UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 38001 / December 2, 1996 Administrative Proceeding File No. 3-8781 ------------------------------------ : In the Matter of : ORDER MAKING FINDINGS : AND IMPOSING REMEDIAL Stuart, Coleman & Co., Inc. : SANCTIONS WITH RESPECT et al., : TO STUART, COLEMAN : & CO. INC. : Respondents. : ------------------------------------ I. In connection with proceedings instituted on August 14, 1995 against Stuart, Coleman & Co., Inc. ("Stuart Coleman"), pursuant to Sections 15(b) and 19(h) of the Securities Exchange Act of 1934 ("Exchange Act"), Stuart Coleman has submitted an Offer of Settlement ("Offer") which the Securities and Exchange Commission ("Commission") has determined to accept. Solely for the purposes of these proceedings or any other proceeding brought by or on behalf of the Commission, or in which the Commission is a party, prior to a hearing pursuant to the Commission's Rules of Practice, and without admitting or denying the Commission's findings, except as to the jurisdiction of the Commission over it and over the subject matter of these proceedings and as to the findings of paragraph II.A., below, which are admitted, Stuart Coleman, by its Offer, consents to the entry of this Order Making Findings and Imposing Remedial Sanctions ("Order"). II. On the basis of this Order, the Order Instituting Public Administrative Proceedings and Stuart Coleman's Offer, the Commission finds that:-[1]- ---------FOOTNOTES---------- -[1]- The findings herein are made pursuant to Stuart Coleman's Offer of Settlement and are not binding on any other person or entity named as a respondent in this or any other proceeding. ==========================================START OF PAGE 2====== Background A. Stuart, Coleman, a New York corporation with its headquarters in New York, New York, has been registered with the Commission as a broker-dealer pursuant to Section 15(b) of the Exchange Act since March 1981. B. During the period from in or about September 1991 to in or about October 1993, Stuart Coleman maintained a branch office in West Palm Beach, Florida (the "branch office"). C. The manager of the West Palm beach branch office, who also was associated with Stuart Coleman as a registered representative, financed the expansion and operation of the branch office with funds loaned to him by Brian D. Paonessa ("Paonessa"). D. During the period from in or about February 1992 to in or about September 1992, Paonessa had an application pending with the Florida Division of Securities to be licensed as a registered representative with Stuart Coleman. During the period from in or about July 1992 to in or about September 1992, Paonessa was appointed by the branch manager as the operations manager of the branch office. Because of an internal inquiry and several complaints at Paonessa's former employer, the Florida Division of Securities refused to register him unless Stuart Coleman agreed to a special undertaking requiring, among other things, that Stuart Coleman "strictly supervise" him and prevent him from acting as a principal, supervisor or in any managerial capacity. On being informed of this in or about September 1992, Stuart Coleman withdrew the application. During the period from in or about September 1992, after withdrawal of Paonessa's application to be a registered representative, to in or about February 1993, Paonessa continued to perform certain administrative duties for the branch office on an unsalaried basis under the direction of the branch manager and maintained accounts with Stuart Coleman. E. At all times relevant herein, Stuart Coleman was responsible for: (i) supervising the branch manager, Paonessa, and the registered representatives of the branch office; and (ii) making sure that operations at the branch office were run in accordance with the rules and regulations of the Commission. The Underlying Violations F. No application for registration as a broker-dealer on Form BD had been filed or is in effect with the Commission pursuant to Section 15(b) of the Exchange Act with respect to Paonessa, L.P. Transfer Services, Inc. ("L.P. Transfer"), or the branch office's registered representatives. ==========================================START OF PAGE 3====== G. During the period from in or about March 1992 until in or about February 1993, L.P. Transfer maintained a securities account at Stuart Coleman. L.P. Transfer's office was at the same address as, and was contiguous to, Stuart Coleman's branch office premises. During all times relevant hereto, Paonessa was the sole owner and director of L.P. Transfer. H. During the period from in or about September 1992 to in or about December 1992, three registered representatives sold approximately $266,000 of limited partnership units from the Stuart Coleman branch office through L.P. Transfer. The limited partnerships were "sold away from" Stuart Coleman; that is, the limited partnerships sold through L.P. Transfer were not approved products of, nor executed through Stuart Coleman or any other registered broker-dealer. I. During the period from in or about September 1992 to in or about December 1992, Paonessa and the three registered representatives willfully violated, and the branch manager willfully aided and abetted violations, of Section 15(a) of the Exchange Act in that Paonessa and the three registered representatives, aided and abetted by the branch manager, acted and conducted business as a securities broker-dealer (and as such made use of the mails or means or instrumentalities of interstate commerce) to effect transactions in or to induce the purchase or sale of securities (other than exempted securities or commercial paper, bankers' acceptances, or commercial bills) otherwise than on a national securities exchange without being registered with the Commission in accordance with Section 15(b) of the Exchange Act. As part of the aforesaid conduct, Paonessa and the three registered representatives would and did engage in acts and practices described in Paragraphs II.C. through II.H., above.- [2]- ---------FOOTNOTES---------- -[2]- On March 13, 1996, by default, the Commission ordered that two of the former Stuart Coleman registered representatives cease and desist from violating Section 15(a) of the Exchange Act, be barred from associating with any broker or dealer with the right to reapply after three years, and pay disgorgement, prejudgment interest and a civil money penalty. On May 10, 1996, the Commission entered an order accepting offers of settlement submitted by Paonessa, the former branch manager and the third former Stuart Coleman registered representative. The Commission ordered that Paonessa cease and desist from violating Section 17(a) of the Securities Act of 1933, Section 10(b) and 15(a) of the Exchange Act and Rule 10b-5, thereunder and barred Paonessa from associating with any broker or dealer with the right to reapply in four years. The Commission ordered that the former branch manager and the former registered representative cease and desist from violating Section (continued...) ==========================================START OF PAGE 4====== Stuart Coleman's Failure to Supervise J. Stuart Coleman failed to supervise Paonessa with a view toward preventing and detecting the underlying violations. Despite the efforts of Paonessa, the branch manager and the registered representative to conceal their activities, Stuart Coleman was confronted with the following red flags: 1) Stuart Coleman knew that Paonessa was the subject of an internal inquiry and had several complaints against him involving limited partnership transactions at his former employer. In light of his history, the State of Florida required a special undertaking as a condition to employing Paonessa as a registered representative. Stuart Coleman ultimately refused to execute this undertaking because the firm was uncomfortable with his background; however, Stuart Coleman allowed Paonessa to remain on or about Stuart Coleman's branch premises as an unsalaried operations manager from July 1992 through September 1992 and thereafter through February 1993 to act as an unpaid assistant to the branch manager for various administrative purposes. 2) Stuart Coleman knew that Paonessa had loaned money to the branch manager to finance branch office operations. Stuart Coleman was also aware that the branch manager and Paonessa were business partners in a corporation unrelated to the branch office business, as well as good friends, and that the branch manager had been terminated from a prior employer for failure disclose his account at another broker-dealer. 3) In September 1992, Stuart Coleman refused to employ Paonessa as a registered representative because of the heightened supervisory responsibilities it would have to assume but nonetheless allowed him to remain on the branch premises. On several occasions following September 1992 after Stuart Coleman refused to employ Paonessa as a registered representative, Paonessa requested permission to engage in limited partnership transactions through Stuart Coleman. Stuart Coleman denied these requests. Stuart Coleman approved a customer account in the name of "L.P. Transfer;" Stuart Coleman knew that this stood for "Limited Partnership Transfer" and that the account was controlled by Paonessa. On several occasions, Paonessa unsuccessfully requested permission to engage in limited partnership transactions. In October 1992, in an effort to convince Stuart Coleman to permit them to participate in limited partnership transactions, the branch manager and Paonessa filed an application for membership on a limited partnership exchange; ---------FOOTNOTES---------- -[2]-(...continued) 15(a) of the Exchange Act and barred them from associating with any broker or dealer with the right to reapply in one year. ==========================================START OF PAGE 5====== the application was copied to Stuart Coleman's New York office. After receiving this application, Stuart Coleman contacted the branch manager and Paonessa and again denied them permission to engage in limited partnership transactions. Thus, Stuart Coleman was on notice that Paonessa wished to engage in limited partnership transactions, but thereafter conducted no independent inquiry into whether Paonessa was engaging in unauthorized limited partnership transactions. 4) Stuart Coleman was aware that the branch office transacted limited Stuart Coleman commission business. Stuart Coleman conducted no inquiry into what business, if any, did support the branch office payroll and into Paonessa's motive for continuing to fund the branch office's operations and performing duties on an unsalaried basis. K. Following a limited visit over a year earlier, Stuart Coleman did not conduct an on-site inspection of the branch office until February 1993. This in-person inspection was made contemporaneously with the Stuart Coleman official's travel to West Palm Beach to testify as an expert witness for Paonessa and the branch manager (who bore his travel expenses) in an unrelated matter. This inspection, which was limited to confirming the existence of certain records without a more detailed review, was inadequate in light of all of the circumstances surrounding these violations. During this visit, the inspecting Stuart Coleman official observed Paonessa's office adjacent to the Stuart Coleman branch offices. After actually viewing the premises, Stuart Coleman determined that the arrangements were problematic and, after later learning of certain of Paonessa's activities with respect to limited partnerships, Stuart Coleman instructed the branch manager to expel him from the premises and to terminate his accounts with the firm. L. Based on the foregoing, Stuart Coleman failed reasonably to supervise Paonessa with a view toward preventing and detecting his violations of Section 15(a) of the Exchange Act, within the meaning of Section 15(b)(4)(E) of the Exchange Act, in that: 1) Stuart Coleman, in view of the branch manager's dependence on financing from the Paonessa to operate the branch office (as well as the other matters set forth in paragraph II.J. 2), above), failed adequately to delegate responsibility for the supervision of Paonessa; 2) Stuart Coleman failed to institute and implement adequate compliance control procedures over the branch office because it failed to take measures including, but not limited to, conducting unannounced branch office inspections, using inspection criteria during on-site visits designed to detect and ==========================================START OF PAGE 6====== prevent the securities law violations underlying this proceeding; and 3) Stuart Coleman failed to place appropriate heightened supervisory procedures in place for Paonessa. III. In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions specified in Stuart Coleman's Offer of Settlement. Accordingly, IT IS HEREBY ORDERED THAT: A. Stuart Coleman be, and hereby is, censured. B. Stuart Coleman shall, prior to the close of business on the third business day following the issuance of this Order, pay a civil penalty in the amount of $ 25,000.00 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) delivered to the Comptroller, Securities and Exchange Commission, 450 5th Street, N.W., Washington, D.C. 20549; and (d) submitted under cover letter which identifies Stuart Coleman as the Respondent in these proceedings, and the Commission's file number in these proceedings, a copy of which cover letter and money order or check shall be sent to Mitchell E. Herr, Regional Trial Counsel, Southeast Regional Office, Securities and Exchange Commission, 1401 Brickell Avenue, Suite 200, Miami, Florida 33131. C. Stuart Coleman shall comply with its agreement and undertakings as follows: 1. Stuart Coleman shall refrain from opening any new branch office until it complies with the requirements of paragraphs III.C.5.(f) & (g) below. 2. Stuart Coleman shall close any existing branch office whose present manager leaves Stuart Coleman's employ prior to complying with the requirements of paragraphs III.C.5.(f) & (g) below. 3. Stuart Coleman shall conduct periodic, unannounced audits (following procedures that will be established by the Consultant -- see paragraph III.C.5.(a)(ii) below) of each of its branch offices as frequently as the circumstances may dictate, but in no event less frequently than twice yearly for the first two years following this Order and for the first two years of any new branch's operation. ==========================================START OF PAGE 7====== 4. Stuart Coleman shall prohibit any person from utilizing the facilities of its offices to conduct any business or perform any service unless that person is a Stuart Coleman employee and is either performing authorized Stuart Coleman business or an outside business activity that has been approved by Stuart Coleman. 5. Stuart Coleman further undertakes as follows: (a) Within 30 days of the date of this Order, Stuart Coleman shall retain an outside consultant (Consultant), not unacceptable to the Commission's staff, at Stuart Coleman's sole expense, to conduct a review of Stuart Coleman's internal procedures, policies and practices which reasonably could have detected and prevented the types of violations of the federal securities laws described above; the Consultant shall consider the addition of policies and procedures not currently in existence to enhance or improve said procedures, policies and practices wherever possible. The Consultant may retain such consultants as he or she shall deem necessary and appropriate for the task. At a minimum, the Consultant shall consider: (i) Stuart Coleman's internal procedures, which include a system of follow up, to adequately and effectively delegate supervisory duties from its home office to its branch office personnel, including branch office managers; (ii) Stuart Coleman's internal procedures related to its periodic audits of its branch offices, including but not limited to the frequency, nature, scope and substantive content of such audits; (iii) Stuart Coleman's policies with respect to supervision of its registered representatives' outside business activities (including periodic reviews of any bank, brokerage or other accounts related to its registered representatives' approved outside business activities conducted on Stuart Coleman's premises); (iv) Stuart Coleman's procedures for supervision of its registered representatives (including heightened supervisory procedures with respect to any registered representative who has a disciplinary history or one or more customer complaints unless Stuart Coleman, after taking reasonable steps, has determined that the customer complaint(s) is/are unfounded); and (v) Stuart Coleman's procedures to deter its registered representatives from conducting business other than that approved by Stuart Coleman or engaging in misconduct similar to that set forth above, as well as its procedures to detect such misconduct if it has occurred. ==========================================START OF PAGE 8====== (b) Stuart Coleman undertakes to cooperate fully with the Consultant in this review, including making such files, book, records and personnel available as the Consultant may reasonably request; (c) The Consultant shall make recommendations in the form of a draft written report, within 120 days from his or her retention by Stuart Coleman, that sets forth the Consultant's recommendations, if any, based on such review as to Stuart Coleman's internal procedures, policies and practices as described above. Stuart Coleman undertakes to provide a copy of the Consultant's report to the Commission's staff within five days of receipt of the report from the Consultant; (d) Within 30 days of the receipt of the draft report submitted by the Consultant, Stuart Coleman shall, in writing, advise the Consultant of those recommendations that Stuart Coleman has determined not to accept because they are unduly burdensome. Regarding any recommendation that Stuart Coleman believes is unduly burdensome, Stuart Coleman shall undertake to propose an alternative policy or procedure designed to achieve the same result. Stuart Coleman and the Consultant shall then attempt in good faith to reach agreement on any policy or procedure as to which there is a dispute. Stuart Coleman will, however, abide by the determination of the Consultant with regard thereto and adopt those recommendations reasonably designed to supervise the activity of Stuart Coleman employees as determined by the Consultant; (e) The Consultant shall complete the aforementioned reviews and submit a final written report thereon to Stuart Coleman and the Commission's staff within 60 days following the date of the draft report; (f) Within 30 days of receipt of the final report, Stuart Coleman shall file an affidavit with the Commission's staff stating that Stuart Coleman has put in place a system of internal procedures, policies and practices reasonably designed to prevent and/or detect the violations of the securities laws which gave rise to this proceeding, or is in the process of so doing and providing a reasonable estimate, not to exceed 30 additional days without the approval of the Commission's staff, as to when implementation shall be completed; and (g) Stuart Coleman shall conduct training seminars lasting at least eight hours (to be completed over a two-day period) the curriculum of which shall be determined by the Consultant pursuant to his review. The training shall be attended by all persons having supervisory and/or managerial responsibilities for its branch offices and shall apprise them of the policies, practices and procedures at Stuart Coleman, ==========================================START OF PAGE 9====== including, but not limited to, those policies, practices, and procedures contained in the Consultant's final report, at dates and places of Stuart Coleman's choosing within 60 days of the Consultant's submission of the final report. (h) To ensure the independence of the Consultant, Stuart Coleman: (i) shall not have the authority to terminate the Consultant, without the prior written approval of the staff of the Southeast Regional Office of the Commission; (ii) shall compensate the Consultant, and persons engaged to assist the Consultant, for services rendered pursuant to this Order at their reasonable and customary rates; (iii) shall not, without the prior written consent of the staff of the Southeast Regional Office of the Commission, enter into any legal, business, or other financial relationship with the Consultant, any firm with which he or she is affiliated or of which he or she is a member, or any person engaged to assist the Consultant in the performance of his or her duties under this Order, during the period of their engagements and for a period of two years following the completion of their duties described in this Order; and (iv) shall not be in and shall not have an attorney-client relationship with the Consultant and shall not seek to invoke the attorney-client or any other doctrine or privilege to prevent the Consultant from transmitting any information, reports, or documents to the Commission or its staff. By the Commission. Jonathan G. Katz Secretary