-------------------- BEGINNING OF PAGE #1 ------------------- UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION Securities Exchange Act of 1934 Release No. 36334 / October 4, 1995 Administrative Proceeding File No. 3-8864 --------------------------- : : In the Matter of : ORDER INSTITUTING : PROCEEDINGS PURSUANT TO LEWCO SECURITIES : SECTION 21C OF CORPORATION, : THE SECURITIES EXCHANGE ACT : OF 1934, MAKING FINDINGS, AND : IMPOSING REMEDIAL SANCTIONS Respondent. : : : --------------------------- I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that a public administrative proceeding be instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") to determine whether Lewco Securities Corporation ("Lewco") violated Section 7(c) of the Securities Exchange Act of 1934 ("Exchange Act") and Regulation T promulgated by the Board of Governors of the Federal Reserve System, 12 C.F.R. Sections 220 et seq. II. In anticipation of the institution of this administrative proceeding pursuant to Section 21C of the Exchange Act, Lewco has submitted an Offer of Settlement which the Commission has determined to accept. Solely for the purpose of this proceeding, and any other proceeding brought by or on behalf of the Commission or to which the Commission is a party and without admitting or denying the allegations contained in this Order Instituting Proceedings Pursuant to Section 21C of the Exchange Act, Making Findings, and Imposing Remedial Sanctions (the "Order"), except Paragraph III.A.1., which is admitted, Lewco consents to the institution of public administrative proceedings, and the findings and the imposition of the remedial sanctions set forth below. -------------------- BEGINNING OF PAGE #2 ------------------- III. On the basis of this Order and the Respondent's Offers of Settlement, the Commission finds-[1]- the following: A. FACTS 1. Respondent Lewco is a broker-dealer registered with the Commission pursuant to Section 15(b) of the Exchange Act. During the relevant period, Lewco was jointly owned by Wertheim Schroder & Co., Inc. ("Wertheim") and Hambrecht & Quist. 2. Background a. During 1993, Lewco provided clearing services for accounts introduced by various broker-dealers, including Donald & Company Securities, Inc. ("Donald"). Under the clearing arrangement with Donald, Lewco was responsible for monitoring Donald's compliance with Regulation T, 12 C.F.R. Sections 220.1 et seq., in the accounts introduced by Donald. b. On March 19, 1993, CRH Holdings, Ltd. ("CRH Holdings") opened a cash account at Donald. The CRH Holdings account at Donald was a prime broker account that cleared its trades through Lewco.-[2]- In exchange for clearing CRH Holdings' trades, Lewco received total fees of $11,402.50. 3. Trading Through Lewco a. When the CRH Holdings account was opened on March 19, securities having a value of about $216,000 were deposited into the account.-[3]- On April 5 and April 12, a total of approximately $80,000 in cash was deposited into the CRH Holdings account. No other funds were deposited into the CRH Holdings account before the account was closed in November 1993. b. Between March 1993 and November 1993, the CRH Holdings --------- FOOTNOTES --------- --------- FOOTNOTES --------- -[1]- The findings herein are solely for the purposes of these proceedings and are not binding on any other person or any respondent in any other proceeding. -[2]- A "Prime Broker Account" is an account at a registered broker-dealer that clears a customer's trades executed by one or more other registered broker-dealers. This system was developed by full-service firms to facilitate the clearance and settlement of securities trades for substantial retail and institutional customers. See Prime Broker Committee, SEC No-Action Letter (Jan. 25, 1994). -[3]- The value of these securities, absent their sale, is irrelevant for purposes of calculating the sufficiency of funds in the account within the meaning of Regulation T. 2 -------------------- BEGINNING OF PAGE #3 ------------------- account purchased over $7.5 million worth of securities. Virtually all of CRH Holdings' securities purchases were offset by a series of matching same-day sales. To settle these trades, Lewco, on at least 25 days, ascertained if there was sufficient cash in the account on a trade date basis to cover the largest purchase of the day; if there was sufficient cash for that purpose, Lewco would offset succeeding purchases against matching same-day sales and treat these purchases as fully paid. In so doing, Lewco failed to comply with Regulation T. c. Lewco treated the day's purchases as being paid for with the proceeds from offsetting same-day sales, as long as the balance in CRH Holdings' account was sufficient to pay for the largest single purchase in the account during the day. d. Lewco's clearing activity on June 17, 1993 illustrates the firm's practice. On the morning of June 17, the CRH account had an opening balance of $132,551 available for purchasing securities (plus an additional $37,125 in proceeds credited to the account from the sale of stock held "long" in the account from the previous day, for a total of $169,676). That day, June 17, Lewco settled the following securities purchases for CRH: Quantity Issuer Price/share Cost 1000 Shrs Burlington Resources $20 1/2 $20,500 1000 Shrs Burlington Resources 20 1/2 20,500 1000 Shrs Chase Manhattan Corp. 29 1/2 29,500 3000 Shrs Chase Manhattan Corp. 29 1/2 88,500 1000 Shrs Chase Manhattan Corp. 29 1/2 29,500 2500 Shrs Chase Manhattan Corp. 29 1/2 73,750 3000 Shrs Chase Manhattan Corp. 29 1/2 88,500 200 Shrs Department 56, Inc. 18 3,600 250 Shrs Department 56, Inc. 18 4,500 500 Shrs Providence Energy Corp. 19 9,500 1000 Shrs Varity Corporation 32 3/4 32,750 1000 Shrs Xerox Corporation 74 1/4 74,320 $ 475,420 e. Each of these purchases was directly offset by the settlement of the matching sale of the same securities, typically at a higher price. f. Using the above illustration, Lewco applied the $169,676 beginning balance to pay for the largest purchase in the account that day (in the example, the 3,000 shares of Chase Manhattan Corp. costing $88,500) and immediately credit the account with the proceeds from the matching sale (in this case, $88,692 from the sale of the 3,000 share block of Chase Manhattan Corp.). Lewco applied these matching sale proceeds toward the next purchase of stock that day. For example, Lewco applied the $88,692 in proceeds from the sale of Chase Manhattan Corp. to finance another purchase of securities, such as the 2,500 share block of Chase Manhattan Corp. As a result, Lewco's practice permitted a potentially unlimited number and amount of securities purchases to be cleared, as long as the balance in the account paid for the largest of these purchases and the purchases were offset by matching sales. g. Under the provisions of Regulation T, Lewco should have aggregated all of the purchases in CRH Holdings' account each day -- irrespective of sales -- to determine whether CRH Holdings had 3 -------------------- BEGINNING OF PAGE #4 ------------------- sufficient funds to pay for its purchases. Applying this rule to the above example, Lewco should have required the account to have a $475,420 balance to settle all of its purchases that day (rather than the mere $169,676) before crediting the account with the matching sale proceeds. B. APPLICABLE LAW 1. Section 7(c) of the Exchange Act provides in part: It shall be unlawful for any member of a national securities exchange or any broker or dealer, directly or indirectly, to extend or maintain credit or arrange for the extension or maintenance of credit to or for any customer - (1) on any security (other than an exempted security), in contravention of the rules and regulations which the Board of Governors of the Federal Reserve System shall prescribe . . . . 2. Regulation T promulgated by the Board of Governors of the Federal Reserve System, 12 C.F.R. Section 220.8(a) (Cash Account), provides in part: In a cash account, a creditor may - (1) buy for or sell to any customer any security if: (i) there are sufficient funds in the account; or (ii) the creditor accepts in good faith the customer's agreement that the customer will promptly make full cash payment for the security before selling it and does not contemplate selling it prior to making such payment; (2) buy from or sell for any customer any security if: (i) the security is held in the account; or (ii) the creditor accepts in good faith the customer's statement that the security is owned by the customer or the customer's principal, and that it will be promptly deposited in the account . . . . 3. Regulation T prohibits a broker from extending any credit to a customer in a cash account to effectuate either purchases or sales. A broker may buy securities for a cash account customer only if the customer has sufficient funds in the account to pay for all purchases independent of the sale proceeds to be received from the sale of those securities. Fed. Res. Staff Op., 2 Federal Reserve Regulatory Service, Part 5-616.11 (May 27, 1994). Likewise, a broker may sell securities for a customer's cash account only if the customer owns the securities and will deposit them in the account promptly. 4. Buying and selling the same security on the same day in a cash account without sufficient funds constitutes "free riding" and is prohibited by Regulation T. SEC v. Jury Matt Hansen, et al., 726 F. Supp. 74 (S.D.N.Y. 1989); Fed. Res. Staff Op., 2 Federal Reserve Regulatory Service, Parts 5-615.959 (Nov. 9, 1989), 5-616.11 (May 27, 1994) and 5-942.22 (March 16, 1993). Accordingly, a cash account cannot be used for day trading unless the account holds sufficient funds to cover all of the purchases made on a single day. "There is no regulatory support for [the] sequencing theory that funds in the cash account need cover only part of a day's transactions when the same securities are purchased and sold on the same day." Fed. Res. Staff Op., 2 4 -------------------- BEGINNING OF PAGE #5 ------------------- Federal Reserve Regulatory Service, Part 5-616.11 (May 27, 1994). See Fed. Res. Staff Op., 2 Federal Reserve Regulatory Service, Parts 5-615.971 (April 19, 1991); 5-615.958 (Oct. 25, 1988). 5. Lewco thus violated Section 7(c) of the Exchange Act and Regulation T by regularly extending credit to CRH Holdings to settle purchases for which the CRH Holdings account did not have sufficient funds to pay, absent the proceeds from offsetting sales. IV. Based on the above, the Commission finds that Lewco violated Section 7(c) of the Exchange Act and Regulation T in connection with its securities clearing operations. V. ORDER Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that Lewco cease and desist from committing or causing any violation, and any future violation, of Section 7(c) of the Exchange Act and Regulation T. IT IS FURTHER ORDERED that Lewco shall pay disgorgement in the amount of $11,402.50, plus reasonable interest of $1,548.36 to the United States Treasury. The $12,950.86 shall be paid within 10 days after the entry of this Order and shall be paid to the Treasury by postal money order, certified check, bank cashier's check or bank money order, payable to the order of the United States Securities and Exchange Commission. The payment shall be transmitted to the Comptroller, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington D.C. 20549, under cover of a letter identifying the name of and number of this administrative proceeding. A copy of the cover letter and payment shall be simultaneously transmitted to Richard H. Walker, Esq., Regional Director, Securities and Exchange Commission, 7 World Trade Center, New York, New York 10048, Attn: Lamond W. Kearse, Esq. IT IS FURTHER ORDERED, that Lewco shall comply with the undertakings set forth in its Offer of Settlement: A. Lewco shall implement such policies and procedures as may be reasonably expected to prevent and detect insofar as practicable any violation of Regulation T, 12 C.F.R. Sections 220 et seq., in particular, that purchases of securities, in accounts with respect to which Lewco has Regulation T compliance responsibility, are not paid for with the proceeds from sales of the same securities. B. Lewco shall retain an independent consultant not unacceptable to the Commission's staff, who shall review Lewco's clearing operations with respect to compliance with Regulation T and who shall make such recommendations as are necessary with respect to Lewco's policies and procedures so that they may be reasonably expected to prevent and detect insofar as practicable any violation of Regulation T, 12 C.F.R. Sections 220 et seq. Within 60 days after the entry of 5 -------------------- BEGINNING OF PAGE #6 ------------------- the Order, the independent consultant shall issue a draft report setting forth its findings and recommendations and shall forward the same to the Commission's New York Regional Office, 13th Floor, New York, New York 10048, to the attention of Lamond W. Kearse, Esq. Within 30 days of receipt of the draft report submitted by the independent consultant, Lewco shall, in writing, advise the independent consultant of those recommendations that Lewco has determined not to accept because they are unduly burdensome. Regarding any recommendation Lewco believes is unduly burdensome, Lewco shall undertake to propose an alternative policy or procedure designed to achieve the same result. Lewco and the independent consultant shall then attempt in good faith to reach agreement on any policy and procedure as to which there is a dispute. If there is a dispute over a policy or procedure recommended by the independent consultant then the independent consultant shall evaluate Lewco's alternative policy and procedure. The independent consultant shall complete the evaluation and submit a written final report to Lewco and the Commission's staff within 60 days following the date of the draft report. Within 30 days after of receipt of the independent consultant's final report, Lewco shall implement the recommendations contained in the independent consultant's report. By the Commission. Jonathan G. Katz Secretary 6