund switch transactions prior to their execution for which the broker receives transaction-based compensation for execution; (c) mutual fund switch reports to be provided to regional compliance analysts for post-transaction review of appropriateness of the switch; and (d) a separate file for all switch letters generated under (a), maintained in each office of supervisory jurisdiction.
2. Retain, within 60 days of the date of the Order, at Respondent's expense, an Independent Consultant, acceptable to the Commission's staff, to conduct a review of Respondent's existing mutual fund switching procedures to ensure that they are adequate. The Independent Consultant will review whether the procedures have been effectively implemented, maintained, and followed. The Independent Consultant also will recommend such other procedures (or amendments to existing procedures), if any, as are necessary and appropriate to prevent and detect reasonably violative mutual fund switching. The Independent Consultant will submit, within 120 days of the date of the Order, to Respondent and to the Commission's staff, a written report (the "Initial Report") describing the review performed, his or her findings, and any recommendations.
3. Adopt and implement, within 150 days of the date of the Order, at Respondent's expense, such procedures recommended by the Independent Consultant in the Initial Report, except as set forth in paragraph III.C.4.
4. Advise in writing, within 150 days of the date of the Order, the Independent Consultant and the Commission's staff, of the recommendations from the Initial Report it considers unnecessary or inappropriate, if any. Respondent shall propose an alternative procedure, designed to accomplish the same objective, for any procedure to which it objects. The Independent Consultant will evaluate reasonably such alternative procedure and, if appropriate, either approve the alternative procedure or amend his or her recommendation. The Independent Consultant will submit, within 180 days of the date of the Order, to Respondent and to the Commission's staff, a written report identifying the alternative procedures or amended recommendations, if any, of which he or she approves, the reasons for the Independent Consultant's decision, and the time period within which Respondent will reasonably adopt and implement them (the "Supplemental Report"). Respondent will abide by the decision of the Independent Consultant.
5. Cooperate fully with the Independent Consultant, including obtaining the cooperation of Respondent employees or other persons under Respondent's control.
6. For the period of engagement and for a period of two years from the completion of the engagement, the Independent Consultant shall not enter into any employment, consultant, attorney-client, auditing, or other professional relationship with Respondent, or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity as such. Any firm with which the Independent Consultant is affiliated or of which he/she is a member, and any person engaged to assist the Independent Consultant in performance of his/her duties under the Order shall not, without prior written consent of the Denver Central Regional Office, enter into any employment, consultant, attorney-client, auditing or other professional relationship with Respondent, or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity as such for the period of the engagement and for a period of two years after the engagement.
D. With respect to the undertakings referred to in Section III.C., above, for good cause shown and upon timely application from the Independent Consultant or Respondent, the Commission's staff may extend any of the deadlines set forth in the undertakings. Furthermore, nothing herein will prevent Respondent from adopting additional policies and procedures or improving upon the policies and procedures adopted pursuant to the undertakings.
By the Commission.
Jonathan G. Katz
|1||The findings herein are made pursuant to Respondent's Offer of Settlement and are not binding on any other person or entity in this or any other proceeding.|
|2||On November 2, 1998, Norwest Corporation, owner of Norwest Investment Services, Inc. ("NISI"), purchased Wells Fargo & Company. NISI maintained its corporate identity until June 2000 when it became known as Wells Fargo Brokerage Services, LLC.|
|3|| The switch letter was a form created by Respondent. Respondent required its registered representatives to complete the form in which he or she indicated, among other things:
1) whether the transaction was solicited; 2) the names of the mutual funds being sold and bought; 3) sales charges; 4) loads; 5) original purchase date and amount of the fund being sold; and 6) the reason for the switch. The form had signature blocks for both the registered representative and the customer. The switch letter form used in 1999 by Respondent's registered representatives did not have a signature block for the branch manager or any other supervisor.
|4||Respondent's switch blotter was generated daily and listed accounts in which a sale and purchase of a mutual fund occurred within thirty days.|
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