UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 38173 / January 15, 1997 ADMINISTRATIVE PROCEEDING File No. 3-9222 ______________________________ : : ORDER INSTITUTING PUBLIC In the Matter of : ADMINISTRATIVE PROCEEDINGS : PURSUANT TO SECTION 15(b) GKN SECURITIES CORP. and : OF THE SECURITIES EXCHANGE ROBERT H. GLADSTONE, : ACT OF 1934, MAKING FINDINGS, : AND IMPOSING REMEDIAL SANCTIONS Respondents. : AND CIVIL PENALTIES : ______________________________: I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest to institute public administrative proceedings pursuant to Section 15(b) of the Securities Exchange Act of 1934 ("Exchange Act") against GKN Securities Corp. ("GKN") and Robert H. Gladstone ("Gladstone"), and such proceedings are hereby instituted. II. In anticipation of the institution of these proceedings, GKN and Gladstone have each submitted an Offer of Settlement to the Commission, 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 set forth herein, except that they admit the jurisdiction of the Commission over them and over the subject matter of these proceedings, GKN and Gladstone each consent to the issuance of this Order Instituting Public Administrative Proceedings Pursuant to Section 15(b) of the Exchange Act, Making Findings, and Imposing Remedial Sanctions and Civil Penalties ("the Order"). ==========================================START OF PAGE 2====== III. FINDINGS On the basis of this Order and GKN's and Gladstone's Offers of Settlement, the Commission finds the following: -[1]- A. Respondents 1. GKN Securities Corp. At all times relevant to this proceeding, GKN has been and it is now registered with the Commission as a broker-dealer pursuant to Section 15(b) of the Exchange Act. GKN has its principal place of business in New York, New York. 2. Robert H. Gladstone Gladstone is an Executive Vice President of GKN. From January 1990 to May 1993, he was the Branch Manager of GKN's New York City office. B. Summary These proceedings arise out of supervisory failures during late 1991 and 1992 in GKN's New York City office. During that period, GKN and Gladstone failed reasonably to supervise a number of GKN registered representatives with a view to preventing certain securities laws violations. From 1990 through 1992, GKN hired a large number of registered representatives and grew rapidly. During this period, the number of customer complaints received by GKN rose substantially and included multiple complaints against certain registered representatives. All of the representatives reported to and were supervised by Gladstone. Gladstone did not regularly review the complaints or the conduct of the registered representatives who were the subject of the complaints. GKN and Gladstone failed to establish adequate supervisory procedures to monitor the sales practice activities of the registered representatives during this period. They also failed to have in place procedures to track customer complaints generally, to determine whether particular representatives had been the subjects of multiple complaints, or to adequately respond to the sales practice violations reflected by the complaints. ---------FOOTNOTES---------- -[1]- The findings herein are made pursuant to GKN's and Gladstone's Offers of Settlement and are not binding on any other person or entity in this or any other proceeding. ==========================================START OF PAGE 3====== C. Facts 1. The Growth of GKN's Sales Force and the Rise in Customer Complaints GKN was formed in the Fall of 1987. In January 1990, Gladstone joined GKN as Executive Vice President, the Branch Manager of GKN's office in New York City, and the third principal of the firm. Gladstone's previous employment had been as a branch manager with another firm, and unlike the other two GKN principals, he had experience in managing a retail sales force. Gladstone undertook to manage GKN's retail operations and to expand this aspect of the firm's business. Starting in January 1990, Gladstone began hiring large numbers of registered representatives and began to expand GKN's retail operations in New York City. The number of registered representatives in GKN's New York City office grew from 10 in January 1990 to 64 at the end of 1990, to 110 by the end of 1991, and to 157 by the end of 1992. Many of the brokers hired by GKN had little or no experience in the retail sale of securities. GKN did not require that a broker have any prior experience in the brokerage industry to be employed at GKN, so long as the individual had passed the National Association of Securities Dealer's Series 7 examination. Gladstone hired a number of brokers who he knew had affirmative responses to questions on the Form U-4 Disclosure Reporting Page concerning, among other things, the existence of prior customer complaints. Although in some instances GKN and Gladstone sought to apply special supervisory procedures to those individuals, the procedures often proved inadequate to monitor their activities effectively. Some of these individuals subsequently received multiple customer complaints regarding their sales practices while they were employed at GKN. During this period of GKN's rapid growth, the number of written customer complaints received by GKN increased sharply. During 1991, GKN received 39 written complaints about the sales practice activities of its individual brokers. During 1992, GKN received 151 such complaints. Many of the complaints contained multiple allegations of misconduct. Ten brokers in GKN's New York City office accounted for 126 of the 245 written complaints received by the firm from 1990 through 1993. Seven of those ten brokers received nine or more written customer complaints each. 2. Violations of Section 10(b) of the Exchange Act and Rule 10b-5 Thereunder by GKN Brokers During late 1991 and 1992, a number of GKN registered representatives, including those who were the subject of the highest number of customer complaints, engaged in sales practices ==========================================START OF PAGE 4====== that violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. These sales practices, which were described in written customer complaints, involved unauthorized trading in customer accounts and the failure to execute appropriately customer sale orders. 3. GKN's and Gladstone's Conduct Prior to the Fall of 1992, GKN and Gladstone did not employ any systematic method to track customer complaints received by the firm. Instead, GKN and Gladstone handled customer complaints on a case-by-case basis. GKN generally, in response to complaints received by the firm, reversed transactions and reimbursed customers or otherwise reached resolutions with customers. However, neither Gladstone nor GKN adequately inquired into the conduct of the registered representatives who were the subject of the complaints or into the overall pattern of the complaints. GKN and Gladstone also failed during 1991 and 1992 to devise or implement any supervisory strategy regarding the customer complaints or the underlying sales practice violations they reflected. GKN and Gladstone failed to institute a formal compliance training program prior to 1993. GKN and Gladstone also failed to include, in evaluating the performance of the firm's registered representatives, the absence or presence of customer complaints. -[2]- Gladstone did not take an active role in the day-to-day supervision of the sales practice activities of the firm's registered representatives. Rather than handling customer complaints himself, Gladstone generally relied on the firm's compliance personnel to handle and respond to those matters. -[3]- Gladstone did not, however, either orally or in writing, clearly delegate supervisory authority regarding customer complaints to the firm's compliance personnel. In May 1993, Gladstone's Branch Manager responsibilities were turned over to full-time compliance and supervisory personnel. ---------FOOTNOTES---------- -[2]- In addition, GKN failed in a number of instances to amend Forms U-4 for its registered representatives, as required, to reflect the receipt of certain customer complaints. -[3]- The growth of GKN's Compliance Department did not keep pace with the firm's expansion. GKN did not hire a full- time Compliance Director until September of 1991. In January 1992, GKN hired an Assistant Compliance Director and in May 1992 the firm hired a part-time Compliance Assistant. In September 1992, GKN hired a Chief Operating Officer, who, among other duties, had supervisory compliance responsibility. ==========================================START OF PAGE 5====== D. Legal Analysis 1. Legal Principles Section 15(b)(4)(E) of the Exchange Act authorizes the Commission to impose sanctions against a broker-dealer if the firm has: failed reasonably to supervise, with a view to preventing violations [of the federal securities laws], another person who commits such a violation, if such person is subject to his supervision. Section 15(b)(6) of the Exchange Act incorporates Section 15(b)(4)(E) by reference and authorizes the Commission to impose sanctions for deficient supervision on individuals associated with broker-dealers. As we have repeatedly emphasized, the responsibility of broker-dealers to supervise their employees is a critical component of the regulatory scheme under the federal securities laws. -[4]- Where a firm's retail operations have expanded rapidly through the hiring of large numbers of relatively inexperienced brokers, there is a particularly strong and obvious need to create and maintain effective supervisory and compliance procedures. Moreover, when a supervisor becomes aware of indications of wrongdoing by employees, he breaches his supervisory responsibilities if he fails reasonably to respond to those indications. -[5]- 2. The Failure to Supervise During late 1991 and 1992, a number of brokers in GKN's New York City office engaged in violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by engaging in unauthorized securities transactions in customer accounts and failing to execute customer sale orders. During this time, Gladstone was the Branch Manager and supervised all of the registered representatives in GKN's New York City office. Despite the firm's rapid growth and its hiring of inexperienced brokers, GKN and Gladstone failed to institute adequate procedures to supervise the sales activities of those brokers with a view to preventing violations of the federal securities laws in connection with unauthorized securities transactions in customer accounts and failing to execute customer sale orders. ---------FOOTNOTES---------- -[4]- See John H. Gutfreund et al., Exchange Act Release No. 31554 (December 3, 1992). -[5]- See William L. Viera, Exchange Act Release No. 26576 (February 28, 1989). ==========================================START OF PAGE 6====== Prior to 1993, GKN and Gladstone failed to monitor or review adequately one of the best available sources of information concerning broker performance -- customer complaints. The firm responded to complaints on a case-by-case basis, and failed to analyze a growing body of evidence of sales practice problems by particular brokers. This evidence included the receipt of large numbers of customer complaints, including multiple complaints of misconduct against certain registered representatives. Moreover, in a number of instances, GKN failed to amend Forms U-4 to reflect the receipt of customer complaints regarding the activities of its registered representatives. When Gladstone was confronted by indications of wrongdoing by employees he supervised, it was his responsibility to see that appropriate action was taken, either by himself or others. He failed to take appropriate action himself, or to require that others take such steps. Under these circumstances, Gladstone inadequately discharged his supervisory responsibilities. GKN also failed to have established procedures, or a system for applying those procedures, which together reasonably could have been expected to detect and prevent violations. -[6]- To the extent GKN and Gladstone were aware of recurring sales practice problems with certain brokers, inadequate preventive measures were instituted. Accordingly, GKN and Gladstone both failed reasonably to supervise persons subject to their supervision with a view to preventing violations of the federal securities laws. IV. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offers of Settlement submitted by GKN and Gladstone and impose the sanctions specified in the Offers of Settlement. Accordingly, IT IS HEREBY ORDERED that: A. GKN Securities Corp. shall: (i) within three (3) business days of the entry of this Order, pay a civil money penalty in the amount of $100,000 to the United States Treasury pursuant to Section 21B(a)(4) of the Exchange Act. 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 to the Comptroller, Securities and Exchange Commission, 450 ---------FOOTNOTES---------- -[6]- See Section 15(b)(4)(E). ==========================================START OF PAGE 7====== Fifth Street, N.W., Washington, D.C. 20549; and (d) submitted under cover letter which identifies GKN as a Respondent in these proceedings, the file number of these proceedings, and the Commission's case number, a copy of which cover letter and money order or check shall be sent to Colleen P. Mahoney, Deputy Director, Division of Enforcement, Securities and Exchange Commission, 450 Fifth Street, N.W., Stop 4-1, Washington, D.C. 20549; (ii) comply with its undertaking to implement and maintain policies and procedures reasonably designed to detect and prevent the types of violations of the federal securities laws which gave rise to these proceedings and which are described in this Order. GKN represents that, since the latter part of 1992, it has undertaken a number of specific efforts to improve its supervisory and compliance systems. GKN shall comply with its undertaking to maintain those policies and procedures or alternative policies and procedures designed to achieve the same purposes, except as those policies and procedures may be inconsistent with, or superseded by, any new policies or procedures adopted in accordance with paragraph A.(iii)(e) below; and (iii) comply with its undertaking to retain, at its sole expense, an Independent Consultant not unacceptable to the Commission's staff. (a) The Independent Consultant shall conduct a review of all GKN policies and procedures, including supervisory and compliance policies and procedures, related to the types of conduct of registered representatives which gave rise to this proceeding and which are described in this Order; (b) GKN shall cooperate fully with the Independent Consultant in this review, and in the review duties described in paragraph (g) below, including making such non-privileged information and documents available as the Independent Consultant may reasonably request and by permitting and requiring GKN's employees and agents to supply such non- privileged information and documents as the Independent Consultant may reasonably request; (c) GKN shall require the Independent Consultant to enter into an agreement, providing that: (i) for the period of the engagement and for a period of two years from the completion of the engagement, the Independent Consultant shall not enter into any employment, consulting, or attorney-client relationship with GKN, or any of its present or former officers, directors, employees or agents acting in their capacity as such; ==========================================START OF PAGE 8====== and (ii) 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 this Order shall not, without prior written consent of the Commission, enter into any employment, consulting or other professional relationship with GKN or any of its present or former officers, directors, 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) The Independent Consultant shall provide a written report to GKN and the staff of the Commission within six (6) months of the date of this Order. The report shall contain the Independent Consultant's recommendations concerning GKN's policies and procedures, including supervisory and compliance policies and procedures, related to the types of conduct of registered representatives which gave rise to this proceeding and which are described in this Order; (e) GKN shall adopt all recommendations contained in the written report of the Independent Consultant; provided, however, that as to any recommendation that GKN believes is unduly burdensome or impractical, GKN may suggest an alternative policy or procedure designed to achieve the same objective, submitted in writing to the Independent Consultant and the Commission's staff. GKN and the Independent Consultant shall then attempt in good faith to reach agreement as to any policy or procedure as to which there is any dispute and the Independent Consultant shall reasonably evaluate any alternative policy or procedure proposed by GKN. GKN will abide by the Independent Consultant's determinations with regard thereto and adopt those recommendations deemed appropriate by the Independent Consultant; (f) Within sixty (60) days of the receipt of the Independent Consultant's written report, GKN shall submit an affidavit to the Commission's staff stating that it has implemented the recommendations of the Independent Consultant and that it has in place a system of policies and procedures reasonably designed to prevent and detect the types of violations of the federal securities laws which gave rise to this proceeding and which are described in this Order; and (g) The Independent Consultant shall also conduct a review, on a random basis, without notice to ==========================================START OF PAGE 9====== Gladstone, to certify that Gladstone is complying with the terms of this Order, which suspend Gladstone from association with any broker, dealer, investment adviser, investment company or municipal securities dealer for a period of thirty (30) days, effective on the second Monday following the entry of this Order, and suspend Gladstone from association in a supervisory capacity with any broker, dealer, investment adviser, investment company or municipal securities dealer for a period of eleven (11) months immediately following the period of his suspension from association. The Independent Consultant shall file a report on a quarterly basis with the staff of the Commission certifying that Gladstone is complying with the terms of this Order and shall promptly notify the staff of the Commission and simultaneously counsel for GKN and Gladstone in the event that the Independent Consultant determines that Gladstone is not in compliance with the terms of this Order. B. Robert H. Gladstone: (i) be, and hereby is, suspended from association with any broker, dealer, investment adviser, investment company or municipal securities dealer for a period of thirty (30) days, effective on the second Monday following the entry of this Order; (ii) be, and hereby is, suspended from association in a supervisory capacity with any broker, dealer, investment adviser, investment company or municipal securities dealer for a period of eleven (11) months immediately following the period of his suspension from association; (iii) shall provide to the Commission, within ten (10) days after the end of the twelve (12) month suspension period described above, an affidavit that he has complied fully with the sanctions described in Sections IV.B.(i) and (ii) above; and (iv) is ordered to pay, within three (3) business days of the entry of this Order, a civil money penalty in the amount of $50,000 to the United States Treasury pursuant to Section 21B(a)(4) of the Exchange Act. 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 to the Comptroller, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549; and (d) submitted under ==========================================START OF PAGE 10====== cover letter which identifies Gladstone as a Respondent in these proceedings, the file number of these proceedings, and the Commission's case number, a copy of which cover letter and money order or check shall be sent to Colleen P. Mahoney, Deputy Director, Division of Enforcement, Securities and Exchange Commission, 450 Fifth Street, N.W., Stop 4-1, Washington, D.C. 20549. By the Commission. Jonathan G. Katz Secretary