Initial Decision of an SEC Administrative Law Judge
In the Matter of
In the Matter of
January 28, 2000
William P. Hicks and William A. Rees for the Division of Enforcement, Securities and Exchange Commission.
Michael J. McAllister and Louis M. Lagalante for Respondent.
Lillian A. McEwen, Administrative Law Judge
Respondent Sandra Logay was charged with failing reasonably to supervise Daniel Zessinger with a view to preventing his violations of the federal securities laws. This Initial Decision concludes that Zessinger was subject to the supervision of Logay when he violated the federal securities laws, and that Logay failed reasonably to supervise him with a view to preventing his securities laws violations.
The United States Securities and Exchange Commission (Commission) instituted these proceedings on March 6, 1996, pursuant to Sections 15(b) and 19(h) of the Securities Exchange Act of 1934 (Exchange Act). The public hearing in this matter took place in St. Louis, Missouri between September 10-20, 1996. The hearing record consists of the testimony of 16 witnesses and numerous exhibits. I admitted 262 exhibits from the Division of Enforcement (Division) into evidence and 32 exhibits from Respondent and supplemented the record by an Order dated November 7, 1996.1
The Order Instituting Proceedings (OIP) alleges that Sandra Logay (Logay) was employed as branch office manager of the Chesterfield, Missouri branch office of Prudential Securities, Inc. (PSI)2 from 1989 through June 1994, where she was responsible for the direct supervision of the registered representatives. The OIP further alleges that between on or about November 30, 1990 through on or about May 30, 1992, Daniel Zessinger, a registered representative subject to Logay's direct supervision, engaged in various fraudulent practices with respect to the securities accounts of customers. According to the Division, Logay failed reasonably to supervise Zessinger with a view toward preventing his violations of Section 17(a) of the Securities Act of 1933 (Securities Act) and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. If I conclude that the allegations in the OIP are true, I must then determine what, if any, remedial sanctions are appropriate in the public interest against Logay pursuant to Sections 15(b) and 19(h) of the Exchange Act.
After the hearing the Division filed Proposed Findings of Fact and Conclusions of Law, its Post-Hearing Memorandum in Support of Proposed Findings of Fact and Conclusions of Law, and its Reply to Respondent's Proposed Findings of Fact and Conclusions of Law. Respondent filed Proposed Findings of Fact and Conclusions of Law, a Post-Trial Brief, and a Post-Trial Reply Brief.
I based the findings and conclusions herein on the entire record and on the demeanor of the witnesses who testified at the hearing. I applied preponderance of the evidence as the applicable standard of proof. See Steadman v. SEC, 450 U.S. 91 (1981). I considered and rejected all arguments and proposed findings and conclusions that are inconsistent with this decision. I find that the Division has proved that Logay violated the federal securities laws as alleged in the OIP.
Logay began her career in the securities industry in 1965 as a switchboard operator at Thompson McKinnon Securities, Inc. (T-Mac), then a registered broker-dealer. (Tr. 247-48.) In 1970, Logay received her Series 7 license. (Tr. 253.) By 1988, she was a branch office manager of T-Mac's Chesterfield, Missouri branch office, a position she retained after PSI took over the office in 1989. (Tr. 247-48.) Logay's position made her responsible for the direct supervision of the registered representatives in the branch office. (Joint Ex. 1, ¶ II.2.) Logay is presently vice-president of clearing operations for FFP Securities, Inc. (Tr. 1404.) Logay supervises the clearing operations staff, which processes order tickets for registered representatives. (Tr. 244-45.)
Between approximately November 30, 1990 and May 20, 1992, Zessinger was a registered representative employed at PSI's Chesterfield, Missouri office. Zessinger had been a registered representative at PaineWebber, Inc. (Joint Ex. 1, ¶ II.3.) While at PSI Zessinger looted the accounts of several customers, including Mildred Weir, Charles and Shirley Horel, and Don Stice. Zessinger effected unauthorized transactions, purchased unsuitable securities, and concealed his activities by selling fictitious mortgages and using the proceeds to cover losses.
Between November 30, 1990 and May 20, 1992, while associated with PSI, Zessinger effected transactions in the joint securities account of Martin and Mildred Weir (Mildred Weir account). (Joint Ex. 1, ¶ II.4.) Mildred Weir, now deceased, was a ninety-year old, partially blind widow with Alzheimer's disease when the account was opened in September 1990. (Joint Ex. 1, ¶ II.7.) Martin Weir, Mildred Weir's son, who had power of attorney, went to Zessinger, then employed at PaineWebber, and opened the account for Mildred Weir. Martin Weir informed Zessinger that the investment objective of the account was conservative and that the account was to finance his mother's living expenses, which would soon include the cost of a nursing home. (Joint Ex. 1, ¶ ¶ II.5-8.) A total of $117,913, Mildred Weir's life savings, was deposited into the account, primarily in a certificate of deposit. (Joint Ex. 1, ¶ ¶ II.5, 17.) Martin Weir transferred the account to PSI in December 1990 by signing the PSI new-account documentation in blank. (Joint Ex. 1, ¶ II.9.) Zessinger, unbeknownst to Martin Weir, later filled in "growth" and "speculation" for Mildred Weir's investment objectives. (Joint Ex. 1, ¶ II.9.) Martin Weir, a high-school graduate, worked from 1955 to 1993 in service, sales, and installation of heating and air-conditioning systems. (Joint Ex. 1, ¶ II.10.) He had limited investment experience and was not a sophisticated investor. (Joint Ex. 1, ¶ II.10.)
Between December 1990 and May 1992, Zessinger knowingly and intentionally effected unauthorized trades, including margin trades, in the Mildred Weir account; made material misrepresentations to the Weirs regarding the profitability of the account; churned the account; and effected unsuitable trades in the account. (Joint Ex. 1, ¶ II.35.) Martin Weir never authorized Zessinger to engage in margin trading; he did not know what a margin agreement was and did not understand margin trading. Moreover, Martin Weir never authorized Zessinger to trade in the Mildred Weir account without his approval. (Joint Ex. 1, ¶ ¶ II.18-19.)
Martin and his wife, Theresa Weir, received account statements, but they did not fully understand the statements. (Joint Ex. 1, ¶ II.22.) Between November 1990 and May 1992, Zessinger falsely told the Weirs that account statements reflecting losses were incorrect and that the Mildred Weir account was making money. Zessinger told the Weirs to disregard the account statements because of computer billing errors that soon would be corrected. (Joint Ex. 1, ¶ ¶ II.23-24.) In early 1991, Martin Weir discovered and objected to Zessinger's unauthorized trading in the Weir account. Zessinger again attempted to assuage Martin Weir's concerns by falsely claiming that the account was profitable. (Joint Ex. 1, ¶ ¶ II.20-21, 24.) When Martin Weir demanded that the account be closed, Zessinger falsely told the Weirs that liquidating the account would adversely affect "the market." (Joint Ex. 1, ¶ ¶ II.26-27.)
In May 1992, Martin Weir asked another broker-dealer to liquidate the account. (Joint Ex. 1, ¶ II.29.) During the eighteen-month period described above, Zessinger executed 109 transactions totaling $1,039,737 in Mildred Weir's account on an average monthly equity of $67,771. The commissions and margin interest/fees amounted to $48,349 and $5,841, respectively. The losses in the account amounted to $67,007.76. The annualized turnover rate was 10.2 and the break-even or cost-to-equity ratio was 53.3%. Finally, during this period, the vast majority of securities in the account were held less than three months. Specifically, 36.1% were held one month or less, 72.1% were held three months or less, 88.5% were held six months or less, and all were held less than nine months. (Joint Ex. 1, ¶ ¶ II.31-33.) When the securities purchased for the Mildred Weir account are classified from the speculative high-risk end of the spectrum to the good-quality investment grade end, 82.4% of the securities purchased by Zessinger are classified as speculative high-risk. Moreover, speculative securities represented 86.9% of the account's losses. At one point, 138% of the account equity (including margin) was invested in one CCC-rated junk bond. (Joint Ex. 1, ¶ II.32.)
Charles and Shirley Horel (the Horels) opened the Charles E. & Shirley J. Horel trust account (Horel trust account) at PSI through Zessinger in November 1991. Shirley Horel opened an IRA account at PSI through Zessinger in January 1992 (Shirley Horel IRA account). Charles Horel opened an IRA account through Zessinger at PSI in May 1992 (Charles Horel IRA account). (Joint Ex. 2, ¶ 39.) Both Charles Horel, sixty-seven years old, and Shirley Horel, sixty-six years old, had liquidated their pensions in lump-sum distributions totaling about $520,000. Other than an annuity valued at approximately $50,000, the pension distributions were the only liquid assets the Horels possessed. Their income consisted of the proceeds from the above described brokerage accounts and Social Security payments. (Joint Ex. 2, ¶ ¶ 40-41.) Their investment objectives for all of the accounts were long-term growth and tax-sheltered income. The Horels' goals were to protect their assets, sustain themselves through retirement, and leave something to their children; Zessinger was aware of these goals. (Joint Ex. 2, ¶ 41.) Nevertheless, and without the knowledge of the Horels, Zessinger marked "speculation" as an investment objective on the new-account documentation. The Horels never advised Zessinger that speculation was one of their investment objectives. (Joint Ex. 2, ¶ 42; Tr. 710-11, 771-72.) The Horels were not sophisticated investors and did not understand what it meant to be on margin. (Joint Ex. 2, ¶ 42; Tr. 714, 773.)
Between November 1991 and May 1992, Zessinger knowingly and intentionally effected unauthorized trades in the accounts, made material misrepresentations to the Horels regarding the accounts, churned the Horel trust account, and effected unsuitable trades in the Horel trust account and the Shirley Horel IRA account. (Joint Ex. 2, ¶ 55.) The Horels did not give Zessinger discretion to trade in their account without express prior approval, yet, after receiving permission to make an initial stock purchase in the Horel trust account, Zessinger immediately began trading in the account. (Joint Ex. 2, ¶ 43.) Moreover, although the Horels never knowingly signed a margin agreement and did not authorize Zessinger to engage in margin trading, Zessinger traded on margin in the Horel trust account. (Joint Ex. 2, ¶ 43.) Zessinger effected at least eleven unauthorized trades in the Horel trust account and at least one in the Shirley Horel IRA account. (Joint Ex. 2, ¶ 46.)
When trade confirmations alerted the Horels to unauthorized trading in their accounts, they demanded that Zessinger cease his activities. Zessinger was specifically instructed by Shirley Horel not to trade in the Shirley Horel IRA account and not to liquidate the Kemper mutual fund which had been transferred into the account. Despite Ms. Horel's instructions, Zessinger continued to make unauthorized trades and eventually sold the Kemper fund on May 11, 1992. (Joint Ex. 2, ¶ ¶ 47-48.) When the Horels asked Zessinger to cancel unauthorized trades, he falsely told them that the trades were "final" and that nothing could be done about them. (Joint Ex. ¶ 48.)
Finally, from January 23, 1992 until April 27, 1992, Zessinger induced the Horels to invest approximately $79,000 in purported government secured mortgages paying a high rate of return. Investors' funds, however, were not actually invested in mortgages, but were diverted to a Ponzi scheme run by Zessinger that made payments derived from the funds of subsequent victims. For example, in May 1992, the Horels received a payment of approximately $24,000 which Zessinger falsely represented was interest and/or principal due on the mortgage investment. Only after he was fired from PSI did the Horels learn that Zessinger had, without authorization, withdrawn funds from the Horel trust account to make the May payment. (Joint Ex. 2, ¶ 53.)
During the seven-month period described above, Zessinger executed 126 transactions totaling $1,905,635 in the Horel trust account on an average monthly equity of $236,991. The commissions and margin interest/fees amounted to $74,369 and $7,258, respectively. The losses in the account amounted to $96,150.40. The annualized turnover rate was 13.8 and the break-even or cost-to-equity ratio was 59%. Finally, during this period, the vast majority of securities in the account were held less than three months. Specifically, 44.4% were held one month or less, 80% were held three months or less, 95.6% were held six months or less, and the average holding period was twenty-six days. (Joint Ex. 2, ¶ ¶ 44, 51.) When the securities purchased for the Horel trust account are classified from the speculative high-risk end of the spectrum to the good-quality investment grade end, 96.2% of the securities purchased by Zessinger are classified as speculative high-risk. Moreover, speculative securities, including some bought on margin, represented 108.7% of the account's losses, totaling $104,517. (Joint Ex. 2, ¶ 50.)
Don Stice (Stice), seventy-seven years old, retired from the Brown Shoe Company in 1986, after forty-two years, taking a lump-sum pension payment of $225,000. After meeting Zessinger, Stice opened several accounts with him at PSI, including the W. Don Stice revocable trust account (Stice trust account), opened in January 1992, and the W. Don Stice IRA account (Stice IRA account), opened in December 1991. (collectively the Stice accounts). (Tr. 641.) Stice's investment objectives were conservative. Stice advised Zessinger that he was investing his retirement money and that the receipt of income and protection of his assets were important to him. (Tr. 641-43.) Stice was not a sophisticated investor. Prior to his retirement, the only experience he had in buying stocks was with the Brown Shoe Company and an employee stock purchase plan. (Tr. 637.) Stice had never heard of margin trading, did not understand it, and never received an explanation from Zessinger. (Tr. 645.) From January 1992 until May 1992, Stice had little understanding of the overall trading in his account. (Tr. 653.)
In December 1991, Stice signed the new-account documentation. Assuming "everything was on the up-and-up," he did not read it. (Tr. 644.) He was unaware that "speculation" was marked as an investment objective on his new-account form. (Tr. 646.) Stice's accounts were non-discretionary accounts, but after Stice signed the documentation, Zessinger immediately began trading in them. (Tr. 647, 649.) Stice never initiated the trades and learned of the unauthorized trading only after he received trade confirmations in the mail. (Tr. 648.) Zessinger also induced Stice to invest in fictitious "guaranteed mortgages," telling him that the mortgages were guaranteed Ginnie Maes which would appear on his account statements. (Tr. 650-51.) Zessinger knew this statement was false and that the "mortgages" were part of his Ponzi scheme. Ultimately, Stice made five investments, totaling over $50,000. (Tr. 653.)
Between December 1991 and May 1992, Zessinger executed fifty-one purchases totaling $649,449 in the Stice IRA account on an average monthly equity of $164,587, with commission fees of $30,443 and out-of-pocket losses totaling $24,196.59. (Div. Exs. 70-125, 69-124.) Out-of-pocket losses are calculated by adding: (1) realized trading gain (loss); (2) unrealized trading gain (loss); (3) dividends and interest; and (4) margin interest, fees, and adjustments. (Div. Ex. 69-124.) This total does not include losses traceable to the Ponzi scheme. (Tr. 872.) The annualized turnover rate was 7.9 and the break-even ratio was 37%, with the majority of securities in the account held less than three months. Specifically, 13.2% were held one month or less, 50.9% were held three months or less, and 92.5% were held six months or less, with an average holding period of approximately forty-five days. (Tr. 831; Div. Ex. 249-485.)
Between January 1992 and May 1992, Zessinger executed twenty-three purchases totaling $140,962 in the Stice trust account on an average monthly equity of $22,101, with commission fees of $4690 and out-of-pocket losses totaling $27,261.11. (Div. Ex. 70-125, 69-124.) The annualized turnover rate was 15.3 and the break-even ratio was 56.3%, with the vast majority of securities in the account held less than three months. Specifically, 50% were held one month or less, 80% were held three months or less, and 90% were held six months or less, with an average holding period of approximately forty-five days. (Tr. 831; Div. Ex. 249-485.)
The Stice IRA account had concentrations of securities which deviated from industry standards and were unsuitable. When the securities purchased for the Stice IRA account are classified from the speculative high-risk end of the spectrum to the good-quality investment grade end, 98.3% of the securities purchased by Zessinger are classified as speculative high-risk. Moreover, through May 1992 speculative securities represented 100.6% of the account's trading losses, totaling $37,457.03. (Div. Ex. 73-128.) When the securities purchased for the Stice trust account are classified from the speculative high-risk end of the spectrum to the good-quality investment grade end, 92.2% of the securities purchased by Zessinger are classified as speculative high-risk. Moreover, through May 1992 speculative securities represented 101% of the account's trading losses, totaling $22,836.81. (Div. Ex. 72-127.)
When PSI took over the Chesterfield office it had approximately twenty registered representatives and gross revenues of $1.8 million, with annual gross revenue averaging just under $200,000 per registered representative. (Tr. 249.) Because the office was losing money, Logay was pressured by Peter Archbold, regional director of PSI's southwest region, to increase office production. Archbold was dissatisfied with the number of registered representatives producing less than $200,000 and he instructed Logay to "upgrade [the office] via recruiting." (Tr. 250, Div. Ex. 90-146.) As of September 1990, the highest registered representative production in the branch, in annualized gross commissions, was $208,668. (Tr. 255.) In November 1990, Logay and Archbold met several times with Zessinger, then a registered representative at PaineWebber. Zessinger's annual production level for the preceding twelve months at PaineWebber had been $480,000. (Tr. 257.) Zessinger, who had almost 600 accounts under management at PaineWebber, was hired by PSI, commencing November 30, 1990. Zessinger received an up-front loan of $168,000 to move to PSI. (Tr. 265.) If Zessinger left PSI before repaying the loan, the amount due was to be charged against the office's production figures until it was repaid. (Tr. 1520.) Logay also received a bonus for recruiting Zessinger, and, after one year, a back-end bonus of $13,400 if Zessinger equaled his production from the preceding twelve months. (Tr. 272.)
Logay knew that Zessinger had two outstanding complaints, from customers Peacock and Hart, in connection with his employment at PaineWebber. (Tr. 258.) Logay also knew that the complaints alleged churning and misrepresentations. (Tr. 259; Div. Ex. 99-159.) Logay forwarded the complaints to PSI's Law Department before hiring Zessinger, in accordance with firm policy. (Div. Ex. 4-4; Tr. 1411-12.) Logay hired Zessinger as a registered representative with the approval of Archbold and other senior officials. (Tr. 266-68.) On the day Zessinger was hired, Logay spoke to Zessinger's former boss at PaineWebber, Chuck Roberts (Roberts). Roberts falsely told Logay that Zessinger had no outstanding problems beyond the Peacock and Hart complaints. (Tr. 262.) Shortly after hiring Zessinger, however, Logay became aware of another customer complaint against Zessinger related to PaineWebber. (Tr. 263.)
On December 3, 1990, during Zessinger's first week at PSI, Logay was called by Mary Ellen Tainer (Tainer), the daughter of Ethyl Mae Swinkunas (Swinkunas), an elderly, retired factory worker who had an account with Zessinger at PaineWebber. (Tr. 1565.) Zessinger had "traded away" her mother's life savings of $20,000, and Tainer called Logay to warn her about what kind of broker she had hired and to get an explanation for what happened to her mother's savings. (Tr. 1567.) Shortly after the argument with Logay, Tainer sent a four-page letter of complaint regarding her mother's account to the NASD, with copies to the Commission; George Ball, CEO of PSI; U.S. Senator Paul Simon; and Donald Marron and Chuck Roberts of PaineWebber. (Div. Ex. 113-182.) Logay never relayed the Tainer incident to anyone at PSI, including the Law Department, nor did she increase her supervision of Zessinger. (Tr. 328, 331.)
By February 25, 1991, Logay had reviewed at least seven Disclosure Reporting Pages (DRPs) completed by Zessinger relating to a number of complaints by PaineWebber customers, including the Word of Life Church, Peter Golio, Melvin and Edna Cramer, and Rose and Barney Lewis (Lewis). (Div. Ex. 125-195 through 130-200; Tr. 347-352.) The complaints, filed in December 1990 and January 1991, alleged unauthorized trading and misrepresentations by Zessinger while he was at PaineWebber. (Div. Exs. 106, 169, 101-162, 108-171, 111-178.) Because she accepted Zessinger's explanations and considered the claims baseless, Logay did not increase her supervision. (Tr. 333, 336-37, 339-40, 355.)
During February or March 1991, Syed Shahid Hussain (Hussain), a registered representative in PSI's Chesterfield office, advised Logay that Zessinger was misrepresenting to customers that Zessinger was a salaried employee and that he did not charge commissions to customers. (Tr. 620.) Several months later, in June or July, Hussain heard a customer, Herb Gudermuth, complain to Logay about Zessinger and an undisclosed $1600 markup on a bond transaction. (632-33.) On March 1, 1991, Logay saw a letter from Missouri state regulators that requested information about some of the above-described complaints. (Tr. 356; Div. Ex. 133-203.) Shortly thereafter in April 1991, Logay sent a signed letter to Pennsylvania state regulators falsely assuring them that she would directly supervise Zessinger and that PSI was aware of his "SRR summary history." (Tr. 365.)
In March 1991, pursuant to her periodic review of customer statements, Logay reviewed Zessinger's customer statements. (Tr. 361-62.) Logay's review revealed no problems. (Tr. 361-62.) However, Zessinger had been effecting unsuitable trades in and churning the Mildred Weir account since at least November 1990. Moreover, his pattern of truly egregious trading which represented a gross departure from industry standards was established by February 1991. (Tr. 911.) In March or April 1991, the Mildred Weir account appeared on the active account list. (Tr. 389-90; Div. Ex. 12-12.) PSI generated the active account list on a monthly basis; the list was an exception report wherein PSI identified customer accounts with a level of trading above parameters set by the Compliance Department. Although PSI procedures required Logay to have "substantive" and "personal contact" with Mildred Weir as soon as possible, Logay never met or spoke to the Weirs before May 1992. (Tr. 301; Joint Ex. 1, ¶ II.37.) Instead, Logay sent a letter, dated July 11, 1991, which was addressed to Mr. and Mrs. Weir, even though the account was held by Martin Weir and his mother, Mildred Weir. (Div. Ex. 25-29.) The letter merely thanked the Weirs for their business, inquired as to their satisfaction with PSI and Zessinger, and suggested that they "examine [their] accounts statements regularly and carefully." (Div. Ex. 25-29.) In June 1991, Logay had performed her quarterly review of Zessinger's customer account statements. Logay indicated on the Manager's Supervision Guide (MSG) checklist that she found no problems in the accounts. (Tr. 384-85.) Thus, shortly before sending the July 11 letter, Logay again failed to detect the churning and unsuitable trading in the Mildred Weir account.
On April 1, 1991, Logay met with two former Zessinger customers, Noletta Cline and Josephine Buntz, who were dissatisfied with Zessinger's actions as a registered representative at PaineWebber. (Tr. 357-59; Div. Ex. 135-209.) Logay assisted them in drafting a complaint letter against Zessinger and spoke to Zessinger about the incident. (Tr. 357-59; Div. Ex. 135-209.) Logay, however, did not feel it necessary to increase her level of supervision of Zessinger. (Tr. 360.) On April 17, 1991, the State of Missouri wrote to PSI requesting information concerning the Merle Cane (Cane) and Lewis complaints. Logay saw the letter and received a subsequent fax from PSI's Law Department with Cane's complaint letter attached. (Tr. 367-68; Div. Exs. 139-215, 142-218.) On April 22, 1991, Zessinger, with Logay's knowledge, withdrew his Wisconsin registration. (Tr. 369.) This action was taken shortly after Wisconsin state regulatory authorities began seeking information in connection with a number of his customer complaints. Two months later, Missouri regulators requested information about a complaint filed against Zessinger by PaineWebber customers Raymond and Joyce Link. (Div. Ex. 160-259.)
On April 23, 1991, the Chesterfield office was charged with one-half of a $375 loss on a Zessinger order-error. (Div. Ex. 123-193.) Two months later, on June 28, 1991, Logay signed off on a memo from Zessinger to customer Bob Livingston (Livingston). In the memo, Zessinger acknowledges placing a $3000 credit in Livingston's account related to a trade loss in Beauty Labs stock. (Div. Ex. 157-253.) Approximately three months later, on September 20, 1991, Logay authorized the crediting of $1174.90 to a customer account. Zessinger was charged for an unsecured debit of that amount in the customer account when the customer would not pay for a trade. (Div. Ex. 165-273.) Finally, on December 3, 1991, as a result of an order-error in the Woodmont account, $11,077 of a $39,677 loss was charged to Zessinger. (Div. Ex. 184-312; Tr. 448-52.)
On June 7, 1991, Logay saw additional DRPs regarding a number of Zessinger's pending complaints. Two of the DRPs, referencing the Cramer and Word of Life Church complaints, indicated that PaineWebber had settled with the clients for $6502.15 and $5023.12, respectively. The DRPs further indicated that PaineWebber would be seeking reimbursement for the entire Cramer settlement and contribution for the Word of Life Church settlement. (Div. Ex. 153-242.) Only three months earlier, however, Zessinger had told Logay that the complaints were baseless. (Tr. 355.) On June 17, 1991, Logay met with Royas J. Rosen (Rosen), a retired shop-machinist, who had invested approximately $30,000 in an account with Zessinger at PSI. Zessinger knew that the money was for Rosen's retirement and that he could not afford to lose it. (Tr. 593-95, 599.) Rosen complained to Logay that Zessinger had, among other things, churned his account and effected unauthorized trades. (Tr. 596-97.) Logay questioned Zessinger about the transactions, but he insisted the trades were authorized. (Tr. 412-13.) Rosen also told Logay that Zessinger had recently sent him an unsolicited, unexplained check for $1000. Logay asked no questions about the check, but rather asked why Rosen simply didn't cash it. (Tr. 600.) Rosen reduced his complaints to writing in a letter dated October 8, 1991, but he used an old address for the Chesterfield office and Logay never received the letter. Logay took no action in regard to Rosen's visit. (Tr. 412-13.)
A second PSI customer visited Logay in October 1991 to complain about activity in her account. Ann Larson (Larson), a sixty-two year old retiree with investment objectives of income and growth, had been Zessinger's client since August 1991. Larson complained that she did not understand the trading in her account. Logay assured her that there would be no further problems. (Tr. 1042-49.) Approximately one month later, Larson's CPA informed her that her account was being churned. Larson responded by making a second appointment to see Zessinger and Logay. (Tr. 1048-49.) On the day of the meeting, Zessinger was absent. (Tr. 1049-50.) At the meeting, Larson told Logay that she remained very unhappy with the trading in her account. Logay assured her that the account was not being churned and she actively discouraged Larson from filing an official complaint against Zessinger. (See Tr. 1049, 1051, 1055.) Logay also falsely told Larson that she would personally supervise her account. (Tr. 1052.) Although Logay knew that Larson's complaint involved churning and that Larson was very upset over the trading in her account, she failed to refer the complaints to PSI's Law Department. (Tr. 419-21, 495, 1497-98.)
In October 1991, a third individual dissatisfied with Zessinger, John Niblock (Niblock), met with Logay at the Chesterfield office to discuss the trading in his parents' account. (Tr. 563-64, 431.) On October 11, 1991, just prior to Niblock's meeting with Logay, Niblock's parents had sent a letter to Zessinger and Logay asking that their account be immediately "frozen [pending] further notice." (Div. Ex. 168-279.) At their meeting, Logay informed Niblock that the new-account documentation indicated Niblock's parents had chosen speculation as an investment objective and that the trading in the account corresponded to that objective. (Tr. 432.) Niblock responded that his parents were in their seventies and never would have chosen speculation as an investment objective. (Tr. 567, 585.) Logay did not refer this complaint to PSI's Law Department either, but instead told Niblock to file a complaint letter. Niblock's parents submitted a letter on February 13, 1992, asking that the portfolio be liquidated. (Div. Ex. 204-367.) The letter was never forwarded to the Law Department.
By October 23, 1991, Logay was aware of complaints against Zessinger by George Schulte and Timothy and Margaret McBride. (Tr. 381.) The complaints involved unsuitable trading, and churning and unauthorized trading, respectively. (Tr. 381; Div. Ex. 171-283, 191-327, 192-328.) During that same month, after state authorities recommended he withdraw his registration as a result of complaints and unanswered and delinquent DRPs, Zessinger withdrew his application for registration as a registered representative in South Carolina. Finally, by November 1991, Logay was also aware of unauthorized trading complaints against Zessinger in the Florence account and misrepresentations in connection with the Mattern account. (Tr. 437-40.) At no time did Logay increase her supervision of Zessinger in response to any of the aforementioned inquiries.
On November 21, 1991, John Messina (Messina), a representative of PSI's Compliance Department, began to investigate Zessinger's activities. Initially, Messina's investigation focused on trade corrections, cross trades, suitability, and credit restrictions. (Div. Ex. 260-400.) In preparation, he reviewed new-account documentation, monthly statements of trading activity, branch trade correction logs and order error stories, active account forms, cross trade reports, and personnel records for Zessinger. (Div. Ex. 260-400; Tr. 1084.)
By December 3, 1991, PSI management had determined that a branch office visit was required and sent Messina to Chesterfield to investigate Zessinger's trading. (Tr. 1083.) Although Logay had become increasingly concerned about the number of PaineWebber complaints leveled against Zessinger, the investigation resulted from the Compliance Department's review, not from complaints or information relayed by Logay from the Chesterfield office. (Tr. 384, 936-40.) Specifically, Steven J. Metz, Deputy Director of Compliance, initiated the investigation after employees of the Compliance Department became aware of cross trades in the account of an elderly customer of Zessinger. (Tr. 936-40, 1082-83.) During his one-day visit, Messina did not focus on a large number of Zessinger's accounts and did not speak to any of Zessinger's customers. (Tr. 1084.) Logay did not advise Messina of any complaints by Zessinger's customers, including Larson, Rosen, and Tainer, nor did she inform Messina that Hussain had alleged Zessinger was making material misrepresentations to customers or that Mr. Niblock had complained that his parents' new-account documentation erroneously listed speculation as an objective. (Tr. 1091-92.)
Messina interviewed Zessinger for more than two hours, focusing on trade corrections. (Tr. 1094.) He noted that on at least two occasions, trade corrections rather than sellouts were used when customers refused to pay for stock. (Tr. 1088.) Messina considered this "red flag" indicative of unauthorized trading. (Tr. 1088.) Moreover, Messina concluded that some of Zessinger's explanations for his actions were questionable. (Tr. 1086.) Messina informed Logay that he would get back to her with a detailed formal report, but he never did so. (Tr. 1452-62.)
Following the review, Messina met with Metz and reported his findings. Messina's concerns included possible cross trades, questionable trade corrections, and suitability issues. (Tr. 941-44.) Messina and Metz relayed their concerns to Archbold and Bartick. Metz recommended that Zessinger be terminated. (Tr. 946-47; Div. Ex. 259-414.) However, Howard Bartnick, Director of Compliance, and Archbold overruled this recommendation, and instead directed that Zessinger be placed under "enhanced supervision." (Tr. 946-47, 953; Div. Ex. 259-414.) Logay never learned of Metz's recommendation to terminate Zessinger, or that the recommendation had been rejected. (Tr. 1468.)
On December 17, 1991, Logay was in Archbold's Dallas office when Metz called and spoke to her about Messina's findings. (Tr. 952-53.) Metz informed her that Zessinger would not be terminated, but instead would be subjected to "enhanced supervision." (Tr. 1463, 1468-70.) This was the first time anyone from the Compliance Department or Regional Director's office had spoken to Logay about Zessinger since Messina's visit to Chesterfield. (Tr. 1462-63.) Metz and Logay discussed the enhanced supervision and on December 23, 1991, Logay sent a memo to Metz outlining the procedures she would follow. The memo stated that Logay would "continue" to call on active accounts; that in addition to reviewing and signing off on Zessinger's five-ways,3 Logay would speak to the affected clients to make sure they understood the activity in their accounts; and that Zessinger would "do smaller pieces and less volatile issues." (Div. Ex. 188-325.)
By the close of 1991, Zessinger had more complaints against him than any other broker in the office. No other broker had even two or three. Zessinger, however, had the highest gross production in the office, exceeding the next highest registered representative by more than $200,000. (Tr. 452-58.) During the enhanced supervision, Logay communicated frequently with the Compliance Department. (Tr. 1469.) During his February 1992 visit to the branch, Archbold at no time criticized Logay's performance of, or adherence to, the enhanced supervision procedures. (Tr. 1480.) In fact, in certain areas the enhanced procedures and Logay's supervision tempered Zessinger's conduct. For example, the number of trade corrections in Zessinger's accounts dropped sharply. For the last three months of 1991, Zessinger had thirty-two, thirty-eight, and twenty-five trade corrections, respectively. (Div. Ex. 248-461.) In contrast, in the first two months after imposition of the enhanced supervisory procedures, Zessinger had only five and eight trade corrections, respectively. (Div. Ex. 248-461.)
In March 1992, however, Logay discovered that Zessinger had executed a cross trade. Logay notified Messina and the Compliance Department. (Tr. 956.) Upon investigating the cross trade, the Compliance Department was able to determine that Zessinger, in contravention of PSI policy, was working with a stock promoter. (Tr. 956.) Zessinger's past conduct also continued to raise red flags. On January 8, 1992, Logay received a number of DRP responses to customer complaints relating to Zessinger's conduct at PaineWebber. These included Zessinger's response to the Schulte complaint alleging unauthorized trading, a response to the Stephan Memorial United Methodist Church complaint alleging unauthorized trading, a response to the John and Virginia Campbell complaint alleging unauthorized trading, a response to the McBride complaint alleging churning and unauthorized trading, and a response to the Augusta Grossman complaint alleging unsuitable and excessive trading. (Tr. 458-64; Div. Ex. 191-337, 193-339, 194-340, 192-338, 195-341.) In February 1992, Don Bell, who held power of attorney over the Mattern account, warned Logay that Zessinger was a "bad broker." (Tr. 477.) Later that same month, Messina telephoned Logay and informed her that the Compliance Department had noticed Regulation T violations involving Zessinger. (Tr. 1100.)
In January 1992, Logay completed the MSG checklist for the December 1991 cycle review. Logay indicated that she had reviewed Zessinger's accounts, including the Mildred Weir, Stice, and Horel accounts, and had found no problems, despite the improper activity in the aforementioned accounts. (Tr. 466-67; Div. Ex. 236-453.) Several months later, on March 31, Logay completed the MSG checklist for the March 1992 cycle review. Logay indicated that she had reviewed Zessinger's accounts and again had found no problems, despite the improper activity in the aforementioned accounts. (Tr. 491-92; Div. Ex. 236-453.)
The Stice IRA account appeared on the active account list on December 31, 1991. Logay talked to Stice by telephone in connection with the active account review. (Tr. 468.) She knew that Stice was retired and had been rolling over distributions from his IRA account. (Tr. 469.) Logay, however, did not discuss investment objectives, the presence of speculative securities, or the frequency of trading with him. (Tr. 469.) Logay merely inquired as to whether Stice had experienced any problems with his account. (Tr. 474.) On February 7, 1992, Logay signed the Active Account Review Information Form for the Stice IRA account and sent it to the Compliance Department. (Tr. 467-68; Div. Ex. 54-84.) On the Information Form, Logay noted that in regard to Zessinger's performance, Stice stated that he was "real pleased, Dan's a great watchdog." (Div. Ex. 54-84.)
During the relevant period, Stice participated in at least five "mortgage" investments, i.e., the Ponzi scheme, with Zessinger. One "mortgage" returned $9500 on a $6500 investment within thirty days, approximately a 600% annualized return. (Tr. 652-53, 667.) In an investigation interview following Zessinger's termination, Stice admitted to William Freilich, PSI's Associate General Counsel, that he attempted to prevent Logay from discovering the "mortgage" investments. (Tr. 1272-74.)
The Horel trust account also appeared on the active account list on December 31, 1991. In February 1992, Logay talked to the Horels by telephone in connection with the active account review. (Tr. 481-82.) Logay knew that the Horels were retired and would be living solely off the money from their accounts. (Tr. 484.) Nonetheless, Logay did not question the new-account form that designated speculation as the Horel's investment objective, nor did she question the numerous purchases of speculative securities including penny stocks and a junk bond in the account. (Tr. 484, 8486-87; Div. Ex. 31-42.) In fact, Logay did not discuss the Horel's investment objectives with them. (Tr. 484.) On February 25, 1992, Logay signed the Active Account Review Information Form for the account and sent it to the Compliance Department. (Tr. 481; Div. Ex. 34-45.) On the Information Form Logay noted that the Horels were "very satisfied [and] making money." The Information Form further noted that "Dan [is] doing a fine job." (Div. Ex. 34-45; Tr. 481-82.)
On March 31, 1992, Logay sent a note to Zessinger congratulating him on his "fantastic first quarter," and urging him to "[k]eep up the great and problemless business." (Tr. 495; Div. Ex. 212-381.) Shortly thereafter and as noted earlier, Logay completed the MSG checklist for the March 1992 cycle review. Despite the improper activity in the Mildred Weir, Stice, and Horel accounts, Logay found no problems in Zessinger's accounts. (Tr. 491-92; Div. Ex. 236-453.) Logay, however, became "uncomfortable" with Zessinger's purchase of junk bonds for some of his accounts. (Tr. 493.) She referred the matter to the Compliance Department in late April 1992. As a result, the Compliance Department launched a second investigation of Zessinger's activities. (Tr. 1488.)
On May 9, 1992, Allen Vest, a PSI customer, delivered four complaint letters to Logay, stating that Zessinger, among other things, made misrepresentations to Vest and effected unauthorized trades in Vest's account. (Div. Ex. 216-390, 217-391, 218, 392, 219, 393.) Zessinger was summoned to New York by the Compliance Department on May 18, 1992, where he was interviewed for two days by representatives of PSI's Law Department and Compliance Department. (Tr. 1261, 1495-96.) Following the interviews, Archbold received a message from the Law and Compliance Departments to terminate Zessinger. Archbold called Logay and instructed her to fire Zessinger upon his return to Missouri. (Tr. 1340.) Zessinger was fired by PSI on May 19, 1992. At the time of his firing, Zessinger owed PSI $105,000 on his up-front loan. It was standard PSI policy that whatever portion of the up-front loan remained would be deducted from the branch's profit. (Tr. 502-03.)
Logay was directly responsible for supervising the Chesterfield office during the time of Zessinger's employment. As branch office manager, Logay was PSI's "first line of defense" against unauthorized trades, unsuitable trading, and churning. (Joint Ex. 1, ¶ II.2; Tr. 934-35; 1299; 1302-05, 1588.) During the period of Zessinger's employment, Logay's supervisory duties as branch office manager were set out in PSI's Compliance Manual or the "Red Book," which Logay had read. (Tr. 275-76; Div. Ex. 4-4.) The Red Book was compiled pursuant to a Commission Order. Prudential-Bache Sec., Inc, 48 S.E.C. 372 (1986) (hereinafter Captain Crab Order). The Captain Crab Order was a consent order that resulted from supervisory deficiencies at PSI. Pursuant to the Captain Crab Order, PSI agreed to retain an independent outside consultant to review PSI's supervisory and compliance policies and procedures and to make recommendations to improve those policies and procedures. (Tr. 966, 1618-19; Div. Exs. 1-1, 2-2.)
In addition to her Red Book duties, Logay was also required to perform the tasks in the Manager's Supervision Guide (MSG), a checklist of actions that Logay was required to perform on a daily, weekly, and monthly basis. (Tr. 276.) Logay completed and signed the MSG checklist monthly. (Tr. 277.) The MSG form required Logay to review periodically each registered representative's customer account statements. Logay reviewed each registered representative's customer accounts at least quarterly. Logay's review was intended to identify trading irregularities including, among other things, suitability problems, unauthorized trading, and churning. (Tr. 277-78.) The MSG form also required Logay to review mistakes in customer accounts, corrected through five-ways. Logay knew that Zessinger had a high number of five-ways. (Tr. 286.)
Logay was further required to review daily the order tickets generated by the branch's securities transactions. (Tr. 280, 283.) Order tickets, among other things, could be used to spot unsuitable trading. Transactions involving orders greater than 1000 shares required advance approval from the branch office manager. Order tickets were sorted by registered representative and Logay was required to review order errors as they occurred. A common example of an order error would be the purchase by a registered representative of the wrong stock for an account. Logay knew that a pattern of order errors could be indicative of unauthorized trading and would be reason to question a registered representative. (Tr. 284-85.) Logay also knew that Zessinger had a high number of order errors. (Tr. 286.)
Another prominent deficiency noted by the Captain Crab Order was the PSI's active account procedure. Prior to the Captain Crab Order, PSI's computer system generated an "active account list" on a monthly basis. An account appeared on the active account list for a variety of reasons, including frequency of trading or commissions generated. According to the Red Book, "[n]o inference should be drawn from the appearance of an account on any report that the account is in any way being improperly handled." (Div. Ex. 4-4.) Branch office managers, nonetheless, were required to make some contact with customers whose accounts appeared on the listing. Customer contact was accomplished in a variety of ways. The most widely used method employed a generic "happiness letter" inquiring as to a customer's satisfaction with their account, rather than some method of personal contact between PSI and the customer. (Joint Ex. 2, ¶ 60.) The Captain Crab Order found that the branch office manager failed to communicate adequately with customers in accordance with the firm's active account procedure. (Joint Ex. 2, ¶ 57.) The Captain Crab Order required PSI to remedy the firm's deficiencies. Accordingly, PSI, with the aid of independent consultant Mahlon Frankhouser, reviewed and revised the active account procedures. (Joint Ex. 2, ¶ 59.)
Under the revised active account procedure, the branch office manager was directed to review the active account list and to require the registered representative to complete Part I of an Active Account Review Information Form for each of his accounts appearing on the active account list for the first time in any twelve-month period. Part I required the registered representative to provide information about the customer and the account. Following the completion of Part I of the form, the branch office manager was required to have an in-depth discussion with the registered representative about the nature of the account and the suitability of the trading in the account. Thereafter, the branch office manager was required "to make personal contact, either by meeting or telephone conversation, with these clients" unless an exception was granted by the Compliance Department. Part II of the form was to be used to memorialize the conversation between the branch office manager and client. The fully completed form, Part I and II, was retained by the branch office and a copy was forwarded to the Compliance Department. Any account reappearing on the active account list was to be recontacted by the branch office manager no less than annually. (Joint Ex. 2, ¶ 62.)
Archbold, Logay's supervisor during Zessinger's tenure, communicated to branch office managers that the active account procedure was the "number one way" to discover or avoid problems with an account. (Tr. 1302, 1309, 1311.) The procedure was, among other things, designed to detect churning, unauthorized trading, and unsuitable trading and concentrations; it also required the branch office manager to talk with customers and discuss their investment objectives, and whether the objectives were being met. (Joint Ex. 2, ¶ 71; Tr. 933-34; Div. Ex. 262-441.) Completion of the Active Account Review Information Form was critical because it documented that the branch office manager had reviewed the trading in the active account, discussed it with the registered representative, and personally contacted the customer to discuss the account. (Joint Ex. 2, ¶ 67.)
In October 1990, Archbold sent Logay a memo highlighting the importance of the active account procedure in avoiding compliance problems. (Div. Ex. 91-147.) Archbold also communicated the importance of the active account procedure to the branch office managers as frequently as he could, at least four times annually at management meetings and on an ongoing basis with frequent conference calls. (Tr. 1312-1314.) On October 17, 1991, Regional Administrator Robert Neylan (Neylan) sent a memo to all branch office managers, including Logay, reminding them that the active account procedure required a "substantive" conversation with the customer. (emphasis in the original). (Div. Ex. 169-281.) Archbold and Metz considered it necessary for the branch office manager to review with the client their investment objectives. (Tr. 930-31; 1312-13.)
Logay never received formal, personal instruction or training from PSI as to proper compliance with PSI's active account review procedure from the time she became employed at PSI through May 1992. (Tr. 1412-13, 1416.) Specifically, Logay never received detailed instruction on how to comply with the "personal contact" requirement of the active account procedure and PSI never explained to branch office managers the meaning behind the "substantive" requirement noted in Neylan's memorandum. (Tr. 1413.) Rather, when an account appeared on the active account list Logay merely contacted that individual and, after thanking them for their business, made general inquiries about the customer's satisfaction. (Tr. 295.) Logay never alerted customers to inappropriate trading in their accounts. Instead, her inquires usually consisted of nothing more than asking the client whether they had experienced any problems with or had any questions concerning their account. (Tr. 295, 310-12.) In connection with Chesterfield's March 1990 audit, Logay was cited for failing to make contact on four of the fourteen active accounts audited. Further, on April 25, 1991, Steven J. Metz, PSI's Deputy Director of Compliance, personally sent a memorandum to Logay instructing her to send in delinquent Active Account Review Information Forms. The memo warned that if Logay did not comply with the directive within two weeks, the matter would be forwarded to Retail Administration in New York. (Div. Ex. 144-221.)
Logay's supervisory obligations relating to customer complaints are covered in PSI's Red Book. PSI separated complaints into two categories: operational and non-operational. Non-operational complaints are defined as "written or oral complaints of misconduct in sales practices or of other legal or regulatory violations." (Div. Ex. 4-4.) Examples of non-operational complaints, according to the Red Book, include "complaints of unauthorized transactions, churning, misrepresentation, unsuitable trading and the sale of unregistered securities." The Red Book clearly sets forth that "[a]ll non-operational complaints are to be referred to the Law Department." (Div. Ex. 4-4.) Finally, the Red Book cautioned that recipients of written complaints, after forwarding the matter to the Law Department, "should not respond substantively to the complaint or in any way attempt to resolve the matter." (Div. Ex. 4-4.)
The Commission has repeatedly emphasized that the duty to supervise is a critical component of the federal regulatory scheme. See, e.g., John H. Gutfreund, 51 S.E.C. 93, 108 (1992). 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 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. In order to show that Logay's actions fall under these provisions, the Division must prove, by a preponderance of the evidence, that Zessinger violated at least one of the provisions of the Securities Act or Exchange Act, that Zessinger was subject to Logay's supervision, and that Logay failed reasonably to supervise Zessinger with a view to preventing Zessinger's violations.
The evidence establishes that during the period from on or about November 30, 1990 through on or about May 20, 1992, while he was employed by PSI, Zessinger, using jurisdictional means, willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder by engaging in a scheme to defraud investors via churning, unauthorized trades, unsuitable recommendations and misrepresentations, and omissions of material fact. Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder are the general antifraud provisions of the federal securities laws. Section 17(a) of the Securities Act makes it unlawful "in the offer or sale of" securities, by jurisdictional means, to: (1) employ any device, scheme or artifice to defraud; (2) obtain money or property by means of an untrue statement of material fact or omission to state a material fact necessary to make the statement not misleading; or (3) engage in any transaction, practice or course of business that operates as a fraud or deceit upon the purchaser. Section 10(b) of the Exchange Act and Rule 10b-5 thereunder proscribe similar practices "in connection with" the purchase or sale of securities.
An action under these provisions requires a showing of materiality and scienter. Aaron v. SEC, 446 U.S. 680, 691 & 697 (1980). Information is material if a reasonable investor would consider it important to an investment decision. TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). See also Basic Inc. v. Levinson, 485 U.S. 224 (1988). Scienter has been defined as a "mental state embracing intent to deceive, manipulate or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 195 n.12 (1976). Scienter is established by showing that the respondents acted intentionally or with severe recklessness. Hackbart v. Holmes, 675 F.2d 1114, 1117 (10th Cir. 1982). Recklessness is defined as "an extreme departure from the standards of ordinary care . . . which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it." Meyer Blinder, 50 S.E.C. 1215, 1229-30 (1992) (quoting Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir. 1977)). No scienter requirement exists for violations of Sections 17(a)(2) or 17(a)(3) of the Securities Act. Aaron v. SEC, 446 U.S. at 695.
Zessinger churned customer accounts. Churning occurs "when a securities broker buys and sells securities for a customer's account, without regard to the customer's investment interests, for the purpose of generating commissions." Olson v. E.F. Hutton & Co., 957 F.2d 622, 628 (8th Cir. 1992) (quoting Thompson v. Smith Barney, Harris Upham & Co., 709 F.2d 1413, 1416 (11th Cir. 1983)). See also Miley, 637 F.2d at 324; McNeal v. PaineWebber, Jackson and Curtis, Inc., 598 F.2d 888, 890 n.1 (5th Cir. 1979). The three elements of churning are: (1) control of the account by the broker, either explicit (discretionary trading) or de facto (through acquiescence, trust, or reliance); (2) excessive trading in light of the investor's trading objectives; and (3) scienter on the part of the broker. Hotmar v. Lowell H. Listrom & Co., 808 F.2d 1384, 1385 (10th Cir. 1987); Miley v. Oppenheimer & Co., 637 F.2d 318 (5th Cir. 1981); Mihara v. Dean Witter & Co., 619 F.2d 814, 821 (9th Cir. 1980); Shad v. Dean Witter, Reynolds, Inc., 799 F.2d 525, 529 (9th Cir. 1986). See also Nesbit v. McNeil, 896 F.2d 380 (9th Cir. 1990). Churning in itself has been held to violate Section 10(b) and Rule 10b-5 of the Exchange Act. Arceneaux v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 767 F.2d 1498 (11th Cir. 1985); Costello v. Oppenheimer & Co., 711 F.2d 1361 (7th Cir. 1983). Churning in the offer and sale of securities also violates Section 17(a) of the Securities Act. Lopez v. Dean Witter Reynolds, Inc., 591 F.Supp. 581 (N.D. Cal. 1984).
Zessinger controlled customer accounts. A formal discretionary account is not needed to demonstrate control. Mihara, 619 F.2d at 814; Newburger, Loeb & Co. v. Goss, 563 F.2d 1057, 1069-70 (2d Cir. 1977). With respect to non-discretionary accounts, such as those discussed herein, factors establishing de facto control include whether the customer is able independently to evaluate the broker's recommendations and exercise independent judgment. Follansbee v. Davis, Skaggs & Co., Inc., 681 F.2d 673, 676-77 (9th Cir. 1982) (citing Mihara, 619 F.2d at 814; Hecht v. Harris, Upham & Co., 283 F. Supp. 417 (N.D. Cal. 1968); Eugene J. Erdos, 47 S.E.C. 985, 989-90 (1983), aff'd, 742 F.2d 507 (9th Cir. 1984)); see also Carras v. Burns, 516 F.2d 251, 259 (4th Cir. 1975) ("The issue is whether or not the customer, based on the information available to him and his ability to interpret it, can independently evaluate his broker's suggestions."). Some additional factors to consider in determining whether or not a broker controlled an investor's account include: the investor's sophistication; the investor's prior securities experience; the trust and confidence the investor has in the broker; whether the broker initiates transactions or whether the investor relies on the recommendations of the broker; the amount of independent research conducted by the investor; and the truth and accuracy of information provided by the broker. 1 Stuart C. Goldberg, Fraudulent Broker-Dealer Practices, § 2.8[b] (1978).
Applying the above described criteria to the instant case, I conclude that Zessinger had de facto control over the accounts at issue. Zessinger's customers were unsophisticated investors with little or no prior securities experience. They did not understand their account statements and, except on the rarest occasions, never initiated transactions in their own accounts. Lastly, when the customers did raise questions about Zessinger's trading, he told them that the account statements that caused them concern were inaccurate. In short, the record clearly indicates that the reliance the investors placed in Zessinger, combined with their lack of understanding or experience in investment matters, resulted in his de facto control of their accounts. See Mihara, 619 F.2d at 821 (holding that control is established when the client routinely follows the recommendation of the broker); Hecht, 283 F. Supp. at 433 (finding control can be inferred from evidence that the customer invariably relied on the dealer's recommendations, especially when the customer is relatively naive and unsophisticated); Carras, 516 F.2d at 259; Follansbee, 681 F.2d at 676-77.
Zessinger traded customer accounts excessively. The gravaman of a churning claim is that the account at issue was traded in a manner that was excessive in light of the objectives and resources of the customer. 15A David A. Lipton, Broker Dealer Regulation, § 5.04[b] (1997 rev.). There is no single precise formula or method for determining whether an account has been churned. Craighead v. E.F. Hutton & Co., 899 F.2d 485, 490 (6th Cir. 1990); Nesbit, 896 F.2d at 383. The turnover rate, cost-to-equity ratio, and the days held analysis are all methods that may be used to determine excessive trading in an account. 1 Goldberg, supra, § 2.9[b].
The annual turnover rate of an account, which is the ratio of total purchases divided by the average equity, measures the number of times per year an account is turned over. Shearson Lehman Hutton Inc., 49 S.E.C. 1119, 1122 n.10 (1989). See also Shearson, Hamill & Co., 42 S.E.C. 811, 845 n.72 (1965); Reynolds & Co., 39 S.E.C. 902, 906 n. 10 (1960). In other words, the turnover ratio allows a determination to be made regarding "how many times in a given period the securities in a customer's account have been replaced by new securities recommended by the broker." Costello, 711 F.2d at 1369 n.11.
Although there is no specific turnover rate that is determinative of churning, an annual turnover rate in excess of six is generally presumed to reflect excessive trading. Arceneaux, 767 F.2d at 1502 ("The courts which have addressed this issue have indicated that an annual turnover rate in excess of six reflects excessive trading."); Mihara, 619 F.2d at 821. For the conservative investment objectives of the accounts in the instant case, the turnover rates here (Mildred Weir account, 10.2; Horel trust account, 13.8; Stice IRA account, 7.9; and Stice trust account, 15.3) are well above the levels necessary to conclusively establish excessive trading. See Arceneaux, 767 F.2d at 1502; Mihara, 619 F.2d at 821; Siegal v. Tucker, Anthony & R.L. Day, Inc., 658 F. Supp. 550, 554 (S.D.N.Y. 1987). See also Samuel B. Franklin & Co., 42 S.E.C. 325, 327-28 (1964) (finding that turnover rates of 3.5 and 4.4 are excessive); J. Logan & Co., 41 S.E.C. 88, 93-97, 99 (1962), aff'd sub nom., Hersh v. SEC, 325 F.2d 147 (9th Cir. 1963) (finding annualized turnover rates of 1.58 to 2.08 were excessive); First Securities Corp., 40 S.E.C. 589, 590 (1961) (finding annualized turnover rate of 1.7 was excessive); R.H. Johnson & Co., 36 S.E.C. 467, 472, 479-80, 485 (1955), aff'd, 231 F.2d 523 (D.C. Cir. 1956). The turnover rates in the instant case establish churning.
A further test of excessive trading examines the net amount of money invested and the transaction cost incurred. Referred to as the "break-even" or "cost-to-equity ratio," this method determines the percentage of return on the customer's average net equity needed to pay broker-dealer commissions and other expenses. See 1 Goldberg, supra, § 2.9[b]. In short, the break-even factor determines the rate of return that the account has to earn on an annual basis just to cover transaction costs, thus providing a gauge for measuring the damages done to an account by the churning violation. Id. Trading practices that require an account to appreciate in excess of 20% just to break even have been held to constitute churning violations. Peter C. Bucchieri, 61 SEC Docket 2771, 2777 (May 14, 1996) (finding excessive trading in account with break-even cost factors of 21% to 30%); Michael David Sweeney, 50 S.E.C. 761, 765 (1991) (finding excessive trading in account with break-even cost factors of 22% to 44%); see also 1 Goldberg, supra, § 2.9[b] (finding break-even cost factors of 16% presumptive of excess trading).
In the instant case, the substantial expenses incurred by Zessinger's customers were incompatible with their stated investment objectives. The break-even ratios in the relevant accounts (Mildred Weir account, 53.3%; Horel Trust account, 59%; Stice IRA account, 56.3%; and Stice trust account, 37%) are greatly in excess of the percentages necessary to conclusively establish excessive trading. There could have been no reasonable expectation that the accounts would earn a return sufficient to cover the costs of the transactions; the depletion in the accounts was caused by Zessinger's excessive trading as shown by the break-even ratios.
The days-held analysis demonstrates that Zessinger traded his customers' accounts excessively. This analysis measures the average period of time that each security was held before being sold. Courts have held that in the face of conservative investment objectives, "in and out trading" that results in the depletion of capital is indicative of churning. Costello, 711 F.2d at 1369; Karlen, 688 F.2d at 1204; Miley, 637 F.2d at 333; Carras, 516 F.2d at 258, Hecht, 283 F. Supp. at 435. An in and out pattern of trading exists when there is "a sale of all or part of the customer's portfolio with the proceeds immediately reinvested in other securities followed in a short period by the sale of the newly acquired securities." Hecht, 283 F. Supp at 435.
In the instant case, typical of churned accounts, the average positions were held for short periods of time. For instance, 72.1% of the securities held in the Mildred Weir account were held three months or less; 80% of the securities held in the Horel trust account were held less than three months; and 50.9% and 80% of the securities held in the Stice IRA account and Stice trust account, respectively, were held less than three months. I find that Zessinger's short-term trading strategy, specifically the in and out trading, was incompatible with the investment objectives of Mildred Weir, the Horels, and Stice and resulted in excessive trading. See Gerald E. Donnelly, 61 SEC Docket 47 (Jan. 5, 1996).
Zessinger acted with a high degree of scienter. The evidence clearly shows that Zessinger executed unsuitable securities transactions in the relevant customer accounts. More importantly, Zessinger understood the costs of his short-term trading strategy and, contrary to his customers' investment objectives, excessively traded their accounts. Zessinger, therefore, acted willfully and continued his fraudulent activity in order to generate large commissions. Zessinger also exercised control of the trading in his customers' accounts, excessively traded the accounts, and acted with scienter. I conclude, therefore, that Zessinger churned the four accounts, the Mildred Weir account, Horel trust account, Stice trust account, and Stice IRA account.
The record further establishes that Zessinger made material misrepresentations and failed to provide material information in connection with his trading in the aforementioned accounts. Zessinger misled his customers regarding the use of margin in their accounts, finality of trades, and so-called "guaranteed mortgages." Zessinger also misled his customers about their accounts' profitability; he falsely told his customers that their accounts were making money when, instead, they were losing money. He also falsely stated that account statements indicating losses were erroneous. Whether their accounts were profitable is a material fact which would have been very significant to his customers. Cf. Albert Vincent O'Neal, 51 S.E.C. 1128, 1131-32 (1994) (finding that salespersons violated antifraud provisions by, among other things, misleading customers regarding losses in their accounts).
Zessinger with scienter made unsuitable purchases of highly speculative securities for the Weirs, Horels, and Stice. All had told Zessinger they had conservative investment objectives and were not interested in speculation. Nonetheless, 82.4% of the securities purchased for the Mildred Weir account, 96.2% of the securities purchased for the Horel trust account, 98.3% of the securities purchased for the Stice IRA account, and 92.2% of the securities purchased for the Stice trust account, are classified as speculative high-risk. The record also clearly demonstrates that Zessinger repeatedly effected unauthorized trades in the Mildred Weir, Stice, and Horel accounts. Unauthorized trading, in general, violates the antifraud provisions when accompanied by deceptive conduct. Donald A. Roche, 64 SEC Docket 2042, 2050 (June 17, 1997); Laurie Jones Canady, 69 SEC Docket 1468, 1479-80 (Apr. 5, 1999). The deceptive conduct requirement is satisfied here by Zessinger's failure to inform his customers--before the trade was made--of the materially significant fact of a trade in their account and by the nondisclosure of the losses, fees, and speculative nature of the trading in the accounts.
In light of the aforementioned findings, I conclude that Zessinger's actions in connection with the Mildred Weir account, Horel trust account, Stice trust account, and the Stice IRA account violated the antifraud provisions of the securities laws: Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Section 17(a) of the Securities Act. Indeed, Logay has stipulated to this conclusion with regard to the Mildred Weir account and the Horel trust account. (Joint Ex. 1, ¶ II.35, Joint Ex. 2, ¶ 55.) These findings and conclusions are also consistent with those described in Daniel L. Zessinger, 62 SEC Docket 1604 (Aug. 2, 1996) (Initial Decision); 62 SEC Docket 3050 (Oct. 8, 1996) (Final Order of Commission).
Under the federal securities laws, the definition of a supervisor is extremely broad. The parties agree that Logay's position as branch office manager made her responsible for the direct supervision of the registered representatives in the Chesterfield branch office. Joint Ex. 1, ¶ II.2, 3. See also James J. Pasztor, 1999 SEC LEXIS 2193, at *19 n.27 (Oct. 14, 1999) (finding that a branch manager has supervisory responsibility so long as the manager occupies that position); John H. Gutfreund, 51 S.E.C. 93, 113 & n.24 (1992) (finding that a supervisor is one that possesses the "requisite degree of responsibility, ability, or authority to affect the conduct of the employee whose behavior is at issue"). I conclude that Logay's supervisory responsibilities covered all areas of the Chesterfield office, including sales, operations, and compliance.
I have concluded that Zessinger while subject to Logay's supervision violated the federal securities laws; I also conclude that Logay failed reasonably to supervise Zessinger with a view to preventing his violations. Establishing a breach of the duty of supervision is a fact-driven exercise. Arthur James Huff, 50 S.E.C. 524, 528-29 (1991) ("What may be a reasonable discharge of supervisory duties in one case can be unreasonable in another. A factual analysis is required in each case."); see also Louis R. Trujillo, 49 S.E.C. 1106, 1110 (1989). The Commission "[has] been careful not to substitute the knowledge, gleaned with hindsight, of actual wrongdoing by someone under a supervisor's control for an assessment of whether the supervisor's conduct was proper under the circumstances." James Harvey Thornton, 69 SEC Docket 49, 57 (Feb. 1, 1999) (concurring opinion of Commissioner Unger). Accordingly, the ultimate issue in this case is not whether Logay was a "model supervisor, but whether [her] supervision was reasonable supervision under all the attendant circumstances." Arthur James Huff, 50 S.E.C. at 528-29 & n.7. I conclude that it was not, and that as a result Logay failed reasonably to supervise Zessinger with a view to preventing his violations of the federal securities laws.
The Commission has articulated several long-standing principles regarding the requirements of reasonable supervision. See, e.g., John H. Gutfreund, 51 S.E.C. at 108 (1992) One clear principle is a vigorous response to red flags. The Commission has stated:
The supervisory obligations imposed by the federal securities laws require a vigorous response even to indications of wrongdoing. Many of the Commission's cases involving a failure to supervise arise from situations where supervisors were aware only of "red flags" or "suggestions" of irregularity, rather than situations where . . . supervisors were explicitly informed of an illegal act.
John H. Gutfreund, 51 S.E.C. at 108 (footnotes omitted).
Logay unreasonably ignored complaints that suggested irregularities, even before the period of enhanced supervision. Immediately upon hiring Zessinger, Logay was confronted with a wave of customer complaints relating to activity at his previous employer, PaineWebber. Complaints against Zessinger, relating to conduct at both PaineWebber and PSI, continued unabated throughout the relevant period. Logay's contention that she referred all complaints to PSI's Law Department in New York is contradicted by the record. The record shows that Logay failed to notify the Law Department of her discussions with Rosen, Larson, Niblock, Tainer, or Hussain. Logay should have recognized these exchanges as oral complaints, investigated them, and forwarded all of them to the Law Department.
Logay also unreasonably relied on Zessinger's unverified assurances regarding these complaints and failed to adequately follow-up the complaints or to impose enhanced supervisory procedures on Zessinger. Logay accepted Zessinger's assurances in spite of the fact that she knew in June 1991 that PaineWebber had consented to reimburse customers and to seek contribution from Zessinger for claims that he had insisted were baseless. Even where a supervisor's knowledge is limited to "red flags" or "suggestions" of irregularity, reliance on the unverified representations of supervised employees can provide a basis for a finding of deficient supervision. John H. Gutfreund, 51 S.E.C. at 108; see also Shearson Lehman Hutton, Inc., 49 S.E.C. at 1123 (1989). Reasonable supervision also requires "adequate follow-up and review when a firm's own procedures detect irregularities or unusual trading activity." Prudential-Bache Sec., Inc., 48 S.E.C. at 401. Logay contends that PSI's Red Book prohibited her from attempting to "in any way resolve" customer complaints. Logay, however, had an obligation to examine or investigate PSI customer complaints. Neylan, in fact, warned Logay, in the October 17, 1991 memo, that regulators would hold a branch office manager to a heightened standard of supervision with respect to registered representatives with prior known compliance problems. Failure to apply enhanced supervisory procedures to employees with a history of past improprieties may also constitute deficient supervision. Consolidated Inv. Services, 52 S.E.C. 582, 588-89 (1996) (holding that a registered representative "who previously evidenced misconduct can be retained only if he is subjected to a commensurably higher level of supervision"); Dan A. Druz, 52 S.E.C. 130 (1995); Frank J. Custable, Jr., 51 S.E.C. 855, 861 (1993); Donald T. Sheldon, 51 S.E.C. 59, 82 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995). In short, by accepting Zessinger's unverified assurances regarding the conduct at issue, failing to take simple and reasonable steps to investigate the numerous red flags and indications of irregularity, and failing to impose enhanced supervisory procedures on Zessinger, Logay failed to exercise reasonable supervision over Zessinger.
Like the supervisor in Pasztor, Logay contends that her supervision was reasonable in light of the sophisticated nature of the underlying illegal activity. In Pasztor, however, the Commission charged the supervisor with the responsibility of understanding the mechanics of wash trades and matched orders. Pasztor, 1999 SEC LEXIS 2193, at *5, *21. I credit the testimony of Mary Calhoun, the Division's expert witness, who opined that the illegal activity in the Mildred Weir account had been clearly established by February 1991. It was unreasonable that Logay did not understand the trading pattern at that time.
Logay's failure to comply with PSI's internal compliance procedures is also another basis for concluding that she failed reasonably to supervise Zessinger. As noted earlier, Logay, in contravention of established PSI policy, failed to relay a number of oral customer complaints and Hussain's concerns to the Law Department. Moreover, as to Larson, Logay dissuaded her from filing a written complaint, which, by Logay's own admission, would have resulted in Zessinger being fired. Logay also failed to comply with PSI's active account procedure. The Captain Crab Order clearly required branch office managers to do more than merely contact customers via a generic "happiness letter" when their names appeared on the active account list. Under the revised active account procedure, branch office managers were required to contact personally clients whose accounts were listed. Branch office managers were further instructed to have a "substantive" conversation with the customers about the trading in their accounts and about their investment objectives.
Logay's contact with the Weirs was both untimely and inadequate. Logay failed to contact the Weirs until at least three months after their names appeared on the active account list. When she did contact them, it was via letter dated July 11, 1991, not personal contact as required under PSI procedures. Moreover, the letter did not provide the Weirs with any warning that there might be a problem with the trading in their account, despite the fact that "truly . . . egregious" trading in the account was apparent as early as February 1991. As for the active account review of the Stice and Horel accounts, Logay's telephone calls to them in February 1992 were also inadequate. Logay had received the Archbold memo highlighting the importance of the active account procedure and the Neylan memo reminding branch office managers that the active account procedure required a "substantive" conversation with the customer. When speaking to Stice and to the Horels, however, Logay did not inquire as to their investment objectives, education, investing experience, or financial condition. Logay also failed to alert Stice and the Horels to the illegal trading activity in their accounts, specifically, the excessive trading, unsuitable concentrations of speculative securities, high commissions, and heavy use of margin. Logay should not have relied on Zessinger's customers to alert her to Zessinger's misconduct, but instead should have recognized a pattern of illegal trading. See Reynolds v. SEC, 39 S.E.C. 917 (stating that supervisors cannot rely on customers to complain).
Reasonable supervision requires "'strict adherence' to internal company procedures." Edwin Kantor, 51 S.E.C. 440, 446 (May 20, 1993) (quoting Nicholas A. Boccella, 49 S.E.C. 1084, 1086 (1989)). The Commission has sanctioned branch office managers, including PSI branch office managers, for failing to follow internal compliance procedures. See Prudential-Bache Sec., Inc., 48 S.E.C. 372 (1986); see also Albert Vincent O'Neal, 56 SEC Docket 2447, 2452-53 (May 26, 1994) (where branch office manager's failure to adhere to internal compliance procedures regarding monthly activity reports caused customers to go without warning that there might be a problem with the trading in their accounts); (Dale E. Barlage, 40 SEC Docket 1157, 1160 (Apr. 8, 1988) (sanctioning branch office manager who repeatedly failed to adhere to internal compliance procedures). Logay's failure to adhere to PSI's internal compliance procedures, especially her failure to report oral complaints and perform timely and adequate active account reviews, allowed Zessinger to continue to defraud his clients undetected. Accordingly, the aforementioned failures provide several bases for concluding that Logay failed reasonably to supervise Zessinger with a view to preventing his violations of the federal securities laws.
Section 15(b)(4)(E) provides a "safe harbor" or good faith defense to remedial actions for failure to supervise. The safe harbor test available to broker-dealers under Section 15(b)(4)(E) is also available to individuals charged under Section 15(b)(6). Under the safe harbor provision, no person may be deemed to have failed reasonably to supervise any other person when two conditions have been met:
(i) there have been established procedures, and a system for applying such procedures, which would reasonably be expected to prevent and detect, insofar as practicable, any such violation by such other person, and
(ii) such person has reasonably discharged the duties and obligations incumbent upon him by reason of such procedures and system without reasonable cause to believe that such procedures and system were not being complied with.
Logay contends that both prongs of the safe harbor test are satisfied and thus she should not be deemed to have failed reasonably to supervise Zessinger. I conclude that the first prong of the safe harbor test is satisfied. During the relevant period of November 30, 1990 until May 1992, PSI procedures, and the system for applying such procedures (as embodied, for example, in the Red Book, the MSG, and the Active Account Review Information Form) were well-established and could reasonably be expected to prevent and detect Zessinger's misconduct. Logay's actions, however, do not satisfy the second prong of the safe harbor test because they were not consistent with PSI compliance procedures. For instance, Logay failed to report oral complaints to the Law Department; discouraged customers from filing written complaints; and failed to adequately perform active account reviews. Moreover, as set forth more fully above, Logay failed reasonably to perform her duties and obligations with respect to supervising Zessinger. Logay, thus, is precluded from relying on the safe harbor.
I have concluded that the Division has established that Logay committed certain acts set forth in the OIP. Hence, the remaining issue is determining what sanction is appropriate. The governing standard in evaluating the propriety of administrative sanctions is whether the sanctions serve the public interest. The public interest analysis demands that several factors be considered, including:
the egregiousness of the defendant's actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant's assurances against future violations, the defendant's recognition of the wrongful nature of his conduct, and the likelihood that the defendant's occupation will present opportunities for future violations.
Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979) (quoting SEC v. Blatt, 583 F.2d 1325, 1334 n.29 (5th Cir. 1978)), aff'd on other grounds, 450 U.S. 91 (1981). The severity of a sanction depends on the facts of each case and the value of the sanction in preventing a recurrence. Berko v. SEC, 316 F.2d 137, 141 (2d Cir. 1963); Richard C. Spangler, Inc., 46 S.E.C. 238, 254 n.67 (1976); Leo Glassman, 46 S.E.C. 209, 211-12 (1975).
The Division recommends that Logay be barred from association with any broker, dealer, or municipal securities dealer. Although the Division makes clear its position that the sanction should not be limited to a bar from association in a supervisory capacity, I conclude that such a bar is the appropriate sanction in the public interest. Sections 15(b) and 19(h) of the Exchange Act authorize the Commission to impose a wide range of sanctions restricting the ability of brokers, dealers, and those persons associated with, or seeking to become associated with, brokers or dealers, to serve in the securities industry if the Commission determines that person has committed wrongful acts, subject to the public interest factors set forth above. Logay has no prior disciplinary history, although she has been employed in the securities industry for many years. While the underlying offenses committed by Zessinger were very serious, Logay did not act with a high degree of scienter, nor does the record before me indicate that the effects of her actions were particularly egregious. In fact, several of Zessinger's victims may well have been willing participants in his fraudulent Ponzi scheme. Although Logay's failures relate to only one employee, Zessinger's fraudulent conduct was spread over eighteen months and spawned a stream of red flags and complaints. Thus, Logay's failures as a supervisor were persistent, rather than isolated. Logay no longer supervises registered representatives, but her current position does present the opportunity for future violations. As for insight into the nature of her conduct or remorse, at the hearing, Logay did not explicitly recognize the wrongfulness of her conduct. However, she does admit that she could have done a better job of supervising Zessinger.
I have analyzed the Commission's recent decisions concerning the responsibility of supervisors, particularly Pasztor. Logay can draw little support from Pasztor. In Pasztor, the supervisor was overruled in his two attempts to halt or limit the wrongdoer's trading activities. Nevertheless, the Commission imposed a three-month supervisory and proprietary suspension. Logay's failure to conduct an independent investigation to determine whether Zessinger's activities violated the federal securities laws allowed Zessinger's criminal conduct to continue unabated for more than a year. Thus, she is more culpable than the supervisor in Pasztor.
I find merit, however, in Logay's contention that her employer, PSI, shares some of the responsibility for Zessinger's actions. The Commission has held that broker-dealers, such as PSI, must "provide effective staffing, sufficient resources and a system of follow up and review to determine that any responsibility to supervise delegated to . . . branch managers and other personnel is being diligently exercised." Mabon, Nugent & Co., 47 S.E.C. 862, 867 (1983). Furthermore, the NASD requires that members, such as PSI, maintain a continuing education program and evaluate their training needs annually and develop a written training plan. See NASD Membership and Registration Rule 1120(b)(2)(A) (Stat. Add. 13A). It is entirely possible that Logay was never sufficiently trained to perform the duties of a supervisor and I conclude that her incompetence should have been addressed by PSI. I credit her testimony that, in certain areas and as to certain procedures, she was ignorant of how to supervise Zessinger. The Compliance Department's lack of communication with Logay also contributed to her failure. Despite access to the same account information as Logay, the Compliance Department and Messina reviewed only a small percentage of Zessinger's accounts and failed to interview a single customer. (Tr. 1084.) Of course, Logay cannot escape all responsibility because of the Compliance Department's failure to recognize Zessinger's violations. Messina was not advised by Logay that PSI customers had complained about Zessinger's conduct, or that Hussain had alleged that Zessinger was misleading clients.
Logay was aware of the purpose and general findings of Messina's investigation and she did not believe that the Compliance Department review gave Zessinger a clean bill of health. (Tr. 1502). Logay's compliance responsibilities were not relieved pursuant to the compliance review, but the failure of PSI executives to sanction Zessinger or communicate clearly with Logay is a mitigating factor. Logay's failure to supervise Zessinger reflects the low priority PSI assigned to compliance. Accordingly, I conclude that the Division's request to bar Logay from association with any broker, dealer, or municipal securities dealer is too harsh a remedy. I conclude that it is in the public interest to bar Logay from acting in a proprietary or supervisory capacity with any broker, dealer, or municipal securities dealer. Thus, her present supervision of the FFP Securities, Inc. clearing operations staff is barred pursuant to this Order.
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.351(b), I certify that the record includes the items set forth in the record index issued by the Secretary of the Commission on February 4, 1997.
Based on the findings and conclusions set forth above,
I order, pursuant to Sections 15(b) and 19(h) of the Exchange Act, that Respondent Sandra Logay be, and she hereby is, barred from acting in a proprietary or supervisory capacity with any broker, dealer, or municipal securities dealer.
This order shall become effective in accordance with and subject to the provisions of Rule 360 of the Commission's Rules of Practice, 17 C.F.R. § 201.360. Pursuant to that rule, a petition for review of this initial decision may be filed within twenty-one days after service of the decision. It shall become the final decision of the Commission as to each party who has not filed a petition for review pursuant to Rule 360(d)(1) within twenty-one days after service of the initial decision upon such party, unless the Commission, pursuant to Rule 360(b)(1), determines on its own initiative to review this initial decision as to any party. If a party timely files a petition for review, or the Commission acts to review as to a party, the initial decision shall not become final as to that party.
Lillian A. McEwen
Administrative Law Judge
1 Citations to the exhibits offered by the Division and the Respondent, and to the transcript of the hearing, will be noted as "Div. Ex. ___," "Resp. Ex. ___," "Joint Ex. ___," and "Tr. ___," respectively.
2 PSI has been registered with the Commission as a broker-dealer since February 18, 1992. PSI is a full-service firm and a member of all the major exchanges. (Joint Ex. 1, ¶ II.3.)
3 Five ways, also referred to as cancels, rebills, and trade correction, covered, for example, a stock purchased for the wrong account that subsequently was transferred to the correct account. (Tr. 276.)
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