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UNITED STATES OF AMERICA
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In the Matter of SG Cowen Securities Corporation, Respondent. |
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ORDER INSTITUTING ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS AND A CEASE- AND-DESIST ORDER PURSUANT TO SECTIONS 15(b) AND 21C OF THE SECURITIES EXCHANGE ACT OF 1934 |
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative and cease-and-desist proceedings be, and hereby are, instituted pursuant to Sections 15(b) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") against SG Cowen Securities Corporation ("Respondent" or "SGC").
In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement (the "Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over Respondent and the subject matter of these proceedings, Respondent consents to the entry of this Order Instituting Administrative and Cease- and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order Pursuant to Sections 15(b) and 21C of the Securities Exchange Act of 1934 ("Order"), as set forth below.
On the basis of this Order and Respondent's Offer, the Commission finds1 that:
1. Respondent failed reasonably to supervise Frank D. Gruttadauria ("Gruttadauria") with a view to preventing and detecting his violations of the federal securities laws during the 27 month period that it employed him from July 1998 to October 2000. From 1987 to January 2002, while employed at a series of five different registered broker-dealers, Gruttadauria defrauded over 60 customers by lying about purchases and sales of securities, misappropriating funds and securities, and sending falsified account documents. By the time that Gruttadauria confessed generally to his fraudulent conduct in a letter to the Federal Bureau of Investigation on January 11, 2002, he had misappropriated over $115 million from customers over a period of 15 years - transferring most of the money to other customers to cover withdrawal requests -- and overstated account values by more than $280 million.
2. Respondent SGC, a wholly-owned subsidiary of Societe Generale, is a New York corporation registered with the Commission as a broker-dealer pursuant to Section 15(b) of the Exchange Act, and has its principal place of business in New York, NY. SG Cowen Securities Corporation was established in July 1998, when Societe Generale, an international bank headquartered in Paris, France, acquired, among other assets, the retail brokerage business of Cowen & Co. ("Cowen"). In July 1998, Societe Generale contributed this brokerage business to its United States broker-dealer subsidiary, SG Securities Corporation, which was renamed SG Cowen Securities Corporation.
3. Frank D. Gruttadauria, 45, was the manager of SGC's Cleveland, Ohio branch office from July 1998 through October 2000. Gruttadauria was also a registered representative of SGC throughout this period. From January 1984 through July 1998, Gruttadauria was employed as a registered representative of several other broker-dealers, including SGC's predecessor, Cowen, beginning in 1989. From 1990 through July 1998, Gruttadauria was also the branch office manager of Cowen's Cleveland branch.
4. On August 29, 2002, Gruttadauria pled guilty to, among other things, federal charges of securities and mail fraud in connection with his fraudulent conduct. On November 14, 2002, Gruttadauria was sentenced to seven years of confinement.
5. In July 1998, SGC acquired Cowen's retail brokerage business. Among the assets of that brokerage business was the branch office in Cleveland, Ohio, of which Gruttadauria was the branch office manager ("BOM"). Gruttadauria had also been among the top-producing brokers at Cowen nationwide.
6. Since 1987, Gruttadauria had been defrauding dozens of customers through various means. He lied to some of those customers about purchases and sales of securities in their accounts and the performance of those accounts, often telling these customers that their accounts contained a wide variety of holdings worth millions of dollars when, in fact, the accounts contained only a few thousand dollars. He falsely told some customers that he used the funds that they deposited into their accounts to buy securities when, in fact, he misappropriated those funds. In a few instances, Gruttadauria induced customers to give him funds to open an account and simply misappropriated the funds. Gruttadauria also told a number of customers from whom he did not misappropriate funds or securities that their accounts were more valuable than the accounts actually were. When those customers sought to withdraw the inflated amounts, Gruttadauria misappropriated funds from other customer accounts to satisfy those withdrawal requests.
7. Gruttadauria used most of the misappropriated funds to conceal and perpetuate the fraudulent acts in which he was engaging. In most instances, he transferred funds or securities deposited by some customers for investment purposes to other customers or their designees, either directly or through an intermediary brokerage or bank account. Virtually all of these transfers were used to satisfy withdrawal requests made by customers to whom Gruttadauria falsely represented that they had sufficient funds to make the transfers out of their own accounts, but whose accounts had been depleted or had fewer assets than Gruttadauria had reported.
8. To further conceal his false representations and misappropriations, Gruttadauria created and sent many of the defrauded customers falsified account statements and other documents that vastly overstated the actual value of the accounts, reflected holdings that did not exist, reflected purchases or sales of securities that had never occurred, and failed to disclose unauthorized withdrawals from the accounts. Gruttadauria caused the actual brokerage statements for some of these customers to be mailed, without the knowledge or authorization of these clients, to entities or post office boxes under his control. The account address information SGC received from Cowen included nearly all of these unauthorized mailing addresses.
9. By the time that Gruttadauria became an employee of SGC by virtue of SGC's acquisition of the Cowen brokerage business in July 1998, Gruttadauria had misappropriated at least $47 million from over 38 customers.
10. During his employment with SGC, Gruttadauria misappropriated over $47 million more from the accounts of at least 19 customers from whom he had previously misappropriated funds, as well as at least four additional customers. Gruttadauria used an intermediary brokerage account to disburse about $20 million of the $47 million that he misappropriated. Gruttadauria disbursed the remaining $27 million without using the intermediary brokerage account. Gruttadauria used virtually all of the misappropriated funds and securities to satisfy customer withdrawal requests.
11. During his employment with SGC, Gruttadauria had sent falsified account statements and other documents to approximately 40 customers representing more than 60 client accounts. Of these clients, about 27 also received funds or securities that Gruttadauria had misappropriated from other clients. He had led the customers to whom he had been sending falsified documents to believe that they had over $294 million in their accounts when, in fact, they had less than $30 million in those accounts.
12. In October 2000, SGC sold certain assets to Lehman Brothers, Inc. ("Lehman Brothers"), which continued to employ Gruttadauria as the manager for its newly acquired Cleveland branch, through January 2002.
13. On January 11, 2002, Gruttadauria disappeared, leaving a letter with the Federal Bureau of Investigation in which he confessed to the general outlines of his fraudulent conduct. At that time, the last falsified account statements that Gruttadauria had sent to clients showed that their accounts were worth over $285 million, when the actual Lehman Brothers statements for those accounts showed an aggregate balance of less than $2 million. About a month later, Gruttadauria surrendered to the Federal Bureau of Investigation.
14. As a result of the conduct described above, Gruttadauria, during the period that SGC employed him, violated Section 17(a) of the Securities Act of 1933, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which prohibit fraudulent conduct in connection with the offer, purchase or sale of securities.
15. The failure of SGC reasonably to supervise Gruttadauria occurred in a context that itself created an inherent risk that Gruttadauria would not be adequately supervised. Gruttadauria was a producing BOM, which means that he was responsible both for the overall supervision of the Cleveland branch and for his own retail brokerage customers. The practice that Cowen had in place at the Cleveland branch, and which SGC adopted when it employed Gruttadauria, was to have an assistant branch office manager, who also served as the branch compliance manager, to oversee all of the daily retail brokerage activity in the Cleveland branch, including activity for those customers serviced by Gruttadauria, even though he reported directly to Gruttadauria. By choosing persons subordinate to Gruttadauria to oversee his daily retail brokerage activity, SGC structured its supervisory and compliance functions in a manner that created an inherent risk that Gruttadauria would not be adequately supervised. As BOM, Gruttadauria had broad authority within the branch relating to personnel matters, such as salaries, bonuses, and continued employment of the branch staff, including that of the individual assigned to oversee his activities as a broker. This type of authority can lead to conflicts of interest that, in turn, can compromise the ability of those subordinate to the BOM to oversee adequately the BOM's activity. This structure may have been a contributing factor in the supervisory failures described below.
16. Further, SGC should have been aware of the potential supervisory risks associated with a producing BOM because the adequacy of Cowen's policies and procedures for the supervision of producing BOMs, with respect to certain supervisory duties, was raised in connection with an investigation by the New York Stock Exchange (the "Exchange") of conduct occurring at Cowen as early as 1994. In that action Cowen, in 1998, consented to a censure, a $380,000 fine and an undertaking to review certain supervisory, compliance and oversight procedures, including those relating to producing BOMs. SGC became responsible for complying with the undertakings as a result of its acquisition of Cowen's retail business at the time of the Exchange action. In accordance with the undertaking in the 1998 Exchange Order, SGC employed a law firm "not unacceptable to the Exchange" to conduct a review of and prepare a report on the efficacy of its efforts to comply with the Order. Although certain improvements were instituted, SGC failed adequately to implement all of the undertakings.
17. SGC failed reasonably to supervise Gruttadauria's conduct as a producing BOM in three principal ways. First, although SGC had procedures addressing the review of outgoing and incoming correspondence, Gruttadauria was able to evade that review because SGC did not have an adequate system for applying these procedures to Gruttadauria, who as a producing BOM had access to a facsimile machine and the office's postage meter.2 Gruttadauria's facsimile machine, which only he and his sales assistants were authorized to use, was located outside of his office. Gruttadauria represented to the compliance staff that he used this machine only for transmitting and receiving confidential internal administrative correspondence such as performance evaluations. However, Gruttadauria also used this facsimile machine to evade the review of outgoing and incoming correspondence, by using it to send fraudulent documents to customers, and to receive correspondence, such as letters of authorization for withdrawals out of depleted accounts. Additionally, because he was the BOM, Gruttadauria also had a key to the otherwise secure area, known as the cage, which contained the branch office's postage meter. Gruttadauria used this key to evade the review of his outgoing correspondence that contained falsified account statements by, on a monthly basis, entering the cage after working hours, and placing a stack of sealed envelopes containing the falsified statements directly on top of the postage meter for mailing. These unreviewed statements were mailed out the next morning with SGC's official envelopes and postage markings.
18. Second, SGC failed to have adequate procedures to prevent a producing BOM from authorizing third-party disbursement requests for his own clients and deviating from the firm's cashiering and related operations procedures in order to process such requests. SGC's written procedures allowed Gruttadauria, as BOM, to approve third-party disbursement requests for his own clients, which he routinely did on the basis of letters of authorization that he forged. In addition, because of Gruttadauria's status as a producing BOM he had his own facsimile machine, and was thus able to approve his own transaction requests and communicate these requests via his personal facsimile machine directly to SGC's margin office without the knowledge of the branch operations manager, who would normally facilitate such transactions.
19. Third, SGC had inadequate procedures for an independent supervisor to follow up on critical missing account documentation involving Gruttadauria's customers. In 1999, SGC's branch compliance examiner discovered that approximately 30 of Gruttadauria's accounts - some of them belonging to victims of his fraudulent acts - were purportedly using post office boxes or "care of" addresses as the mailing address for account statements, but for which SGC had no letter of authorization on file authorizing use of the post office box or "care of" address. This finding was noted in the compliance examination report, which was forwarded to senior staff in SGC's headquarters office. However, SGC's inadequate procedures allowed Gruttadauria to resolve the matter himself, which he did by creating 30 false and forged letters of authorization on his personal computer and forwarding them on to the compliance department. No one at SGC investigated either the circumstances under which addresses for 30 of Gruttadauria's customer accounts were changed without a letter of authorization, or the manner in which Gruttadauria obtained and supplied the missing documentation.
1. Failures Related to the Monitoring and Use of Personal Computers
20. SGC did not have supervisory procedures expressly for monitoring the use of personal computers that were separate from SGC's company-wide computer system.3 Unlike the company-wide system, such personal computers do not have built-in safeguards against creating false account data. At Cowen and throughout the period that SGC employed him, Gruttadauria had a personal computer that was networked to similar computers used by his two sales assistants, but not to the company-wide system. Gruttadauria ostensibly used this computer system as an electronic posting book, into which he had his sales assistants enter trading data and out of which he generated reports reflecting a client's holdings and year-end profit and loss statements for tax preparation purposes. However, Gruttadauria also used this computer system to generate the falsified account statements that he mailed to many of his defrauded customers. Thus, SGC did not have procedures reasonably designed to prevent and detect Gruttadauria's generation of falsified account statements on personal computers.
2. Failures Related to Third-Party Transfers
21. A crucial component of Gruttadauria's fraudulent conduct was misappropriating funds and securities out of customer accounts and then transferring them into an intermediary brokerage account or directly to other customers or their designees. This type of transfer is known as a third-party transfer because the assets at issue change ownership. Under circumstances pertinent here, SGC's written procedures required a notarized letter of authorization from the customer for a third-party disbursement, as well as approval by the branch office manager or his designee. However, SGC did not have an adequate system for applying its procedures for the processing and approval of third-party transfers. Gruttadauria's third-party requests for checks were routinely processed through the branch operations department with non-notarized (and forged) letters of authorization. SGC failed to detect or prevent Gruttadauria from making over $45 million in unauthorized third-party transfers. As described above, Gruttadauria usually faxed wire transfer requests directly to SGC's margin office also using forged and non-notarized letters of authorization.
22. SGC failed to have a reasonable system or failed to devote adequate resources to develop a system for applying its procedures relating to periodic review of account statements. SGC's procedures required the monthly review of one third of customer account statements, with focus on account statements that reflected an unusual amount of transfers of funds or securities from one account to another. SGC's procedures also required periodic review of letters of authorization for third-party payments, including verification of customer signatures, when appropriate. The branch compliance manager who was designated to conduct these reviews, in practice, conducted limited reviews of customer account statements, and reported his limited review to senior staff at SGC headquarters. However, SGC's inadequate system for implementing account statement reviews failed to provide for appropriate follow-up. In fact, the branch compliance manager failed to focus on statements with unusual amounts of funds and securities transfers, and failed to review letters of authorization supporting these transfers. Since much of Gruttadauria's fraudulent activities involved unauthorized third-party transfers, an adequate system for applying SGC's procedures relating to customer account statement review could have been an important safeguard in preventing and detecting Gruttadauria's fraudulent activities.
3. Failures Related to Compliance Examinations
23. SGC also failed to develop an adequate system to implement its procedures relating to compliance examinations of its branches, particularly relating to back office operational functions like monitoring compliance with the requirement for notarized letters of authorization for third-party transfers and disbursements. SGC employed a branch compliance examiner in 1998 as a result of the 1998 Exchange Order and utilized that individual to perform compliance examinations at all of SGC's eight branch offices nationwide. Although this compliance examiner utilized a firm-approved outline in branch examinations that contemplated review of both sales practices and back office operations, in practice, he focused only on sales practices and informed his superiors of his limited reviews. An adequate system to implement procedures for reviewing back office operations is a necessary component of procedures reasonably designed to prevent and detect fraudulent third-party transfers.
24. SGC's failure to develop an adequate system for branch examinations of back office operations is compounded by the fact that this failure also violated a specific undertaking, as mentioned above, that SGC made to the Exchange in 1998, which included addressing poor branch examination procedures and practices. In connection with that undertaking, SGC represented that it would perform exams consistent with the branch examination outline identified above, which contemplated review of back office operations and third-party disbursements. Based upon the conduct described in paragraph 23, SGC violated this undertaking.
4. Failures Related to Account Documentation
25. A brokerage firm is responsible for the accuracy of the account documentation that it maintains for its customers. The addresses on the account documentation SGC received from Cowen for certain of the defrauded customers of Gruttadauria had been falsified by him prior to the time that he joined SGC. SGC failed to have adequate procedures relating to account documentation that it acquired from Cowen. For example, SGC failed to have procedures requiring it to review Cowen's account documentation procedures, including the procedures that permitted Gruttadauria to make customer address changes directly into the firm's system without review or customer authorization. Alternatively, irrespective of any review of Cowen's procedures relating to account documentation, SGC did not undertake its own review of Cowen's deficient account documentation, or did not implement other measures reasonably designed to prevent and detect Gruttadauria's continuing diversion of actual account statements to unauthorized addresses.
26. Section 15(b)(4)(e) of the Exchange Act requires broker-dealers to supervise reasonably persons subject to their supervision, with a view toward preventing violations of the federal securities laws. See e.g., Smith Barney, Harris Upham & Co., Exchange Act Rel. No. 21813, 32 SEC Docket 999, 1004 (March 5, 1985). This section also provides an affirmative defense to broker-dealers which can show that they have "established procedures and a system for applying such procedures" that could reasonably be expected to prevent and detect such violations. The Commission has emphasized that the "responsibility of broker-dealers to supervise their employees by means of effective, established procedures is a critical component in the federal investor protection scheme regulating the securities markets." Id.
27. For the reasons stated in paragraphs 1-25, SGC failed reasonably to supervise Gruttadauria with a view to preventing or detecting his violations of the federal securities laws.
28. Section 17(a) of the Exchange Act and Rule 17a-3 thereunder require that registered brokers and dealers make and keep current certain specified books and records relating to their business. Implicit in the Commission's recordkeeping rules is the requirement that information contained in a required book or record be accurate. In re Merrill Lynch, Pierce, Fenner & Smith Inc., Exchange Act Release No. 33367 (Dec. 22, 1993).
29. SGC violated Section 17(a) of the Exchange Act and Rule 17a-3 thereunder because it failed to maintain complete and accurate books and records as required by those provisions. For example, SGC's addresses for certain of Gruttadauria's defrauded clients were incorrect. SGC also failed to maintain complete and accurate books and records for customer ledger accounts, journal entries, memoranda of customer orders, and transfers of funds as a result of Gruttadauria's fraudulent acts.
Respondent undertakes to participate in a special arbitration process for potential victims of Gruttadauria's fraudulent acts as further set forth in Appendix A.
Respondent has further undertaken to make accelerated payments to customers who have not previously settled their claims against SGC, and from whom Gruttadauria misappropriated funds or securities (including unauthorized transfers), such payments representing the net amount of principal due such persons taking into account the value of their accounts prior to Gruttadauria's fraudulent activity and any subsequent deposits or withdrawals, as further set forth in Appendix B. Such accelerated payments are not designed to represent payment in full, and the acceptance of such accelerated payments does not result in or require the release of any claims against SGC. Customers who receive such accelerated payments may pursue additional remedies through the special arbitration process set forth in Appendix A or as otherwise provided by law. In determining whether to accept the Offer, the Commission has considered these undertakings.
In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions specified in SGC's Offer.
ACCORDINGLY, IT IS HEREBY ORDERED:
A. That SGC be, and hereby is, censured pursuant to Section 15(b)(4) of the
Exchange Act.
B. Pursuant to Section 21C of the Exchange Act that SGC cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Exchange Act and Rule 17a-3 thereunder.
C. That SGC shall, within ten days of the entry of this Order, pay the amount of $5 million. SGC shall make payments as follows: (i) pursuant to Section 21B of the Exchange Act, SGC shall pay a civil monetary penalty of $2,500,000 to the United States Treasury; and (ii) pursuant to SGC's agreement with the New York Stock Exchange in related proceedings, SGC shall pay a fine in the amount of $2,500,000 to the New York Stock Exchange. Such payment to the United States Treasury shall be: (A) made by United States postal money order, certified check, bank cashier's check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Office of Financial Management, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3,
Alexandria, VA 22312; and (D) submitted under cover letter that identifies SG Cowen Securities Corporation as a Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Lawrence A. West, Division of Enforcement, Securities and Exchange Commission, 450 5th Street N.W., Washington, D.C. 20549-0801.
By the Commission.
| Jonathan G. Katz Secretary |
This Appendix A sets forth terms and conditions of a special arbitration process that Lehman Brothers, Inc. ("Lehman") and SG Cowen Securities Corp. ("SG Cowen") (the "Firm" or "Firms") have agreed to make available to qualifying former customers of Frank Gruttadauria. This process is completely voluntary on the part of qualifying former customers, and does not preclude former customers who elect not to participate in this process from pursuing other remedies in any forum.
Qualifying Customers. Persons eligible to participate in this process are former customers of Frank Gruttadauria from whom Gruttadauria misappropriated funds or securities (including unauthorized transfers) and/or who received falsified account documents from or at the direction of Gruttadauria (whether or not they also received genuine account documents) during the period that Gruttadauria was employed at Cowen & Co. or the Firms ("Qualifying Customers"). A customer who has previously released his or her claims against either Firm in connection with a settlement of such claims is not a Qualifying Customer with respect to that Firm. All disputes, claims, or controversies ("Claims") of Qualifying Customers relating to any accounts or purported accounts for which Gruttadauria was or purported to be the account representative may be brought in this process. The arbitrator(s) assigned to hear a Claim shall also decide any disputes as to whether the person submitting that Claim is a Qualifying Customer. The arbitrator(s) shall render any such decision promptly and before proceeding with any other aspects of this special arbitration process. Qualifying Customers may only name as a Respondent in these proceedings those Firms at which Gruttadauria was employed when he misappropriated from the Qualifying Customer any funds or securities (including unauthorized transfers) and/or provided any falsified account documents to the Qualifying Customer. SG Cowen will pay all awards made for conduct during the period from May 12, 1989 to October 13, 2000 (the "SG Cowen Time Period"). Lehman will pay all awards made for conduct during the period from October 16, 2000 to January 18, 2002 (the "Lehman Time Period"). The arbitrator(s) will determine liability for conduct that occurred on October 14 or 15, 2000.
Arbitration Rules. Subject to paragraph 6, the Firms will make this special arbitration process available to Qualifying Customers at the New York Stock Exchange ("NYSE") pursuant to the NYSE Arbitration Rules. At the election of the customer, certain timeframes and deadlines may be modified as set forth in paragraph 3 below. However, nothing in this Appendix A is intended to preclude the parties in a particular case from agreeing, in consultation with the arbitrator(s) or the NYSE Director of Arbitration as appropriate, to resolving Claims under any other procedures or rules. A Qualifying Customer may elect to proceed under the Random List Selection or Enhanced List Selection alternatives contained in the NYSE Voluntary Supplemental Procedures for Selecting Arbitrators, and the Firms will not object to any such election. The Firms will also make mediation available to Qualifying Customers pursuant to NYSE Rule 638 or, if an arbitration proceeding is already in progress at the National Association of Securities Dealers ("NASD"), pursuant to NASD Code of Arbitration Procedure 10400.
Modified Timeframes and Deadlines. In order to expedite the hearing of Claims, customers may elect to proceed as set forth below. All other terms of this special arbitration process will apply whether or not customers elect to proceed in this manner.
The time period set forth in Rule 612(c)(1) shall be 20 calendar days.
Parties may serve requests under Rule 619(b) immediately upon service of the Statement of Claim. The time for satisfying or objecting to requests under Rule 619(b)(2) shall be twenty-five (25) calendar days.
Subject to other determination by the NYSE Director of Arbitration, a discovery conference to resolve discovery issues will be held within twenty (20) calendar days of the receipt of a written request by a party under Rule 619(b)(4).
Subject to other determination by the NYSE Director of Arbitration, the hearing will be held within 180 days from the date that the Statement of Claim is filed, and a decision or award will be rendered within thirty (30) days of the conclusion of the hearing.
The time period set forth in Rule 627(g) shall be twenty (20) calendar days.
Notice.
Within ten (10) days of the date of the Commission's orders and the New York Stock Exchange Hearing Panel Decisions in these proceedings (collectively, "the Orders"), the Firms will send the following to the last known address of, or, if known, to counsel for, all persons whom they have reason to believe are or may be Qualifying Customers:
Copies of the Orders and the Commission's press release;
To the extent located by each Firm as of the date of the Orders, and not previously produced to the Qualifying Customer, with respect to any account or purported account of the customer from which Gruttadauria misappropriated funds or securities (including unauthorized transfers) and/or with respect to which a customer received falsified account documents from or at the direction of Gruttadauria (a "Qualifying Account"), all genuine account statements issued by the Firm during its Time Period for any Qualifying Account of the customer, and all falsified account statements and other falsified documents pertaining to the Qualifying Account.
The notice in paragraph 4.a. will also provide that the Qualifying Customer may request from the Firm sending the notice any of the following documents during the respective Firms' Time Periods with respect to transactions for which the Qualifying Customer seeks additional information:
copies of checks, wire transfers, journals, or other transfers of cash or securities out of the Qualifying Account and letters of authorization relating to same;
copies of receipts for checks, cash, or securities received by the Firm from the Qualifying Customer and documents sufficient to show whether those checks, cash, or securities were actually deposited into the Qualifying Account;
documents sufficient to identify any checks, cash, or securities received by or for the benefit of the Qualifying Customer from a source other than his or her account; and
all account opening documents, all margin agreements for any customer's Qualifying Accounts at the respective Firms.
The Firm will respond to such a request by providing such documents or information to the extent located by each Firm as of the date of the Orders, and not previously produced to the Qualifying Customer. If a Firm seeks to satisfy such a request by reference to a prior production to the Qualifying Customer, the Firm must identify each responsive, previously produced document by Bates number. The Firms shall provide such documents or information within fourteen (14) days of receiving the request.
c. If at any time within 180 days of the date of this Order, the Firms learn of other persons whom they have reason to believe are or may be Qualifying Customers, the Firms will provide the notice described in paragraph 4.a. within seven (7) days of the date that they learn of such persons.
Initiation of Process.
Qualifying Customers who receive notice under paragraph 4.a. must file their Submission Agreement and Statement of Claim with the Director of Arbitration (as required by Rule 612 of the NYSE Arbitration Rules) along with a statement clearly setting forth their intention to take part in this process, whether the Qualifying Customer elects to proceed under any of the arbitrator selection options referred to in paragraph 2, and the bases for their status as Qualifying Customers, within 90 days of the date of mailing of such notice. Former customers of Gruttadauria who believe that they are Qualifying Customers but did not receive notice pursuant to paragraph 4.a must submit these materials within 180 days of the date of the Order. Any Qualifying Customer who elects to proceed under the modified timeframes and deadlines set forth in this Appendix A, must clearly state the election at the time of submission of the Claim.
As an alternative to refiling their Claim pursuant to paragraph 5.a Qualifying Customers with Claims pending against either of the Firms at the NYSE Department of Arbitration as of the date of the Order may elect to bring their existing proceeding under the terms and conditions of this special arbitration process by giving written notice to the Firms and the NYSE Director of Arbitration as described in paragraph 5.a. All of the terms and conditions of this Appendix A will apply, except that the provisions of paragraphs 2 and 3 above will apply only as determined to be practicable by the Director of Arbitration or arbitrator(s), as appropriate, given the stage of the existing proceedings.
Existing Arbitration Proceeding. Any Qualifying Customer who, at the time of the Orders, has an arbitration proceeding pending against either or both of the Firms at any forum other than the NYSE Department of Arbitration may elect to continue that proceeding under the principles set forth in this Appendix A. All of the terms and conditions of this Appendix A will apply, except that the provisions of paragraphs 2 and 3 above will apply only as determined to be practicable by the forum's Director of Arbitration or arbitrator(s), as appropriate, given the stage of the existing proceedings. The Firms will give all consents necessary to achieve this result.
Other Proceedings. Qualifying Customers who elect to take part in this process must unconditionally stay any other actions or proceedings seeking legal or equitable redress arising out of the same facts and circumstances described in the Statement of Claim, and dismiss with prejudice any such action or proceeding after a decision or award is rendered by the arbitrator and, if necessary, satisfied by the Firm(s). However, if the arbitrator(s) decide(s) that a person who elected to take part in this process is not a Qualifying Customer, that person's obligation under this paragraph 7 to stay or dismiss other actions or proceedings terminates upon issuance of that decision. Qualifying Customers who elect only to pursue arbitration of a matter referred to in paragraph 13(b) are not required to comply with this paragraph 7.
Fees and Expenses. All filing fees, forum fees, and fees and expenses of mediators and arbitrators, including reasonable travel expenses, shall be paid by the Firms and allocated among them pursuant to their agreement, or, if no agreement is reached, the decision of the arbitrator(s). The arbitrator(s) may otherwise determine the allocation of costs as provided for in the NYSE Arbitration Rules.
Certain Defenses. Solely for the purposes of this special arbitration process, and in consideration of the Qualifying Customers' agreements to submit their disputes for resolution hereunder, the Firms will not assert statutes of limitation or statutes of repose, and no other time bar principles, such as the claims eligibility requirements set forth in NYSE Rule 603, will apply, as to (a) Claims arising out of Gruttadauria's misappropriation of funds or securities (including unauthorized transfers), the receipt of falsified account documents from or at the direction of Gruttadauria, the unauthorized changing of the mailing address for the Qualifying Customer's account, or the Firm's conduct in relation to same, and/or (b) any other Claim permitted to be brought pursuant to this special arbitration process and which did not arise out of Gruttadauria's misappropriation of funds or securities (including unauthorized transfers), or the receipt of falsified account documents from or at the direction of Gruttadauria, or the Firm's conduct in relation to same, but for which the Qualifying Customer was not aware of the basis for such Claim because such customer received falsified account documents from or at the direction of Gruttadauria.
No Contest of Liability. Solely for the purposes of this special arbitration process, and in consideration of the Qualifying Customer's agreement to submit his or her disputes for resolution hereunder:
The Firm shall not contest its liability for (i) Gruttadauria's misappropriation of funds or securities (including unauthorized transfers) from the Qualifying Customer's account, (ii) the Qualifying Customer's receipt of falsified account documents sent by or at the direction of Gruttadauria, (iii) the unauthorized changing of the mailing address for the Qualifying Customer's account (collectively, (i), (ii), and (iii), "Unauthorized Act(s)"), and/or (iv) the Firm's conduct, as described in the Order, in relation to any such Unauthorized Act(s).
Except as set forth above and in Paragraphs 9 and 11, the Firm may contest claims alleging churning, unsuitable trading, or any other misconduct alleged by the Qualifying Customer to have been committed in the Qualifying Customer's account by or at the direction of Gruttadauria ("Additional Claims"). However, as to any Additional Claim(s) based on misconduct that allegedly occurred after the date of the first Unauthorized Act at the Firm in connection with the Qualifying Customer's account, the Firm will be liable to the Qualifying Customer for any such Additional Claim(s) based upon such misconduct of Gruttadauria, provided that the misconduct is established, except to the extent that the Firm can establish the defenses of waiver, estoppel and/or ratification based upon the Qualifying Customer's conduct.
Notwithstanding anything in subparagraphs (a) and (b) above, the Firm may contest the amount claimed by the Qualifying Customer, including contesting, to the extent relevant, the Qualifying Customer's claimed reliance on any misrepresentations or other unlawful conduct of Gruttadauria, the reasonableness of any such reliance, and the Qualifying Customer's factual proof supporting damages. Moreover, nothing contained herein precludes the Firm from contesting on any basis any claim that is brought in any judicial or arbitration forum outside of this process.
Counterclaims. Solely for the purposes of this special arbitration process, and in consideration of the Qualifying Customers' agreements to submit their disputes for resolution hereunder, any claims by the Firms against Qualifying Customers who proceed in this forum may be brought only in this forum and not in any other forum. Further, the only claims that the Firms may assert in this forum against Qualifying Customers are claims based on the Qualifying Customer's knowing participation in Gruttadauria's unlawful conduct.
Punitive Damages. Punitive, exemplary, treble, or other multiple damages will not be awardable.
Accelerated Payment Dispute.
A Qualifying Customer who elects to pursue a Claim under this special arbitration process and who also disputes the application of the Accelerated Payment formula to the facts and circumstances of their account in connection with a payment pursuant to Appendix B of the Orders against SG Cowen ("Appendix B"), may pursue both Claims under this special arbitration process.
In the event that a Qualifying Customer disputes under this process only the application of the Accelerated Payment formula to the facts and circumstances of their account in connection with a payment pursuant to Appendix B the Qualifying Customer may submit a Claim to have that issue alone resolved pursuant to, at the election of the Qualifying Customer, the special arbitration process set forth in this appendix, or the NYSE Rules governing Simplified Arbitration, within 45 days of SG Cowen's written explanation and response pursuant to a customer objection referred to in paragraph II.B.2 of Appendix B, without waiving any right to otherwise proceed against the Firms in any other proceedings. In the event that a Qualifying Customer elects to proceed pursuant to the Simplified Arbitration rules, the dollar amount limitation pertaining to such claims shall not apply, and the applicable fees to be paid by SG Cowen shall be determined by the arbitrator. All other provisions of this Appendix A shall apply.
Respondent shall make accelerated payments, as designated below, to former customers of Cowen & Co. ("Cowen") and SG Cowen Securities Corporation ("SGC" or "Respondent") from whom Gruttadauria misappropriated cash or securities (including unauthorized transfers) during the period from May 1989 through October 13, 2000.4 Respondent may make such accelerated payments prior to the effective date of the Commission's order, and may offset the amount of the payment otherwise payable to any customer pursuant to this Appendix B by the amount of such prior payment to the customer. Such prior payments shall be deemed to be payments pursuant to this Appendix B for the purpose of dispute resolution, as described in paragraph II.B.4 of this Appendix B and paragraph 13 of Appendix A to this Order.
Overview of APA Calculation. Respondent shall calculate the Accelerated Payment Amount ("APA") by taking the value of the account before Gruttadauria's first unauthorized act ("Unauthorized Act") with respect to the account (the "Starting Value"), adding the money and securities the customer contributed to the account after the date on which the Starting Value is calculated (the "Credits"), and subtracting the money and securities the customer withdrew from the account after the same date (the "Debits").
Calculation Detail. Respondent shall base its APA calculation on the following:
Starting Value. The Starting Value is the customer's net equity in an account -- including cash, the market value of securities and any other debits or credits -- as shown on the monthly account statement5 immediately preceding Gruttadauria's first Unauthorized Act.6
Credits. Money and securities contributed by the customer are considered credits whether or not the funds or securities were actually credited to the customer's account.
Debits. Money and securities withdrawn by the customer are considered debits whether or not the funds and securities were in fact drawn on the customer's own account. The net value of the account actually transferred to Lehman Brothers, Inc. ("Lehman") in or about October 2000 is also a debit.
Unauthorized Act. An Unauthorized Act with respect to a particular account occurred whenever Gruttadauria (1) sent the customer a falsified account document, (2) misappropriated cash or securities from the account, (3) made a payment to or for the benefit of the customer using cash or securities misappropriated from another customer or (4) changed the address of the customer's account without the customer's authorization.
Valuation of securities. Respondent shall value each security at market, i.e., its closing price on the day that it was deposited to or withdrawn from the account.7
Aggregation of APA. Respondent may aggregate the APA for all of a customer's eligible accounts.8 Any customer whose aggregate APA is a positive number is an APA Recipient.9
A. Notification
1. Initial Letter to APA Recipients
Respondent shall, within 7 days of the entry of this order, send a letter (the "Initial Letter") to the last known address of, or, if known, to counsel for, each APA Recipient. The Initial Letter to each Recipient must include a statement of that customer's APA and enclose (1) a copy of this Appendix B; (2) a detailed schedule supporting the APA calculation and (3) a form requesting the customer's payment instructions.10 The Initial Letter shall also state that the Recipient may within 30 days of receiving the Initial Letter advise Respondent in writing, with any supporting documentation, of any objections, disagreements, errors, mistakes or omissions in Respondent's calculation of the APA ("Customer Objection"). The Letter shall also state that Respondent will consider any such objection in good faith and will make any change to the calculation of the APA, which Respondent believes is reasonable and appropriate. In addition, the Initial Letter shall advise the Recipient that the APA is being made as repayment, not necessarily in full, of the customer's funds that were misapplied by Gruttadauria, and that acceptance of the APA will not result in or require the release of any claims against Respondent.
2. Notification to Non-Recipients
Respondent shall, within 7 days of the entry of this order, send a letter (the "Notification Letter") to the last known address of, or, if known, to counsel for, each former customer from whom Gruttadauria misappropriated cash or securities (including unauthorized transfers), who is not an APA Recipient. The Notification Letter must include a statement that according to Respondent's calculations, the customer's APA is a negative number, and enclose a copy of this Appendix B. The Notification Letter shall also state that the Recipient may within 30 days of receiving the Notification Letter advise Respondent in writing, with any supporting documentation, that the customer challenges Respondent's conclusion that the customer's APA is a negative number. The Letter shall also state that Respondent will provide a detailed APA calculation within 30 days of receipt of such a challenge. The Notification Letter must also state that Respondent will consider any such challenge in good faith and will make any change to the calculation of the APA which Respondent believes is reasonable and appropriate. The customer may, within 30 days after receipt of the detailed schedule advise Respondent in writing, with any supporting documentation, of any objections, disagreements, errors, mistakes or omissions in Respondent's calculation of the APA ("Non-Recipient Customer Objection"). Such an Objection will be treated as a Customer Objection pursuant to sections B.2 and B.4 below in all respects except that Respondent shall have no payment obligation unless its calculation of the customer's APA, as revised, results in a positive number.
B. Respondent's Further Obligations
1. No Customer Objections
In the event that Respondent receives written notice that the Recipient will not submit a Customer Objection, or receives no Customer Objection within 35 days after the Initial Letter was sent, Respondent will promptly remit the APA to the Recipient, pursuant to the payment instructions provided by the Recipient.
2. Customer Objections
In the event that Respondent receives a Customer Objection within 35 days after the Initial Letter was sent or after the detailed schedule was sent in the case of a Non-Recipient Customer Objection, Respondent shall have 10 business days from the date of receipt of such objection to investigate the facts supporting the objection. After such investigation as Respondent believes to be reasonable and appropriate, Respondent shall determine the APA due to the Recipient and promptly remit payment of the APA, together with a written explanation setting forth Respondent's response to the Customer Objection.
3. Documents and Reporting
Within 10 business days after (a) remitting the final APA, or (b) responding to the final timely Customer Objection, or (c) expiration of the final time period for submission of a timely Customer Objection, whichever is last, Respondent shall provide the staff of the Division of Enforcement of the U.S. Securities and Exchange Commission with a copy of all Initial Letters, Notification Letters, Customer Objections, Non-Recipient Customer Objections, and Respondent's responses to such Objections. Respondent shall also provide a written report stating the number of APA Recipients, the identity of each Recipient and the amount of his or her APA.
4. Dispute Resolution
In the event that an APA Recipient or Notification Letter Recipient, after the objection and response procedures described above, continues to dispute the application of the Accelerated Payment formula to the facts and circumstances of their account pursuant to this Appendix B, the Recipient may submit a claim to have that issue alone resolved pursuant to paragraph 13 of Appendix A to this Order.
1 The findings herein are made pursuant to Respondent's Offer and are not binding on any other person or entity in this or any other proceeding.
2 SGC's procedures required that all outgoing correspondence from brokers be reviewed by the BOM, or his designee, prior to being sent out. The practice in the Cleveland branch was that the branch compliance manager would review all outgoing correspondence, including that of Gruttadauria, before the mail room staff would affix the postage using a machine located in a locked area. With respect to incoming correspondence, SGC's procedures required that the BOM, or his designee, review all incoming correspondence prior to being delivered to the broker. The practice in the Cleveland branch was that the operations manager would open all mail and receive all faxes coming into the branch's fax machine and forward on any complaints or other significant correspondence to the branch compliance manager for his review.
3 To the extent that a broker or sales assistant used a personal computer to generate client correspondence, that correspondence was subject to the review procedures described in footnote 2.
4 Notwithstanding any other provision of this Appendix B, Respondent is not required to make an Accelerated Payment as defined in this Appendix B to any customer who has previously settled their claims against SGC as of the date of this Order.
5 The account statements showed the net equity under different headings at different times: (a) "Equity" from May 1989 through August 27, 1993; (b) "Net Value" from August 28, 1993 through September 25, 1998; and (c) "Total Portfolio Value" from September 23, 1998 through October 13, 2000.
6 If the first Unauthorized Act took place during the first month the account was open, the Starting Value is zero, and contributions or withdrawals during that month are considered to be Credits or Debits. If there is no account statement for the applicable month, Respondent shall calculate net equity to arrive at a reasonable approximation of what would have appeared on the statement.
7 If no such closing price is available, an alternate valuation method may be used, for example: (a) the nearest month-end account statement value; (b) if no value is shown on the account statement, the sales price or (c) if the security was sold short prior to its delivery into an account, its short sale price.
8 An account is an eligible account if an Unauthorized Act occurred with respect to it.
9 If a customer who would otherwise be an APA recipient received cash and securities while the account was at Lehman Brothers Inc. in an amount that exceeded the combined total of the customer's contributions during that period and the APA calculated by Respondent, then that customer shall not be considered an APA recipient for purposes of this Appendix B.
10 Respondent shall also send the Initial Letter, along with a copy of this Appendix B and a detailed schedule supporting the APA calculation, to any customer who would have been an APA recipient except for amounts received while the account was at Lehman Brothers Inc., as described in footnote 6 above. In addition, Respondent shall provide each such customer with an explanation of the adjustment arising from the period the account was at Lehman Brothers Inc.
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