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UNITED STATES OF AMERICA
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| In the Matter of MICHAEL T. SULLIVAN, III Respondent.
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ORDER INSTITUTING PROCEEDINGS, |
I.
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 203(f) and 203(k) of the Investment Advisers Act of 1940 (the "Advisers Act") and Sections 9(b) and 9(f) of the Investment Company Act of 1940 (the "Investment Company Act") against Michael T. Sullivan, III ("Sullivan").
II.
In anticipation of the institution of these administrative proceedings, Sullivan has submitted an Offer of Settlement ("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 in which the Commission is a party, and without admitting or denying any of the findings contained herein, except those findings pertaining to the jurisdiction of the Commission over him and over the subject matter of these proceedings, which he admits, Sullivan consents to the entry of this Order Instituting Proceedings, Making Findings, Imposing Remedial Sanctions and Cease-and-Desist Order ("Order").
III.
On the basis of this Order and the Offer submitted by Sullivan, the Commission finds that:1 A. Relevant Person and Entities
1. Sullivan, 37, was employed by Scudder Kemper Investments, Inc., most recently as a derivatives trader in the Boston office, from July 30, 1984, until his resignation on October 13, 1998.
2. Scudder Kemper Investments, Inc. (the "registrant"), is registered with the Commission as an investment adviser pursuant to Section 203(c) of the Advisers Act (File No. 801-252). The registrant is headquartered in New York, N.Y., and operates principally from offices in Boston, New York, N.Y., and Chicago. The registrant manages more than $280 billion in assets for mutual fund investors, retirement and pension plans, institutional and corporate clients, insurance companies, and private family and individual accounts.2 B. Facts 1. Summary
This matter arises from unauthorized trading by Sullivan while employed as a derivatives trader at the registrant. Although he had been given limited discretion to execute a derivatives trading strategy in twenty institutional accounts, Sullivan executed over one hundred unauthorized transactions in twelve of those accounts from July 1997 through October 9, 1998 by repeatedly exceeding loss limits and other limits on that discretion. Sullivan avoided detection by miscoding order tickets, forging the signatures of the portfolio managers on order tickets and, in many instances, not submitting any order ticket at all. By the time his activities were discovered, Sullivan's unauthorized trading had resulted in losses of more than $16 million. Sullivan's unauthorized trading was not consistent with portfolio manager presentations to several participating investment companies regarding risk levels associated with the registrant's derivatives trading, because it caused the investment companies to be exposed to a higher level of risk than that regarded by the portfolio managers as appropriate, as reflected by the trading limits they established. Sullivan thereby caused the portfolio managers' presentations to such investment companies to be false and misleading as to a material fact. Moreover, Sullivan's miscoding, forgery and failure to submit order tickets rendered inaccurate and incomplete the books and records of the registrant and several registered investment companies. By virtue of his conduct, Sullivan willfully violated Section 34(b) of the Investment Company Act, and willfully aided and abetted and caused violations of Sections 204, 206(1) and 206(2) of the Advisers Act and Rule 204-2(a)(3) thereunder, and Section 31(a) of the Investment Company Act and Rule 31a-1(b)(6) thereunder. 2. The Trading Program
In September 1996, the registrant's derivatives trading desk implemented a derivatives trading strategy referred to at the registrant as the "fixed income derivatives overlay" program (the "overlay program"). The overlay program was a hedging strategy, designed to improve the risk-return profiles of fixed-income portfolios by taking advantage of short-term movements in the U.S. Treasury futures market. As designed, the overlay program was consistent with portfolio manager presentations to several registered investment companies indicating that derivatives were not used to expand the total risk characteristics of the investment companies beyond those regarded as appropriate to their specific investment policies and objectives. As it developed, the overlay program came to involve, almost exclusively, short sales of 30-year Treasury Bond futures traded on the Chicago Board of Trade, mostly in intraday transactions (i.e., transactions in which the positions were closed out at the end of the day on which they were opened).
Unlike other derivatives trading at the registrant, portfolio managers who chose to participate in the registrant's overlay program did not initiate trades themselves, but gave limited discretion to the derivatives trading desk to initiate the trades. Sullivan was primarily responsible for exercising that limited discretion on behalf of the derivatives trading desk. The types of limitations on the trading desk's discretion included basis point loss limits, duration limits and limits on the losses that could be incurred on any individual transaction. For example, the portfolio managers for all of the accounts participating in the overlay program imposed a monthly basis point loss limit on overlay trades, which varied from 3 to 15 basis points. In any month when Sullivan lost an amount equal to the basis point limit, measured against the total net asset value of the account as of the prior month's end, Sullivan was to cease overlay trading for the month unless expressly authorized by the portfolio manager to continue. 3. Sullivan's Unauthorized Trading
On numerous occasions during the period from July 1997 through October 9, 1998, Sullivan exceeded overlay program limits for twelve of the twenty participating institutional accounts, including eight registered investment companies. Sullivan avoided detection by making it appear that many of the overlay transactions were not overlay transactions, but rather regular derivatives trades that were not subject to the overlay program limits. He accomplished this by forging portfolio managers' signatures on order tickets, miscoding hundreds of overlay trades on order tickets as non-overlay trades and, more than fifty percent of the time, failing to submit order tickets.3 For example, during a one year period, Sullivan executed over 1,100 derivatives trades in the account of one participating registered investment company. The order tickets for over ninety percent of those trades were forged, miscoded or not submitted.
Sullivan's disregard for the loss limits, duration limits and other limits imposed on his trading caused the Short Term Bond Fund and other participating investment companies to be exposed to a higher level of risk than that regarded by the portfolio managers as appropriate, as reflected by the trading limits they established. By the time the registrant discovered Sullivan's misconduct in October 1998, Sullivan's unauthorized trading in that account and eleven others had caused more than $16 million in losses. C. Violations 1. The Antifraud Provisions of the Investment Company Act and the Advisers Act
a. Sullivan Willfully Violated Section 34(b) of the Investment Company Act.
Section 34(b) of the Investment Company Act makes it "unlawful for any person to make any untrue statement of a material fact" in any document filed or transmitted pursuant to [the Investment Company Act] or the keeping of which is required pursuant to section 31(a)." Rule 31a-1(b)(6), promulgated pursuant to Section 31(a) of the Investment Company Act, requires the keeping of a record of all portfolio purchases and sales, other than purchases and sales of securities, indicating, among other things, the "name of the person who placed the order in behalf of the investment company." By forging the signatures of the portfolio managers on the order tickets, Sullivan made those records materially misleading and thus willfully violated Section 34(b).
b. Sullivan Willfully Aided and Abetted and Caused Violations of Sections 206(1) and 206(2) of the Advisers Act.
Sections 206(1) and 206(2) of the Advisers Act make it unlawful for any investment adviser to employ any device, scheme or artifice to defraud, or to engage in any act, transaction, practice, or course of business which operates as a fraud or deceit on any client or prospective client. To establish a cause of action under Section 206(1), scienter must be proved. See SEC v. Steadman, 967 F.2d 636, 641-43 & n.5 (D.C. Cir. 1992) (citing SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 195 (1963)). Scienter is not a necessary element of a violation of Section 206(2). Steadman, 967 F.2d at 43 & n.5. The Supreme Court has defined the term "scienter" to refer to a "mental state embracing intent to deceive, manipulate or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976).
Aiding and abetting liability may be established by demonstrating: (1) a primary or independent securities law violation that has been committed by some other party; (2) awareness or knowledge by the aider and abettor that his or her role was part of an overall activity that was improper; and (3) knowing and substantial assistance by the aider and abettor of the conduct that constitutes the violation. See Investors Research v. SEC, 628 F.2d 168, 178 (D.C. Cir. 1980); Woods v. Barnett Bank of Fort Lauderdale, 765 F.2d 1004, 1009 (11th Cir. 1985). A finding that a person aided and abetted a violation will also establish that the person caused the violation. Dominick & Dominick, Inc., Exchange Act Rel. No. 29243 n.11 (May 29, 1991), 1991 SEC LEXIS 1016.
Sullivan's unauthorized trading was not consistent with portfolio manager presentations to several participating investment companies regarding risk levels associated with the registrant's derivatives trading, because it caused the investment companies to be exposed to a higher level of risk than that regarded by the portfolio managers as appropriate, as reflected by the trading limits they established. Sullivan thereby caused the portfolio managers' presentations to such investment companies to be false and misleading as to a material fact, in violation of Sections 206(1) and 206(2) of the Advisers Act. Sullivan provided substantial and knowing assistance to the violations by carrying out all of the activities giving rise to the fraud. Sullivan's awareness that his actions were wrongful is most clearly established by his attempts to conceal them. Accordingly, Sullivan willfully aided and abetted and caused violations of Sections 206(1) and 206(2) of the Advisers Act. 2. Books and Records Provisions
a. Investment Company Act
Rule 31a-1(b)(6), promulgated under Section 31(a) of the Investment Company Act, requires registered investment companies to maintain and keep current a record of all portfolio purchases or sales, other than purchases and sales of securities, showing details comparable to those prescribed by Rule 31a-1(b)(5). In turn, Rule 31a-1(b)(5) requires registered investment companies to maintain and keep current:
A record of each brokerage order given by or in behalf of the investment company for, or in connection with, the purchase or sale of securities, whether executed or unexecuted. Such record shall include the name of the broker, the terms and conditions of the order and of any modification or cancellation thereof, the time of entry or cancellation, the price at which executed, and the time of receipt of report of execution. The record shall indicate the name of the person who placed the order [on] behalf of the investment company.
As described above, Sullivan failed to submit hundreds of order tickets for the registered investment companies affected by his unauthorized trading, and forged and miscoded tickets, causing violations of Section 31(a) and Rule 31a-1(b)(6) thereunder. Sullivan thereby willfully aided and abetted and caused violations of the books and records provisions of Section 31(a) and Rule 31a-1(b)(6) thereunder.
b. Investment Advisers Act
Section 204 of the Advisers Act and Rule 204-2 thereunder require registered investment advisers to make and keep true, accurate and current certain specified books and records relating to its investment adviser business. Rule 204-2(a)(3) requires registered investment advisers to maintain, among other things, a memorandum of each order given by the adviser for the purchase or sale of a security, showing the terms and conditions of the order.
Sullivan's failure to submit many order tickets and his forgery and miscoding of many others caused the registrant to fail to maintain an accurate memorandum of each brokerage order, as required by Rule 204-2(a)(3). Accordingly, Sullivan willfully aided and abetted and caused the registrant to violate Section 204 and Rule 204-2(a)(3) thereunder. D. Sullivan's Financial Inability to Pay a Civil Penalty
Sullivan has submitted a sworn financial statement and other evidence and has asserted his financial inability to pay a civil penalty. The Commission has reviewed the sworn financial statement and other evidence provided by Sullivan and has determined that Sullivan does not have the financial ability to pay a civil penalty.
IV.
In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer and to impose the sanctions set forth therein.
V.
Accordingly, IT IS HEREBY ORDERED, pursuant to Sections 203(f) and 203(k) of the Advisers Act and Sections 9(b) and 9(f) of the Investment Company Act, that:
A. Sullivan shall cease and desist from committing or causing any violation or any future violation of Section 34(b) of the Investment Company Act, and from causing any violation or future violation of Sections 204, 206(1) and 206(2) of the Advisers Act and Rule 204-2(a)(3) thereunder, and Section 31(a) of the Investment Company Act and Rule 31a-1(b)(6) thereunder;
B. Sullivan be, and hereby is, barred from association with any investment adviser or registered investment company, with the right to reapply for association after five years to the appropriate self-regulatory organization, or if there is none, to the Commission; and
C. the Division of Enforcement may, at any time following the entry of this Order, petition the Commission to: (1) reopen this matter to consider whether Sullivan provided accurate and complete financial information at the time such representations were made; (2) determine the amount of the civil penalty to be imposed; and (3) seek any additional remedies that the Commission would be authorized to impose in this proceeding if Sullivan's offer of settlement had not been accepted. No other issues shall be considered in connection with this petition other than whether the financial information provided by Sullivan was fraudulent, misleading, inaccurate or incomplete in any material respect, the amount of civil penalty to be imposed and whether any additional remedies should be imposed. Sullivan may not, by way of defense to any such petition, contest the findings in this Order or the Commission's authority to impose any additional remedies that were available in the original proceeding.
By the Commission.
Jonathan G. Katz
Secretary
| 1 | The findings herein are made pursuant to the Offer of Settlement of Sullivan and are not binding on any other person or entity in this or any other proceeding. |
| 2 | Prior to a December 31, 1997, combination with Zurich Kemper Investments, Inc., the registrant was known as Scudder, Stevens & Clark. |
| 3 | The registrant and its registered investment company clients were required accurately to maintain the order tickets pursuant to the books and records provisions of the Advisers Act and the Investment Company Act. |
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