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Initial Decision of an SEC Administrative Law JudgeIn the Matter of
INITIAL DECISION RELEASE NO. 179
|
In the matter of DEAN WITTER REYNOLDS INC., | : |
INITIAL DECISION January 22, 2001 |
APPEARANCES: John S. Yun and Karen Hanson Wellman for the Division of Enforcement, Securities and Exchange Commission.
Jeffrey S. Facter and Susan Samuels Muck of Shearman & Sterling, and Michelle Bryan Oroschakoff of Morgan Stanley Dean Witter, Law Department, for Respondent Dean Witter Reynolds Inc.
Gilbert R. Serota and Gina M. Roccanova of Howard, Rice, Nemerovski, Canady, Falk & Rabkin for Respondent Dennis W. Peterson.
BEFORE: Robert G. Mahony, Administrative Law Judge
I. INTRODUCTION
Procedural Background
The Securities and Exchange Commission (Commission) instituted this proceeding by an Order Instituting Public Administrative and Cease-and-Desist Proceeding (OIP) dated August 26, 1998, pursuant to Sections 15(b), 19(h) and 21C of the Securities Exchange Act of 1934 (Exchange Act). The OIP alleges that Dean Witter Reynolds Inc. (Dean Witter), Henry L. Auwinger (Auwinger) and Dennis W. Peterson (Peterson) failed reasonably to supervise a registered representative subject to their supervision, and that Dean Witter willfully violated Section 17(a) of the Exchange Act and Rule 17a-3 thereunder. Dean Witter, Peterson, and Auwinger each filed answers to the OIP. Dean Witter and Peterson both asserted certain affirmative defenses in their respective answers.
Prior to the hearing, the Division of Enforcement (Division) sought summary disposition of various affirmative defenses asserted by Dean Witter.1 Upon consideration of the Division's motion, as well as Dean Witter's responsive filings, I issued an order stating that the Division's motion would be treated as a motion to strike affirmative defenses, and deferred ruling on the motion until after the hearing and the close of all the evidence.2 The evidentiary record does not support Dean Witter's affirmative defenses. Accordingly, the Division's motion to strike affirmative defenses is GRANTED.
On March 8, 1999, the Commission accepted Auwinger's Offer of Settlement. Dean Witter Reynolds Inc., Order Making Findings and Imposing Remedial Sanctions Against Henry L. Auwinger, 69 SEC Docket 886 (Mar. 8, 1999).3 Therefore, any reference to "Respondents" in this initial decision shall include only Dean Witter and Peterson.
A hearing was held in San Francisco, California on March 8-12, 15-17, 1999, during which the Division and Respondents introduced documentary and testimonial evidence.4 The findings and conclusions contained herein are based upon the record, my observation of testifying witnesses, all arguments and proposals of fact and law, as well as the relevant statutes and regulations. Preponderance of the evidence was applied as the standard of proof.5 All arguments, proposed findings, conclusions, and contentions put forth by the parties were considered and those consistent with this initial decision were accepted.
Allegations and Arguments
From January 1989 through September 1995, Michael J. Oberholzer (Oberholzer) was an account executive employed by Dean Witter at its branch office in Hayward, California (Hayward Branch). From 1990 to September 13, 1994, he was under the direct supervision of Auwinger, the Hayward Branch manager. From September 13, 1994, until September 1995, Peterson was the Hayward Branch manager responsible for the direct supervision of Oberholzer.
During his employment with Dean Witter, Oberholzer serviced numerous client accounts, including the accounts of Ruth Betz (Betz), Dr. Pearl Huey (Dr. Huey), Leona Svogar (Ms. Svogar), and Anne Marie O'Connor (O'Connor) (collectively, the "Four Clients").
The Division alleges that Oberholzer engaged in fraudulent conduct in the accounts of the Four Clients.6 The Division further alleges that Dean Witter and Peterson failed reasonably to supervise Oberholzer with a view towards preventing this conduct. The Division also alleges that Dean Witter willfully violated the securities laws by maintaining inaccurate books and records, and that Oberholzer aided and abetted this violation.
Both Dean Witter and Peterson argue that their supervision of Oberholzer was reasonable. Furthermore, Peterson argues that he had no duty to supervise Oberholzer prior to September 13, 1994, and that no underlying violations occurred in the Four Clients' accounts during his tenure as Hayward Branch manager. Both Dean Witter and Peterson argue they are insulated from the Division's failure to supervise claim by operation of the safe-harbor provision in Section 15(b)(4)(E) of the Exchange Act.
II. SUMMARY OF THE EVIDENCE
Dean Witter
Dean Witter is a Delaware corporation with its principal place of business in New York. It is a wholly-owned subsidiary of Morgan Stanley Dean Witter & Co., and engages in a general securities business. It is registered with the Commission as a broker-dealer and has approximately 400 branch offices throughout the United States.
The Hayward Branch is part of Dean Witter's Pacific region that includes fifty to sixty branch offices. (Tr. 526-27, 533-34.) There are approximately twenty-four account executives operating out of the Hayward Branch. (Tr. 298, 1216-17.) The small Dean Witter office in Fremont, California (Fremont Office) is a satellite office of the Hayward Branch and has a capacity for twelve account executives. (Tr. 298, 640-41.) The Hayward Branch manager is responsible for supervising operations at the Fremont Office. (Tr. 640-41.)
Michael Oberholzer
Oberholzer joined Dean Witter as an account executive at the Hayward Branch in 1989, after earning a bachelor's degree in business from St. Mary's College. (Tr. 689-90.) Oberholzer had no professional securities licenses when hired by Dean Witter and began a Series 7 training program paid for and conducted by Dean Witter. (Tr. 690-91.) After passing the Series 7 exam, Oberholzer received further training in Dean Witter's New York offices. (Tr. 691-92.) Oberholzer was terminated in September 1995 for violating Dean Witter policy regarding borrowing funds from clients. (Tr. 636-37, 699, 703.)
Henry Auwinger
Auwinger graduated from the University of California at Berkeley in 1970, earning a bachelor's degree in business administration. (Tr. 296.) Auwinger joined Dean Witter in 1975 as an account executive. In 1979, he became the branch manager of the Dean Witter branch office in Stockton, California. In 1983, Auwinger became a regional director for Dean Witter. In 1985, he became the branch manager for Dean Witter's San Francisco branch office, a position he held until 1990 when he became the Hayward Branch manager. On September 13, 1994, Auwinger became the branch manager of Dean Witter's Sacramento, California branch office. In December 1998, he left this position to again become an account executive. (Tr. 297-98.)
Dennis Peterson
Peterson earned a bachelor's degree in psychology from Stanford University in 1973, and a master's degree in education in 1976. In 1979, he became an account executive in Dean Witter's Cupertino, California branch office. In 1984, he was promoted to assistant branch manager for that office. In 1985, he became the branch manager of Dean Witter's Modesto, California branch office, a position he held until 1987 when he became branch manager of Dean Witter's Maritime Plaza branch office in San Francisco, California. He remained at the Maritime Plaza branch until he took over as Hayward Branch manager on September 13, 1994. (Tr. 584-85.)
The Four Clients
Ruth Betz and Pearl Huey
Betz and Dr. Huey resided in the same Hayward, California home from 1956 until September 1996 when Dr. Huey moved into a nursing home. (Joint Ex. 1, ¶1.) Betz, a nurse, worked with Dr. Huey, an anesthesiologist, from 1946 until 1978 when they both retired. (Joint Ex. 1, ¶2.) They also owned and operated a dog kennel from 1956 until 1986. (Joint Ex. 1, ¶ 3.)
In July 1989, they opened their first accounts at Dean Witter after receiving a "cold-call" from Oberholzer. (Joint Ex. 1, ¶5.) They both told Oberholzer that their investment objective was income. (Joint Ex. 1, ¶5.) Dr. Huey, who had no prior investment experience, was seventy-two years old and Betz was seventy-five years old at this time. (Joint Ex. 1, ¶4, Div. Ex. 48 at DWR006603, DWR000082.) They did not have cable television in their home, although they sometimes watched "Wall Street Week" on PBS. (Joint Ex. 1, ¶7, ¶14.)
During 1991 and 1992, Betz and Dr. Huey loaned Oberholzer several thousand dollars for the purchase of automobiles. Oberholzer frequently visited Betz and Dr. Huey at their home and brought them meals on several holidays, including Easter in 1995. (Joint Ex. 1, ¶8.)
Dr. Huey was in a rest home and considered incompetent to testify at the time of the hearing. (Tr. 662.) Therefore, the Division sought Betz's testimony to establish facts regarding Dr. Huey. (Tr. 653, 657-58, 662-65.) However, Betz was unwilling to testify as she felt physically unable to travel to the hearing. (Tr. 24, 660.) While the Division continued efforts to obtain her testimony by telephone, I encouraged the parties to enter into a stipulation of facts in lieu of her testimony. (Tr. 417, 522, 664-65, 672-77, 687.) Once completed, this stipulation was read into evidence.7 (Tr. 854-59, 863; Joint Ex. 1.) On the sixth day of the hearing, I ruled that the Division could make no further efforts to obtain Betz's testimony.8 (Tr. 1140-41.)
Leona Svogar
Ms. Svogar suffered a stroke three weeks prior to the hearing, rendering her unable to testify. (Tr. 23, 720.) Her son, Joseph Svogar (Mr. Svogar), with whom she had been residing for approximately three and one-half years, testified at the hearing. (Tr. 720.) Mr. Svogar was familiar with, and had personally met Oberholzer. (Tr. 721-22.)
Ms. Svogar was sixty-three years old when she opened her first accounts at Dean Witter.9 (Div. Ex. 50 at DWR2605.) Although her initial accounts were transfers from another broker-dealer firm, Mr. Svogar knew of no other investments his mother maintained while her accounts were at Dean Witter. (Tr. 734, 758-59.) He stated that his mother did not watch financial programs or financial news and he was unaware of his mother subscribing to financial newspapers or periodicals. (Tr. 729.)
Ms. Svogar had a tenth-grade education. She did not understand securities and relied on and trusted Oberholzer's judgment and investment advice. (Tr. 719, 724, 727-28.) She told Oberholzer her investment objectives were income and safety and Oberholzer assured her that these objectives could be accomplished. (Tr. 727.) Joseph Svogar was present when Oberholzer recommended an investment in Western Water Company (Western Water) to Ms. Svogar. (Tr. 724-25.) Oberholzer stated he had heard Western Water's stock was "going to go through the roof" and that an investment in Western Water would be wise. (Tr. 724, 749.) In reliance on Oberholzer's recommendation, Ms. Svogar instructed Oberholzer to invest in Western Water on her behalf. (Tr. 724.)
Ms. Svogar also relied on Oberholzer to explain documentation regarding her accounts. She received confirmation slips that she did not understand.10 (Tr. 728, 737-38, 754.) When she asked Oberholzer to explain them, he told her not to worry about the confirmation slips as they were bookkeeping materials and he had taken care of everything. (Tr. 728, 754.)
While an Oberholzer client, Ms. Svogar loaned Oberholzer and his wife $90,000 with no interest provision. The loan was memorialized by a promissory note prepared by Joseph Svogar and executed by Oberholzer and his wife on March 2, 1992. (Tr. 723-24; Div. Ex. 89.)
Anne Marie O'Connor
O'Connor contacted Oberholzer and opened her Dean Witter account pursuant to a recommendation from Ms. Svogar and Joseph Svogar. (Joint Ex. 2, ¶1, ¶5.) Mr. Svogar told O'Connor's son, J.W. Glaser (Glaser), that he was pleased with Oberholzer's handling of his mother's investments and felt Oberholzer was responsive, honest, and easy to talk to.11 (Tr. 747, 750.) Ms. Svogar felt that Oberholzer was supplying her with a good income and investing her money well. (Joint Ex. 2, ¶1.)
O'Connor opened her Dean Witter account in February 1994 with a $100,000 deposit, which represented approximately one-half of her assets, not including her home. (Tr. 320; Joint Ex. 2, ¶2.) O'Connor was seventy-eight years old at the time.12 (Div. Ex. 51 at DWR1714, DWR006632.) She authorized Glaser to discuss her account with Oberholzer and informed Oberholzer of this authorization. (Joint Ex. 2, ¶7.)
O'Connor made monthly withdrawals of $1000 from her account. (Joint Ex. 2, ¶9.) She received, read, and kept her monthly account statements. (Joint Ex. 2, ¶6.) She looked up some of her securities, including Western Water, in the daily newspaper and received information regarding Western Water from Oberholzer through the mail. (Joint Ex. 2, ¶8.)
O'Connor underwent hip replacement surgery on the first day of the hearing. She was in the hospital receiving intravenous pain medication and was unable to testify. (Tr. 24, 417, 522, 663-64, 685, 850, 863-64.) As with Dr. Huey, the parties entered into a stipulation of facts in lieu of O'Connor's testimony.13 (Tr. 863-64; Joint Ex. 2.)
Expert Witnesses
Norman Padgett
Padgett testified for the Division as an expert witness in the areas of suitability, churning and supervision. He earned a bachelor of science degree from Jackson College and entered the securities industry in 1961 as an account executive for Dean Witter. From 1964 to 1974, he was employed by Francis I. duPont & Company as branch manager, national sales manager, and national director of training.14 From 1974 to 1980, he was not active in the securities industry. (Tr. 794-95; Div. Ex. 1 at Tab E.)
From 1980 to 1981, he served as national director of recruiting for E.F. Hutton & Company. (Tr. 795; Div. Ex. 1 at Tab E.) From 1981 to 1987, he was employed by Lehman Brothers as manager of the firm's Chicago office, and subsequently its Los Angeles office.15 (Tr. 795-96; Div. Ex. 1 at Tab E.) He also served as national sales manager for slightly over a year, overseeing twelve branch offices. (Tr. 795-99; Div. Ex. 1 at Tab E.) Since 1987, Padgett's primary employment has been as an expert witness in securities matters. (Tr. 796.)
Robert Kleinburg
Kleinburg testified for Respondent Dean Witter as an expert witness regarding securities industry practice between 1990 and 1995. He opined on the reasonableness of Dean Witter's supervisory systems and procedures, including the compliance department's performance. (Tr. 1475-76.) Kleinburg graduated from the Columbia University School of Law in 1961 and served as a trial attorney for the Commission from 1962 to 1965. From 1965 to 1967, he was employed by a private law firm emphasizing corporate and securities law. From 1967 to 1971, he served as counsel to two brokerage firms. From 1971 to 1978, he was employed by White Weld & Company, Inc., as legal counsel, associate director of marketing, and administrator of the domestic branch office system overseeing thirty-two branch offices. From 1978 to 1980, he was employed by the capital markets group of Merrill Lynch, Pierce Fenner & Smith, Inc., as managing director and general counsel. (Tr. 1469-70; Resp. Ex. 402.)
From 1980 to 1998, Kleinburg was general counsel and managing director of Oppenheimer & Company, Inc.16 (Tr. 1470-72; Resp. Ex. 402.) During this time, Kleinburg was in charge of the firm's compliance department. (Tr. 1471-72.) Kleinburg was responsible for drafting the firm's compliance manual, and actively participated in subsequent revisions of the manual. (Tr. 1472.) This included reviewing the supervisory systems and procedures of comparable firms. (Tr. 1476-77.)
From 1989 to 1991, Kleinburg served on a National Association of Securities Dealers (NASD) district committee, and served as its chairman in 1991. (Tr. 1472-73; Resp. Ex. 402.) From 1992 to 1993, he served on the NASD National Business Conduct Committee and was chairman of the same during 1993. (Tr. 1473; Resp. Ex. 402.) From 1992 to 1995, he served on the Board of Governors of the NASD, serving as vice chairman in 1994 and 1995. (Tr. 1473; Resp. Ex. 402.) Kleinburg also served on the NASD National Arbitration Committee in 1993, and has served as arbitrator for the NASD, the New York Stock Exchange, and the American Stock Exchange. (Tr. 1475; Resp. Ex. 402.) He was also active in the Securities Industry Association, serving on its Federal Regulation Committee in 1990 and as president of its Compliance and Legal Division from 1991 through 1992. (Tr. 1475; Resp. Ex. 402.)
Neil Hennessy
Hennessy testified for Respondent Peterson as an expert witness in the area of branch office supervision and opined on Peterson's alleged failure to supervise Oberholzer. From 1980 to 1984, Hennessy was employed as an account executive for PaineWebber Incorporated and Hambrecht & Quist. From 1984 to 1988, he was employed by PaineWebber Incorporated as a branch office manager, and subsequently as a divisional sales manager overseeing thirty-six branch offices. In 1989, Hennessy started his own broker-dealer firm and has been president of the same since that time. (Tr. 1349; Resp. Ex. 401.)
From 1987 to 1990, Hennessy served on an NASD district business conduct committee. (Tr. 1350; Resp. Ex. 401.) He was elected to the nominating committee of an NASD district business conduct committee in 1992, 1993 and 1998. He was elected Chairman of an NASD district business conduct committee for the 1993-1994 term. Hennessy has served as an NASD arbitrator since 1990. (Tr. 1350; Resp. Ex. 401.) He has served as an expert in securities matters since 1991. (Tr. 1352; Resp. Ex. 401.)
John Maine
Maine testified as an expert on behalf of Respondent Dean Witter regarding the adequacy of Dean Witter's compliance department procedures from 1990 through 1995. (Tr. 1285-86, 1288-89.) He earned a bachelor of arts degree from Dartmouth College in 1964 and immediately began his securities experience as a retail account executive for Smith Barney and Company. (Tr. 1281-82; Resp. Ex. 403.) After seven years as a retail account executive, he became national sales manager for Mitchum, Jones and Templeton. (Tr. 1282.) In 1974, he became branch office manager of the largest retail office of Smith Barney and Company. (Tr. 1282.) In approximately 1983, he left the securities industry, returning several months later as regional director for Smith Barney and Company. (Tr. 1283.) During this time, he also served on the board of directors and as executive vice president of the firm. (Tr. 1282-83.) He retired from Smith Barney and Company in 1990 and began consulting. In addition to conducting in-house compliance seminars for broker-dealer firms, Maine has also acted as arbitrator and mediator in securities matters. (Tr. 1283.) He is on the board of arbitrators for the NASD, the New York Stock Exchange, the Pacific Stock Exchange, and the American Stock Exchange. (Resp. Ex. 403.) He has been a pretrial consultant and expert in approximately 600 matters, testifying approximately 200 times. (Tr. 1283.)
Maine testified that his experience with supervision and compliance began when he became a national sales manager for Mitchum, Jones and Templeton, and continued in increasing increments until he retired in 1990. He specifically noted the time he spent as branch manager, who he stated is the "pivotal person in coordinating the compliance of the firm, and regulatory procedures within their branch." (Tr. 1284-85.)
John Smith
Smith testified as a fact witness for Respondent Dean Witter. (Tr. 1167-68.) He testified regarding his observations of the supervisory procedures and systems employed by broker-dealer firms from 1991 through August 1995. (Tr. 1170.) Smith has approximately thirty-one years of experience in the securities industry, including service on a securities law advisory council for the state of Florida, chairmanship of an NASD district business conduct committee, and chairmanship of the NASD National Advisory Council. (Tr. 1160-62.) His primary occupations are serving as a securities consultant, testifying as an expert witness in securities matters, and drafting and revising compliance manuals. (Tr. 1156-57.) As a securities consultant, Smith reviewed supervisory procedures of broker-dealer firms as directed by various regulatory entities. (Tr. 1164-65.) From 1990 through 1994, he testified as an expert witness on behalf of or against approximately sixty broker-dealer firms and served as consultant to a number of major broker-dealer firms. (Tr. 1168-70.)
Dean Witter's Supervisory Procedures17
Branch Managers
Dean Witter's branch managers are primarily responsible for direct supervision of the business conducted in their branch offices and the activities of each account executive in that branch. (Tr. 299, 552, 591; Joint Ex. 3.) Dean Witter relies heavily upon each branch manager's judgment, especially in branch offices with experienced branch managers. (Tr. 552.) Branch managers are not unsupervised, but are empowered to make many decisions in their discretion. (Tr. 552-53.) They interview, hire, train, and generally have the authority to terminate, account executives under their supervision. (Tr. 299, 591; Joint Ex. 3, ¶1.) In addition to monitoring each account executive's performance, branch managers must ensure each account executive complies with all applicable rules and regulations, including those specific to Dean Witter. (Tr. 299, 594-95; Joint Ex. 3, ¶1.)
Branch managers must familiarize themselves with the clients and accounts serviced through their branch offices. (Joint Ex. 3, ¶1.) This includes supervising and approving all new accounts. (Joint Ex. 3, ¶2.) As part of this function, branch managers review and approve all new account forms. (Tr. 300.) Dean Witter's account executives complete new account forms, obtaining certain information from the client. Account executives are also responsible for updating this information if and when it changes. (Tr. 259-60, 907-08; Joint Ex. 3, ¶7.) Branch managers must confirm that all required documentation is collected when an account is opened, and are ultimately responsible for updating and maintaining accurate client information. (Joint Ex. 3, ¶2.)
Branch managers must also perform a daily review of order tickets. (Tr. 300, 591-92; Joint Ex. 3, ¶2.) This review includes ensuring that the ticket was completed properly and identifying large transactions or investments requiring branch manager approval. (Tr. 592.) It also allows the branch manager to determine whether an account executive has multiple clients buying or selling a security on an allegedly "unsolicited" basis. (Joint Ex. 3, ¶2.) In the Hayward Branch, there were fifty to seventy order tickets to review each day.18 (Tr. 592, 1217.)
When absent from the branch office, branch managers may delegate order ticket review and other duties to a Series 8 licensed assistant branch manager. (Tr. 218, 231; Joint Ex. 3, ¶2.) At the time Peterson was appointed Hayward Branch manager, there was no day-to-day manager at the Fremont Office. Peterson spent approximately 40% of his time at the Fremont Office until a day-to-day manager was hired, approximately six weeks after he became the Hayward Branch manager. When at the Fremont Office, Peterson delegated certain responsibilities to Thomas Cowperthwait (Cowperthwait), the Series 8 licensed assistant branch manager at the Hayward Branch. This included order ticket review and approval. (Tr. 640-42.) Cowperthwait has been a Dean Witter employee since 1975, and the assistant branch manager of the Hayward Branch since 1981. (Tr. 218.)
Branch managers are required to supervise active accounts and investigate any unusual activity occurring therein. (Joint Ex. 3, ¶4, ¶5.) They must review active accounts each month, and are provided a monthly activity report generated by Dean Witter's computer surveillance system to aid in this duty. (Joint Ex. 3, ¶4, ¶5.) The activity report lists all accounts that meet or exceed certain account activity parameters, such as number of transactions, amount of commissions, commission versus equity percentage, and turnover ratio. (Joint Ex. 3, ¶5.) The activity report includes a transaction detail, as well as information regarding number of transactions, commission volume, average equity, and margin debit balance. Branch managers are responsible for reviewing the accounts appearing on the activity report, interviewing the account executive and, if they deem necessary, contacting the clients. (Joint Ex. 3, ¶5.)
Branch managers must contact clients whose accounts regularly appear on the activity report by letter, telephone, or in person. (Joint Ex. 3, ¶4.) To assist branch managers in this duty, Dean Witter provides a set of seven suggested model letters called activity letters.19 (Joint Ex. 3, ¶4, ¶6.) Dean Witter encourages branch managers to individualize these letters by adding specific information, such as amount of commissions, margin costs, profit and loss figures, and information regarding specific transactions.20 (Joint Ex. 3, ¶6.) These letters are designed to serve various functions, including introduction of the branch manager to the client, reinforcement of client awareness of account activity, and identification of potential problems in the account. The letters are numbered consecutively and become progressively more cautionary and detailed. The earlier letters invite the client to call the branch manager directly, whereas the later letters discuss the costs and risks associated with a high level of trading activity.21 (Joint Ex. 3, ¶6.)
Each month, branch managers must complete a supervisory log confirming the completion of all daily, weekly, and monthly supervisory activities. This log is then sent to the compliance department. (Joint Ex. 3, ¶3, ¶5.) Among other things, the branch managers must certify that the account executives' "Daytimers," in which important communications with clients are recorded, have been reviewed at least annually and that active clients have been contacted. (Tr. 594; Joint Ex. 3, ¶3.)
The Compliance Department
The compliance department also reviews active accounts on a monthly basis, providing additional information to the branch managers.22 (Joint Ex. 3, ¶10.) Whereas branch managers are responsible for the monthly review of all active accounts, the compliance department identifies and reviews only certain accounts each month by computer surveillance utilizing selected account activity parameters.23 (Tr. 136-37, 359-60.) Each month, the compliance department's computer surveillance identifies certain accounts based on selected "current" and "current versus historical" account activity parameters. A total of sixteen account activity parameters are used. (Tr. 87-88, 107, 169, 773-775; Joint Ex. 3, ¶10.)
The specific parameters to be used each month are determined by the compliance team leaders. (Tr. 87, 107, 773.) Kim McDaniel-Remer (McDaniel-Remer) was the compliance team leader responsible for general oversight of the San Francisco compliance unit.24 This unit monitored activity at the Hayward Branch. (Tr. 358-59.) Three regional coordinators reported to McDaniel-Remer and approximately eight compliance analysts were under her supervision. (Tr. 84-85, 359.)
Accounts identified by computer surveillance are then reviewed by compliance analysts. (Tr. 87, 107; Joint Ex. 3, ¶11.) Donna L. Dey (Dey) and Kathleen Needham (Needham) were the regional compliance analysts assigned to review activity at approximately twenty-three Dean Witter branch offices, including the Hayward Branch. (Tr. 85-86, 107, 193.) Dey reviewed the activities of the Hayward Branch from 1991 through June 1993, when she was succeeded by Needham.25 (Tr. 83-84, 86, 186.)
The compliance department's computer surveillance system provides various account information for the compliance analysts' review, including commissions, net asset value, and turnover ratio. It also provides certain client profile information such as income, net worth, and investment objectives. (Tr. 90-91, 258.) Compliance analysts must consider whether a client's trading activity appears to be consistent with the client's sophistication, stated investment objectives, and financial means. (Joint Ex. 3, ¶11.) They also attempt to detect improper sales practices, such as churning. (Joint Ex. 3, ¶11.)
Although concentration is not a parameter specifically used in monthly computer surveillance, compliance analysts are required to consider concentration in the identified accounts. (Tr. 773-74; Joint Ex. 3, ¶10, ¶16.) Furthermore, both the compliance department and the credit department perform other reviews geared to identify concentration in client accounts. (Joint Ex. 3, ¶16, ¶17.)
If the compliance analyst identifies a questionable transaction, she may send an account inquiry to the branch manager depending on her review of the branch office binder. (Tr. 88, 107, 251-52, 779; Joint Ex. 3, ¶11.) Branch office binders contain previous account inquiries, as well as responses received from branch managers, and are maintained for each branch office. (Tr. 108, 186, 251-52.) The information in the binder is filed according to account executive and account. (Tr. 108, 186.) Compliance analysts review this information and consider whether a branch manager has adequately responded to the same issue before another account inquiry is issued. (Tr. 107, 251-52.)
The compliance analyst is responsible for follow-up on the account inquiry, which includes ensuring that a satisfactory response is received from the branch manager. The branch manager must complete an account report form responding to the account inquiry and return the same to the compliance department within the requested time frame. The branch manager may also provide an explanatory note or memorandum and copies of any activity letters sent to the client. (Joint Ex. 3, ¶11.) Often, account report forms received from branch managers contain client profile information differing from the client profile information reviewed by the compliance analysts. In such event, the compliance analyst relies on the account report form.26 (Tr. 259-60.)
The compliance analyst generally does not verify the information provided by the branch manager. (Tr. 173, 207.) It is the branch manager's duty to ensure that such information is correct. (Tr. 207.) By signing the account report form, the branch manager signals that his review is complete and the information provided is correct. (Tr. 172-73, 280.) After a satisfactory response is received from the branch manager, compliance analysts generally do not continuously monitor such accounts each month thereafter. The branch manager is responsible for subsequent monitoring of the account. (Tr. 128-29, 135-36.)
If the branch manager fails to respond to the account inquiry in the requested time frame, or if the compliance department is dissatisfied with his response, the issue must be brought to the attention of the regional sales manager or regional director. (Tr. 362, 779; Joint Ex. 3, ¶14.) In the Pacific region, Thomas O'Connell (O'Connell) was the regional sales manager, and Steve Miller (Miller) was the regional director. (Tr. 527.) The branch managers in the Pacific region reported to O'Connell and Miller. (Tr. 533-34.) If the regional director fails to act within thirty days, the compliance team leader must bring the issue to the attention of the assistant director of compliance for consultation with either the deputy director of compliance or the director of compliance. Lynn Konop (Konop) was the assistant director of retail compliance and three compliance team leaders, including McDaniel-Remer, reported to her.27 (Tr. 770-71.) After consultation with either the deputy or assistant director of compliance, the director of compliance must notify the national sales manager of the issue and the inaction by both the regional director and the branch manager. In appropriate cases, the director of compliance can refer the matter to the law department. (Joint Ex. 3, ¶14.)
Although the compliance department may recommend action to the branch manager and notify the branch manager's supervisors if its recommendations are disregarded, the compliance department's responsibilities are informational and advisory only.28 (Tr. 360-01, 465; Joint Ex. 3, ¶9.) Dean Witter's compliance department is to collect, assess, and transmit information to, and request and evaluate information from, the branch manager. It has no authority to terminate or discipline an account executive. (Joint Ex. 3, ¶9.) The authority to take "any and all corrective action," including the authority to place restrictions on an account or terminate an account executive, resides in the branch manager and his supervisors. (Tr. 361-62; Joint Ex. 3, ¶9.) Furthermore, the compliance department has no contact with clients. (Tr. 118.)
Betz's Accounts
Betz opened her first account at Dean Witter in July 1989 (Betz Initial Account). The new account form listed investment objectives in order of preference as: (i) income, (ii) aggressive income, (iii) capital appreciation, and (iv) speculation.29 (Div. Ex. 48 at DWR006603.) In August 1989, Betz opened a joint account listing Dr. Huey as the tenant partner (Betz Joint Account). (Div. Ex. 48 at DWR000396, DWR000399.) She signed a form requesting margin privileges in this account. (Div. Ex. 48 at DWR000401.) The new account form listed investment objectives in order of preference as: (i) income, (ii) aggressive income, (iii) capital appreciation, and (iv) speculation. It also listed annual income of $24,000, net worth of $300,000, and liquid assets of $280,000. (Div. Ex. 48 at DWR000396.)
During May and June 1992, all of the assets held by the Betz Joint Account, with the exception of an annuity, were transferred and used to fund a trust account in which Betz requested margin privileges (Betz Trust Account). (Div. Ex. 2 at Tab 12, Div. Ex. 48 at DWR000390, DWR2806.) The new account form for the Betz Trust Account listed investment objectives in order of preference as: (i) capital appreciation, (ii) income, (iii) aggressive income, and (iv) speculation. According to this form, net worth was $500,000 as opposed to $300,000 as previously reported. (Div. Ex. 48 at DWR000390.)
On or about January 6, 1993, Dey sent Auwinger an account inquiry regarding, among other accounts, the Betz Trust Account. (Tr. 277-79; Div. Ex. 21 at DWR3045-46, Resp. Ex. 254.) According to Dey's inquiry, there had been twenty-three transactions during the previous month generating $5,873.10 in commissions. There were fifty-seven transactions in 1992 that generated $10,014.24 in commissions. Dey requested an account report form, noting that the Betz Trust Account had been actively trading. (Div. Ex. 21 at DWR3045-46, Resp. Ex. 254.) She requested information regarding the profitability of the account and the percentage of solicited transactions. (Div. Ex. 21 at DWR3045-46, Resp. Ex. 254.)
Auwinger responded with an account report form dated January 12, 1993. (Tr. 279; Div. Ex. 21 at DWR3047 and unnumbered "Annotation," Resp. Ex. 255.) According to the form, Betz's approximate annual salary was $50,000 and approximate annual investment income was $11,000. Investment objectives were listed as: (i) trading profits, (ii) income, (iii) long-term growth, and (iv) safety of principal. (Div. Ex. 21 at DWR3047 and unnumbered "Annotation," Resp. Ex. 255.)
According to the form, the Betz Trust Account had realized losses of approximately $4,320 and unrealized profits of $19,080 for the six months prior to December 31, 1992. The form also reflected that 30% of the transactions in the account were solicited. (Tr. 279-80; Div. Ex. 21 at DWR3047 and unnumbered "Annotation," Resp. Ex. 255.)
In March 1993, Betz closed her account and urged Dr. Huey to do the same.30 (Tr. 284-85; Joint Ex. 1, ¶16.)
Dr. Huey's Accounts
In August 1989, Dr. Huey opened a joint account listing Betz as the tenant partner (Huey Joint Account). (Div. Ex. 49 at DWR000143, DWR000146.) She signed a form requesting margin privileges in this account. (Div. Ex. 49 at DWR000149.) The new account form listed investment objectives in order of preference as: (i) income, (ii) aggressive income, (iii) capital appreciation, and (iv) speculation. It listed annual income as $24,000, net worth as $450,000, and liquid assets as $150,000. (Div. Ex. 49 at DWR000143.) An option form for the Huey Joint Account completed on February 28, 1992, listed investment objectives in order of preference as: (i) income, (ii) investment hedge, (iii) aggressive income, and (iv) speculation. This form listed annual income of $40,000, net worth (excluding residence) of $200,000, and liquid net worth of $100,000. (Div. Ex. 49 at DWR000147.)
In May 1992, the assets of the Huey Joint Account, with the exception of certain annuities, were transferred and used to fund a trust account in which Dr. Huey requested margin privileges (Huey Trust Account). (Div. Ex. 3 at Tab 13, Div. Ex. 49 at DWR000067, DWR000071.) The new account form for the Huey Trust Account listed investment objectives in order of preference as: (i) capital appreciation, (ii) income, (iii) aggressive income, and (iv) speculation. It listed annual income of $24,000, net worth of $450,000, and liquid assets of $150,000. (Div. Ex. 49 at DWR000067.)
Dey sent Auwinger an account inquiry regarding June 1992 activity in the Huey Joint Account. (Tr. 263-64; Div. Ex. 14 at DWR3039, Resp. Ex. 240.) According to the inquiry, there were three transactions in the account during June 1992 generating commissions of $288.44. There were fifty-five transactions year-to-date generating commissions of $6,203.10. Dey noted the activity and requested an account report form. She also requested Auwinger ensure that Oberholzer provide information regarding profit and/or loss and percentage of solicited transactions. (Tr. 264; Div. Ex. 14 at DWR3039, Resp. Ex. 240.)
Dey received an account report form in response to her inquiry. (Tr. 264; Div. Ex. 14 at DWR3040, Resp. Ex. 239.) It listed approximate annual salary as $24,000, approximate annual investment income as $30,000, and estimated liquid net worth as $400,000. Investment objectives were listed as: (i) trading profits, (ii) long-term growth, (iii) income, and (iv) safety of principal.
According to the form, 40% of the transactions in the Huey Joint Account were solicited. For the six months prior to April 6, 1992, realized profits totaled $6,250. The account report form also contained Oberholzer's explanation of particular transactions noted by Dey. (Tr. 264-66; Div. Ex. 14 at DWR3040, Resp. Ex. 239.) Auwinger supplied another account report form on the Huey Joint Account on or about August 17, 1992. He commented that related accounts had $140,000 in securities and that $80,000 in securities were journaled from the Huey Joint Account to the Huey Trust Account.31 (Tr. 266-67; Div. Ex. 15 at DWR3035, Resp. Ex. 241.) Auwinger's signature on these two account report forms satisfied Dey that Auwinger was properly monitoring the Huey Joint Account. (Tr. 268-69.)
On or about January 22, 1993, Dey sent Auwinger an account inquiry regarding, among other accounts, the Huey Trust Account. According to the inquiry, there had been thirteen transactions in December 1992, generating commissions of $2,789.49. There had been sixty-two transactions in 1992 generating commissions of $10,298.38. (Tr. 269-70; Div. Ex. 22 at DWR3049, Resp. Ex. 256.) Dey noted in-and-out trading and year-to-date commissions that were over 10% of the account's equity value. She also noted that many of Oberholzer's clients were trading the same securities. She requested an account report form and information on the account's profit and percentage of solicited transactions. (Tr. 270-73; Div. Ex. 22 at DWR3049, Resp. Ex. 256.)
Auwinger responded with an account report form dated February 8, 1993. (Tr. 271; Div. Ex. 22 at DWR3050, Resp. Ex. 257.) Investment objectives were listed as: (i) trading profits, (ii) income, (iii) safety of principal, and (iv) long term growth. According to the form, 40% of the transactions were solicited.32 For the six months prior to January 2, 1993, realized profits were $16,851 and unrealized profits were $2,921.33 (Tr. 273; Div. Ex. 22 at DWR3050, Resp. Ex. 257.)
The account report form also contained Oberholzer's explanation for the activity Dey noted. He responded to Dey's comment regarding multiple clients trading the same securities by stating that most of his clients knew each other. (Tr. 271-72; Div. Ex. 22 at DWR3050, Resp. Ex. 257.) Dey considered this a sufficient explanation because account executives obtain many clients by referral and it was common for clients who knew each other to trade similar securities in a similar fashion. (Tr. 272-73.)
On or about March 3, 1993, Dey inquired into the Huey Trust Account pursuant to a special senior citizen review.34 (Tr. 275-76; Div. Ex. 23 at DWR3053, Resp. Ex. 261.) Auwinger responded with an account report form dated March 4, 1993. (Tr. 276; Div. Ex. 23 at DWR3054, Resp. Ex. 262.) According to the form, Dr. Huey had an approximate annual salary of $24,000 and approximate annual investment income of $16,000. Her investment objectives were listed in order of preference as: (i) trading profits, (ii) income, (iii) safety of principal, and (iv) long term growth. The form reflected that 35% of transactions in the account were solicited. Realized profits for the six months prior to March 4, 1993, were $16,851 and unrealized profits were $2,921.35 (Div. Ex. 23 at DWR3054, Resp. Ex. 262.)
In the account report form, Auwinger noted that Dr. Huey had received numerous activity letters, but expressed no dissatisfaction with her account. He also stated that most of the transactions in her account were unsolicited. (Tr. 276; Div. Ex. 23 at DWR3054, Resp. Ex. 262.) This response, in addition to Auwinger's response from February 1993, eliminated Dey's concerns regarding the Huey Trust Account. (Tr. 276-77.)
On or about August 9, 1993, Needham inquired into the Huey Trust Account pursuant to a special senior citizen review. (Tr. 123-24; Div. Ex. 26 at DWR3059, Resp. Ex. 274.) According to the inquiry, there were seventy transactions year-to-date generating $13,822 in commissions. The account had a margin debit balance of $86,052, was at 36% equity, and had generated $1,431.35 in margin interest charges through June 1993. (Tr. 124-25, 175; Div. Ex. 26 at DWR3059, Resp. Ex. 274.) The account inquiry also reflected the commission versus equity ratio was 16.9 and the year-to-date turnover ratio was 3.2. (Div. Ex. 26 at DWR3059, Resp. Ex. 274) Needham requested a manager's memorandum and the latest activity letter, noting that the account was actively trading. Needham requested Auwinger to "address the overall trading, on margin, in the account relative to the client's age (76)." (Div. Ex. 26 at DWR3059, Resp. Ex. 274.)
A typewritten paragraph on the account inquiry read:
Account 126-660662-041, Pearl Huey TTEE, trades on a regular basis. Even though she is 76 years old, she is very alert and interested in the stock market. She watches the stock channel daily for the entire trading session. She solicits some of her orders based on what she sees and hears through the stock channel and her research. This is not her primary income; since her retirement, it is a hobby and what keeps her going. The client is aware of her trades and her account balances.
(Div. Ex. 26 at DWR3059, Resp. Ex. 274.) Needham did not know who authored this paragraph. (Tr. 125.)
On or about August 11, 1993, Auwinger spoke with Dr. Huey by telephone for five to ten minutes.36 (Tr. 313-14.) Auwinger wanted to discuss the margin debit balance and margin interest charges. (Tr. 314, 318.) Also, Dr. Huey was actively trading and paying fairly sizable commissions. (Tr. 315, 318-19.) Auwinger and Dr. Huey discussed the benefits and risks of margin and the interest costs associated therewith. He suggested that Dr. Huey reduce her margin debit balance. According to Auwinger, Dr. Huey appreciated his concern and stated she enjoyed trading. She stated that she followed the market regularly through the newspaper and financial news on television. Dr. Huey stated that she had supplemental income from a dog kennel she operated and could afford losses in her account, but would consider his advice. Auwinger felt Dr. Huey understood the activity in her account and enjoyed the seemingly recreational trading. (Tr. 315-16.) Auwinger then discussed Dr. Huey with Oberholzer, informing him of the telephone conversation. He did not tell Oberholzer to cease soliciting transactions in Dr. Huey's account. (Tr. 319-20.)
Auwinger responded to Needham's account inquiry into the Huey Trust Account with a memorandum dated August 18, 1993. (Tr. 125-26, 175; Div. Ex. 26 at DWR3058, Resp. Ex. 276.) It read:
[Dr.] Huey has been a client of the Hayward office for several years and many, possibly half, of the investments in her account were her choices, based on ideas she and friends pick up from watching the financial news channels on television. She has indicated no dissatisfaction with her Account Executive and enjoys following the stock market.
On August 11 she was called and it was suggested to her to reduce her debit balance which she did through the sale of securities. Her debit balance is now $65000, down from $85000 and we will attempt to work with her in reducing both her debit balance and level of trading.
(Tr. 126-27, Div. Ex. 26 at DWR3058, Resp. Ex. 276.) Auwinger's response alleviated Needham's concerns regarding the Huey Trust Account, indicating that Dr. Huey was making the investment decisions.37 (Tr. 126-27, 176.) Needham stated that at this time, she had no reason to believe that anyone at Dean Witter was not complying with Dean Witter procedures regarding the Huey Trust Account, or that Auwinger was not supervising Oberholzer with respect to the Huey Trust Account. (Tr. 129-30.)
On or about December 5, 1994, Needham sent Peterson an account inquiry regarding the Huey Trust Account. (Tr. 129, 1245.) Peterson responded via memorandum dated December 19, 1994. He included an account report form dated December 9, 1994, and an activity letter sent to Dr. Huey on or about December 8, 1994. (Tr. 1226-27, 1245; Div. Ex. 37, Resp. Exs. 307, 308, 310.) According to the account report form, there were five transactions during November 1994 generating $871 in commissions, fifty-six transactions year-to-date generating $9,959 in commissions, and 40% of the transactions in the account were solicited. The form also listed realized profits of $12,000 and unrealized losses of $872 for the previous six months.38 Investment objectives were listed as: (i) trading profits, (ii) income, (iii) safety of principal, and (iv) long term growth. The form also contained Oberholzer's assertion that Dr. Huey had expressed no dissatisfaction, and that the transactions were necessary to cover checks written by Dr. Huey.39 (Div. Ex. 37, Resp. Ex. 308.)
O'Connor Trust Account
O'Connor opened her Dean Witter account in February 1994 and signed a form requesting margin privileges (O'Connor Trust Account). (Tr. 320; Joint Ex. 2, ¶2, Div. Ex. 51.) The new account form listed investment objectives in order of preference as: (i) capital appreciation, (ii) aggressive income, (iii) speculation, and (iv) income. It also listed annual income of $36,000, net worth of $500,000, and liquid assets of $100,000. (Div. Ex. 51 at DWR1714, DWR006632.)
The O'Connor Trust Account was very active. Auwinger was concerned that O'Connor had just opened the account and had taken on aggressive positions. (Tr. 321.) Auwinger was also concerned about O'Connor's age, her manner of trading, and the losses in the account. He called her in March 1994 to discuss his concerns. (Tr. 321, 323-24.) O'Connor told Auwinger that she had been referred to Oberholzer by her son, Glaser, who was a friend of Mr. Svogar. (Tr. 322-23.) Mr. Svogar and his mother appeared to be pleased with the way Ms. Svogar's accounts were being handled, and advised O'Connor to invest in the same manner.40 O'Connor told Auwinger that although she spoke with Oberholzer on a regular basis regarding the account, it was maintained for her son's benefit. (Tr. 323.) Auwinger then told Oberholzer that although O'Connor desired active trading, Oberholzer should reduce activity in the account, as well as the margin debit balance, as soon as possible. Auwinger did not tell Oberholzer to stop soliciting transactions in the O'Connor Trust Account. (Tr. 325-27.)
On or about April 8, 1994, Needham sent Auwinger an account inquiry regarding March 1994 activity in the O'Connor Trust Account. Needham requested an account report form and activity letter, noting O'Connor's age, as well as in-and-out trading, commissions at 11.8% of account equity, and a margin level of 50%. (Tr. 131-32; Div. Ex. 31 at DWR3076, Resp. Ex. 283.) In response, Needham received an account report form dated April 20, 1994. (Tr. 133; Div. Ex. 31 at DWR3077, Resp. Ex. 286.) According to the form, O'Connor had an approximate annual salary of $40,000, approximate annual investment income of $10,000, and estimated liquid net worth excluding residence of $950,000. In contrast to the new account form completed in February 1994, this form listed investment objectives as: (i) trading profits, (ii) long term growth, (iii) income, and (iv) safety of principal. According to the form, 50% of the transactions in the account were solicited. It listed realized profits of $11,250 and unrealized losses of $30,000.41 (Div. Ex. 31 at DWR3077, Resp. Ex. 286.)
Auwinger noted that "Ms. O'Connor's son is helping her with her investments and all trades are okayed with Ms. O'Connor. I have spoken with [Oberholzer] about the trading and he has agreed to reduce both the trades and margin debit. The client is aware of the unrealized losses." (Tr. 133-34; Div. Ex. 31 at DWR3077, Resp. Ex. 286.) Auwinger also sent Needham a copy of an activity letter he sent O'Connor on or about April 18, 1994. (Div. Ex. 31 at DWR3078, Resp. Ex. 285.) Auwinger's response indicated to Needham that he had discussed reducing the account activity and the margin debit balance with Oberholzer, and that O'Connor was aware of the losses.42 (Tr. 134-35, 180.)
On or about July 14, 1994, Glaser, sent a letter to Oberholzer. O'Connor had discussed this letter with him and understood that it instructed Oberholzer not to sell certain securities in her account, including Western Water, until the price rose. (Joint Ex. 2, ¶11.) O'Connor realized that she owned a substantial amount of Western Water and the price had gone down. (Joint Ex. 2, ¶3.) She continued to withdraw $1,000 from the O'Connor Trust Account each month. (Joint Ex. 2, ¶4). The letter, dated July 14, 1994, stated as follows:
[d]id enjoy talking to you on the 11th, we must do it more often; which is probably my mistake.
Concerning my mother's account, I agree completely that we must hold on to the stocks until they go up [listing certain securities, including Western Water, Scitex Corporation Ltd. (Scitex), and MTC Electronic Technologies Co. Ltd. (MTC Electronic)]. By far, the smart thing to do. But if something hot comes by your desk, please call me; doing her spreadsheet has me excited about the whole thing.
I'm having trouble finding a couple of stocks in the Wall Street Journal. Please let me know how to find [certain securities, including MTC Electronic].
By holding the line, I'm sure things will only get better. They can't get any worse.
Have to run, take care and give my best to your loving wife.
(Resp. Ex. 289.)
Ms. Svogar's Accounts
In January 1991, Ms. Svogar opened three accounts at Dean Witter. One was a joint account, listing Mr. Svogar as tenant partner (Svogar Joint Account).43 (Div. Ex. 50 at DWR005501-04.) The new account form for the Svogar Joint Account listed investment objectives in order of preference as: (i) capital appreciation, (ii) income, (iii) speculation, and (iv) aggressive income. (Div. Ex. 50 at DWR005503.) She also opened a margin account (Svogar Margin Account). (Div. Ex. 50 at DWR000557, DWR006605-07.) The new account form for the Svogar Margin Account listed investment objectives in order of preference as: (i) income, (ii) capital appreciation, (iii) aggressive income, and (iv) speculation. (Div. Ex. 50 at DWR006606.) Ms. Svogar also opened a rollover individual retirement account and named Joseph Svogar the beneficiary (Svogar IRA). (Div. Ex. 50 at DWR2605-06, DWR009313.) The new account form for the Svogar IRA listed income as the primary investment objective, and an option form listed investment objectives in order of preference as: (i) income, (ii) investment hedge, (iii) aggressive income, and (iv) speculation. (Div. Ex. 50 at DWR2606, DWR009313.) These forms also listed annual income of $24,000, net worth of $500,000, and liquid assets $47,000. (Div. Ex. 50 at DWR2606, DWR009313.)
In July or August 1991, Ms. Svogar opened three custodial accounts (Svogar Custodial Accounts). (Div. Ex. 50 at DWR000021, DWR000997, DWR001035.) The new account forms for the Svogar Custodial Accounts listed investment objectives in order of preference as: (i) capital appreciation, (ii) income, (iii) speculation, and (iv) aggressive income. (Div. Ex. 50 at DWR000021, DWR000997, DWR001035.)
On or about February 3, 1992, Auwinger sent the compliance department an account report form for the Svogar Joint Account. According to the form, Mr. Svogar was thirty-six years old, divorced, and a self-employed theater owner. It listed approximate annual salary as $24,000 and approximate annual investment income as zero. Investment objectives were now listed as: (i) trading profits, (ii) long term growth, (iii) safety of principal, and (iv) income. The account report form reflected that there were thirty-nine transactions in the account during 1991, and 40% of the transactions in the account were solicited. (Div. Ex. 11 at DWR3037, Resp. Ex. 231 at DWR3037.)
On or about February 20, 1992, Dey sent Auwinger an account inquiry regarding various accounts active during January 1992, including the Svogar IRA. According to the inquiry, there were twenty-nine transactions during January 1992, generating commissions of $5,614.57. In addition to noting the level of activity, Dey specifically questioned whether Ms. Svogar made her own investment decisions. (Tr. 247-48; Div. Ex. 12, Resp. Ex. 233.)
On or about March 2, 1992, Auwinger responded with an account report form. According to the form, Ms. Svogar's approximate annual salary was $43,000 and her approximate annual investment income was $25,000. Investment objectives were listed as: (i) trading profits, (ii) income, (iii) long term growth, and (iv) safety of principal. It also reflected that Oberholzer solicited 10% to 15% of the transactions in the account. Oberholzer's comments on the account report form asserted that Ms. Svogar had expressed no dissatisfaction with her account, and explained the activity that had been noted by Dey. Auwinger commented that Ms. Svogar had expressed no dissatisfaction with Oberholzer or the handling of her account. (Tr. 248-50; Div. Ex. 13, Resp. Ex. 234.)
Auwinger's response satisfied Dey's concerns regarding the Svogar IRA. Auwinger's comment that Ms. Svogar had expressed no dissatisfaction implied to Dey that Auwinger had in some way communicated with Ms. Svogar. Dey stated that based on this response, and considering Auwinger's experience as a branch manager, she would not investigate the account further to determine if Ms. Svogar was in fact satisfied.44 (Tr. 249-50.)
On or about March 3, 1992, the Svogar Joint Account was closed and its assets transferred to the Svogar Margin Account. (Div. Ex. 4 at Tab 23, Resp. Ex. 417.) Also in March 1992, the assets of the Svogar Margin Account were transferred and used to fund a new trust account which Ms. Svogar designated the beneficiary of the Svogar IRA (Svogar Trust Account). (Div. Ex. 4 at Tab 16, Div. Ex. 50 at DWR006613-15, DWR009280.) Margin privileges were requested in this account. (Div. Ex. 50 at DWR1077-79, DWR2816.) The new account form for the Svogar Trust Account listed investment objectives in order of preference as: (i) capital appreciation, (ii) income, (iii) aggressive income, and (iv) speculation. According to this form, Ms. Svogar's net worth was $1,000,000 and liquid assets totaled $750,000. This form also stated that Ms. Svogar was a retired business owner and began her market experience with stocks in 1975. (Div. Ex. 50 at DWR00614.)
On or about December 3, 1992, Dey received an account report form on the Svogar IRA from Auwinger.45 (Tr. 206, 253; Div. Ex. 17, Resp. Ex. 249.) The account report form listed approximate annual salary of $70,000 and an approximate annual investment income of $36,000. Investment objectives were listed in order of preference as: (i) trading profits, (ii) income, (iii) long term growth, and (iv) safety of principal. According to the account report form, 50% of the transactions in the account were solicited. It also reflected that there had been 189 transactions year-to-date generating $30,075 in commissions. For the six months prior to May 1, 1992, the form listed realized profits of $84,000 and unrealized losses of $3,210. (Tr. 206, 254; Div. Ex. 17, Resp. Ex. 249.)
On December 10, 1992, Dey sent a memorandum to Auwinger seeking, among other things, clarification on the Svogar IRA account report form claiming realized profits of $84,000. Dey noted that this figure supplied by Oberholzer was stated as of May 1, 1992, rather than December 3, 1992, when the account report form was completed. She specifically asked if the account was still profitable and requested the profit and loss figures.46 (Tr. 255; Div. Ex. 18, Resp. Ex. 250.)
Auwinger responded to Dey's December 10, 1992 memorandum via memorandum dated December 23, 1992. (Tr. 257; Div. Ex. 19, Resp. Ex. 253.) In regards to the Svogar IRA, he stated:
[a]ttached are the calculations of the profitability of this account. As you can see the account had made a profit of approximately $60000 after commission. Nonetheless, I have spoken with the [account executive], Michael Oberholzer, regarding the activity in this account and I will continue to monitor the trading, which I expect to be less in 1993.47
(Tr. 257, 262-63; Div. Ex. 19, Resp. Ex. 253.) The Svogar IRA account report form from December 3, 1992, stated that the main investment objective was trading profits, and Dey concluded from Auwinger's memorandum that trading profits were being obtained. (Tr. 257-58.) Dey was satisfied that the Auwinger had reviewed the account and her concerns were alleviated. (Tr. 262-63.)
Presumably in response to an activity letter dated June 5, 1993, Ms Svogar sent Mr. Auwinger a letter dated July 20, 1993, which read:
I appreciate your concern in regards to the activity to my account. However, Michael Oberholzer and I communicate almost on a daily basis regarding all transactions in my account. And I'm well aware of the commission generated. There is no need for concern. I'm very satisfied with Michael's advice. As I've stated before, if I have any concerns or problems I will be sure to contact you.
(Tr. 348; Resp. Ex. 272.) Mr. Svogar testified that his mother prepared this letter at Oberholzer's request. According to Mr. Svogar, Oberholzer dictated the content of the letter to Ms. Svogar over the telephone. Mr. Svogar stated that he then spoke with Oberholzer and reviewed the letter to ensure that it contained the requested information. Mr. Svogar stated that Oberholzer did not indicate why he needed the letter, but that he wanted the letter to state that Ms. Svogar was aware of the trading in her account and she was satisfied with the account and Dean Witter. (Tr. 725-26.)
On or about August 5, 1993, Needham sent Auwinger an account inquiry regarding three accounts, including the Svogar IRA. (Tr. 113; Div. Ex. 25, Resp. Ex. 273.) According to the account inquiry, there were eighteen transactions during June 1993 generating commissions of $3,119.64. There had been 119 transactions year-to-date generating commissions of $21,654.94. Needham requested an account report form and activity letter, noting that the Svogar IRA was very active for an individual retirement account. Needham also noted Ms. Svogar's age and that year-to-date commissions were 90% of Ms. Svogar's stated income of $24,000. (Tr. 113-14, 173; Div. Ex. 25, Resp. Ex. 273.)
Auwinger testified that at or around this time, he spoke to Ms. Svogar by telephone for five to ten minutes.48 Auwinger stated that up until early 1993, the Svogar IRA had been profitable. There was a slight loss in June or July 1993, which Auwinger estimated to be $1,800 to $1,900. He testified Ms. Svogar had always been an active client, buying and selling securities on a frequent basis. Auwinger stated that Ms. Svogar also had been withdrawing money out of the Svogar IRA on a regular basis, usually about $1,700 to $1,800 each month. The frequency and size of the withdrawals began to increase, which concerned Auwinger.49 (Tr. 311.)
Ms. Svogar told Auwinger she was sending money to her son on a regular basis. Ms. Svogar stated she was forced to sell securities almost immediately after purchase to provide money for her son. She rarely held a security long enough to recognize a gain and transaction costs were eroding her account's value. Auwinger suggested she curb her son's spending or limit her withdrawals, and cautioned her against active trading. He also suggested she keep cash available to meet future needs. Ms. Svogar stated that this was the same advice Oberholzer gave her. (Tr. 311-13.)
Auwinger and Ms. Svogar also discussed her use of margin in the Svogar Trust Account and the resulting interest charges. Auwinger testified that Ms. Svogar understood the use of margin, and he explained the associated risks to her. He testified that she appeared to understand the risks, and appreciated his call. (Tr. 311-13.)
They also discussed generally solicited transactions. Ms. Svogar said she sometimes called Oberholzer with an investment idea, and he often advised her against particular investments. Auwinger felt that the investments in the account were the idea of both Ms. Svogar and Oberholzer. According to Auwinger, approximately 50% of Ms. Svogar's transactions were solicited around this time. (Tr. 313.) She also intimated that Auwinger ought not be concerned with her account. (Tr. 348.)
Considering the letter from Ms. Svogar and talking with her on the telephone, Auwinger felt that Ms. Svogar controlled her account and understood the activity occurring therein. Auwinger believed there were no sales practice violations in her accounts. (Tr. 348-49.) However, Auwinger discussed the telephone conversation with Oberholzer and told him he was concerned with Ms. Svogar's withdrawals and the sales needed to meet those distributions. Auwinger suggested Oberholzer work with Ms. Svogar to reduce her margin debit balance. Auwinger did not expect immediate liquidating sales to reduce the margin debit balance, but that it would be reduced as soon as practical. He did not tell Oberholzer to cease soliciting transactions in Ms. Svogar's accounts. (Tr. 319-20.)
In response to Needham's inquiry into the Svogar IRA, Auwinger submitted an account report form dated August 10, 1993, and the activity letter he sent Ms. Svogar on or about July 14, 1993. (Tr. 114, 116; Div. Ex. 27, Resp. Exs. 271, 275.) The account report listed approximate annual salary of $70,000 and approximate annual investment income of $300,000. Investment objectives were listed in order of preference as: (i) long term growth, (ii) trading profits, (iii) income, and (iv) safety of principal. (Div. Ex. 27, Resp. Ex. 275.) According to the form, 40% of the transactions in the Svogar IRA were solicited. It also reflected that for the prior six months, the account had unrealized losses of $2,800 and realized profits of $80,000.50 (Tr. 172-74; Div. Ex. 27, Resp. Ex. 275.)
In the account report form, Oberholzer asserted that Ms. Svogar had expressed no dissatisfaction and referred to the letter Ms. Svogar sent Auwinger on or about July 20, 1993. (Tr. 116; Div. Ex. 27, Resp. Ex. 275.) After reviewing the account report form, the activity letter, and the letter from Ms. Svogar, Needham was satisfied that Auwinger had reviewed the account. (Tr. 118.)
On or about May 13, 1994, Needham sent Auwinger an account inquiry regarding the Svogar IRA. (Tr. 118-19; Div. Ex. 33, Resp. Ex. 287.) Needham noted year-to-date transactions and commissions, in-and-out trading and an annual turnover ratio of 2.58. Needham requested an updated account report form, manager's memorandum, and Auwinger's confirmation that transactions in the account were suitable. (Tr. 119-20; Div. Ex. 33, Resp. Ex. 287.)
Auwinger responded with a memorandum dated May 19, 1994, and an account report form dated May 17, 1994. (Tr. 120-21; Div. Ex. 34, Resp. Ex. 288.) The memorandum stated:
Ms. Svogar follows the market through the Financial New[s] Network and calls to Mike Oberholzer or he calls her daily. Recently her son has borrowed a good deal of money from her which has caused her to sell some securities relatively soon after she had purchased them. She has expressed no dissatisfaction and yet [Oberholzer] and I have discussed keeping more funds liquid to meet unanticipated cash needs from her son. I will continue to monitor the account closely.
(Tr. 121; Div. Ex. 34 at DWR3344, Resp. Ex. 288 at DWR3344.)
According to the account report form, there were 102 transactions year-to-date generating $22,641 in commissions. It also reflected that 10% of the transactions in the account were solicited. Approximate annual income was listed as $40,000 and approximate annual investment income as $20,000. Investment objectives were listed as: (i) trading profits, (ii) income, (iii) income for her son, (iv) long term growth, and (v) safety of principal. According to the form, realized profits were $34,000 and unrealized losses were $5,094 for the six months prior to May 17, 1994.51 (Div. Ex. 34 at DWR3345, Resp. Ex. 288 at DWR3085.) Auwinger also included copies of two activity letters and the letter he received from Ms. Svogar dated July 20, 1993. (Div. Ex. 34 at DWR3346-48, Resp. Exs. 271, 272, 280, Resp. Ex. 288 at DWR3086-87, DWR3348.)
Auwinger's response indicated to Needham that his review was complete, and it alleviated her concerns regarding the Svogar IRA. Needham noted that Auwinger was to closely monitor the account. As of May 1994, Needham stated that she had no reason to believe that anyone was failing to comply with Dean Witter procedures in regards to the Svogar IRA, or that Auwinger was failing to supervise Oberholzer with respect to the account. (Tr. 122-23.)
On or about October 10, 1994, Needham purportedly sent Peterson an account inquiry regarding the Svogar IRA.52 (Tr. 112, 138-39.) When she received no response from Peterson, she sent the account inquiry again, noting that it was a second request. The second account inquiry was sent on or about November 11, 1994. (Tr. 112, 138-39; Div. Ex. 36 at DWR3341, Resp. Ex. 302.) Needham did not speak with Peterson to determine if he received the initial account inquiry.53 (Tr. 162.)
In the account inquiry, Needham noted Ms. Svogar's age, as well as in-and-out trading, year-to-date transactions, commissions representing approximately 31% of the account's equity, and an annual turnover ratio of 5.60. She asked Peterson to "advise in the form of a memo if the account is profitable and what percentage of the trading is solicited. In addition, please confirm that you have reviewed the account activity and you feel that the trading in the account is [suitable]." (Tr. 139-40; Div. Ex. 36 at DWR3341, Resp. Ex. 302.)
Peterson responded to Needham's account inquiry by memorandum dated December 2, 1994. (Tr. 140-41, 1224; Div. Ex. 36 at DWR3342, Resp. Ex. 305.) In the memorandum, Peterson stated that he had not been Hayward Branch manager long enough to specifically research the Svogar IRA and form an opinion as to its activity, but he had discussed the account with Oberholzer and ascertained certain information.54 According to the memorandum, the account was opened on January 14, 1991, as a transfer from another broker-dealer firm, with an initial deposit of $240,000. It summarized the account's valuation and distributions on a yearly basis, noting that distributions from the account from 1991 until October 1994 totaled $302,984. (Div. Ex. 36 at DWR3342, Resp. Ex. 305.) Peterson closed the memorandum by stating:
[c]lient trades account unsolicited 95% of the time. In the past three years client will call Mike and ask him to buy a certain security and within anywhere from a couple of days to [a] month she will call Mike back and request him to sell the position and pay out a distribution so she can give it to her 40 year old son. Mike has discussed with [Ms. Svogar] that she is trading her account to[o] heavily and depleting her principal with each withdrawal but she feels obligated to take care of her son.
(Div. Ex. 36 at DWR3342, Resp. Ex. 305.)
Needham's December 22, 1994 Memorandum
Needham felt that Peterson's response did not provide the information needed to satisfy her account inquiry into the Svogar IRA.55 Therefore, she took her concerns to McDaniel-Remer. Needham stated that she was not finding fault with Peterson's judgment or behavior, but fulfilling her responsibility to bring the issue to McDaniel-Remer's attention. McDaniel-Remer instructed her to prepare a memorandum to O'Connell with regard to the Svogar IRA, and all other Oberholzer client accounts displaying similar trading. (Tr. 97, 141-45, 394.)
On or about December 22, 1994, Needham presented her completed memorandum for McDaniel-Remer's review. The memorandum discussed nine Oberholzer client accounts, including the Svogar IRA, the Svogar Trust Account, the Huey Trust Account, and the O'Connor Trust Account. (Tr. 96-98, 147; Div. Ex. 38 at DWR3338-39, Resp. Ex. 311 at DWR37496-97.)
Needham noted in-and-out trading of over-the-counter securities, particularly Western Water, in both the Svogar IRA and Svogar Trust Account. (Tr. 97; Div. Ex. 38 at DWR3338, Resp. Ex. 311 at DWR37496.) In regards to Svogar IRA, Needham also noted that as of December 1993, the account valuation was $227,241. During 1994, distributions totaled $117,184, and the account valuation as of November 1994 had dropped to $57,581. There were 198 transactions year-to-date generating $46,443 in commissions. The annual turnover ratio was 6.1. (Div. Ex. 38 at DWR3338, Resp. Ex. 311 at DWR37496.)
According to the memorandum, the Svogar Trust Account had a concentrated position in Western Water. The margin debit balance was $2,114 and the market value of the account was $5,850. There were forty-eight transactions year-to-date generating commissions of $6,165. Needham also noted that there had been three overdrafts in the account during 1994 and the annual turnover ratio was 19.93. (Div. Ex. 38 at DWR3338, Resp. Ex. 311 at DWR37496.)
The memorandum also reflected in-and-out trading of over-the-counter securities, particularly Western Water and InaCom, in the Huey Trust Account. The account had a margin debit balance of $5,481 and a market value of $9,599.56 (Tr. 164; Div. Ex. 38 at DWR3338, Resp. Ex. 311 at DWR37496.) There had been sixty-two transactions in the account year-to-date generating $8,957 in commissions. The annual turnover ratio was 7.84. (Div. Ex. 38 at DWR3338, Resp. Ex. 311 at DWR37496.)
Needham also noted in-and-out trading of over-the-counter securities and a margin debit balance of $75,084 in the O'Connor Trust Account. The market value of the account was $113,124. Needham noted that the account had been opened in March 1994, and had sixty transactions since that time generating commissions of $2,565. The annual turnover ratio was 8.7. Needham also noted that the current equity in the account was $38,040, and considering unrealized losses of $34,208, the account was valued at $3,832. (Div. Ex. 38 at DWR3339, Resp. Ex. 311 at DWR37497.)
Needham's memorandum also discussed her concerns regarding the indicated accounts. It read in part:
[t]he active accounts that I have been monitoring consist of elderly single or widowed women, their ages vary from 37 to 78. They are all on margin and many of them are trust accounts. [Oberholzer] notes that the majority of trading in all of the accounts is unsolicited. This could be questionable as the majority of his trading is in Western Water and InaCom, which [Dean Witter] is a market maker. In addition, these client's (sic) live in the state of California, and the California Solicitation Policy is more stringent in its interpretation of a solicited transaction.
I have discussed Mr. Oberholzer's trading practices with the credit department and they share our concern with regard to his trading in low priced securities, the number of maintenance calls and trade adjustments th[at] occur in his accounts.
To assist you in making a determination, our recommendations would be to eliminate the margin debits, and most if not all speculative trading. . . .
Secondly, I feel the trading in these accounts [is] unsuitable and I am concerned about the level of control that seems to be prevalent. I have discussed these issues with Henry Auwinger and the new manager, Dennis Peterson. While Dennis has provided the information we asked for, as a new manager we understand that it is difficult to make heavy handed decisions in the first few months. In addition, we felt this matter was of importance and would welcome your comments.
(Tr. 147-48; Div. Ex. 38 at DWR3340, Resp. 311 at DWR37498.)
Needham testified that although her memorandum raised issues of control and suitability and recommended elimination of margin debit balances and speculative trading, she had come to no conclusions regarding the activity in any of the accounts.57 (Tr. 148-55, 181-82.) The information available to Needham was insufficient to support a conclusion that any wrongdoing or sales practice violations had occurred. Such conclusion would require Peterson's investigation into the accounts and communication with the various clients involved. Needham's intent in drafting the memorandum was to identify issues to O'Connell so he could direct an investigation by Peterson. (Tr. 147-53, 181-82.) As Hayward Branch manager, Peterson was in the best position to exercise supervisory judgment and determine the scope of investigation regarding each account. (Tr. 181-82.)
After McDaniel-Remer reviewed Needham's memorandum, McDaniel-Remer and Needham presented the memorandum to O'Connell at a meeting on or about December 23, 1994. (Tr. 98, 146, 395, 401, 1202.) Greg Taylor (Taylor), the regional compliance officer assigned to the Hayward Branch, was also present at this meeting.58 Attached to the memorandum were printouts of the accounts identified. (Tr. 1202.) McDaniel-Remer and Needham asked O'Connell's help in investigating the accounts and getting satisfactory responses from the Hayward Branch. (Tr. 539-40.)
O'Connell reviewed the memorandum, and it was discussed briefly.59 (Tr. 147, 538-39.) O'Connell's reaction was one of concern and he considered the issues raised by Needham to be serious.60 (Tr. 570, 1202.) He called Peterson and told him that McDaniel-Remer, Needham and Taylor were there discussing a memorandum outlining certain accounts of concern to the compliance department.61 (Tr. 99, 402, 477, 539-41.) O'Connell read through the accounts by name and account number as Peterson took notes. O'Connell gave Peterson certain information regarding the clients and accounts, including clients' ages, account market values, margin debit balances, year-to-date commissions and turnover ratio. (Tr. 610-11.) O'Connell's tone was firm and direct, and he instructed Peterson to investigate thoroughly the accounts. Peterson was to report his findings, as well as his recommendations on any needed corrective action. (Tr. 402, 540-41, 610-11.) O'Connell did not instruct Peterson to place restrictions on the accounts at this time. (Tr. 611.)
Peterson's Investigation
After the conversation, Peterson reviewed the information on the accounts to verify the information given to him by O'Connell. (Tr. 611-13.) Peterson did not meet with Oberholzer immediately after his telephone conversation with O'Connell, waiting until after the Christmas holiday. Peterson stated that he waited so that he could give the matter his full attention. (Tr. 546.)
On January 6, 1995, O'Connell spoke with Peterson regarding his investigation into the accounts. Peterson was to send O'Connell an analysis of the accounts on that date. (Tr. 544-45; Div. Exs. 93, 94.) O'Connell told Peterson that he wanted him to take the investigation seriously and directed Peterson to report back his findings upon completion of the investigation. (Tr. 546.)
Also on January 6, 1995, O'Connell discussed Oberholzer with Auwinger. The information O'Connell received from Auwinger was very similar to the information he would receive from Peterson. (Tr. 553.) Auwinger had spoken with Oberholzer's clients while Hayward Branch manager and had found no wrongdoing in their accounts. O'Connell stated that Auwinger specifically recalled Ms. Svogar stating she was pleased with the way her accounts were being handled. Auwinger told O'Connell that Ms. Svogar enjoyed trading securities based on information she received from watching financial news on television. (Tr. 553-55.)
After his conversation with Auwinger, O'Connell believed that Oberholzer had committed no sales practice violations during Auwinger's tenure as Hayward Branch manager. He also believed Auwinger had adequately supervised Oberholzer. (Tr. 557.) O'Connell knew Auwinger to be an experienced branch manager and former regional director, a position senior to O'Connell's. O'Connell had confidence in Auwinger's assessments of Oberholzer and his clients.62 (Tr. 554.)
As part of his investigation into the accounts identified in Needham's memorandum, Peterson talked with both Oberholzer and Auwinger. (Tr. 350-51, 642-43.) According to Auwinger, Oberholzer was a "good guy" who was aggressive and attracted aggressive clients. (Tr. 351, 622.) Auwinger had spoken to and written a number of Oberholzer's clients and concluded that they were aware of and controlled the activity in their accounts. (Tr. 351.)
Peterson and Auwinger discussed the specific accounts referenced in Needham's memorandum. Auwinger mentioned that Joseph Svogar and Glaser were friends and the O'Connor Trust Account was a referral from Ms. Svogar. (Tr. 351, 622, 643.) According to Auwinger, O'Connor's trading activity was similar to Ms. Svogar's because of the relationship between the two sons and their familiarity with their mothers' accounts. (Tr. 643.)
Auwinger did not express any concern as to Oberholzer nor did he indicate that Peterson should specially monitor the accounts of Ms. Svogar, Dr. Huey, or O'Connor. (Tr. 351-52.) Based on his conversation with Auwinger, Peterson concluded that Auwinger had adequately supervised Oberholzer client accounts while he was Hayward Branch manager. (Tr. 621-22, 649.)
As part of his investigation into the accounts indicated by Needham's memorandum, Peterson called Ms. Svogar after obtaining Joseph Svogar's telephone number from Oberholzer. (Tr. 623-25, 1228.) Joseph Svogar answered the call. Peterson identified himself and asked to speak to Ms. Svogar.63 (Tr. 624-26, 628.)
Peterson introduced himself to Ms. Svogar and told her he worked at Dean Witter with Oberholzer. He told her he was calling to verify and update certain information regarding her accounts. According to Peterson, Ms. Svogar immediately stated she was happy with Oberholzer and Dean Witter.64 (Tr. 625-26.)
Peterson used a printout of the Svogar IRA to take notes during and immediately after his telephone conversation with Ms. Svogar. (Tr. 1228-29; Div. Ex. 103 at DP00771, Resp. Ex. 313.) This printout contained figures for income, net worth and liquid assets, which Peterson asked Ms. Svogar to verify. (Tr. 1229; Div. Ex. 103 at DP00771, Resp. Ex. 313.) Ms. Svogar verified that her income was $24,000, her net worth was approximately $500,000, and her current liquid assets were approximately $47,000. (Tr. 626, 1229.) When Peterson stated that her investment objective was listed as income, Ms. Svogar disagreed, stating that she preferred to trade securities. (Tr. 626.) Ms. Svogar acknowledged the active trading in the Svogar IRA, as well as frequent disbursements from the account. (Tr. 626.) Peterson also asked her about a specific transaction in which she bought a security, sold it shortly thereafter and had the proceeds from the sale distributed out of the account. Ms. Svogar responded that the transaction was her idea because she needed money for family reasons. (Tr. 627.)
Peterson's notes from the conversation read as follows:
[Ms. Svogar] stated she was very happy with [Dean Witter] and Mike Oberholzer. She said she was taking money out of the account for family matter[s] and needs. . . . [Ms. Svogar] stated that most of the time she asked Mike to buy certain stocks for her and soon there after would need the [money] and call Mike to sell and send check. She stated that most of the time she acted on her own ideas and Mike would try to talk her out of it. Mike keeps me well informed. I advised her to keep some IRA [money] in cash and not buy any stock with cash because she might need it and we don't want to buy [and] sell so often.
(Div. Ex. 103 at DP00771, Resp. Ex. 313.)
Peterson encouraged Ms. Svogar to refrain from active trading, specifically her pattern of buying securities and selling them shortly thereafter. He also encouraged her to set aside funds for future needs. Peterson told her to call him if she had any problems. (Tr. 627.) Peterson did not recall whether he discussed margin use in the Svogar Trust Account with Ms. Svogar. (Tr. 645-46.)
Peterson also called Dr. Huey after he obtained her telephone number from Oberholzer. (Tr. 1231.) Peterson introduced himself to Dr. Huey and told her he worked with Oberholzer. He stated he wanted to verify certain information regarding her account. (Tr. 629.) As was the case with Ms. Svogar, Peterson had a printout of the Huey Trust Account that he used to take notes during his conversation with Dr. Huey. (Tr. 1230-31; Div. Ex. 103 at DP00772, Resp. Ex. 312.) According to this printout, Dr. Huey's income was $24,000, her approximate net worth was $450,000 and her current liquid assets were approximately $150,000. (Div. Ex. 103 at DP00772, Resp. Ex. 312.) Dr. Huey acknowledged these figures, as well as her stated investment objective of capital appreciation. (Tr. 629, 1230.)
Peterson and Dr. Huey discussed her use of margin, including the equity and margin debit balances in the Huey Trust Account.65 (Tr. 629, 1230.) Dr. Huey acknowledged the dangers of margin, as well as the losses and poor performance in her account during the prior year. (Tr. 629, 1230-31.) Dr. Huey stated she had no complaints with Oberholzer. (Tr. 629.) Peterson's notes from the conversation indicate that "[Dr. Huey] felt her investment objectives were capital appreciation [and] she was aware of her losses this past year. No complaints with [Oberholzer]." (Div. Ex. 103 at DP00772, Resp. Ex. 312.)
Based on the low equity in the Huey Trust Account, Peterson concluded the account could not have maintained a large position in more than one or two securities. Peterson did not specifically determine whether the securities in the Huey Trust Account were suitable because the purchases were not made during his tenure as Hayward Branch manager. He did not recall discussing solicitation of transactions with Dr. Huey. (Tr. 630.)
Peterson did not call O'Connor during his investigation. In fact, he never spoke with or received correspondence from O'Connor regarding her account. (Tr. 614.) Because Peterson received no complaints regarding the account from either O'Connor or Glaser, he based his decision not to call O'Connor on his review of the account, as well as his conversations with Auwinger and Oberholzer. (Tr. 642-43.)
By the time Peterson became Hayward Branch manager, the O'Connor Trust Account was basically limited to liquidating transactions. (Tr. 620-21, 649.) The account had not shown up during Peterson's reviews of active accounts. (Tr. 620.) Although there had been no recent purchases in the account, the account was not performing well. (Tr. 620-21, 643-44.) In reviewing the O'Connor Trust Account, Peterson discovered several liquidations to fulfill disbursements from the account. (Tr. 620.) O'Connor withdrew approximately $1,000 per month from the account and Oberholzer often sold securities in the account to cover these monthly withdrawals. (Tr. 644.) Peterson also identified margin liquidations and margin interest charges in the account. (Tr. 620-21.)
Oberholzer told Peterson that the value of the securities in the O'Connor Trust Account had fallen, but that he expected them to recover. Oberholzer planned to wait for their value to rise, then liquidate the securities to reduce the margin debit balance. Oberholzer was familiar with the securities in the O'Connor Trust Account, and Peterson trusted Oberholzer's judgment that the particular securities were suitable for the account and that their value would in fact increase. (Tr. 617-18.)
O'Connell talked with Peterson again on January 11, 1995. (Tr. 546-57; Div. Ex. 94 at TO 00003, Resp. Ex. 325.) Peterson had talked with certain clients, and O'Connell felt Peterson understood the activity. Furthermore, Peterson had identified what he felt to be the biggest issues. (Tr. 558-59.) Peterson stated he had discussed the Svogar IRA with Ms. Svogar and that most of the activity was caused by withdrawals from the account to give money to her son. Peterson told O'Connell that these were unsolicited transactions and not improper. (Tr. 560.) O'Connell again told Peterson that upon completion of his investigation, he was to report any wrongdoing to O'Connell. (Tr. 560-61.) O'Connell wanted Peterson's determination of any wrongdoing in the accounts, and if so, his recommendations as to a proper course of action. (Tr. 561.)
Based upon his conversations with Auwinger and Oberholzer's clients, Peterson concluded that there had been no wrongdoing in any of the accounts. (Tr. 621-22.) However, Peterson told O'Connell that he and Oberholzer had agreed to restrict certain accounts. (Tr. 547.) According to Peterson, the restricted accounts were limited to liquidations only and any unsolicited purchases would have to be approved by him. (Tr. 633.) If a client with a restricted account wanted to purchase a security, Peterson wanted to speak with the client beforehand to ensure that the transaction was in fact unsolicited and the client did want to purchase the particular security. After the restrictions were placed on the accounts, Oberholzer did not seek Peterson's approval for any purchases. (Tr. 646-47.)
Peterson believed no purchases should be made in the accounts, especially in light of the margin debit balances. He hoped the value of the securities held in the various accounts would increase and the securities would then be sold to eliminate the margin debit balances. (Tr. 644.) Peterson did not tell Ms. Svogar or Dr. Huey that he was going to put restrictions on their accounts during his telephone conversations with them, or at any time thereafter. (Tr. 631-32.)
O'Connell's notes also indicated that the restrictions would not prohibit unsolicited purchases approved by Peterson. (Tr. 577; Div. Ex. 93 at TO 00001, Resp. Ex. 324 at TO 00001.) Sales of securities in restricted accounts to reduce margin debit balances would not require Peterson's preapproval.66 (Tr. 578.)
On or about January 17, 1995, Peterson drafted a memorandum to Oberholzer, which stated: "[p]er our conversation, I am restricting the following accounts to liquidations only. No new positions are to be bought." (Div. Ex. 41; Resp. Ex. 328.) Six accounts are listed, including the Svogar IRA, the Svogar Trust Account, the O'Connor Trust Account, and the Huey Trust Account.67 Copies of the memorandum were sent to Miller, O'Connell and Needham.68 (Div. Ex. 41, Resp. Ex. 328.)
Also on or about January 17, 1995, Peterson sent a memorandum to McDaniel-Remer, with copies to Miller and O'Connell. (Tr. 1232-33; Div. Ex. 40, Resp. Ex. 329.) It listed four Oberholzer clients, including Ms. Svogar and Dr. Huey, and stated:
I have spoken with each of the above clients. In regard to their margin accounts I mentioned the two edged sword theory - when the market is up it will help you and when the market is down it will hurt you. They all acknowledged they have experienced their hurt this year but none of them had complaints of how Mike has handled their accounts.
I asked each client what their goals and investment objectives were and they all stated they were speculation or aggressive growth. Everything I reviewed in our discussions was consistent with what Mike had described relative to the client's objectives and backgrounds.
I also spoke with the sons of two of the clients. . . . Ms. Svogar's son also had no complaints.
I will continue my review of these accounts in regard to the activity of 1994. I will go into further detail as far as my conversations and findings; but at this point, all of these accounts have been restricted to liquidating orders only.69
(Tr. 403-04; Div. Ex. 40, Resp. Ex. 329.) After January 17, 1995, Peterson's further investigation into the Svogar IRA, the Svogar Trust Account, the Huey Trust Account, and the O'Connor Trust Account consisted of his usual surveillance responsibilities. He also reviewed the accounts from time to time to note if any transactions had occurred. (Tr. 638.) He stated that neither McDaniel-Remer nor O'Connell contacted him seeking more information after he sent them the January 17, 1995 memoranda. (Tr. 1233.) Neither O'Connell nor anyone from the compliance department indicated to Peterson that they felt the memoranda to be inadequate or his actions insufficient. (Tr. 648-49, 1233.)
After O'Connell reviewed Peterson's memorandum to McDaniel-Remer, he was satisfied that Peterson had conducted an investigation into the accounts and had concluded that there was no wrongdoing. (Tr. 563.) O'Connell felt by placing restrictions on the accounts, Peterson was supervising the accounts and the issues would not resurface. (Tr. 566.) He considered it significant that Peterson had spoken to the clients in question, explained the risks of margin, inquired as to if their investment objectives were being met and whether they were happy with their accounts. (Tr. 548-50, 562.) He also noted that the clients' responses were consistent with the information Peterson had received from Oberholzer. O'Connell also noted that the information he received from Auwinger corroborated the information he received from Peterson, and the information from both corroborated the information they were reporting from Oberholzer. (Tr. 549-50, 562-64.)
Considering Peterson's memorandum to McDaniel-Remer and his conversations with Peterson, O'Connell concluded there was a high level of activity in the accounts, but it was acknowledged by the clients. (Tr. 549.) This is what both Auwinger and Oberholzer had indicated to O'Connell and was Peterson's initial response to Needham's account inquiry. (Tr. 549-550; Div. Exs. 93, 94, Resp. Exs. 324, 325.) O'Connell concluded that Peterson was adequately handling the situation, and that he would be informed of any new information. (Tr. 550, 581.)
O'Connell testified that if the compliance department was in any way dissatisfied with his response to the issues presented in December 1994, they could have sought assistance from either Dean Witter's law department or their compliance department superiors. (Tr. 550.) McDaniel-Remer did not suggest to him that Peterson's memoranda or the restrictions imposed were inadequate. (Tr. 577.)
Activity After the Restrictions
In early 1995, three purchases were made in restricted accounts. In March 1995, two purchases were made in the Svogar IRA. (Div. Ex. 4, Tab 9.) On April 18, 1995, Oberholzer submitted an order ticket for the purchase of 300 shares of Western Water by the Svogar Trust Account. (Tr. 572, 633-34; Div. Exs. 4, 66.) Oberholzer also submitted an order ticket purchasing Western Water in another client's account on the same date and at the same time as the order ticket for the Svogar Trust Account. (Tr. 634-35; Div. Ex. 66.)
Taylor discovered the purchase of Western Water by the Svogar Trust Account and informed Peterson.70 (Tr. 638, 1206.) He subsequently met with both Oberholzer and Peterson. (Tr. 1207.) Oberholzer told Taylor that he understood the restrictions to mean that he could not solicit orders in the restricted accounts, but that he could accept unsolicited orders. (Tr. 1208; Resp. Ex. 334 at DWR37462.) Oberholzer also told Taylor he had advised Ms. Svogar to slow trading, and that she bought and sold securities because her son needed money. (Tr. 1208; Resp. Ex. 334 at DWR37462.) According to Oberholzer, the large distributions from the Svogar IRA were for Joseph Svogar's business. (Tr. 1208; Resp. Ex. 334 at DWR37462.)
Taylor also alerted O'Connell, who then called Peterson and instructed him to investigate and stop the trading in the accounts. (Tr. 572-73.) O'Connell stated that he had no reason to believe that there was any wrongdoing in the Svogar IRA or the Svogar Trust Account, but he did not want the issues from January 1995 to resurface. O'Connell wanted Peterson to stop the trading, investigate the transactions, and if he found any wrongdoing, terminate Oberholzer. (Tr. 573-74; Resp. Ex. 324.)
Peterson did not know of or approve the purchases in the Svogar accounts. (Tr. 634.) After Taylor alerted him to the purchases, Peterson verified the information and sought Oberholzer's explanations for the purchases. Peterson told Oberholzer that any unsolicited purchases in the restricted accounts required his prior approval. Oberholzer expressed surprise and told Peterson he understood the restrictions to not include unsolicited purchases. Peterson informed Oberholzer that unsolicited purchases were included and that Oberholzer was to make no more purchases in restricted accounts. If a client requested an unsolicited purchase in a restricted account, Oberholzer was to inform Peterson who wanted to speak with the client before the transaction was executed. (Tr. 647.)
Peterson stated that after his conversation with Oberholzer, he reviewed his January 17, 1995 memorandum to Oberholzer and felt it did not specifically detail his intended procedure regarding unsolicited purchases. (Tr. 647-48.) On or about May 17, 1995, Peterson sent Oberholzer a memorandum that stated "[t]his memo is to further clarify my last memo dated [January 17, 1995]. The accounts listed below are restricted to liquidations only. Any unsolicited buy orders must be approved by me before entering." (Tr. 647-48; Div. Ex. 42, Resp. Ex. 336.) The memorandum listed six accounts, including the Svogar IRA, the Svogar Trust Account, the O'Connor Trust Account, and the Huey Trust Account. (Div. Ex. 42, Resp. Ex. 336.)
Taylor testified that Oberholzer had notes in his Daytimer regarding the purchases, which he asserted were unsolicited. Taylor testified that he checked the notes. (Tr. 1207-08, 1213-14; Resp. Ex. 334 at DWR37462.) Peterson testified that he was not certain if these were solicited or unsolicited purchases, but that he believed they were unsolicited. (Tr. 635.) However, Peterson knew that Oberholzer had previously submitted security solicitation request forms for Western Water and that Oberholzer was soliciting purchases and perhaps sales of Western Water in 1995. (Tr. 634.)
Peterson did not call Ms. Svogar after he discovered the purchases by the Svogar IRA and the Svogar Trust Account. (Tr. 651.) Peterson felt calling Ms. Svogar was unnecessary because the purchases had already occurred, Ms. Svogar had received confirmation slips and account statements acknowledging the purchases, and she had made no complaints. (Tr. 652.)
Speculative Investments
The Division alleges that Oberholzer engaged in unsuitable trading by investing a substantial portion of the Four Clients' accounts in speculative securities. Padgett concluded that an investment by any of the Four Clients in Western Water, InaCom Corp. (InaCom), MTC Electronic Technologies Co. Ltd. (MTC Electronic), Bioject Medical Technologies Inc. (Bioject), Cholestech Corporation (Cholestech), or Creative Medical Development, Inc. (Creative Medical) was unsuitable. (Tr. 890-92.) Padgett stated that these were generally small capitalization companies with a short history of being publicly held, operating at losses and paying no dividends. In his opinion, these were highly speculative investments not suitable for investors seeking income and safety of investment.71 (Tr. 892-93.)
If an account executive wishes to solicit more than ten clients to purchase a security not recommended by Dean Witter, he must complete a security solicitation request form, which must be reviewed and approved by the branch manager and the regional sales director. (Tr. 155; Joint Ex. 3, ¶15.) A security solicitation request form is "[r]equired for solicitation of [ten] or more customers for purchases of equity securities which are not rated B+ or better by [Standard & Poor's], or followed by [Dean Witter] Research, or the subject of an underwriting in which [Dean Witter] was a participant within [the] last [six] months." (Resp. Ex. 290.)
On or about November 30, 1994, Needham sent Peterson a memorandum seeking security solicitation request forms for certain non-recommended securities in which Oberholzer's clients had invested. Western Water, InaCom, MTC Electronic, Creative Medical and Bioject were the securities listed in Needham's memorandum. (Tr. 155-56; Div. Ex. 43 at DP00521, Resp. Ex. 304.) Needham requested that Oberholzer complete security solicitation request forms for the referenced securities, and advised that solicited purchases of the securities were prohibited until the completed forms were approved by the branch manager and regional sales manager. (Tr. 155-56; Div. Ex. 43 at DP00521, Resp. Ex. 304.) Peterson responded to Needham's inquiry by memorandum dated December 19, 1994, and provided security solicitation request forms for Western Water, InaCom, and Bioject. (Tr. 156; Div. Ex. 43, Resp. Ex. 309.)
Needham noted that four account executives, including Oberholzer, had submitted a security solicitation request form for Western Water on or about September 6, 1994. (Resp. Ex. 290.) Approval under this form expired on October 31, 1994, but trading had continued. (Div. Ex. 43, Resp. Ex. 309.) The Svogar IRA, Svogar Trust Account, Huey Trust Account, and O'Connor Trust Account had each purchased shares of Western Water. (Div. Ex. 116.) While Peterson was Hayward Branch manager, there were four purchases of Western Water by the Svogar IRA, four by the Svogar Trust Account, one by the Huey Trust Account, and one by the O'Connor Trust Account. (Div. Exs. 2-5, 67.)
Needham noted Oberholzer and another account executive had also submitted a securities solicitation request form for InaCom on October 21, 1994. (Tr. 155-56; Resp. Ex. 292.) All purchases of InaCom took place while Peterson was Hayward Branch manager and occurred between late September and October 1994. The Huey Trust Account made three purchases of InaCom during this period, while the Svogar IRA made four purchases of InaCom. (Div. Exs. 2-5, 69.)
Bioject was also mentioned in Needham's memorandum. (Tr. 155-56; Div. Ex. 43 at DP00521, Resp. Ex. 304.) The Svogar IRA purchased 2000 shares of Bioject on September 16, 1994. (Div. Ex. 68.) On September 23, 1994, the Svogar IRA purchased an additional 2000 shares, and the Huey Trust Account purchased 700 shares. (Div. Ex. 66, Tab A.) The Svogar IRA purchased an additional 1100 shares of Bioject on November 25, 1994. (Div. Ex. 68.)
MTC Electronic was another non-recommended security mentioned in Needham's memorandum. (Div. Ex. 43 at DP00521, Resp. Ex. 304.) In Peterson's response, he indicated that there was only one position in MTC Electronic for 1000 shares and that Oberholzer would not be soliciting any additional shares. (Div. Ex. 43, Resp. Ex. 309.) Each of the Four Clients had invested in MTC Electronic, but no purchases were made while Peterson was Hayward Branch manager. (Div. Ex. 116.)
Needham's memorandum also referenced Creative Medical as a non-recommended security Oberholzer's clients had purchased. (Div. Ex. 43 at DP00521, Resp. Ex. 304.) In his response, Peterson stated that Oberholzer had solicited only 2,900 shares of Creative Medical in two accounts not owned by any of the Four Clients. He stated that eleven other positions totaling 13,700 shares were transferred to Dean Witter. (Div. Ex. 43, Resp. Ex. 309.) Of the Four Clients' accounts, only the Svogar IRA invested in Creative Medical, although no purchases of this security were made while Peterson was Hayward Branch manager. (Div. Ex. 116.)
Expert Testimony
Padgett prepared an expert report summarizing his conclusions regarding Dean Witter and Peterson's alleged failure to supervise Oberholzer, as well as the alleged underlying violations in the Four Clients' accounts. He prepared this report by reviewing the information available when a particular event would have triggered an account analysis by Dean Witter employees. (Div. Ex. 1.) Such events included account inquiries sent by the compliance department or a Hayward Branch manager's completion of an account report form in response. Padgett sought to determine whether the compliance department or the Hayward Branch manager had sufficient information at those particular instances to detect and prevent the violations alleged by the Division. (Tr. 1051-52.) According to Padgett, his expert report was only meant to identify alleged "red flags," and did not detail all relevant events, such as telephone conversations between the clients and Auwinger or Peterson.72 (Tr. 980-81.)
Padgett prepared analyses of the Four Clients' accounts and offered testimony on the alleged underlying violations therein. (Div. Exs. 2-5.) Hennessy also prepared exhibits illustrating the performance of the O'Connor Trust Account, the Svogar IRA, the Svogar Trust Account, and the Huey Trust Account during Peterson's tenure as Hayward Branch manager.73 (Tr. 1366-67; Resp. Ex. 400.)
Padgett correctly identified the elements of churning as control by the account executive, excessive trading, and scienter. (Tr. 893; Div. Ex. 1 at 4.) In addition to concluding that Oberholzer controlled the accounts of the Four Clients, Padgett concluded that there was excessive trading in a number of the accounts. (Div. Ex. 1 at 4-10.) He further concluded that Oberholzer's scienter was established for two reasons: first, high transaction costs in a number of relevant accounts precluded any reasonable expectation of profit or breaking even; second, activity in certain accounts had no economic logic other than to generate commissions.74 (Tr. 902.)
Padgett considered three elements in determining whether particular investments were suitable for the Four Clients. These were the Four Clients' investment objectives, financial needs, and sophistication. (Tr. 870, 877-78, 1006-07; Div. Ex. 1 at 1.) Padgett stated that the relevant investment objective is determined by the client at the time a particular investment recommendation is made. (Tr. 1007.) As to financial needs, Padgett stated that the Four Clients were all elderly women with limited funds of varying amounts. (Tr. 872; Div. Ex. 1 at 2.) He stated that the danger with such investors is that they generally lack the ability to recoup losses. (Tr. 872, 879-80.) Padgett used a two-part analysis to determine the sophistication of the Four Clients. After determining whether the Four Clients possessed the capability to independently evaluate the risk involved in a particular investment, he investigated the extent to which the clients exercised independent judgment in evaluating a recommended investment. (Tr. 877-78; Div. Ex. 1 at 1.)
Padgett also considered the Four Clients' investment strategies, use of margin, and concentration in determining suitability. (Tr. 832, 878, 1130-31; Div. Ex. 1 at 2-3.) He considered frequency of transactions in determining whether the Four Clients' investment strategies were appropriate for their particular accounts. Padgett generally stated that the investment strategy directed by Oberholzer resulted in levels of activity in the accounts that were unsuitable for the Four Clients. He concluded that transaction costs precluded any reasonable expectation for the accounts to make a profit or break even. (Tr. 872; Div. Ex. 1 at 2.)
Padgett stated that undue concentration is a suitability consideration, taking into account a client's investment objective. (Tr. 832, 1130-31.) Padgett stated this is especially true for elderly clients and clients who have a need for capital preservation. (Tr. 832-86.) However, Hennessy took issue with Padgett's method of determining concentration in margin accounts. He disagreed with Padgett's use of net equity to determine concentration and argued that market value was the appropriate consideration. Hennessy stated that Padgett calculated concentration in margin accounts by determining the percentage of net equity comprised by one security, mainly Western Water. Padgett's use of net equity ignored investments in other securities, and resulted in a higher reported concentration in Western Water. It also ignored Western Water's rise in price. Hennessy opined that a price increase would also affect concentration, particularly if an account employed a liquidation strategy. Hennessy viewed the accounts of Ms. Svogar, Dr. Huey, and O'Connor as small accounts where concentration levels are increased. Hennessy concluded that during Peterson's tenure as Hayward Branch manager, there was no unsuitable concentration in the accounts of Ms. Svogar, Dr. Huey, or O'Connor. (Tr. 1381-85.) He further opined that allowing sales to reduce margin debit balances, but resulting in higher concentration levels, was not a failure to supervise by Peterson. (Tr. 1383-85.)
Betz's Accounts
Padgett measured the Betz Initial Account from July 1989 to September 1991. (Div. Ex. 2 at Tab 1.) During this period, the average equity was $91,388, purchases and sales totaled $383,478, the annual turnover ratio was 1.3, commissions totaled $10,280, and there was a net gain of $10,856. (Div. Ex. 2 at Tab 1.) It appears there were only three purchases in the account, the last one being a purchase of an annuity on October 31, 1990. (Div. Ex. 2 at Tab 16.)
He measured the Betz Joint Account from August 1989 through April 1992. (Div. Ex. 2 at Tab 1.) During this period, the average equity was $79,379, purchases and sales totaled $415,439, the annual turnover ratio, measured through May 1994, was 1.1, commissions totaled $10,891, and the net gain, measured through May 1994, was $15,410. (Div. Ex. 2 at Tab 1.)
Padgett measured the Betz Trust Account from May 1992 to May 1993. (Div. Ex. 2 at Tab 1.) During this period, the average equity was $111,500, purchases and sales totaled $759,549, average percent on margin was 7%, annual turnover ratio was 4.4, commissions totaled $20,090, and the net loss was $7,638. (Div. Ex. 2 at Tab 1.) The return needed to break even was 23.9%. (Div. Ex. 2 at Tab 3.) Padgett's analysis identified six transactions without apparent economic logic in 1992 and three in 1993. (Div. Ex. 2 at Tab 4.) There was one purchase of MTC Electronic in the account occurring on March 9, 1993. (Div. Ex. 2 at Tab 6.)
Dr. Huey's Accounts
Padgett measured the Huey Joint Account from August 1989 through April 1992. (Div. Ex. 3 at Tab 1.) During this period, the average equity was $101,902, purchases and sales totaled $628,811, the annual turnover ratio was 1.4, commissions totaled $17,196, and the net gain, which Padgett measured through September 1995, was $25,233. (Tr. 895; Div. Ex. 3 at Tab 1.) Padgett did not conclude there was excessive trading in the Huey Joint Account. (Tr. 895.)
Padgett measured the Huey Trust Account from May 1992 through December 1994. The average equity for this period was $52,904, purchases and sales totaled $1,674,590, commissions totaled $46,329, and the net loss, which was measured through September 1995, was $77,732.75 (Div. Ex. 3 at Tab 1.) The annual turnover ratio for this period was 5.9 and the return needed to break even was 36%. (Tr. 894; Div. Ex. 3 at Tab 3.) The average percent on margin was 39%. (Div. Ex. 3 at Tab 1.) Padgett identified seven transactions without apparent economic logic in 1992, fifteen in 1993, and six in 1994. (Div. Ex. 3 at Tab 4.) None of these purchases occurred while Peterson was Hayward Branch manager. (Div. Ex. 3 at Tab 4.)
According to Padgett, Oberholzer churned the Huey Trust Account. In concluding that Oberholzer controlled the account, Padgett claimed that Oberholzer solicited most transactions in the account. (Tr. 890, 900-01.) Padgett considered Dr. Huey's financial situation precarious just to maintain her standard of living and concluded there was no indication that she had an understanding of the risk involved in her account. (Tr. 884.) Padgett concluded there was excessive trading in the Huey Trust Account in light of Dr. Huey's investment objectives, which he considered to be income. (Tr. 884, 893-95.)
Padgett also concluded that Oberholzer engaged in unsuitable trading in the Huey Trust Account. He opined that certain investments in the Huey Trust Account were unsuitable, and his account analysis identified positions in Bioject, InaCom, MTC Electronic, and Western Water.76 (Tr. 885-87; Div. Ex. 3 at Tab 7.) Padgett stated that transactions in the account were not suitable for an investment objective of income. (Tr. 884, 900-01.) He found the investment strategy utilized in the account to be unsuitable as it resulted in high transactional costs precluding a reasonable return. (Tr. 885.) He also found the use of margin unsuitable and identified unsuitable concentration in MTC Electronic, Scitex and Western Water. (Tr. 885-86; Div. Ex. 3 at Tab 5.)
Padgett stated that the underlying violations in the Huey Trust Account during Peterson's tenure as Hayward Branch manager were churning and unsuitable trading resulting from excessive trading and undue concentration. (Tr. 1024.) However, Padgett acknowledged that suitability hinged on Dr. Huey's investment objectives, financial needs and sophistication and there was no evidence of this while Peterson was Hayward Branch manager. (Tr. 1024.) Padgett acknowledged that undue concentration in the account was the result of trading occurring prior to Peterson's tenure as Hayward Branch manager. (Tr. 1025.) With regard to excessive trading, Padgett stated the restrictions imposed by Peterson were an adequate response, but not to trading occurring between September 1994 and December 1994.77 (Tr. 1025.)
According to Hennessy, the Huey Trust Account suffered a loss of $1,408 while Peterson was Hayward Branch manager. (Tr. 1380.) In reviewing the Huey Trust Account, Hennessy noted that there were no purchases in the account after Peterson restricted the account on January 17, 1995. The activity in the account was limited to liquidating sales to reduce the margin debit balance, which was reduced during this time. (Tr. 1377-79; Resp. Ex. 400.)
O'Connor's Account
Padgett measured the O'Connor Trust Account from March through October 1994. (Div. Ex. 5 at Tab 1.) The average equity for the period was $57,494. Purchases and sales totaled $918,559, and the annualized turnover ratio was 13. (Tr. 823, 897; Div. Ex. 5 at Tab 1.) The return needed to break-even was 77.9% and the average percent on margin was 65%. (Tr. 823, 826; Div. Ex. 5 at Tab 1, Tab 3.) Padgett also identified six transactions in the O'Connor Trust Account with no apparent economic logic, none of which occurred while Peterson was Hayward Branch manager. (Tr. 828-29; Div. Ex. 5 at Tab 4.)
According to Padgett, Oberholzer churned the O'Connor Trust Account. In concluding that Oberholzer controlled the O'Connor Trust Account, Padgett considered the amount of commissions paid from March 1994 through November 1995, which he determined to be $23,482.78 (Tr. 823, 899-900; Div. Ex. 5 at Tab 1.) He concluded that most transactions in the O'Connor Trust Account were solicited and that from March 1994 through October 1994, trading was excessive in light of O'Connor's investment objectives. (Tr. 889-90, 897-98.) However, Padgett noted there were no purchases in the account after October 18, 1994.79 (Tr. 823, 903-04; Div. Ex. 5 at Tab 6, Tab 9.)
Padgett also concluded that Oberholzer engaged in unsuitable trading in the O'Connor Trust Account. According to Padgett, the investment strategy in the account was unsuitable. Padgett noted that O'Connor opened the account with an initial investment of $100,000 and desired to withdraw $1,000 per month. He concluded that this would require a 12% return on her investment, necessitating acceptance of normal investment risk. Considering her financial needs and her age, Padgett concluded that a normal investment risk was not suitable. (Tr. 886-87.) Furthermore, Padgett testified that high transactional costs precluded any reasonable expectation of return. (Tr. 874.)
Padgett concluded that certain investments in the O'Connor Trust Account were unsuitable, and his account analysis identified investments in Western Water and MTC Electronic. (Tr. 886-87; Div. Ex. 5 at Tab 8.) Padgett also concluded that margin use and concentration in Western Water was unsuitable.80 (Tr. 830-32, 887; Div. Ex. 5 at Tab 5, Tab 7.)
During Peterson's tenure, the only underlying violations Padgett alleged were the monthly margin interest charges, and allowing alleged unsuitable concentration to continue. However, Padgett acknowledged that the margin interest charges resulted from transactions prior to Peterson's tenure. (Tr. 1019-21.) He also acknowledged that determining whether use of margin results in unsuitable trading necessarily requires consideration of the particular client's investment objectives. Padgett stated there was no evidence of O'Connor's investment objectives while Peterson was Hayward Branch manager. (Tr. 1027-28.)
Hennessy reviewed the O'Connor Trust Account for a period spanning October 1994 to November 1995, noting the single purchase during this period. (Tr. 1373; Resp. Ex. 400.) All other transactions during this period were liquidating sales to reduce the margin debit balance.81 (Tr. 1373-74.) Hennessy concluded that the activity in the O'Connor Trust Account during Peterson's tenure as Hayward Branch manager was consistent with the stated strategy to liquidate and reduce the margin debit balance, which was in fact reduced. (Tr. 1374-76; Resp. Ex. 400.) Although Padgett stated that the account incurred additional losses after September 1994, Hennessy attributed those, in part, to O'Connor's withdrawals during the period totaling $19,893. (Tr. 836, 1376; Div. Ex. 5 at Tab 6, Resp. Ex. 400 at 12.)
Ms. Svogar's Accounts
Padgett measured the Svogar Joint Account from January 1991 through March 1992. During this period, equity averaged $15,580, purchases and sales totaled $181,004, the annual turnover ratio was 5.1, commissions totaled $5,742, and there was a net loss of $6,450. (Div. Ex. 4 at Tab 1.) The return needed to break even for this period was 32.3%. (Div. Ex. 4 at Tab 18.) Padgett identified twelve transactions without apparent economic logic, all occurring in 1991. (Div. Ex. 4 at Tab 19.)
Padgett measured the Svogar Custodial Accounts from April 1991 to June 1995. Each account had an average equity of approximately $7,300, purchases and sales totaling approximately $74,600, an annual turnover ratio of 1.5, commissions totaling approximately $2,300 and a net loss of $7,150. (Div. Ex. 4 at Tab 1.) Padgett did not conclude there was excessive trading in any of the Svogar Custodial Accounts. (Tr. 896-97.) Each account made one purchase of MTC Electronic on April 16, 1993, and one purchase of Western Water on September 14, 1994. (Div. Ex. 4 at Tab 25, Tab 29, Tab 33.)
Padgett measured the Svogar IRA from January 1991 through December 1994. During this period, average equity was $268,969, purchases and sales totaled $6,716,260, and the annual turnover ratio was 3.9. (Tr. 873, 895; Div. Ex. 4 at Tab 1.) Padgett stated that the return needed to break-even for the period was 19.8%. (Div. Ex. 4 at Tab 3.) From January 1991 through August 1995, commissions totaled $171,790, and the net loss was $123,991. He identified fourteen transactions with no apparent economic logic in 1991, twenty-one in 1992, twenty-nine in 1993 and twenty-one in 1994. (Div. Ex. 4 at Tab 4.) None of these purchases occurred during Peterson's tenure as Hayward Branch manager.
According to Padgett, Oberholzer churned the Svogar IRA. Padgett concluded that there was excessive trading in the Svogar IRA in light of Ms. Svogar's investment objective, which he stated was income. (Tr. 883, 895-97.) In concluding that Oberholzer controlled the account, Padgett identified only one transaction in the account he believed was not solicited by Oberholzer. (Tr. 889, 898.) Padgett considered the no-interest loan Ms. Svogar made to Oberholzer and the amount of commissions paid as evidence that Oberholzer controlled the account. (Tr. 873, 898.) Padgett also noted Ms. Svogar's tenth grade education, and Mr. Svogar's testimony regarding his mother's lack of investment experience. (Tr. 899.)
Padgett stated that he saw no evidence indicating that Ms. Svogar had any financial sophistication. (Tr. 881.) In reaching this conclusion he considered the aforementioned loan, as well as her letters expressing satisfaction with her account. (Tr. 882.) Considering the turnover rate and amount of commissions, Padgett considered the letters evidence of a lack of financial sophistication. (Tr. 882.) However, Padgett acknowledged that Auwinger and Peterson's testimony regarding conversations with Ms. Svogar contradicted his conclusions regarding control. (Tr. 1031-32.)
According to Padgett, Oberholzer engaged in unsuitable trading in the Svogar IRA. He believed the investment strategy was unsuitable as high transaction costs precluded a reasonable return on investment. (Tr. 883.) He identified concentration in Western Water and InaCom he considered unsuitable. (Tr. 885-86; Div. Ex. 4 at Tab 5.) Padgett also testified that certain investments in the Svogar IRA were unsuitable, and his analysis of the account identified positions in Bioject, Cholestech, Creative Medical, InaCom, MTC Electronic, and Western Water.82 (Tr. 883; Div. Ex. 4 at Tab 7.)
Padgett stated that during Peterson's tenure as Hayward Branch manager, the underlying violation in the Svogar IRA was excessive trading for a short period of time. (Tr. 1028-29.) However, Padgett's calculations regarding excessive trading were prepared on an annual basis, and did not reflect trading occurring specifically while Peterson was Hayward Branch manager.83 Padgett also acknowledged that undue concentration was a result of trading that occurred prior to Peterson becoming Hayward Branch manager. (Tr. 1029.) Hennessy also reviewed the Svogar IRA, noting that there was no margin in this account and that Ms. Svogar withdrew $27,152 from the account during the period spanning October 1994 through August 1995. (Tr. 1372-73; Resp. Ex. 400 at 10.)
In March 1992, the assets of the Svogar Margin Account were transferred and used to fund the Svogar Trust Account. (Div. Ex. 4 at Tab 16.) Padgett combined his analysis of the two accounts to cover the period spanning January 1991 through August 1995. (Div. 4 at Tab 1.) For this period, the average equity was $31,687, purchases and sales totaled $631,738, the annual turnover rate was 2.2, commissions totaled $16,742, and the net loss was $19,450. (Div. Ex. 4 at Tab 1.) Padgett calculated the average percent on margin for this period to be 32%. (Div. Ex. 4 at Tab 1.) While he stated the margin use was questionable, he could not conclude that it was unsuitable. (Tr. 883.) Padgett identified four transactions with no apparent economic logic in 1991, five in 1992, one in 1993, and seven in 1994.84 (Div. Ex. 4 at Tab 12.)
Padgett concluded that Oberholzer had churned the Svogar Trust Account, but stated that excessive trading only occurred during 1994. (Tr. 895-97.) The annual turnover rate for 1994 was 21.0. (Div. Ex. 4 at Tab 13.) He calculated the return needed to break even for the period spanning January 1994 to December 1994 as 127.7%. (Div. Ex. 4 at Tab 11.)
Padgett also concluded there was unsuitable trading in the Svogar Trust Account. In addition to Western Water, Padgett identified investments in MTC Electronic, although no purchases of this security occurred during Peterson's tenure. (Div. Ex. 4 at Tab 14.) A total of four purchases of Western Water occurred while Peterson was Hayward Branch manager. (Div. Ex. 4 at Tab 16.)
Hennessy stated that the margin debit balance was reduced in the Svogar Trust Account during Peterson's tenure as Hayward Branch manager. (Tr. 1369; Resp. Ex. 400.) Hennessy measured the account from October 1994 through August 1995. During this period, there were only four purchases in the account, two in October 1994, one in November 1994, and one in April 1995. (Tr. 1370-71; Resp. Ex. 400 at 3.) He stated that there was no excessive trading in the account during this period and the account appreciated in value. (Tr. 1371-72; Resp. Ex. 400.)
III. FINDINGS OF FACT AND CONCLUSIONS OF LAW
Section 15(b)(4)(E) of the Exchange Act authorizes sanctions against a broker-dealer that fails reasonably to supervise, with a view toward preventing securities laws violations, a person subject to its supervision who commits such a violation. See James Harvey Thornton, 69 SEC Docket 49, 53 (Feb. 1, 1999), aff'd, 199 F.3d 440 (5th Cir. 1999) (unpublished table decision). Section 15(b)(6) of the Exchange Act authorizes sanctions against "associated persons of broker-dealers who fail reasonably to supervise persons subject to their supervision with a view to preventing violations of the federal securities laws." James J. Pasztor, 70 SEC Docket 2611, 2620 (Oct. 14, 1999); see also Thornton, 69 SEC Docket at 53.
This statute establishes four elements of proof for a failure to supervise claim against a broker-dealer or an associated person: (i) an underlying violation of the securities laws, (ii) association of the registered representative or other person who committed the violation, (iii) supervisory jurisdiction over that person, and (iv) failure to reasonably supervise the person committing the violation. See Philadelphia Investors, LTD., Initial Decision, 66 SEC Docket 2645, 2657 (Mar. 20, 1998), final, 68 SEC Docket 572 (Oct. 6, 1998). The second and third elements cited above, association and supervisory jurisdiction, are not disputed in this case. Therefore, the Division must prove that Oberholzer violated the securities laws and that Respondents failed reasonably to supervise him with a view toward preventing the violations.
The five-year statute of limitations of 28 U.S.C. § 2462 is applicable to administrative proceedings brought pursuant to Section 15(b) of the Exchange Act. See Johnson v. SEC, 87 F.3d 484, 492 (D.C. Cir. 1996). However, conduct occurring outside this five-year period can be considered in examining the conduct occurring within the five-year period. See Jacob Wonsover, 69 SEC Docket 694, 713-14 (Mar. 1, 1999), petition denied, 205 F.3d 408 (D.C. Cir. 2000).
The OIP was filed on August 26, 1998. Dean Witter and the Division agreed to toll the applicable statute of limitations as of January 23, 1998. In accordance with the statute and cases cited above, and in light of the Division's assertion that it would not seek findings of facts and conclusions of law based upon conduct prior to February 1993, conduct that occurred prior to January 23, 1993, will not be considered to support a finding that Respondents failed reasonably to supervise Oberholzer prior to that time. Therefore, I make no findings that Dean Witter failed reasonably to supervise Oberholzer with regard to the Betz accounts, as they were closed in early 1993. Similarly, I make no findings that Dean Witter failed reasonably to supervise Oberholzer with respect to the Svogar Joint Account, Svogar Margin Account, or the Huey Joint Account. However, conduct occurring in connection with these accounts was considered in determining whether Dean Witter failed reasonably to supervise Oberholzer after January 23, 1993. The accounts at issue are the Svogar IRA, Svogar Trust Account, O'Connor Trust Account, and the Huey Trust Account.
Oberholzer's Securities Laws Violations
The Division alleges that Oberholzer willfully violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, by churning, engaging in unsuitable trading, and making materially false and misleading statements. It is further alleged that he aided and abetted Dean Witter's alleged violations of Section 17(a) of the Exchange Act and Rule 17a-3 thereunder.
As stated by the Commission, "[c]hurning occurs when a broker enters into transactions and manages a client's account for the purpose of generating commissions rather than furthering his client's interests." Joseph J. Barbato, 69 SEC Docket 178, 194 (Feb. 10, 1999) (citation omitted). To establish churning, the Division must prove: (1) excessive trading in light of the particular client's investment objectives, (2) Oberholzer's control over the trading, and (3) scienter, which is Oberholzer's intent to defraud or willful and reckless disregard for the particular client's interests. See Barbato, 69 SEC Docket at 194-95; see also Michael E. Tennenbaum, 47 S.E.C. 703, 706 (1982) ("Churning occurs when a broker, exercising control over an account's volume and frequency of trading, abuses his customer's confidence for personal gain by initiating transactions that are excessive in view of the account's investment objectives.") (citations omitted). As is discussed below, I find that Oberholzer churned the accounts at issue.
Because the Four Clients' accounts were non-discretionary, the Division contends that Oberholzer exercised "de facto" control over their accounts.85 In a non-discretionary account, an account executive may exercise "de facto" control if the client places her trust and faith in the account executive and routinely follows his advice. See Rowe v. Morgan Stanley Dean Witter, 191 F.R.D. 398, 407 (D.N.J. 1999). "De facto" control may be inferred, but requires an intensive review of all facts and circumstances. See Hotmar v. Lowell H. Listrom & Co., 808 F.2d 1384, 1386 (10th Cir. 1987); Rowe, 191 F.R.D. at 407-08. Although the Four Clients did not testify, Oberholzer's control over their accounts may be established through other evidence. See Laurie Jones Canady, 69 SEC Docket 1468, 1479 (Apr. 5, 1999) (quoting Michael David Sweeney, 50 S.E.C. 761, 767 (1991)), petition denied, 230 F.3d 362 (D.C. Cir. 2000).
Control may be inferred in a non-discretionary account when the client is unable to manage the account and must rely on the account executive, routinely following the account executive's recommendations. See Canady, 69 SEC Docket at 1477; see also Rowe, 191 F.R.D. at 408. The following factors are considered when determining whether an account executive has assumed control over a non-discretionary account:
age, education, intelligence and investment experience of the investor, whether the broker was socially or personally involved with the investor (it may be concluded that a customer relinquished control because of a relationship of trust and confidence), whether many of the transactions occurred without the investor's prior approval (this may be interpreted as an usurpation of control by the broker) and, whether a broker and investor spoke frequently with each other regarding the status of the account or the prudence of a particular transaction (an investor, by maintaining such an active interest in the account, may be found to have maintained control over said account).
Rowe, 191 F.R.D. at 408.
In light of these factors, most notably the apparent vulnerability of these elderly clients stemming from their personal relationships with Oberholzer, I find that Oberholzer controlled the trading in the accounts at issue. Although Dr. Huey was a retired anesthesiologist, she was seventy-two years old when she opened her first account at Dean Witter and had no prior investment experience. Oberholzer frequently visited her home, and brought her meals on several holidays. She also made a personal loan to Oberholzer for the purchase of an automobile. Ms. Svogar had a tenth grade education and was sixty-three years old when she opened her first accounts at Dean Witter. She did not understand documentation regarding her accounts and relied upon Oberholzer's advice for her investment decisions. Joseph Svogar testified that his mother trusted Oberholzer's advice and assured both Auwinger and Peterson that she was satisfied with her accounts at Oberholzer's request. Most tellingly, Ms. Svogar made a $90,000 interest-free loan to Oberholzer. O'Connor was seventy-eight years old when she opened her account, and there is no conclusive evidence that she had any prior investment experience or financial sophistication. Considering all other evidence, I find Glaser's July 14, 1994 letter evinces a personal relationship with Oberholzer and not O'Connor's ability and willingness to make her own investment decisions.
Excessive trading must be measured in light of the client's investment objectives. Hotmar, 808 F.2d at 1386; see also Rowe, 191 F.R.D. at 410 ("[A] churning claim is necessarily premised on excessive trading which, in turn, is directly connected to the investment objectives of a given plaintiff. . . . Excessive trading, therefore, can only be evaluated by inquiring into the character of the account of the investor, as well as the character of the investor.") (citations omitted). Ms. Svogar, Dr. Huey, and O'Connor were each elderly, single or widowed, and had limited financial resources. At the time they opened their first accounts with Dean Witter, both Dr. Huey and Ms. Svogar specifically told Oberholzer that their investment objective was income. O'Connor's initial deposit to open her account totaled one-half of her assets, not including her home, obviously necessitating a conservative investment objective. Furthermore, their conservative investment objectives and limited financial means are most accurately reflected in forms completed upon their initial contact with Oberholzer.86
While no single test is determinative of excessive trading, courts have traditionally considered turnover ratio, break-even level, in-and-out trading, and the number and frequency of transactions.87 See Canady, 69 SEC Docket at 1475-76. In this regard, I credit Padgett's testimony and analysis and conclude that there was excessive trading in the accounts at issue in light of the relatively conservative investment objectives of Dr. Huey, Ms. Svogar, and O'Connor.
To satisfy the scienter requirement of its churning claim, the Division must prove that Oberholzer acted with the intent to defraud, or with reckless disregard for the clients' interests. O'Connor v. R.F. Lafferty & Co., 965 F.2d 893, 899 (10th Cir. 1992). In addition to transaction costs resulting in the above-described break-even levels, Padgett noted a number of transactions with no apparent economic logic. In the Huey Trust Account, Padgett identified twenty-eight transactions without apparent economic logic. He identified eighty-five in the Svogar IRA and seventeen in the Svogar Trust Account. Padgett also identified six transactions with no apparent economic logic in the O'Connor Trust Account. I credit this testimony to support my conclusion that Oberholzer acted with scienter.
An account executive engages in unsuitable trading "when he or she makes recommendations that are unsuitable in light of the customer's stated investment objectives, in connection with actual misrepresentations and omissions." Barbato, 69 SEC Docket at 193-94 (citations omitted); see also Brown v. E.F. Hutton Group Inc., 991 F.2d 1020, 1031 (2d Cir. 1993); Banca Cremi, S.A. v. Alex. Brown & Sons, Inc., 132 F.3d 1017, 1032 (4th Cir. 1997). The OIP alleges that Oberholzer engaged in unsuitable trading by investing a substantial portion of the Four Clients' accounts in speculative securities. It also alleges that the Four Clients were exposed to further risk by purchasing these securities on margin.
I find that Oberholzer engaged in unsuitable trading in the accounts at issue. Considering the age, sophistication, financial needs, and conservative investment objectives of Dr. Huey, Ms. Svogar, and O'Connor, investments in Western Water, InaCom, Bioject, MTC Electronic, or Creative Medical were unsuitable. Not only did Padgett testify that these were highly speculative and unsuitable investments, but each was identified by Dean Witter as requiring a security solicitation request form before an account executive could recommend its purchase. The Svogar IRA, Svogar Trust Account, O'Connor Trust Account, and Huey Trust Account all invested in Western Water and MTC Electronic. The Svogar IRA and the Huey Trust Account invested in InaCom and Bioject. Only the Svogar IRA invested in Creative Medical. I also credit Padgett's testimony that concentration and use of margin in certain accounts was unsuitable. Padgett identified unsuitable concentrations of Western Water in the Huey Trust Account, the O'Connor Trust Account, and the Svogar IRA. He also identified unsuitable concentrations of Scitex and MTC Electronic in the O'Connor Trust Account, and InaCom in the Svogar IRA. He identified unsuitable use of margin in the Huey Trust Account and the O'Connor Trust Account.
Based on the conduct described above, I conclude that Oberholzer willfully violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, by engaging in churning and unsuitable trading in the accounts at issue. The Division has carried its burden of proving an underlying violation for purposes of its failure to supervise claim against Respondents. Therefore, what remains to be considered is whether Respondents failed reasonably to supervise Oberholzer with a view towards preventing the churning and unsuitable trading discussed above.
Dean Witter's Supervisory Procedures and Reasonableness of Supervision
The Division has the burden of proving that Respondents failed reasonably to supervise Oberholzer with a view toward preventing the violations described above. However, neither Dean Witter nor Peterson shall be liable if the safe harbor provision of Section 15(b)(4)(E) of the Exchange Act is satisfied. As the Commission has stated, "[n]o firm or individual shall be disciplined for failure to supervise, however, if (1) there were in place `procedures, and a system for applying such procedures, which would reasonably be expected to prevent and detect' the securities violation in question, and (2) the person responsible for administering such procedures and system `reasonably discharged [his] duties and obligations . . . without reasonable cause to believe that such procedures and system were not being complied with.'" Thornton, 69 SEC Docket at 53-54 (alteration in original) (quoting Exchange Act § 15(b)(4)(E)). As discussed below, I conclude that Dean Witter has satisfied the requirements of Section 15(b)(4)(E) of the Exchange Act, and therefore is not liable for a failure to supervise Oberholzer.
Dean Witter's supervisory procedures, and the Respondents' discharge of their supervisory duties, are subject to a test of reasonableness. See Louis R. Trujillo, 49 S.E.C. 1106, 1110 (1989) (holding that the standard is "reasonable supervision under the attendant circumstances"); see also Albert Vincent O'Neal, 51 S.E.C. 1128, 1135 (1994). This determination must be made in the light of the particular violations at issue. Cf. O'Neal, 51 S.E.C. at 1135 ("Under Section 15(b)(4)(E), the test is whether [the branch manager's] supervision was reasonably designed to prevent the violations at issue, not . . . whether, if all the many other supervisory functions he performed were taken into account, his overall supervisory performance somehow earned him a hypothetical passing grade."). The test is not whether Respondents' supervision of Oberholzer was reasonable generally, but whether it was reasonably designed to detect and prevent Oberholzer's churning and unsuitable trading.
Each of these violations has objective and subjective elements. According to Dean Witter's supervisory procedures, the compliance department identifies objective elements to the branch manager, prompting his investigation of subjective elements. For example, if the compliance department identifies excessive trading possibly indicative of churning, the branch manager must investigate control. Determining the subjective elements of churning and unsuitable trading requires a factually intensive investigation, including a review of the specific account and communication with the account executive. It often requires communication with the specific client at issue. Dean Witter's procedures place the branch manager in the best position to do this. Furthermore, it is reasonable to rely on his conclusions. Branch managers are generally experienced and are subject to specific licensing requirements. Most importantly, they can be personally liable for a failure to supervise if they fail to adequately perform their duties. In light of the duties required of them, and their potential liability for failure to perform, it is reasonable for Dean Witter to place primary reliance on its branch managers.88
The Division alleges a number of deficiencies in Dean Witter's supervisory procedures, and for proof relies upon Padgett's testimony and expert report.89 As is more fully discussed below, these alleged deficiencies are made with the hindsight of Oberholzer's misconduct and do not support a conclusion that Dean Witter's procedures as applied in this case were unreasonable.
The Division alleges that Dean Witter's procedures were not reasonably designed to detect and prevent Oberholzer's violations of the securities laws because they did not require timely responses to indications of irregularities in client accounts. Padgett's testimony regarding this allegation involved the Svogar IRA account inquiry Needham sent Peterson on or about October 10, 1994. When no response was received, Needham sent a second account inquiry giving Peterson thirty more days to respond. (Tr. 1103-04.) Because the compliance department reviews activity based upon close of business for the prior month, Padgett argued this resulted in a four-month delay between the irregularity and an appropriate response by O'Connell. (Tr. 972-73, 1095-96, 1104-05.) He believed this was an excessive delay Dean Witter should have prevented. (Tr. 1096, 1100.) According to Padgett, Dean Witter could have prevented this alleged deficiency by empowering the compliance department with the authority to take corrective action. (Tr. 1096-97, 1123.) However, Padgett acknowledged that from 1990 to 1994, most broker-dealer firms had compliance departments that were informational or advisory and that the Commission had ruled it reasonable to have a compliance department with such functions.90 (Tr. 1099.)
According to Maine, there was no unreasonable delay between alleged irregularities and an appropriate response. (Tr. 1303-04.) He was not aware of any broker-dealer firm whose compliance department reviewed account activity upon any basis other than close of business for the prior month. Maine stated that allowing the branch manager thirty days to respond to an account inquiry was reasonable as the branch manager was required to review account records, interview the account executive, and frequently contact the client. (Tr. 1304-05.) Furthermore, Maine found no instance in which the compliance department's review of an account and issuance of an account inquiry was not timely. He also found no instance in which Auwinger or Peterson did not issue a timely response to an account inquiry. (Tr. 1324.)
Maine favorably noted Dean Witter's requirement of regional director notification if a satisfactory response was not received from a branch manager within thirty days of an account inquiry. He stated that this requirement was unique to Dean Witter and provided for a timely response to account irregularities. (Tr. 1298, 1300-03, 1311.) However, the Division noted that the compliance department was solely responsible for determining if a branch manager's response was in fact reasonable. It alleges this is a failure to provide escalated responses to accounts repeatedly identified by the compliance department and another example of how Dean Witter's procedures were not reasonably designed to detect and prevent Oberholzer's violations.
According to Maine, Dean Witter's procedures were not only reasonable, but also common in the securities industry. (Tr. 1300-01.) Pursuant to these procedures, the compliance department identified possible irregularities to the branch manager. The branch manager gathered all necessary information, interviewed the account executive, and contacted the client if necessary.91 The branch manager then responded to the compliance department. (Tr. 1326.) Maine stated it was reasonable to place this responsibility on the branch manager because they are in the best position to assess the credibility of the account executive and contact the clients. Branch managers generally have the most experience and the most to lose if they do not adequately supervise the account executives. In addition to liability for failure to supervise account executives, Maine stated litigation costs reduce the profitability of the branch, which reduces the branch manager's compensation. (Tr. 1306-07.)
Conversely, the compliance department serves in a support function. Its role is to quantitatively identify accounts warranting further inquiry by the branch manager. (Tr. 1325-26.) Generally, the compliance department does not interact with clients or the account executive. (Tr. 1325.) Therefore, Maine concluded it was reasonable for the compliance department to rely on the Hayward Branch managers' responses to account inquiries, especially in light of their experience, performance records, and previous responses.92 (Tr. 1325-27, 1330.) He also stated there was nothing to alert the compliance department that its performance in this case was unreasonable or that any further action on its part was required. (Tr. 1325.)
The Division alleges Dean Witter's procedures were not reasonably designed to detect and prevent Oberholzer's securities law violations because they did not require a review of branch managers' determinations regarding accounts repeatedly identified by the compliance department. The Division argues that Dean Witter should have required the branch managers' supervisors, the regional directors and sales managers, review such accounts. However, Kleinburg, Maine, and Smith testified that from 1990 to 1994, they knew of no broker-dealer firm mandating a review of a branch manager's determinations based on an account being repeatedly identified by the compliance department. (Tr. 1177-78, 1296, 1482-83.) Kleinburg testified this would be an example of "micro-management" and would preclude reliance on the branch manager's experience and judgment. (Tr. 1483.)
According to Maine, the branch manager should have supervisory responsibility until he fails to adequately perform. Until then, there is no reason for a regional supervisor to become involved with the immediate supervision of an account executive. (Tr. 1298-99.) Furthermore, the compliance department's computer surveillance establishes minimum quantitative criteria to identify active accounts. Therefore, many accounts will be indicated each month. (Tr. 1296-97.) Maine felt it would be impractical to require a review of the branch manager's determinations regarding accounts based solely upon the number of times the account was identified by the compliance department. (Tr. 1297-98.)
Padgett alleged that from February 1993 through September 1995, there were several occasions when the compliance department identified questionable activity, but did not send an account inquiry to the Hayward Branch manager. He alleged that this constituted an ineffective response to indications of account irregularities. (Tr. 938-39; Div. Ex. 1.) However, Dean Witter's procedures allow the compliance department to rely on satisfactory responses to account inquiries for a period of twelve months unless there is a change in the trading pattern. (Tr. 1328-29; Div. Ex. 7 at DWR41048, Resp. Ex. 358 at DWR41048.) Maine stated this was standard in the industry. (Tr. 1327-29.) Furthermore, the compliance department does not continuously monitor accounts after they are identified to the branch manager.93 Continued activity in a previously indicated account appears on the monthly activity report, which the branch manager is required to review. (Tr. 1329-30.) Kleinburg also stated it was reasonable for the compliance department to not monitor accounts on a monthly basis after identified to the branch manager and to rely on his prior responses. He knew of no broker-dealer firm that required its compliance department to monitor accounts after they were identified to the branch manager. He stated that such a requirement would be an unreasonable drain on resources. (Tr. 1494.)
The Division alleges that Dean Witter's procedures were not reasonably designed to detect and prevent Oberholzer's securities law violations because there was no procedure to ensure that new branch managers were promptly and thoroughly briefed on personnel with a history of compliance difficulties. Specifically, Padgett stated Dean Witter lacked procedures to ensure that Peterson was promptly informed of potential compliance problems when he became Hayward Branch manager.94 (Tr. 936, 1032-33.) However, Padgett was unaware of any broker-dealer firms with such a requirement from 1990 through 1994, and he was unclear as to what would constitute a "prompt" briefing. (Tr. 1109-12, 1115-16.) Kleinburg, Maine, and Smith all testified that they knew of no broker-dealer firm with a procedure mandating new branch managers be promptly and thoroughly briefed on persons with a history of compliance difficulties. (Tr. 1176-77, 1294, 1481-82.) According to Maine, a firm's procedures cannot account for every possible scenario and a specific procedure requiring briefing of new branch managers would be unreasonable.95 He noted that the branch office files would contain all client complaints and a new branch manager would inevitably learn of any true compliance problem. (Tr. 1294-95.)
Padgett also alleged that Dean Witter's procedures failed to verify the personal data recorded for new clients. (Tr. 907-08.) Dean Witter's account executives complete new account forms, as well as subsequent account report forms sent in response to account inquiries from the compliance department. The account executive is responsible to make any changes in client information on subsequent account report forms. These changes are not verified to ensure that they are correct. (Tr. 907-08.) Padgett contended that this results in reliance on possibly inaccurate client profiles. (Tr. 908.) Therefore, suitability determinations may be based upon erroneous information.96 (Tr. 913.)
Padgett stated that Dean Witter should have verified reported changes in the Four Clients' investment objectives. (Tr. 915.) He opined that the Four Clients' investment objectives either were not recorded initially as income, or if so, they were changed on subsequent account report forms to inappropriate investment objectives. (Tr. 914-15.) Padgett stated this was also true of information regarding the Four Clients' financial sophistication. (Tr. 914-15.) As a result of the alleged failure to verify client information, Padgett claimed Dean Witter failed to determine the sophistication of the Four Clients. (Tr. 913-14.)
Padgett stated that a personal inquiry would be required to determine sophistication because clients with similar net worth and income might have vastly different levels of sophistication. Accordingly, developing a form to determine sophistication would be difficult and he was aware of no firms that did so during the relevant period.97 (Tr. 1129-30.) He stated that two methods could be used to verify client information contained in new account forms and account report forms. Dean Witter could have telephoned each client to verify the information listed on new account forms or subsequent account report forms. Dean Witter could have also used "negative consent" letters, whereby the client is asked to verify, sign, and return to the broker-dealer firm a letter detailing relevant information.98 (Tr. 909-12, 1089-90.) Padgett stated that although one broker-dealer firm currently uses such letters, he was not aware of any firm that used negative consent letters to verify client information during 1990 through 1994. (Tr. 911, 1086-87, 1106.)
Kleinburg stated that determining a client's sophistication is one of an account executive's most difficult tasks. Broker-dealer firms vary in the information they request from the client to make such a determination. New account forms generally request information such as investment experience, existence of other accounts, and similar facts in an attempt to measure sophistication. (Tr. 1477-78.) He knew of no broker-dealer firm having additional procedures to determine a client's financial sophistication.99 (Tr. 1478-79.) Maine was also unaware of any broker-dealer firms with specific procedures to determine the financial sophistication of clients during 1990 through 1994. He stated that financial sophistication varies with each client. (Tr. 1290.) It is a subjective inquiry not lending itself to uniformity. (Tr. 1290-91.)
Padgett also opined that Dean Witter's procedures were deficient because they failed to identify unsuitable concentration in client accounts to the compliance department and ultimately the branch manager.100 (Tr. 1072-74.) Although concentration was a consideration specifically listed in Dean Witter's Compliance Department Procedure Manual, Padgett saw no evidence that concentration was being identified to branch managers for investigation. (Tr. 905-07, 1071-72.) Padgett stated that one solution would be to use concentration as a parameter in the compliance department's monthly computer surveillance. (Tr. 907.)
Maine was unaware of any broker-dealer firms using concentration as a parameter in monthly account surveillance.101 According to Maine, identifying every account in which concentration might be an issue would result in identification of many accounts and render the surveillance system ineffective. (Tr. 1291-92.) Therefore, the most common method of identifying undue concentration is to rely on the branch manager's review of the monthly account statements and yearly review of the account executive's books and records.102 (Tr. 1292-93.)
Kleinburg also knew of no firm using concentration as a parameter for computer surveillance from 1990 through 1994.103 (Tr. 1479.) He also stated the most common method to identify undue concentration was for the branch manager to review the account statements when an account was identified for investigation. (Tr. 1480-81, 1499.) Kleinburg noted that a determination that concentration was unsuitable would also involve the client's investment strategy and investment objectives. (Tr. 1500.) Therefore, he concluded that information on concentration alone would not be very valuable. (Tr. 1479-80, 1499-1500.)
According to Padgett, Dean Witter's procedures were deficient because they did not require client notification when restrictions were placed on accounts. (Tr. 936-37, 1033.) In Padgett's opinion, this constituted a failure to deal fairly with the Four Clients, and a failure to supervise Oberholzer. (Tr. 937.) However, Kleinburg knew of no broker-dealer firm requiring client notification of account restrictions. (Tr. 1484, 1508.) He stated that restrictions are an infrequent occurrence and a specific written procedure requiring client notification of imposed restrictions is not needed. His view was that it is sufficient to inform the client if and when they wished to purchase securities. (Tr. 1484-85.)
Padgett claimed Dean Witter's procedures were inadequate because they failed to ensure that indications of irregularity in the Four Clients' accounts were promptly and thoroughly investigated, financial injury determined, and that the Four Clients promptly informed of such findings. (Tr. 1033-34.) Padgett noted that O'Connell ordered an immediate investigation when he learned that the compliance department had concerns regarding certain accounts. (Tr. 933.) Padgett concluded that O'Connell's actions both before and after Peterson restricted the accounts were proper. (Tr. 929-30.) According to Padgett, either McDaniel-Remer or Peterson should have examined the accounts in detail to determine the breadth of the alleged wrongdoing and any harm that had been incurred by the Four Clients. (Tr. 932.)
According to Maine, Dean Witter had a quickened response procedure that ensured that irregularities in the Four Clients' accounts were identified and thoroughly investigated. (Tr. 1305-08.) Maine opined that the combination of the branch manager's investigations initiated as a result of his review of monthly account reports, investigations initiated by account inquiries received from the compliance department, and Peterson's investigation initiated at O'Connell's direction constituted a reasonable procedure for ensuring the prompt and thorough investigation of any questionable trading in the Four Clients' accounts. (Tr. 1309.) He also noted O'Connell's testimony that had any wrongdoing been found, financial injury would be determined and the Four Clients would have been notified and compensated.104 (Tr. 1308-09.)
I note with particularity Padgett's testimony that Dean Witter's supervisory procedures provided Auwinger with sufficient information to detect and prevent the violations occurring in 1993 and 1994. (Tr. 1054-55.) Padgett concluded that with the information provided by Dean Witter's procedures, a reasonable branch manager would have detected and prevented Oberholzer's violations. (Tr. 1053.) He specifically stated that a reasonable branch manager possessing the information Dean Witter's systems and procedures supplied Auwinger in April 1994 would have been able to detect and prevent the violations in the O'Connor Trust Account. (Tr. 1067-68.)
Padgett also stated that a reasonable branch manager possessing the information Dean Witter's supervisory systems and procedures provided Auwinger in the summer of 1993 would have detected and prevented the alleged violations in the Huey Trust Account. (Tr. 1067.) Padgett offered similar testimony regarding information Dean Witter's systems provided Auwinger concerning Ms. Svogar's accounts. Padgett felt Auwinger should have been alarmed at Ms. Svogar's asserted satisfaction with her accounts in light of the losses incurred and turnover ratio. Dean Witter's systems and procedures provided Auwinger with evidence of the losses and turnover ratio. (Tr. 1063-65.) Padgett concluded that if Auwinger had asked appropriate questions and exercised proper judgment during his telephone conversation with Ms. Svogar, he would have detected and prevented the alleged violations in her accounts. (Tr. 1066.)
After reviewing Dean Witter's supervisory and compliance manuals, and considering relevant testimony, Maine concluded that Dean Witter's procedures were reasonably designed to detect and prevent Oberholzer's alleged securities law violations. (Tr. 1299-1300.) Maine stated that between 1990 and 1994, Dean Witter's supervisory procedures were industry standard or better and Dean Witter responded promptly in this case. (Tr. 1305-06, 1131.) He also stated that Dean Witter's manuals were lengthier than most broker-dealer firms' manuals and were particularly complete and clearly written. (Tr. 1295.) Maine reviewed the compliance department's account inquiries and the branch manager's responses, and considering all other testimony and exhibits, concluded that the compliance department acted reasonably in this case.105 (Tr. 1323-24.) He stated that the compliance department had no reason to believe that any of Dean Witter's supervisory procedures were not being complied with between February 1992 and December 1994. (Tr. 1323-25.)
After considering the same evidence, Kleinburg also concluded that Dean Witter's systems and procedures were reasonably designed to detect and prevent Oberholzer's alleged violations. (Tr. 1485-86.) Kleinburg also found Dean Witter's manuals among the most detailed of those he had reviewed. (Tr. 1483-84.) He stated that Dean Witter's supervisory procedures were very thorough, organized, and performed reasonably in this case. (Tr. 1486-87.)
Dean Witter's procedures cannot be judged in hindsight or with information learned long after the events in question occurred. I find that the alleged deficiencies discussed above do not identify ways in which Dean Witter's procedures were unreasonable, rather they constitute speculation by Padgett about additional procedures that might have deterred Oberholzer's illegal conduct. This speculation is offered in hindsight of Oberholzer's violations and cannot support a finding that Dean Witter's existing procedures, which Padgett does not criticize, were unreasonable. Cf. Thornton, 69 SEC Docket at 58 (Unger, Comm'r, concurring) ("Our prior decisions have 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.") Padgett's testimony, and all other evidence, fell short of satisfying the Division's burden of proving that Dean Witter's procedures as applied in this case were not reasonably designed to detect and prevent Oberholzer's churning and unsuitable trading. I credit the testimony of Dean Witter's experts, Kleinburg and Maine, which supports my conclusion that Dean Witter's supervisory procedures were reasonable.
By utilizing the compliance department to identify qualitative factors and then relying on the branch manager to perform a factually intensive investigation into the account to determine if a violation has occurred, I conclude that Dean Witter's supervisory procedures, and its systems for applying such procedures, were reasonably designed to prevent and detect Oberholzer's churning and unsuitable trading. The compliance department repeatedly detected questionable trading in the Four Clients' accounts and raised questions about it with Auwinger. In each case Auwinger, an experienced branch manager, provided a response to the compliance department that nothing was wrong and the accounts would be monitored. Under the circumstances of this case, it was reasonable for the compliance department to rely on these responses. Additionally, Padgett stated that Dean Witter's procedures provided Auwinger the information he needed to detect and prevent Oberholzer's violations. However, Auwinger is no longer a party to this case and his liability for failing to supervise Oberholzer is not at issue.
The compliance department also brought questionable trading to Peterson's attention. When Needham was not satisfied with Peterson's response to an account inquiry in December 1994, she went to O'Connell, as required by Dean Witter's procedures. O'Connell insisted on a more in-depth investigation into the accounts at issue. I conclude that this was reasonable under the circumstances.
Finally, the evidence I have credited supports my conclusion that Dean Witter discharged its supervisory duties without reason to believe that its procedures and systems were not being complied with.106 Therefore, Dean Witter is entitled to the safe-harbor protection provided by Section 15(b)(4)(E) of the Exchange Act.
Peterson's Alleged Failure to Supervise
As stated above, Sections 15(b)(4)(E) and 15(b)(6) of the Exchange Act authorize an administrative proceeding against a branch manager who fails to supervise reasonably an account executive subject to his supervision. See Sharon M. Graham, 68 SEC Docket 2056, 2071 (Nov. 30, 1998), aff'd, 222 F.3d 994 (D.C. Cir. 2000). In order for Peterson's supervision to be deemed reasonable, he had to comply with Dean Witter's supervisory procedures. See Consolidated Inv. Servs., Inc., 52 S.E.C. 582, 586 (1996) ("Supervision is reasonable only if there is adherence to appropriate internal company procedures.") (citing Nicholas A. Bocella, 49 S.E.C. 1084, 1086 (1989)). As the Commission has held, "different supervisors may have different responsibilities depending on how each firm devises its compliance program. 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." Arthur J. Huff, 50 S.E.C. 524, 528 (1991).
A branch manager's supervision of his subordinates is not required to be exemplary, but must be reasonable under the particular circumstances. See Huff, 50 S.E.C. at 528-29. In Thornton, Commissioner Unger distinguished unreasonable supervision from
those situations where a supervisor either fails to uncover misconduct despite the proper discharge of his supervisory duties, or uncovers misconduct and takes quick, effective action to remedy the situation. The duty to exercise reasonable, effective supervision has never been construed to be an absolute guarantee against every malfeasance by errant subordinates. . . . [T]he Commission must exercise continuing vigilance to resist the pitfall of mistaking the cleverness of a wrongdoer in eluding appropriate supervisory measures for a failure at the supervisory level.
Thornton, 69 SEC Docket at 58-59 (Unger, Comm'r, concurring). A branch manager's discharge of supervisory responsibilities will always be subject to this reasonableness test, even if he is confronted with indications of wrongdoing. See Trujillo, 49 S.E.C. at 1110 (quoting William L. Vieira, 49 S.E.C. 1091 (1989)). However, reasonable supervision in such cases will require that the branch manager respond with "particular vigilance." Trujillo, 49 S.E.C. at 1110 (citing Wedbush Sec., Inc., 48 S.E.C. 963, 967 (1988)).
Peterson contends that Oberholzer committed no underlying violation of the securities laws while Peterson was Hayward Branch manager. He argues that there were so few purchases in the accounts at issue that there was no churning, excessive trading, or unsuitable trading. Further, any unsuitable investments, concentration, or margin use resulted from account activity occurring prior to his tenure.
During Peterson's tenure, the O'Connor Trust Account had only one purchase, which was in October 1994. (Tr. 1362; Div. Ex. 5, Resp. Ex. 400 at 11.) Other transactions involved sales to reduce her margin debit balance from $90,608 in October 1994 to $19,568 in October 1995. During this time, O'Connor withdrew $19,893 from the account. (Resp. Ex. 400 at 12.) There were only four purchases in the Svogar Trust Account: two in October 1994, one in November 1994, and one in April 1995. (Tr. 1370-71; Resp. Ex. 400 at 3.) The margin debit balance was reduced from $6,424 in November 1994, to $2,074 in August 1995. (Tr. 1371-72; Resp. Ex. 400 at 7.) The Svogar IRA had two purchases in October 1994, six in November 1994, two in December 1994, two in January 1995, and two in March 1995. (Resp. Ex. 400 at 8.) From October 1994 to April 1995, Svogar withdrew $27,152 from the account. (Tr. 1373; Resp. Ex. 400 at 10.) There were only five purchases in the Huey Trust Account: one in October 1994 and four in November 1994. (Tr. 1377; Resp. Ex. 400 at 16.) From November 1994 to September 1995, the margin debit balance was reduced from $14,925 to $2,156. By June 1995, the equity balance exceeded the margin debit balance. (Resp. Ex. 400 at 17.)
As discussed below, the Division alleges that Peterson failed to supervise Oberholzer with a view toward preventing his illegal conduct by failing to respond to alleged "warning signs" both before and after O'Connell's instruction to investigate the accounts at issue, conducting an inadequate investigation into the accounts at issue, and failing to notify the relevant clients that restrictions were placed on their accounts. In support of its contention, the Division relies largely on Padgett's testimony. I find that Padgett's analysis of Peterson's conduct suffers from the same flaw as his analysis of Dean Witter's supervisory procedures: it constitutes hindsight speculation of additional actions that Peterson could have taken.
The Division alleges that Peterson failed to respond to "warning signs," including a conversation with the operations manager,107 account inquiries, a large number of margin calls and liquidations, O'Connell's instruction to stop trading in Ms. Svogar's account, and Oberholzer's violations of the trading restrictions. However, I find that prior to Needham's memorandum, Peterson's supervision was reasonable and there were no indications of irregularity requiring Peterson to respond with particular vigilance. When irregularity was brought to Peterson's attention, I find that he did respond reasonably with particular vigilance.
Padgett acknowledged that when Peterson became Hayward Branch manager, neither Oberholzer nor Auwinger had any prior disciplinary history. There were no complaints from any of the Four Clients. (Tr. 992-93.) Further, they were not Oberholzer's most active accounts, and Oberholzer ranked between third and seventh in office production during Peterson's tenure. (Tr. 1218, 1220-21.)
Peterson only received two account inquiries prior to Needham's December 22, 1994 memorandum: the December 5, 1994 inquiry into the Huey Trust Account, and the November 11, 1994 inquiry into the Svogar IRA which led to Needham's memorandum. In both instances, Peterson's response was reasonable. Hennessy reviewed the account inquiries Peterson received from the compliance department, as well as Peterson's responses and concluded that Peterson was forthright and dutiful in responding. (Tr. 1363-64.) In responding to the November 11, 1994 inquiry into the Svogar IRA, Peterson responded that he had talked with Oberholzer regarding the account. He reported the substance of that conversation, but he also admitted that he had not been Hayward Branch manager long enough to specifically research the account and form his own opinion of its activity. I find this to be a reasonable response under the circumstances. Hennessy stated that a new branch manager must become familiar with the account executives, office staff, and accounts in the branch office. (Tr. 1388-89.) He stated this process would take approximately ninety days in a branch office complex the size of the Hayward Branch and the Fremont Office. Kleinburg also stated that branch managers should be allowed a reasonable amount of time to become familiar with the branch. (Tr. 1501-02.) Padgett also stated that when Peterson became branch manager, it was reasonable for him to rely on the truthfulness of Oberholzer's representations until some irregular activity occurred. (Tr. 993-94.) In this case, receipt of two account inquiries is not a "red flag" sufficient to render Peterson's reliance on Oberholzer's representations unreasonable.
The Division alleges that Peterson failed reasonably to supervise Oberholzer by conducting an inadequate investigation into the accounts indicated by Needham's December 22, 1994 memorandum. Although Peterson was not responsible for supervision of Oberholzer prior to becoming Hayward Branch manager, Padgett stated that he was responsible for investigating Oberholzer's misconduct before that time and determining the negative results possibly resulting from such conduct. (Tr. 1019-20, 1117.) Padgett opined that Peterson's failure to adequately investigate transactions occurring while Auwinger was Hayward Branch manager gives rise to a claim that Peterson failed to supervise Oberholzer with a view toward preventing such violations. (Tr. 1021-22.) This view, however, is contrary to the plain wording of Section 15(b)(4)(E) of the Exchange Act. Further, Padgett testified on cross-examination that a failure to supervise charge must be based on events that occur when there is supervisory responsibility over the perpetrator of the violations. (Tr. 988-92.) Not only could Peterson not exercise supervision at the time the violations occurred, but his investigation in January 1995 would have no effect on violations committed prior to September 13, 1994.
Padgett asserted that Peterson failed to determine O'Connor's financial sophistication because he never contacted her. (Tr. 916-17.) Hennessy stated that Peterson had no reason to contact O'Connor and his failure to do so did not constitute a failure to supervise. (Tr. 1360, 1362, 1374.) According to Hennessy, from October 1994 to November 1995 the activity in the O'Connor Trust Account was consistent with a liquidation strategy to reduce the margin debit balance. (Tr. 1374; Resp. Ex. 400.) He noted that a liquidation strategy was employed in the account in September 1994. (Tr. 1360, 1362.) Therefore, barring a change in this pattern of activity, there was no reason for Peterson to contact O'Connor. (Tr. 1363, 1374.)
Based on Peterson's testimony regarding his telephone conversation with Ms. Svogar, Padgett concluded that Peterson failed to effectively determine Ms. Svogar's level of sophistication. Padgett stated that Peterson needed to ask questions that would determine whether she had the capacity to independently evaluate the risk involved, use of margin and types of securities. (Tr. 917.) Specifically, Padgett stated that Peterson should have asked Ms. Svogar more pointed questions regarding losses in the account and commissions paid. (Tr. 917-18.) Hennessy disagreed, noting that Peterson and Ms. Svogar discussed trading in her accounts, and that Ms. Svogar was aware of the losses. He also noted that Ms. Svogar explained her trading pattern of purchases followed quickly by sales and disbursements. Ms. Svogar had also told Peterson that she needed money for family reasons and that she had no complaints with Dean Witter or Oberholzer. (Tr. 1360-61.)
In Padgett's opinion, Peterson failed to determine Dr. Huey's level of sophistication. (Tr. 918.) He again stated that Peterson should have used more pointed questions to determine her understanding of the losses incurred and commissions paid. (Tr. 918-19.) Hennessy again disagreed, stating that Dr. Huey expressed no dissatisfaction with Dean Witter or Oberholzer to Peterson, and that she understood Peterson's explanation of margin and acknowledged the losses in her account. (Tr. 1360.)
Padgett further opined that Peterson failed to supervise Oberholzer because he did not ensure that the relevant clients were informed of the account restrictions. (Tr. 938, 1004, 1006.) Hennessy stated that Peterson was not required to communicate the restrictions to the clients under any applicable standards. (Tr. 1365-66, 1405.)
According to Hennessy, Peterson did not fail to supervise Oberholzer, and his investigation into Oberholzer's prior conduct was reasonable.108 (Tr. 1355.) In light of the time that it would take a branch manager to become familiar with the office, Hennessy concluded that Peterson acted promptly with respect to the accounts at issue. (Tr. 1389.) Peterson reviewed each account and there were no client complaints indicating irregularities. (Tr. 1357.) Peterson also discussed the accounts at issue and Oberholzer with Auwinger. (Tr. 1356.) Auwinger told Peterson that Oberholzer was a young, aggressive account executive that attracted aggressive clients. Auwinger had also sent activity letters to and had direct contact with the clients in question. (Tr. 1356.) Hennessy stated that it was reasonable for Peterson to rely on the information that he received from Auwinger because it mirrored the information he had received from Oberholzer, and Auwinger had a good reputation as a branch manager. (Tr. 1356, 1358-59.) He had been promoted from the Hayward Branch to the Sacramento branch office and had no client complaints. (Tr. 1358-59.) Cf. Huff, 50 S.E.C. at 528-29 (holding it reasonable for a supervisor to rely on an apparent prior resolution of certain issues).
Hennessy concluded that from October 1994 until January 17, 1995, it was reasonable for Peterson to rely on the information he received from Oberholzer as there was no reason for Peterson to discredit it. (Tr. 1357-58.) Furthermore, Peterson had spoken with certain Oberholzer clients and they had expressed no concerns regarding Oberholzer.109 (Tr. 1358.) Hennessy also concluded that the restrictions placed on the accounts by Peterson were effective in slowing the trading and reducing the margin debit balances. (Tr. 1364-65.)
Based on the relatively few purchases in the accounts, I conclude that no underlying violations occurred while Peterson was Hayward Branch manager and had supervisory jurisdiction over Oberholzer. Therefore, as a matter of law, Peterson cannot be held liable for a failure to supervise Oberholzer. I also reject the Division's contention that Peterson can be liable for a failure reasonably to supervise Oberholzer with a view toward preventing violations that occurred prior to the time Peterson became Hayward Branch manager.
Moreover, assuming that violations did occur while Peterson was Hayward Branch manager, I find that Peterson's supervision of Oberholzer was reasonable. Prior to Needham's memorandum and his conversation with O'Connell, there were no indications of irregularity that would have dictated Peterson exercise particular vigilance in supervising Oberholzer. When Peterson received the first account inquiry, he reasonably relied on Oberholzer's responses, but still admitted to the compliance department that he had not become familiar with the accounts at issue. When confronted with O'Connell's telephone conversation, Peterson conducted a reasonable and timely investigation into the accounts. In concluding that no violations had occurred in the accounts, he reasonably relied on Auwinger's statements as well as statements from the clients themselves. While other options may have been available to Peterson, the Division has not proved that Peterson's actions were unreasonable. Although three purchases were made after the restrictions were enacted, these were isolated purchases discovered by compliance department personnel. Peterson reasonably responded to these purchases and their occurrence alone will not support a finding that he failed to reasonably supervise Oberholzer.
As previously concluded, Dean Witter's supervisory procedures and system were reasonably designed to detect and prevent Oberholzer's churning and unsuitable trading. I find, as acknowledged by Padgett, that Peterson complied with Dean Witter's supervisory procedures. (Tr. 986.) Furthermore, Peterson's discharge of his duties under those procedures was reasonable. Hennessy's opinion, which I credit, supports my conclusion that Peterson supervised Oberholzer in a reasonable manner. Assuming Oberholzer committed securities laws violations during Peterson's tenure, Peterson is entitled to the protection of the safe harbor provision of Section 15(b)(4)(E) of the Exchange Act.
Dean Witter's Alleged Books and Records Violations
The Division alleges that Dean Witter willfully violated Section 17(a) of the Exchange Act and Rule 17a-3 thereunder by maintaining inaccurate books and records. Specifically, the Division alleges that Oberholzer: (i) supplied account documentation containing untrue and exaggerated information about customer investment objectives, investment experience, assets, and occupations, (ii) submitted order tickets falsely recording unauthorized trades as "unsolicited," and (iii) forged signatures on letters of authorization and other documents pertaining to the transfer of assets between accounts. The Division contends that in so doing, Oberholzer aided and abetted Dean Witter's alleged books and records violations.
The only evidence of possible forgery is the testimony of Mr. Svogar. He claimed he did not sign certain documentation regarding the Svogar Joint Account, including a tax form, a joint account agreement, an authorization to journal securities between the Svogar Joint Account and the Svogar Margin Account, and a check from Dean Witter payable to Mr. Svogar and his mother as joint tenants. (Tr. 739-47; Resp. Exs. 415, 417-18.) He also contended that his mother's signature was forged on the authorization and the check. I find, however, that when comparing the signatures of Ms. Svogar on the check and authorization with all other account documents, they appear to be written by the same person. I further find that the acknowledged signature of "Joseph B. Svogar" on Respondent's Exhibit 416 is similar to the signatures on the allegedly forged documents. I conclude the signatures were not forged and the Division has failed to prove that Oberholzer forged customer signatures on any documents maintained by Dean Witter.
The Division also alleges that Oberholzer supplied account documentation containing false information. In light of the surrounding evidence regarding the Four Clients and their relationship with Oberholzer, I did not consider account report forms the best evidence of the Four Clients' investment objectives or financial needs. However, without client testimony that the information contained in account documentation was in fact false, and in light of Auwinger's and Peterson's testimony regarding assertions made by the Four Clients themselves, I find the evidence insufficient to conclude that Oberholzer supplied false account documentation that could support a finding that Dean Witter willfully violated Section 17(a) of the Exchange Act and Rule 17a-3 thereunder.
With regard to the order tickets, the Division alleges that Oberholzer improperly marked certain order tickets as unsolicited when he had actually solicited the particular transaction. Padgett concluded that the majority of transactions in the Four Clients' accounts were solicited although the corresponding order tickets were marked as though the order was unsolicited. (Tr. 888.) He based this conclusion on his review of the Four Clients' trading activity, stating that the trading in Dr. Huey and Betz's accounts was similar to the trading in Ms. Svogar and O'Connor's accounts.110 (Tr. 888; Div. Ex. 116). However, Padgett also acknowledged that determining whether a particular transaction was solicited was a factual inquiry, requiring evidence of the content of conversations between the client and the account executive, as well as the particular factors considered by the client when making a particular purchase of a security. (Tr. 1008-11.) As is discussed below, the required evidence is not present in this case.
There is evidence that this was an area of concern for the compliance department. Needham considered whether Oberholzer had improperly marked order tickets in her December 22, 1994 memorandum to O'Connell. Needham stated she had not concluded that Oberholzer had improperly designated transactions as unsolicited, but she wanted O'Connell to investigate the issue.111 (Tr. 154-55, 157-58.) On February 23, 1995, Dey conducted the annual inspection of the Hayward Branch. (Tr. 198-99, 201.) At the end of the inspection, Dey wrote a note to Peterson regarding Oberholzer and left it on his desk.112 (Tr. 200-02, 244; Div. Ex. 109, Resp. Ex. 331.) It stated that Oberholzer should mark order tickets solicited when Oberholzer tells the client which securities he is purchasing for his personal account and the client then purchases the same security. (Tr. 244-45, 291-92; Div. Ex. 109, Resp. Ex. 331.) The note makes no reference to any of the Four Clients or any particular transaction. (Div. Ex. 109, Resp. Ex. 331.)
On or about June 16, 1995, Needham sent Peterson a memorandum regarding purchases of Western Water in multiple accounts, not including the Four Clients' accounts. (Div. Ex. 44.) The memorandum noted that on June 13, 1995, three account executives, including Oberholzer, entered orders for Western Water marked unsolicited. She requested Peterson confirm that the orders were unsolicited and that he submit a securities solicitation request form for Western Water. (Div. Ex. 44.)
On or about July 19, 1995, Peterson sent a responsive memorandum and the requested securities solicitation request forms to Needham. He also included his memoranda to the account executives and their explanation of the trading. (Div. Exs. 45, 46.) Each of Oberholzer's clients submitted an acknowledgment specifically stating that their purchase of Western Water was unsolicited. (Div. Ex. 45.)
The Division argues that because a number of Oberholzer clients traded the same securities on the same day and at or about the same time, such transactions were solicited and the order tickets mismarked. It submitted order tickets for at least twenty other Oberholzer clients reflecting transactions in various securities on at least twelve separate dates. A majority of the tickets were marked unsolicited.113 (Div. Ex. 66.)
However, the Division only entered the tickets in evidence. No testimony from any of the Oberholzer clients was offered. There is no evidence of Oberholzer's relationship with these clients, or of any conversations he may have had with them. The date-time stamp alone does not establish whether the trades were solicited or unsolicited. Furthermore, there is credible evidence that certain trades were unsolicited even though made on the same day. (Div. Ex. 45.) More definitive proof from any of these clients regarding individual trades, if it exists, could have been obtained during the investigation. I decline to speculate that any particular transaction was solicited and corresponding order ticket mismarked based on this evidence alone.
I conclude that the evidence adduced at trial is insufficient to establish Dean Witter's willful violation of Section 17(a) of the Exchange Act and Rule 17a-3 thereunder as alleged by the Division.
IV. RECORD CERTIFICATION
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 May 26, 2000, as corrected on June 15, 2000.
V. ORDER
Based on the findings and conclusions set forth above:
IT IS ORDERED that this administrative proceeding is DISMISSED as to Dean Witter Reynolds Inc.
IT IS FURTHER ORDERED that this administrative proceeding is DISMISSED as to Dennis W. Peterson.
This initial decision 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 the 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 that 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.
______________________________
Robert G. Mahony
Administrative Law Judge
1 On January 11, 1999, I received the Division's Motion for Summary Disposition and a Memorandum of Points and Authorities in Support of its Motion. The Division sought summary disposition of Dean Witter's affirmative defenses of: (i) lack of Commission authority to conduct the proceedings, (ii) laches, (iii) waiver, and (iv) equitable estoppel.
2 The Division's motion was predicated on Rule 250 of the Commission's Rules of Practice. This rule states that a party "may make a motion for summary disposition of any and all allegations of the order instituting proceedings" with respect to a particular respondent. 17 C.F.R. § 201.250 (emphasis added). The affirmative defenses were pled in Dean Witter's answer to the OIP in accordance with Rule 220(c) of the Commission's Rules of Practice. 17 C.F.R. § 201.220(c). Therefore, I denied the Division's motion in so far as it was predicated on Rule 250, and treated it as a motion to strike affirmative defenses.
3 Without admitting or denying the Division's allegations, Auwinger consented to a three-month suspension from association with any broker or dealer, a nine-month suspension from association in a supervisory and proprietary capacity with any broker or dealer, and a $10,000 penalty. Dean Witter, 69 SEC Docket at 891.
4 I will refer to the Division's exhibits as "(Div. Ex. ___.)" and to Respondents' Exhibits as "(Resp. Ex. ___.)." Joint Exhibits will be referred to as "(Joint Ex. ___.)." I will refer to the transcript as "(Tr. ___.)."
5 See Steadman v. SEC, 450 U.S. 91 (1981).
6 Without admitting or denying the allegations made against him, Oberholzer consented to a permanent injunction enjoining future violations of the securities laws in SEC v. Oberholzer, Civ. Action No. 97-03320-CW (N.D. Cal. Sept. 9, 1997). Oberholzer also consented to the entry of an administrative order barring his association with any broker, dealer, municipal securities dealer, investment adviser, or investment company. Michael J. Oberholzer, 65 SEC Docket 1416 (Sept. 25, 1997).
7 The parties stipulated that Betz never heard Dr. Huey discuss any particular investment or use of margin with Oberholzer, although she was aware that Dr. Huey had telephone conversations and meetings with Oberholzer outside her presence. (Joint Ex. 1, ¶6, ¶9, ¶13.) Furthermore, Betz had no specific recollection of circumstances giving rise to any particular transaction occurring in any of Dr. Huey's accounts. (Joint Ex. 1, ¶17.)
8 In addition to the factors discussed above, I also considered the Division's failure to secure Betz's testimony prior to the hearing.
9 Ms. Svogar worked in a café and roller skating rink that she and her husband owned until Joseph Svogar was approximately five years old. Ms. Svogar did not work outside the home thereafter. (Tr. 718-19.) Her husband had exclusively handled financial matters, and invested to provide monthly income. When her husband died in 1989, Ms. Svogar assumed management of her financial affairs. (Tr. 721.)
10 After each transaction, Dean Witter clients receive a confirmation slip detailing the security, price, number of shares, principal amount, and commission. (Joint Ex. 3, ¶7.) In addition, clients receive monthly account statements summarizing all account activity. (Joint Ex. 3, ¶7.)
11 Mr. Svogar and Glaser were acquaintances. (Tr. 731-32.)
12 The new account form indicated that O'Connor was a retired teacher. (Div. Ex. 51 at DWR1714, DWR006632.) The Division disputes this and asserts that O'Connor had a tenth-grade education. The Division bases this assertion on a certain declaration made by O'Connor in a prior settled civil action. (Div. Ex. 121.) Declarations made by Ms. Svogar, Dr. Huey and Betz in the same civil action were also admitted into evidence. (Div. Exs. 120, 122, 123.) As I stated at the hearing, these declarations are biased and self-serving, and their probative evidentiary value is minimal. The declarations have received little or no weight as evidence to support any findings of fact. (Tr. 1137-38.)
13 On the sixth day of the hearing, I also ruled that the Division could make no further efforts to obtain O'Connor's testimony. In so ruling, I considered her physical condition, the stipulation, and the Division's inaction in securing her testimony prior to the hearing. (Tr. 1140-41.)
14 Francis I. duPont & Company subsequently became duPont Walston, Inc. (Tr. 795.)
15 Lehman Brothers subsequently became Shearson Lehman Brothers. (Tr. 795-96.)
16 Oppenheimer & Company, Inc. subsequently became CIBC Oppenheimer Corporation. (Tr. 1470-71.)
17 In addition to witness testimony regarding Dean Witter's supervisory procedures, the parties agreed to certain stipulations regarding the same, which are incorporated herein by reference. (Joint Ex. 3.) Dean Witter's Compliance Department Procedure Manual, Account Executive Compliance Guide, and MAPPS Branch Manager's Manual were also received into evidence. (Div. Exs. 7, 83, 99, Resp. Exs. 358, 359, 360.)
18 When combined with order tickets from the Fremont Office, there were 90 to 110 order tickets to review each day. (Tr. 1217.)
19 Auwinger sent Betz and Dr. Huey, collectively, five activity letters. Singularly, he sent each of them three activity letters. He sent Ms. Svogar sixteen activity letters, and O'Connor one activity letter. (Resp. Ex. 407.) Peterson sent one activity letter to Dr. Huey. (Resp. Ex. 307.)
20 Auwinger stated that he basically sent the activity letters as they appeared in the MAPPS Branch Manager's Manual, as his experience was that Dean Witter preferred the branch managers use the standard letters. (Tr. 329-330.) Auwinger stated that he sent the activity letters once a quarter if an account appeared frequently on the activity report. (Tr. 330.) The account executive also received a copy of any activity letter sent to a client. (Tr. 330-31.)
21 For example, Activity Letter No. 5 states that there are "risks attendant to a high level of trading activity" and invites the client to "take this opportunity to review your investment goals in light of your strategy." Activity Letter No. 6 states that "active trading incurs substantial commission charges which will affect the overall profitability" of the client's account and suggests contacting the account executive and the manager to discuss the trading strategy. (Joint Ex. 3, ¶6.)
22 In addition to the monthly review of active accounts, the compliance department also reviews daily trading meeting certain criteria on a "trade date plus one" basis. This includes day trading, in-and-out trading, and trading in low priced, speculative securities. (Joint Ex. 3, ¶12.)
23 The branch manager performs month-to-month and day-to-day account monitoring, a type of monitoring not performed by the compliance department. (Tr. 129, 286.)
24 McDaniel-Remer joined Dean Witter in September 1979 and began her work in the compliance department in March 1990 as a regional compliance officer. (Tr. 355-56, 472.) In March 1993, she was promoted to compliance team leader. She held this position until she left Dean Witter in February 1998. (Tr. 356.)
25 At the time Needham succeeded Dey, Dey wrote Oberholzer's account executive number on a note attached to the Hayward Branch binder. (Tr. 186-87, 243.) Dey stated the note was intended to indicate that Oberholzer's clients were actively trading, not that Oberholzer himself was at issue or that anyone at Dean Witter had failed to comply with Dean Witter's procedures in connection with Oberholzer client accounts. (Tr. 187-88, 243, 289.) She did not believe that any violations had occurred in any of the Oberholzer client accounts and she had no reason to believe that Auwinger was not supervising Oberholzer with respect to the accounts at issue. (Tr. 289.)
26 The compliance analyst assumes that the client profile information provided by the compliance department's computer surveillance system will be updated and the most recent information is in the account report form received from the branch manager. (Tr. 259-60.)
27 Konop has been employed by Dean Witter since 1982 and is currently the assistant director of product compliance in Dean Witter's New York office. (Tr. 768-70.)
28 The Compliance Department Procedure Manual contains the following mission statement: "(1) to develop and maintain policies and procedures reasonably designed to detect and prevent potentially violative activities; (2) to provide tools for management designed to aid in discharging their supervisory duties; (3) to provide a resource to [Dean Witter] with regard to sales practice related risks." (Joint Ex. 3, ¶8.)
29 The new account form for the account Dr. Huey opened at this time was also admitted into evidence. (Div. Ex. 48 at DWR000082.) However, no testimony regarding this account was offered and it was not reviewed by the Division's expert.
30 There were various transfers to another broker-dealer firm during April 1993, and the May 31, 1993 account statement indicated that the entire account had been transferred. (Tr. 282, 284; Resp. Ex. 217 at DWR000366, DWR000368.) Dey testified that the transfer request would have likely been submitted in March 1993. (Tr. 284.)
31 According to Dey, this indicated that Dr. Huey had other less active accounts, probably in more conservative securities. (Tr. 267-68.)
32 Dey was not alarmed by the aggressive trading, even considering 40% of the transactions were solicited. Most people rely on their account executive to recommend investments, so she expected a significant portion of transactions to be solicited. (Tr. 273-75.)
33 The Division alleges that the profit figures contained in this account report form were erroneous and the account had actually suffered a loss of $2,850 at this time. (Div. Ex. 117.)
34 The compliance department occasionally performed special reviews of accounts belonging to clients over the age of seventy-five. (Tr. 124.) Accordingly, Dr. Huey's account was identified and reviewed by Dey. (Tr. 275-76.)
35 The Division alleges that the profit figures contained in this account report form are erroneous and the account had actually suffered a loss of $15,427 at this time. (Div. Ex. 117.)
36 Auwinger reported this conversation and its substance to Needham. (Tr. 346.)
37 Needham stated that activity in the account was reduced, as the account was identified only once more by the compliance department's computer surveillance. This occurred in December 1994 and is discussed below. (Tr. 128.)
38 The Division alleges that these profit and loss figures were erroneous and the account had an actual profit of $1,173 at this time. (Div. Ex. 117.)
39 Dr. Huey had requested check-writing privileges in the Huey Trust Account. (Div. Ex. 49 at DWR000069.) However, the Division alleges that there were no checks or cash withdrawals during November. (Div. Ex. 3, Tab 9.)
40 Because O'Connor asked Oberholzer for his advice and desired her account to be similar to Ms. Svogar's accounts, Auwinger believed the majority of transactions in the O'Connor Trust Account were solicited. (Tr. 322-23, 326.)
41 The Division asserts that these profit and loss figures were erroneous, and the account had suffered actual losses of $39,655. (Div. Ex. 117.)
42 Needham testified that activity in the account was reduced after she received Auwinger's response. (Tr. 135, 179.)
43 Mr. Svogar stated he was not aware of existence of the Svogar Joint Account until his attorney's investigation into his mother's accounts. (Tr. 735.) He stated that he had never seen certain opening documents for the account and claimed that his signature was forged on such documents. (Tr. 739-48, 761-66; Div. Ex. 50 at DWR005501-02, Resp. Exs. 415, 417.) On or about December 3, 1993, a Dean Witter check was issued to Joseph Bradley Svogar and Leona Svogar as holders of the Svogar Joint Account. (Resp. Ex. 418.) The check is purportedly endorsed by both Mr. Svogar and his mother, although he contends both endorsements are forgeries. (Tr. 746-47; Resp. Ex. 418 at DWR36028.)
44 Various witnesses testified as to Auwinger's experience, credibility, and performance as Hayward Branch manager. Needham found Auwinger to be experienced and credible, stating that his responses to her account inquiries were satisfactory, thorough and prompt. (Tr. 137, 159.) This sentiment was echoed by Dey, who stated Auwinger was very "compliance-oriented" and a "great manager." (Tr. 261.)
45 The account inquiry prompting this account report form could not be found, but Dey testified it was fair to conclude that one was sent to Auwinger. (Tr. 253-54.)
46 Additional typewritten information appeared on Dey's memorandum to Auwinger. It stated that "[the Svogar IRA] is still a profitable account. The profit stated should have been as of [December 3, 1992 versus May 1, 1992]. I wrote the wrong date. The information received on this account was as of [December 3, 1992]." (Div. Ex. 18, Resp. Ex. 250.) Dey assumed Oberholzer supplied this information. (Tr. 257.)
47 The Division asserts that the profit and loss figures contained in the account report form, and the $60,000 profit claimed by Auwinger in his memorandum were erroneous. According to Padgett, the Division's expert, the account had suffered losses of $7,814 at this time. (Div. Ex. 117.)
48 He reported this conversation and its substance to Needham. (Tr. 346.)
49 Prior to 1996, Joseph Svogar was the owner of a theater in Sacramento, California. (Tr. 715-16.) Each month, he borrowed money from his mother to pay the rent on the theater of $1,200. Mr. Svogar estimated that he borrowed $15,000 to $18,000 from his mother during his ownership of the theater. (Tr. 729-30, 735-36.) Although Mr. Svogar stated he never told Oberholzer to sell securities in his mother's account, he did tell Oberholzer to withdraw money from his mother's account if funds were available. (Tr. 730.) However, withdrawals from Ms. Svogar's accounts, which totaled several hundred thousand dollars, far exceeded the amounts Mr. Svogar borrowed to pay rent on the theater. He had no explanation as to use or purpose of the withdrawn funds. (Tr. 755-57.)
50 The Division alleges that the reported profit and loss figures were erroneous and the account had an actual profit of $29,720 at this time. (Div. Ex. 117.)
51 The Division alleges that these profit and loss figures were and erroneous and that the account had suffered a loss of $62,213 at this time. (Div. Ex. 117.)
52 The parties were unable to produce a copy of this account inquiry Needham purportedly sent to Peterson. (Tr. 162.)
53 Peterson did not recall receiving Needham's first account inquiry regarding the Svogar IRA. (Tr. 1224.)
54 Peterson stated that upon receipt of Needham's account inquiry, he began his investigation by talking with Oberholzer to obtain background information on Ms. Svogar. He then instructed the operations manager to gather the Svogar IRA account statements so he could review the activity in the account and verify the information provided by Oberholzer. Peterson testified it would take several months of reviewing trading activity in an account in order to form a reasoned opinion regarding the same. Such review would necessitate interviewing the account executive to determine his understanding of the client's investment objectives. (Tr. 1224-26.)
55 As is discussed above, Dean Witter's Compliance Department Procedure Manual states that once a compliance analyst obtains information indicating questionable activity in an account, she may request further information from the branch manager. If the branch manager fails to provide the requested information, the compliance team leader must notify the regional director. (Tr. 142-43; Resp. Ex. 358 at DWR41076.)
56 On or about August 9, 1993, Needham had noted that the margin debit balance in the Huey Trust Account was $86,052. (Tr. 164; Resp. Ex. 274.) On or about August 18, 1993, Auwinger stated that Dr. Huey had sold securities in the account, and the margin debit balance had dropped to $65,000. (Tr. 165; Resp. Ex. 276.) Needham noted that the progressive decrease in the margin debit balance from $86,052 to $65,000 to $5,481 was one of the actions she had recommended. (Tr. 165.)
57 O'Connell read Needham's comment on suitability as requesting him to focus on that issue. He stated that a suitability determination would involve the branch manager's investigation and judgment. According to O'Connell, suitability is a legal conclusion necessarily involving Dean Witter's law department and the compliance department is not in a position to make a suitability determination based on the information it reviews during computer surveillance. (Tr. 569-70.)
58 Taylor has been employed by Dean Witter since 1966. (Tr. 1194.) In 1993, he became the regional compliance officer assigned to the Hayward Branch. (Tr. 363, 1195.) Taylor succeeded McDaniel-Remer, the prior regional compliance officer, when she was promoted to compliance team leader. (Tr. 363.) As regional compliance officer, Taylor reported to McDaniel-Remer. While he had no direct reporting responsibilities to the regional sales manager, O'Connell, they did have a "dotted-line" reporting relationship. (Tr. 1195.)
59 This was the first time the compliance department had brought Oberholzer to O'Connell's attention. (Tr. 539.)
60 According to O'Connell, any time the compliance department identified accounts of elderly clients with high commissions, it warranted investigation. (Tr. 543.)
61 Peterson was surprised by O'Connell's telephone call. The compliance department had not contacted Peterson after his December 2, 1994 memorandum, and no one had indicated that his responses were untimely or inadequate. (Tr. 1226, 1247-48.)
62 Although Auwinger told O'Connell that Oberholzer was an aggressive account executive, this did not concern O'Connell. According to O'Connell, Auwinger was very conservative and his description of Oberholzer as "aggressive" meant that Oberholzer was eager. (Tr. 554, 556.) O'Connell stated that an aggressive account executive is not necessarily a danger if such account executive is properly supervised and trained by the branch manager. (Tr. 556-57.)
63 Peterson stated he introduced himself to Mr. Svogar so that Mr. Svogar could express any concerns he had with his mother's account. (Tr. 645.)
64 According to Mr. Svogar, Oberholzer told Ms. Svogar that Peterson would be calling and instructed her to tell Peterson she had no complaints. (Tr. 726-27.)
65 According to Peterson, he explained to Dr. Huey that margin was a "two-edged sword" meaning that during a rising market, it results in beneficial leverage, but during a falling market, it could result in large losses. (Tr. 629, 1230.)
66 According to O'Connell, the restrictions prohibited Oberholzer from recommending purchases to his clients. If the client wanted to purchase a security with no recommendation from Oberholzer, Peterson would be required to approve the purchase. (Tr. 577.) It did not matter to O'Connell if the restrictions prohibited all purchases of securities or if unsolicited purchases approved by Peterson were allowed. If Peterson had desired restrictions allowing him the discretion to approve certain transactions, Peterson had the power to implement such restrictions and O'Connell would have approved them if asked to do so. O'Connell's concern was that Peterson ensure that activity was slowed and that all transactions were proper. (Tr. 566-67.)
67 O'Connell was not concerned that the memorandum did not list all of the accounts indicated by Needham in her December 22, 1994 memorandum. He felt that Peterson had performed a complete investigation and O'Connell trusted his judgment as to which accounts should be restricted. (Tr. 567-68.)
68 Taylor also received Peterson's January 17, 1995 memoranda to Oberholzer and McDaniel-Remer. Taylor's understanding of the restrictions was that they were intended to slow the trading in the various accounts and reduce the margin debit. (Tr. 1203-04.)
69 Peterson testified that by stating that he would "go into further detail as far as his conversations and findings" he meant that he would continue to monitor the accounts in question and promptly report any improprieties. (Tr. 1232.) O'Connell interpreted this to mean Peterson was "watching the store" and would provide any more information uncovered by his investigation. O'Connell did not interpret the sentence as Peterson's promise of more information regarding the accounts. (Tr. 581.)
70 After the December 22, 1994 meeting, McDaniel-Remer told Needham to monitor Oberholzer's accounts. (Tr. 102, 367-68.) Both Needham and Taylor reviewed the accounts periodically thereafter. (Tr. 160-61.)
71 Other than Padgett's statement of opinion, there was no other evidence regarding Cholestech's alleged unsuitability. Of the Four Clients, only Ms. Svogar invested in Cholestech. The Svogar IRA purchased 1000 shares on January 6, 1995. (Div. Ex. 66, Tab H.)
72 Padgett also did not interview the Four Clients, Mr. Svogar, or Glaser. (Tr. 980.)
73 Hennessy noted that the Betz accounts were closed prior to Peterson becoming Hayward Branch manager. (Tr. 1360.)
74 In support of this conclusion, Padgett prepared a report detailing transactions that he alleged had no apparent economic logic. (Tr. 981-82; Div. Ex. 1 at App. A-D.) According to Padgett, transactions with no apparent economic logic are those in which Oberholzer and Dean Witter benefited rather than the particular client. He stated that such transactions are indicative of churning. (Tr. 830.) None of the transactions so indicated by Padgett occurred during Peterson's tenure as Hayward Branch manager. (Tr. 982-83.) However, in a separate exhibit, Padgett identifies three transactions in the Svogar Trust Account he alleges are transactions with no apparent economic logic. (Div. Ex. 4 at Tab 12.) See infra note 84 and accompanying text.
75 Padgett stated that the average equity refers to the net amount invested by the client. (Tr. 824.) Padgett stated that the amount of commissions paid is an indicator of control. (Tr. 899-90.)
76 There were two purchases of InaCom, one purchase of Bioject, and one purchase of Western Water while Peterson was Hayward Branch manager. (Div. Ex. 3 at Tab 9.)
77 Padgett did not provide an analysis of excessive trading specifically for the period spanning September 1994 to December 1994. (Tr. 1024-25.)
78 According to Padgett's analysis, the account also suffered a net loss of $64,127 during this period. (Div. Ex. 5 at Tab 1.)
79 On October 18, 1994, the account purchased 600 shares of Western Water. This was the only purchase in the account while Peterson was Hayward Branch manager. (Div. Ex. 5 at Tab 9.)
80 However, Padgett did acknowledge that a branch manager would consider Glaser's letter to Oberholzer dated July 14, 1994, instructing Oberholzer to hold onto certain securities, including Western Water, in determining whether concentration in Western Water was in fact unsuitable. (Tr. 1133.) Padgett stated that although the letter was evidence of O'Connor's investment objectives, it did not reduce the risk of undue concentration. (Tr. 1133-34.)
81 According to Hennessy, Peterson did not fail to supervise Oberholzer by approving liquidating sales to reduce the margin debit balance and allowing the resulting concentrations to continue. (Tr. 1385.) Hennessy stated that concentration is expected to increase over time in an account employing a liquidating strategy. (Tr. 1383.)
82 Three purchases of Bioject, one purchase of Cholestech, four purchases of InaCom, and five purchases of Western Water were made while Peterson was Hayward Branch manager. (Div. Ex. 4 at Tab 9.)
83 Padgett also acknowledged that the restrictions on purchases imposed by Peterson were an adequate response to alleged excessive trading. (Tr. 1029.)
84 Three of these transactions occurred during Peterson's tenure as Hayward Branch manager and involved Western Water. (Div. Ex. 4 at Tab 12.)
85 Non-discretionary accounts are those in which the investor must give prior approval to all transactions. In a discretionary account, the account executive has discretionary authority to trade, "hence his control is quite clear." Hotmar v. Lowell H. Listrom & Co., 808 F.2d 1384, 1385 (10th Cir. 1987).
86 I consider forms completed upon each client's initial contact with Oberholzer the best evidence of the clients' investment objectives or financial needs. I find that subsequent new account forms, account report forms, and communications from the clients are not conclusive on these issues as some may reflect Oberholzer's personal relationship with the clients.
87 "A traditional method of showing excessive trading in an account is by presenting an expert who will testify to such items as the `turnover rate' and the `in and out trading' in a particular account." Hotmar, 808 F.2d at 1386.
88 The Commission has stated that supervisory procedures relying solely on the branch manager are not sufficient. See Donald T. Sheldon, 51 S.E.C. 59, 79 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995). In Sheldon, the Commission noted that the broker-dealer firm did not monitor the branch managers and had no procedures to monitor the branch managers' performance of their supervisory responsibilities. This is not the case here and I find that Dean Witter's supervisory procedures do not rely solely on the branch manager. Among other things, Dean Witter required branch managers to complete a supervisory log certifying performance of all duties and submit such log to the compliance department. Furthermore, Dean Witter required its compliance department to proceed to the regional level if it did not receive satisfactory responses from the branch managers.
89 In reviewing Dean Witter's supervisory systems and procedures, Padgett sought to determine if they were deficient, but not in relation to industry standards. (Tr. 1126-27.)
90 Padgett was aware of one large broker-dealer firm in which the compliance department had some responsibility to ensure compliance. However, he was not sure if this included the authority to take corrective action. (Tr. 1123-24.) Kleinburg stated that it was common for compliance departments to be informative and advisory only, and it was reasonable for Dean Witter's compliance department to lack the authority to take corrective action. (Tr. 1487-88.)
91 Maine noted that in addition to investigating accounts as requested by the compliance department, Dean Witter's MAPPS Branch Manager's Manual required branch managers perform other supervisory duties. These included investigating accounts appearing on the monthly activity report, regardless of a compliance department inquiry into such accounts. (Tr. 1300-01.)
92 Smith also stated that most broker-dealer firms placed much reliance on the experience of the branch manager. (Tr. 1177.) Kleinburg stated that reliance is placed on the branch manager because of his proximity to and familiarity with the account executives and particular accounts. Additionally, the branch manager is better equipped to communicate with clients when necessary. (Tr. 1488-89, 1500.) Compliance department personnel are not located in such proximity to the accounts or account executive and are therefore at a disadvantage in performing investigations into account irregularities. Kleinburg also noted that the compliance department would consider a particular branch manager's experience in determining whether his response to an account inquiry was satisfactory. (Tr. 1489, 1492.) He felt the compliance department received satisfactory responses from Auwinger and Peterson. Considering Auwinger's and Peterson's experience and good record, it was reasonable for the compliance department to rely on their responses. (Tr. 1492-94.)
93 Maine also noted that the compliance department's identification of an account was not a "red flag." (Tr. 1297.) The compliance department's computer surveillance did not alert the compliance department to "red flags," but was used to identify irregular account activity. (Tr. 1297-98.)
94 Peterson met with Auwinger a few days after he took over and they discussed the Hayward Branch generally, but did not specifically discuss Oberholzer or any other individual account executive at the Hayward Branch. (Tr. 333-34.)
95 Kleinburg also stated it would be unreasonable to specifically require a briefing of new branch managers. (Tr. 1481-82.)
96 Padgett stated that accurate client information is important primarily for determining suitability of a particular investment. Suitability is based upon the investment objective, financial needs, and sophistication of the client. Accurate new account forms and subsequent account report forms provide indications of investment objectives and financial needs. (Tr. 913.)
97 Smith was unaware of any new account forms used by broker-dealer firms specifically questioning sophistication. He stated that most new account forms have a number of questions designed to ascertain relevant information, such as investment experience, but he was unaware of any broker-dealer firm specifically questioning or having a procedure to determine client sophistication. (Tr. 1173-74.)
98 Padgett stated that Dean Witter's use of activity letters is similar to the use of negative consent letters. (Tr. 1014.) However, Padgett believed Dean Witter's activity letters were so "benign" that clients would not respond to them. (Tr. 1015-16.) Maine and Kleinberg testified that activity letters were the most common method of communicating with clients during the years in question. (Tr. 1309-10, 1489-90.) Maine stated that each of the activity letters used by Dean Witter was very complete and comported with industry standards. (Tr. 1309-10.)
99 Other than with respect to option accounts, Maine and Smith were similarly unaware of any broker-dealer firm with a procedure to verify new or updated client information provided by the account executive on internal forms during 1990 through 1994. (Tr. 1172-73, 1289.)
100 However, Padgett was unable to identify any broker-dealer firms with a procedure to identify unsuitable concentration during the relevant period. (Tr. 1093-94.) Padgett also acknowledged that broker-dealer firms commonly rely on the branch manager to determine unsuitable concentration by reviewing account statements when the compliance department identified an active account. (Tr. 1094.)
101 Smith was also unaware of any broker-dealer firm using concentration as a parameter, stating that concentration is obvious from a review of the account statements or a current position list. (Tr. 1175-76.) According to Smith, Dean Witter's computerized surveillance system surpassed all others in the industry in terms of sophistication and number of parameters used to identify accounts. (Tr. 1179-80.) Not all broker-dealer firms had a computerized surveillance system from 1990 through 1994. (Tr. 1175, 1179.) Smith noted Dean Witter's system used approximately nineteen parameters from 1992 through 1993, some of which were unique to Dean Witter such as age for special review of senior citizen accounts. (Tr. 1179-80.)
102 Maine noted that Dean Witter's procedures, which he stated were uniform in the industry, mandated that after an account was indicated in an activity report, the branch manager was to review the account records. The account records would include the monthly account statements where concentration would be most evident. (Tr. 1293-94.)
103 Kleinburg also stated he knew of no company which offered software that would have allowed a broker-dealer firm to identify concentration in accounts during 1990 through 1994. (Tr. 1479.)
104 O'Connell stated that if a client had been defrauded, Dean Witter would act without a client complaint to determine the amount of loss and immediately compensate that client. However, Peterson had determined there was no wrongdoing in any of the accounts at issue. (Tr. 570-72.)
105 After reviewing the compliance department's account inquiries, the responses received from the branch managers, and witness testimony, Kleinberg also concluded that the compliance department performed reasonably. (Tr. 1491-92, 1498.) He stated that the compliance department had no reason to believe that anyone was not complying with Dean Witter's procedures between February 1992 and December 1994. (Tr. 1492-94.)
106 In its posthearing brief, the Division argues that the compliance department's alleged knowledge of wrongdoing is imputed to Dean Witter. Therefore, Dean Witter had knowledge that its procedures and system were not being complied with, and is precluded from protection by the safe harbor provision. The Division relies on Prudential-Bache Securities, Inc., 48 S.E.C. 372 (1986), and Smith Barney, Harris Upham & Co., 32 SEC Docket 999 (Mar. 5, 1985), two settled cases, as support for its argument. Settled cases are of little, if any, precedential value. See Carl L. Shipley, 45 S.E.C. 589, 591 n.6 (1974). Furthermore, there is no evidence that the compliance department ever knew that Auwinger was not properly supervising Oberholzer, or that Oberholzer was engaging in misconduct. The compliance department always received timely responses to its inquiries from Auwinger and it was reasonable for the compliance department to rely on those responses. When Peterson did not give a satisfactory response to a compliance department inquiry, the matter was brought to O'Connell's attention and prompt action was taken. This was how the system was designed to work.
107 On or about September 26, 1994, Gary M. Fonda (Fonda), the operations manager at the Hayward Branch, spoke with Peterson regarding Oberholzer. (Tr. 502-03, 505, 515-16; Div. Ex. 95 at GF00069.) Fonda has been employed at the Hayward Branch for nineteen years, becoming operations manager in February 1985. (Tr. 502-03.) He testified that as operations manager, he oversaw "back office" branch operations including the non-sales staff and reported to the Hayward Branch manager. (Tr. 503.) Fonda testified that he did not have a Series 8 license, and had no responsibilities to monitor trading or sales practices, or to review client account statements. (Tr. 520-21.) Fonda told Peterson that Oberholzer had more clients failing to meet margin calls than any other account executive. (Tr. 503-04.) Fonda considered Oberholzer a problem in terms of "back office" issues, such as trade adjustments and letters of authorization. (Tr. 503-05.) Fonda's notes from the conversation indicate that he told Peterson he should "be aware" of Oberholzer. (Tr. 517-18; Div. Ex. 95 at GF00069.)
108 Hennessy reviewed Dean Witter's MAPPS Branch Manager's Manual to determine if Peterson violated any of Dean Witter's supervisory procedures. In determining whether Peterson violated the supervisory standard of care in the industry, Hennessy considered the statute, and relied on his professional experience, his experience on an NASD District Business Conduct Committee, and his experience as an expert witness. (Tr. 1353-54.)
109 Hennessy stated that Peterson's direct contact with certain active clients was reasonable and comported with industry standards. (Tr. 1355, 1359, 1361.) He stated that there was no rule, regulation, or Dean Witter procedure requiring Peterson to meet personally with Ms. Svogar, Dr. Huey, or O'Connor. (Tr. 1386.)
110 According to Padgett, Dr. Huey and Betz were familiar with each other, as were O'Connor and Ms. Svogar. However, Padgett asserted that the two groups were not familiar with each other. (Tr. 888.)
111 Peterson's December 2, 1994 memorandum asserted that 95% of the transactions in the Svogar IRA were unsolicited. (Tr. 156-57; Div. Ex. 36 at DWR3342, Resp. Ex. 305.) However, Needham noted the account had purchased both Western Water and InaCom securities. In response to a memorandum from Needham dated November 30, 1994, Peterson had submitted securities solicitation request forms for Western Water and InaCom completed by Oberholzer. (Tr. 157-58; Div. Ex. 43 at DWR3358-59, DWR3361, Resp. Ex. 309 at DWR3358-59, DWR3361.) According to Needham, this was questionable but did not conclusively indicate Oberholzer was marking order tickets incorrectly. (Tr. 154-55, 157-58.)
112 Peterson had been in the Hayward Branch the morning of the inspection, but was out of the office when Dey completed the inspection that afternoon. (Tr. 202, 244, 1234.)
113 The Division relies on the date-time stamp on the particular order tickets as evidence that the trades were solicited but marked unsolicited. For example, on September 23, 1994, Dr. Huey, Ms. Svogar and four other Oberholzer clients bought Bioject. All order tickets were marked unsolicited and three tickets, including Ms. Svogar and Dr. Huey's, were time-stamped within five minutes of each other. (Div. Ex. 66, Tab A.) On November 11, 1994, Ms. Svogar and one other Oberholzer client bought InaCom. The two order tickets were time-stamped at 6:17 a.m. and 6:18 a.m., and both were marked unsolicited. (Div. Ex. 66, Tab D.) On November 14, 1994, Ms. Svogar, Dr. Huey, and one other Oberholzer client purchased InaCom. Ms. Svogar and Dr. Huey's order tickets were time-stamped at 12:10 p.m. and 12:18 p.m., respectively. The other order ticket was time-stamped at 11:09 a.m. (Div. Ex. 66, Tab E.) On November 18, 1994, Ms. Svogar and four other clients bought Western Water. Four of the order tickets, including Ms. Svogar's, were marked unsolicited. Ms. Svogar's order ticket was time-stamped at 7:37 a.m., as was one other order ticket. (Div. Ex. 66, Tab F.) On April 18, 1995, Ms. Svogar and two other clients purchased Western Water. The three order tickets were all time-stamped at 10:35 a.m., and all were marked unsolicited. (Div. Ex. 66, Tab K.)
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