UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
SECURITIES EXCHANGE ACT OF 1934
Release No. 51266 / February 25, 2005
File No. 3-11515
In the Matter of
NORMAN R. HESS
|ORDER MAKING FINDINGS AND IMPOSING REMEDIAL SANCTIONS PURSUANT TO SECTION 15(b) OF THE SECURITIES EXCHANGE ACT OF 1934.|
In connection with the public administrative proceedings previously instituted pursuant to Section 15(b) of the Securities Exchange Act of 1934 ("Exchange Act")1 Respondent Norman R. Hess ("Hess") 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 as to the Commission's jurisdiction over him and the subject matter of these proceedings, which are admitted, Respondent consents to the entry of this Order Making Findings and Imposing Remedial Sanctions pursuant to Section 15(b) of the Securities Exchange Act of 1934 as set forth below.
On the basis of this Order and Respondent's Offer, the Commission finds2 that:
1. Norman R. Hess, 69, resides in Fernandina Beach, Florida. Hess was president of a registered broker-dealer (the "Broker-Dealer") from 1994 through July 2000 and had overall responsibility for compliance matters at the firm. Hess holds Series 7, 8, 23, 27 and 63 securities licenses and has over thirty years of experience in the brokerage industry working at many large brokerage firms. Hess voluntarily left the Broker-Dealer in March 2001 and is currently employed at another brokerage firm.
The Ponzi Scheme
2. In December 1997, a customer ("Customer") opened a brokerage account (the "Account") at the Broker/Dealer. Beginning in June 1998 and continuing through the closing of the Account in September 1999 (the "relevant period"), Customer operated a Ponzi scheme in which he deposited approximately $6.3 million of investor funds into the Account. He told investors that he would use their funds to buy and sell securities through a brokerage account at Broker/Dealer in his name and under his management at Broker/Dealer. In most cases, Customer promised guaranteed returns of up to fifty (50%) percent in 90 days or less. Customer often provided investors with agreements at the end of the investment period, or at other times, rolling over the investment and purported profit. These agreements indicated a higher value of their investments than actually existed. Customer's investment strategy consisted of short-term trading of options and equities in the Customer Account using a momentum computer program.
3. Contrary to representations made to investors, Customer consistently lost money from his trading. Through December 31, 1998, Customer lost approximately $225,000 in the Account.
4. In 1999, Customer's trading in the Account, in stock and options, increased substantially. Between December 1998 and July 1999, the annual turnover ratio increased from 22 to approximately 189. His trading losses increased as well. For the nine-month period from January 1, 1999 through September 30, 1999, net losses in the Account exceeded $630,000. The Account lost money every month in 1999 with the exceptions of January and March.
5. Despite the fact that Customer was losing money in the Account, he paid more than $3.6 million to investors from the Account. In most instances, Customer paid earlier investors from deposits into the Account from later investors. Customer was dependent on new money from investors to keep his Ponzi scheme from crashing.
6. Customer's registered representative at Broker-Dealer substantially assisted Customer in furtherance of his Ponzi scheme by executing all the trades in the Account as well as by providing certain investors with information that had the effect of assuring the investors of the soundness of their investments.
Hess's Failure To Supervise
7. Hess was the Broker-Dealer's President and General Securities Principal. He was also the immediate and only supervisor of Customer's registered representative. The Broker-Dealer's Supervisory Procedures and Compliance Manual states that the "General Securities Principal" is responsible "for the supervision of all general securities representatives and their activities" and "for the daily review of order tickets and quarterly review of all trading activity."
8. Hess reviewed exception reports, which flagged the high level of trading in the Account, and signed five "active account" letters sent to Customer regarding the activity in the Account. Hess also examined the Account's order tickets on a daily basis, reviewed Customer's registered representative's commission runs on a monthly basis and active account compliance reports at least three times a year. As a result of this review, Hess was aware of the Account's large losses.
9. In accordance with firm procedure, Hess reviewed monthly statements that showed checks were being paid to third parties who had previously put money into the Account despite massive losses. As the immediate and direct supervisor of Customer's registered representative, Hess was responsible for conducting further investigation into whether Customer's registered representative was facilitating a violation of the securities laws. Hess did not discharge his supervisory duties and failed to investigate these "red flags.".
10. Commissions from the Account were approximately eight percent of the total commissions received by the Broker-Dealer during the period from October 1998 to September 1999. During this time, the Broker-Dealer served between 2,800 and 3,000 accounts. Commissions from the Account during this time amounted to one-third of the income of Customer's registered representative from the Broker-Dealer. Hess also knew that the Account was the Broker-Dealer's most active during the relevant time period. During its existence, Hess received an override on the Account of $5,828. From June through September of 1999 Hess received override commissions for his supervisory work totaling $17,784.17.
11. Although Hess was aware of the Account's heavy trading, large losses and large commissions and knew or was reckless in not knowing of 3rd party checks which were deposited into the Account, the funds provided to Customer by third parties for deposit into the Account as well as checks issued out of the Account to third parties who had previously deposited money into the Account despite massive losses, he did not investigate the conduct of Customer's registered representative or take appropriate reasonable steps to determine whether any illegal activity was occurring in the Account.
12. In addition, as president of the Broker-Dealer, Hess was ultimately and solely responsible for establishing supervisory procedures and a system to effectively implement those procedures. Hess failed to establish a system for implementing the Broker-Dealer's procedures that called for review of (a) incoming customer correspondence regarding customer accounts; and (b)
13. Because Hess failed to establish a system to implement these procedures, Hess and others at the Broker-Dealer failed to detect a pattern of unusual deposits and other unusual activity such as (a) that virtually none of the deposits into the Account were Customer's money; (b) that several third-party checks were deposited into the Account without appropriate approval as required by Fidelity's policies and procedures; (c) that numerous checks containing notations such as "loan," "investment," "stock" or "agreement" were deposited into the Account; and (d) that Customer wrote a number of checks from the Account to third parties who previously had written checks that were deposited into the Account despite massive losses. In addition, Hess failed to take action despite the Broker-Dealer receiving, during the first week of June 1999, correspondence from two of its customers instructing the firm to transfer all assets in their accounts at the Broker-Dealer to the Account. One of the letters stated that the purpose of the transfer was to have Customer manage the customer's funds. Had Hess implemented an adequate system to review this correspondence, in light of other red flags concerning this Account, this suspicious pattern of activity could have been detected and follow up taken, to uncover Customer's Ponzi scheme and the facilitation of such scheme by Customer's registered representative.
14. Had Hess ensured that the Broker-Dealer had a system in place to detect and take follow-up action in these areas, he could have detected and prevented violations of the securities laws. Hess's supervision was deficient as the Broker-Dealer's supervisory procedures did not provide for a meaningful review of records that would have alerted Hess and the Broker-Dealer to potential violations of the securities laws. Because Hess and the Broker-Dealer failed to establish adequate procedures and a system to implement these procedures, requiring an effective review of these records and/or an effective system to investigate and address the results of such a review, Hess and the Broker-Dealer failed to detect that Customer's registered representative was facilitating Customer's violation of the securities laws.
15. Hess did not reasonably delegate responsibility for seeing that the Broker-Dealer's procedures were implemented. As president of the Broker-Dealer, Hess was responsible for ensuring that the firm had a system in place to implement procedures and that all the procedures were followed unless and until he reasonably delegated particular functions to another person in the Broker-Dealer, and neither knew nor had reason to know that such person's performance was deficient. Consol. Inv. Serv., Inc., 1994 SEC LEXIS 4045 (Dec. 12, 1994) initial decision has become final, 52 S.E.C. 582 (1996). Hess never delegated supervisory responsibility to see that compliance procedures were implemented.
16. As a result of the conduct described above, Customer's registered representative aided and abetted Customer's violations of Section 17(a) of the Securities Act of 1933 ("Securities Act"), Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which prohibit fraudulent conduct in the offer and sale of securities and in connection with the purchase or sale of securities.
17. As a result of the conduct described above, Hess failed reasonably to supervise Customer's registered representative with a view toward preventing his aiding and abetting violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
In view of the foregoing, the Commission deems it appropriate, in the public interest to impose the sanctions agreed to in Respondent Hess's Offer. Accordingly, pursuant to Section 15(b) of the Exchange Act, it is hereby ORDERED that:
A. Pursuant to Section 15(b)(6) of the Exchange Act, that Respondent be, and hereby is, barred from association in any supervisory capacity with any broker or dealer.
B. Any reapplication for association by the Respondent will be subject to the applicable laws and regulations governing the reentry process, and reentry may be conditioned upon a number of factors, including, but not limited to, the satisfaction of any or all of the following: (a) any disgorgement ordered against the Respondent, whether or not the Commission has fully or partially waived payment of such disgorgement; (b) any arbitration award related to the conduct that served as the basis for the Commission order; (c) any self-regulatory organization arbitration award to a customer, whether or not related to the conduct that served as the basis for the Commission order; and (d) any restitution order by a self-regulatory organization, whether or not related to the conduct that served as the basis for the Commission order.
C. Respondent shall, within seven (7) days of the entry of this Order, pay disgorgement and prejudgment interest in the amount of $24,384.65 ($17,784.17 plus prejudgment interest) and a civil money penalty in the amount of $10,000 for a total payment of $34,385.65 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 Office of Financial Management, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Alexandria, Stop 0-3, VA 22312; and (D) submitted under cover letter that identifies Hess as a 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 Michael J. O'Leary, Senior Trial Counsel, Securities and Exchange Commission, Atlanta District Office, 3475 Lenox Road, N.E., Suite 1000, Atlanta, GA 30326-1232. Such civil monetary penalty may be distributed pursuant to Section 308(a) of the Sarbanes-Oxley Act of 2002 ("Fair Fund distribution"). Regardless of whether any such Fair Fund distribution is made, amounts ordered to be paid as civil monetary penalties pursuant to this Order shall be treated as penalties paid to the government for all purposes, including all tax purposes. To preserve the deterrent effect of the civil penalty, Respondent agrees that he shall not, in any Related Investor Action, benefit from any offset or reduction of any investor's claim by the amount of any Fair Fund distribution to such investor in this proceeding that is proportionately attributable to the civil penalty paid by Respondent ("Penalty Offset"). If the court in any Related Investor Action grants such an offset or reduction, Respondent agrees that he shall, within 30 days after entry of a final order granting the offset or reduction, notify the Commission's counsel in this action and pay the amount of the Penalty Offset to the United States Treasury or to a Fair Fund, as the Commission directs. Such a payment shall not be deemed an additional civil penalty and shall not be deemed to change the amount of the civil penalty imposed against Respondent in this proceeding. For purposes of this paragraph, a "Related Investor Action" means a private damages action brought against Respondent by or on behalf of one or more investors based on substantially the same facts as alleged in the Order in this proceeding.
By the Commission.
Jonathan G. Katz
1 The Order Instituting Proceedings in this matter was issued on June 8, 2004.
2 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