UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7278 / April 9, 1996 SECURITIES EXCHANGE ACT OF 1934 Release No. 37084 / April 9, 1996 INVESTMENT ADVISERS ACT OF 1940 Release No. 1560 / April 9, 1996 ADMINISTRATIVE PROCEEDING File No. 3-8983 ______________________________ : In the Matter of : : ORDER INSTITUTING : PUBLIC ADMINISTRATIVE : PROCEEDINGS, MAKING GRUNTAL & CO., INCORPORATED, : FINDINGS, IMPOSING : REMEDIAL SANCTIONS, AND : ISSUING CEASE AND : DESIST ORDER Respondent. : ______________________________: I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be instituted against Gruntal & Co., Incorporated ("Gruntal") pursuant to Section 8A of the Securities Act of 1933 ("Securities Act"), Sections 15(b)(4) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") and Sections 203(e) and 203(k) of the Investment Advisers Act of 1940 ("Advisers Act"). In anticipation of the institution of these administrative proceedings, Gruntal has submitted an Offer of Settlement, which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceeding brought by or on behalf of the Commission, or to which the Commission is a party, Gruntal, by its Offer of Settlement, prior to a hearing pursuant to the Commission's Rules of Practice and without admitting or denying the findings set forth herein, consents to the entry of this Order Instituting Public Administrative Proceedings, Making Findings, Imposing Remedial Sanctions, and Issuing Cease and Desist Order ("Order"). ==========================================START OF PAGE 2====== II. Accordingly, IT IS HEREBY ORDERED that proceedings pursuant to Section 8A of the Securities Act, Sections 15(b)(4) and 21C of the Exchange Act, and Sections 203(e) and 203(k) of the Advisers Act be, and hereby are, instituted. III. The Commission makes the following findings:-[1]- Respondent A. At all times from January 1, 1993 to the present, Gruntal has been a broker-dealer registered with the Commission pursuant to Section 15(b) of the Exchange Act and has been an investment adviser registered with the Commission pursuant to Section 203(c) of the Advisers Act. Throughout that period, Gruntal has been a member of several national securities exchanges, including the New York Stock Exchange, Inc. ("NYSE"), and of the National Association of Securities Dealers, Inc. As a broker-dealer, Gruntal provides a full range of securities brokerage and trading services, as well as related financial services. As an investment adviser, Gruntal manages client accounts or advises on the selection and monitoring of other investment managers. According to Gruntal's Form ADV filed on September 29, 1994, Gruntal advised 325 clients with assets of $164 million. Summary B. This proceeding involves violations of the antifraud and record-keeping provisions of the federal securities laws in connection with Gruntal's execution of brokerage transactions for investment advisory clients and other customers. Between January 1993 and November 1995, Gruntal, through its three investment advisory divisions, executed at least 8,813 transactions for its advisory clients on a principal basis or by crossing advisory client orders with orders for other Gruntal customers. These transactions were contrary to the disclosure in Gruntal's Form ADV and in many instances violated the notice and consent requirements of the Advisers Act. In addition, confirmations sent to advisory clients and other Gruntal brokerage clients wrongly identified certain principal transactions as agency transactions. Gruntal also charged commissions, commission equivalents or mark-ups/mark-downs (collectively, "transaction ---------FOOTNOTES---------- -[1]- The findings herein and the entry of this Order are solely for the purposes of this proceeding and shall not be binding on any other person or entity named in any other proceeding. ==========================================START OF PAGE 3====== charges") on transactions for certain advisory clients who had chosen to pay only an asset-based fee to Gruntal for brokerage and execution services ("fee-only clients"), contrary to statements in Gruntal's Form ADV and brochures provided to clients. From March 1995 to November 1995, Gruntal also failed to disclose to its advisory clients that it received payment for directing order flow to two affiliated broker-dealers. Finally, Gruntal failed to keep and maintain accurate records concerning the capacity in which it executed transactions. Gruntal's Investment Advisory Divisions C. At all times from January 1993 to the present, Gruntal has provided investment advisory services through three divisions: Managed Accounts, Sterling Advisors and Professional Asset Management ("PAM"). D. Managed Accounts and Sterling provide investment advisory services on both a discretionary and non-discretionary basis. Clients are offered a choice of fee arrangements including (1) an all-inclusive fee based on a percentage of total assets under management or (2) a management fee based on a percentage of total assets under management and a separate payment for custody and execution services. E. PAM provides various services including establishing investment guidelines and objectives, selecting appropriate investment managers and monitoring investment performance. PAM does not have any discretionary authority over its clients' accounts but rather recommends non-affiliated investment advisers. PAM's clients pay their investment advisers separately. PAM's clients may direct that all transactions for their accounts be executed through Gruntal and have two alternatives for compensating Gruntal: (1) an all-inclusive fee based on a percentage of total assets under management; or (2) Gruntal's standard commission schedule. F. At all relevant times, Gruntal's Form ADV has stated that the all-inclusive fee for Sterling includes "advisory services, trade execution and settlement, custodial fees, and accounting services. . . ." Gruntal distributed brochures to Sterling and Managed Accounts clients which state that the all- inclusive fee for Managed Accounts and Sterling covers "both investment advisory services and custody (Gruntal only) and execution services with no separate charged [sic] imposed for brokerage commissions on agency trades or markups or markdowns on principal transactions, except mutual fund purchases and syndicate issues, if any." G. At all relevant times, Gruntal's Form ADV has stated with respect to PAM that "the client may pay a pre-determined, asset based commission that covers all trading related charges ==========================================START OF PAGE 4====== for the account (with the exception of certain minor NYSE charges) no matter what the trading activity." Gruntal distributed brochures to PAM clients which state that PAM's asset-based commission covers "PAM consulting services and all custody (Gruntal only) and execution services with no separate charge imposed for brokerage commissions on agency trades or markups or markdowns on principal transactions, except mutual fund purchases and syndicate issues, if any." H. On September 27, 1994, Gruntal filed the Sterling, Managed Accounts, and PAM brochures with the Commission, as Schedule H to Gruntal's Form ADV. The 1992 Examination and Related Representations by Gruntal I. An examination of Gruntal's investment advisory activities conducted by the Commission's staff in late 1992 revealed various deficiencies. As the staff advised Gruntal in a deficiency letter dated January 29, 1993, among other things: (1) Gruntal had failed to comply with the notice and consent requirements of Section 206(3) of the Advisers Act with respect to principal and agency cross transactions; (2) Gruntal's Form ADV, which stated that Gruntal generally did not effect principal transactions with its advisory clients and would, in substance, comply with the notice and consent requirements of the Advisers Act in the event that Gruntal did effect such transactions, was inaccurate in that Gruntal had in fact executed transactions on a principal basis with its advisory clients without complying with such requirements; (3) Gruntal's Form ADV failed to disclose that Gruntal effected agency cross transactions with its advisory clients; and (4) Gruntal had improperly imposed transaction charges on certain trades for its fee-only clients' accounts. J. In response to the staff's deficiency letter, Gruntal informed the staff in writing that Gruntal was amending its Form ADV and that it was creating a special order ticket to be used when effecting transactions for advisory clients' accounts. The special order ticket was to carry a notice stating: "Agency Transaction - Do not Cross" to prevent principal and agency cross transactions from being effected. K. Gruntal filed an amended Form ADV on March 30, 1993 which stated, in pertinent part: Gruntal & Co. does not permit principal or cross transactions with investment advisory clients. A special order ticket is utilized for advisory clients which states "Agency Transaction - Do not Cross" to ensure compliance with the above. In addition, managers of those areas review all transactions daily to ensure that orders are entered and executed properly. ==========================================START OF PAGE 5====== The Principal and Agency Cross Transactions L. From January 1993 through November 1995 (the "relevant period"), Gruntal executed at least 8,792 purchases and sales of securities for advisory clients on a principal basis and at least 21 transactions on an agency cross basis. Gruntal did not disclose to the clients (including clients of Managed Accounts and Sterling whose accounts were managed by Gruntal) in writing, prior to the completion of each such transaction, the capacity in which Gruntal was acting in the transaction and did not obtain client consent thereto. M. On certain of the principal trades, as well as for certain principal trades involving non-advisory brokerage customers, Gruntal wrongly stated in customer confirmations that it had acted as agent in the transaction when, in fact, Gruntal had acted as principal. N. Contrary to its representations to the staff and in its Form ADV, Gruntal never used the new order tickets when effecting transactions for its advisory clients' accounts and did not adequately review all transactions daily to ensure that orders for advisory clients' accounts were executed properly. O. In certain of the principal transactions, clients were disadvantaged in that Gruntal caused them to pay transaction charges greater than the amount of commission the client (other than a fee-only advisory client) would have been charged had the transaction been executed on an agency basis. P. Certain of the transactions referred to above were executed other than on a national securities exchange. The Transaction Charges on Certain Trades For Fee-Only Clients Q. During the relevant period, Gruntal imposed transaction charges on certain trades for advisory clients who had chosen to pay Gruntal an all-inclusive, asset-based fee. In many of these transactions, Gruntal did not disclose such transaction charges in customer confirmations. Imposing the transaction charges was contrary to the representations in Gruntal's Form ADV and the brochures provided to clients. Payment for Order Flow R. From March 1995 through November 1995, Gruntal effected additional purchases and sales of securities for advisory clients through two registered broker-dealers which are 99.9% owned by a limited liability company in which Gruntal owns an interest exceeding ten percent. Gruntal received payment for directing trades to these broker-dealers. ==========================================START OF PAGE 6====== S. Item 13 of Part II of Form ADV requires an adviser to describe additional compensation it receives from non-clients in connection with giving advice to clients. Gruntal did not disclose Gruntal's financial interest in the affiliated broker- dealers, or Gruntal's receipt of payments for order flow in its Form ADV. Failure to Maintain Accurate Books and Records T. Gruntal's customer confirmations and other records in some instances wrongly stated that brokerage transactions had been executed on an agency basis when they were in fact executed on a principal basis. Gruntal therefore failed to maintain an accurate memorandum of certain customer orders, for both advisory clients and non-advisory customers, showing the terms and conditions of such orders. Specifically, Gruntal failed to maintain an accurate memorandum showing the capacity in which Gruntal acted in certain transactions. IV. Violations A. Section 17(a) of the Securities Act prohibits, in the offer or sale of securities, (1) devices, schemes, or artifices to defraud, (2) misrepresentations or omissions of material facts, or (3) transactions, practices, or courses of business that would operate as a fraud. Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit devices, schemes, and artifices to defraud in connection with the purchase or sale of securities. Sections 206(1) and 206(2) of the Advisers Act prohibit an investment adviser from employing any device, scheme, or artifice to defraud clients or engage in any transaction, practice, or course of business that defrauds clients. Scienter is a required element to prove violations of Section 17(a)(1), Section 10(b) and Rule 10b-5, and Section 206(1). Aaron v. SEC, 446 U.S. 680, 701-02 (1980); Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976); Steadman v. SEC, 603 F.2d 1126, 1134 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981). B. Gruntal violated Section 17(a), Section 10(b) and Rule 10b-5, and Sections 206(1) and 206(2) by (1) falsely representing to advisory clients in its Form ADV that it did not execute principal or agency cross transactions for its advisory clients, (2) falsely representing to fee-only advisory clients that it did not impose transaction charges on trades it executed for them; and (3) failing to disclose to advisory clients that it received payment for directing trades to two affiliated broker-dealers. ==========================================START OF PAGE 7====== C. Section 206(3) of the Advisers Act prohibits an investment adviser from effecting transactions for its advisory clients on a principal or agency cross basis without, in each instance, notifying the clients in writing, prior to the completion of the transaction, of the capacity in which the investment adviser is acting and obtaining the client's consent. D. Gruntal violated Section 206(3) by executing transactions for clients of Managed Accounts and Sterling on a principal or agency cross basis without, prior to the completion of the transaction, disclosing the capacity in which it acted in the transaction and without obtaining the client's consent thereto. E. Section 15(c) of the Exchange Act, and Rules 10b-3(a) and 15c1-2 thereunder prohibit any broker or dealer from employing any manipulative, deceptive, or otherwise fraudulent device or contrivance when effecting any transaction in any security otherwise than on a national securities exchange. Rule 10b-10(a)(2)(prior to April 3, 1995, Rule 10b-10(a)(1)), requires brokers to provide their customers with written notification at or before completion of each transaction specifying the capacity in which the broker is acting when executing the transaction. F. Gruntal violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, Rules 10b-3(a), 10b-5, 10b- 10(a)(2) and 15c1-2 under the Exchange Act, and Sections 206(1) and 206(2) of the Advisers Act by falsely identifying transactions on advisory client and other customer confirmations as agency transactions when such transactions were in fact principal transactions. G. Section 207 of the Advisers Act prohibits the willful making of untrue statements of material fact in applications and reports required to be filed with the Commission pursuant to Section 203 and 204 of the Advisers Act or the omission in such applications and reports of material facts required to be stated therein. H. Gruntal violated Section 207 by (1) willfully making the following false statements in its Form ADV: (a) that Gruntal did not permit principal and agency cross transactions with advisory clients, (b) that Gruntal utilized certain specified procedures to prevent and detect such transactions, and (c) that clients choosing to pay an asset-based fee would not pay separate transaction charges and by (2) willfully omitting to disclose: (a) the arrangement by which Gruntal received payment for directing order flow to certain broker-dealers, and (b) that Gruntal executed certain transactions through other broker- dealers in which it has an ownership interest and for which it clears transactions. ==========================================START OF PAGE 8====== I. Section 17(a) of the Exchange Act and Rule 17a-3 thereunder require registered broker-dealers to make and keep certain books and records. The requirement that certain books and records be made also requires that those records be made accurately. U.S. v. Sloan, 389 F. Supp. 526, 528 (S.D.N.Y. 1975); In the Matter of Michael Alan Pettis, Exchange Act Release No. 33254 (Nov. 29, 1993). The Commission has emphasized the importance of the records maintained by broker-dealers pursuant to the Exchange Act, describing them as the "keystone of the surveillance of brokers and dealers by our staff and by the securities industry's self-regulatory bodies." Edward J. Mawod & Co., 46 SEC 865, 873 n.39 (1977), aff'd, 591 F.2d 588 (10th Cir. 1979). Rule 17a-3(a)(6) requires a broker-dealer to maintain a memorandum of each brokerage order or other instruction given or received for the purchase or sale of securities, showing the terms and conditions of the order or instructions. J. Gruntal violated Section 17(a) and Rule 17a-3 by failing to maintain an accurate memorandum of each brokerage order correctly reflecting the capacity in which the order was executed by Gruntal. K. Section 204 of the Advisers Act and Rule 204-2 require registered investment advisers to make and keep certain books and records. Rule 204-2(a)(3) requires an investment adviser 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. L. Gruntal violated Section 204(a) and Rule 204-2 by failing to maintain an accurate memorandum of each brokerage order correctly reflecting the capacity in which the order was executed by Gruntal. M. While engaged in the conduct described above, Gruntal, directly and indirectly, used the means or instrumentalities of interstate commerce or the mails. V. Based on the foregoing, the Commission finds that Gruntal willfully violated Section 17(a) of the Securities Act, Sections 10(b), 15(c) and 17(a) of the Exchange Act and Rules 10b-3, 10b- 5, 10b-10, 15c1-2 and 17a-3(a)(6) thereunder, and Sections 204, 206(1), (2), and (3) and 207 of the Advisers Act and Rule 204-2 thereunder. VI. In view of the foregoing, it is in the public interest to impose the sanctions specified in the Offer of Settlement. ==========================================START OF PAGE 9====== Accordingly, IT IS HEREBY ORDERED that: A. Gruntal be, and hereby is, censured; B. Gruntal, pursuant to Section 8A of the Securities Act, Section 21C of the Exchange Act, and Section 203(k) of the Advisers Act, cease and desist from committing or causing any violation, and any future violation, of Section 17(a) of the Securities Act, Sections 10(b), 15(c) and 17(a) of the Exchange Act and Rules 10b-3, 10b-5, 10b-10, 15c1-2 and 17a-3(a)(6) thereunder, and Sections 204, 206(1), (2), and (3) and 207 of the Advisers Act and Rule 204-2 thereunder; C. Gruntal shall pay a civil money penalty in the amount of $1 million pursuant to Section 21B of the Exchange Act and Section 203(i) of the Advisers Act. Such payment shall be: (1) made by United States postal money order, certified check, bank cashier's check, or bank money order; (2) made payable to the Securities and Exchange Commission; (3) hand-delivered, within 10 business days of the date of this Order, to the Comptroller, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549; and (4) submitted under cover letter identifying Gruntal as a Respondent in these proceedings, and the Commission's case number (NY-6306), a copy of which shall be sent to Wayne M. Carlin, Assistant Regional Director, Northeast Regional Office, U.S. Securities and Exchange Commission, 7 World Trade Center, 13th floor, New York, N.Y. 10048; D. Gruntal shall comply with the following undertakings: 1. Gruntal shall retain, within 45 days of the date of this Order, at Gruntal's expense, an Independent Consultant, acceptable to the staff of the Northeast Regional Office of the Commission, to: a. conduct a comprehensive review of Gruntal's policies and procedures concerning: (i) execution of orders for advisory client accounts managed by Gruntal and for Gruntal fee- only clients, including but not limited to principal and agency- cross transactions and execution by broker-dealers from whom Gruntal receives payments for order flow; and (ii) the coding, and reporting on client confirmations and internal Gruntal records, of brokerage transactions executed by Gruntal with respect to the capacity in which such transactions are executed; b. review any policies and procedures that Gruntal has adopted and implemented since the activities described in this Order, to determine whether and to what extent there is a need for additional or amended policies and procedures designed reasonably to prevent and detect, insofar as ==========================================START OF PAGE 10====== practicable, the same or similar violations of the federal securities laws; c. recommend policies and procedures (or amendments to existing policies and procedures) designed reasonably to prevent and detect, insofar as practicable, the same or similar violations of the federal securities laws; d. (i) identify all advisory clients and brokerage customers financially harmed by the improper principal and agency cross transactions, improper transaction charges on trades for fee-only clients, and principal transactions improperly identified as agency transactions on client confirmations, and (ii) quantify the amount of financial harm to each such client; e. quantify the amount of payment Gruntal received for order flow on transactions executed for advisory client accounts; f. be entitled, to the extent that he or she deems appropriate, to rely upon work performed or to be performed by Ernst & Young LLP ("E&Y"), Deloitte & Touche LLP ("D&T"), Gruntal's Quality Assurance Task Force, and Gruntal's Operations Department, including but not limited to, Gruntal's Operations Control Group; g. be entitled, to the extent that he or she deems appropriate, to hire such persons as are reasonably necessary to perform his or her duties as set forth in this Order, to require Gruntal to continue the engagement of D&T, and to require Gruntal to maintain resources within its Operations Control Group to support the efforts of the Independent Consultant; h. submit a written report to Gruntal's Board of Directors of his or her findings and recommendations, within six months of the date of this Order. Gruntal shall be provided a reasonable opportunity, but in no event less than 30 days, to comment on the Independent Consultant's review and recommendations; i. simultaneous with the submission of the written report referenced above to the Board of Directors of Gruntal, submit a copy of such report to the staff of the Northeast Regional Office of the Commission; j. conduct, on an annual basis for a period of three years commencing with the date of this Order, an audit of the policies and procedures described in Paragraphs VI.D.1.a. through c. above, and the policies and procedures adopted pursuant to the Independent Consultant's recommendations, to ensure compliance ==========================================START OF PAGE 11====== with those procedures. As a result of such audit, the Independent Consultant may recommend new procedures or revisions to existing procedures, and to the system for applying such procedures, to achieve the objectives outlined in Paragraph VI.D.1.a. through c. above; and k. report to the staff of the Northeast Regional Office of the Commission and Gruntal: (i) any material failure to comply with the procedures and system for applying those procedures, described in Paragraphs VI.D.1.a. through c. above, and the policies and procedures adopted pursuant to the Independent Consultant's recommendations; and (ii) any other material failure by Gruntal to comply with this Order; 2. Gruntal shall adopt and implement, no later than 90 days after receipt of the Independent Consultant's report (or such other time as the Independent Consultant believes is necessary), such policies and procedures as recommended by the Independent Consultant; provided however, that as to any of the Independent Consultant's recommendations that Gruntal determines is unduly burdensome and impractical, Gruntal may propose an alternative procedure reasonably designed to accomplish the same objectives. The Independent Consultant shall reasonably evaluate such alternative procedure and, if appropriate, either approve the alternative procedure, amend the recommendation, or reassert the original recommendation. Gruntal shall abide by the decision of the Independent Consultant and adopt and implement the alternative procedure, amended recommendation, or the original recommendation within the time period set by the Independent Consultant in light of the nature of the procedures; ==========================================START OF PAGE 12====== 3. Gruntal shall pay to each client identified by the Independent Consultant's report as having been financially harmed pursuant to Paragraph VI.D.1.d. above, within 90 days of the submission of the Independent Consultant's report to Gruntal's Board of Directors, an amount equal to the amount by which each such client was harmed plus accrued interest thereon, calculated at the Internal Revenue Service rate of interest on tax underpayments, compounded quarterly, excluding partial months, from the date of the violation to the date of this Order. If it is not possible or is impractical to make such payments to each client harmed, then the monies not returned to customers shall be paid into the United States Treasury. In any event, Gruntal shall not retain the benefit of any monies improperly obtained in connection with the violations referred to herein; 4. Gruntal shall pay into the United States Treasury the amount of payment Gruntal received for order flow on transactions executed for advisory client accounts determined by the Independent Consultant's report plus accrued interest thereon, calculated at the Internal Revenue Service rate of interest on tax underpayments, compounded quarterly, excluding partial months, from the date of the violation to the date of this Order, within 45 days of the submission of the Independent Consultant's report to Gruntal's Board of Directors; 5. Gruntal shall cooperate fully with the Independent Consultant, including using all reasonable efforts to obtain the cooperation of Gruntal's employees or other persons under their control, including E&Y and D&T, and giving the Independent Consultant full access to all documents and premises under Gruntal's control; 6. To ensure the independence of the Independent Consultant, Gruntal: a. shall not have the authority to terminate the Independent Consultant, without the prior written approval of the staff of the Northeast Regional Office of the Commission; b. shall compensate the Independent Consultant, and persons engaged to assist the Independent Consultant for services rendered pursuant to this Order at their reasonable and customary rates; ==========================================START OF PAGE 13====== c. shall not, without the prior written consent of the staff of the Northeast Regional Office of the Commission, enter into any legal, business, or other financial relationship with the Independent Consultant, any firm with which he or she is affiliated or of which he or she is a member, or any person engaged to assist the Independent Consultant in the performance of his or her duties under this Order, other than as described in this Order, during the period of their engagements and for a period of two years following the completion of their duties described in this Order; and d. shall not be in and shall not have an attorney- client relationship with the Independent Consultant and shall not seek to invoke the attorney-client or any other doctrine or privilege to prevent the Independent Consultant from transmitting any information, reports, or documents to the Commission or its staff; 7. Gruntal shall maintain for a period of at least three years after the date of this Order a Committee of its Board of Directors (the "Committee"), consisting of no fewer than three persons, which shall: (a) monitor Gruntal's implementation of any changes in Gruntal's policies and procedures adopted as a result of the Independent Consultant's review process described in Paragraphs VI.D.1.a. through c. above; and (b) monitor Gruntal's efforts to detect, correct, and prevent failures to comply with applicable rules and regulations. The Committee shall provide a quarterly report to the Board of Directors of Gruntal, which shall include a summary of the activities of the Committee in ensuring the fulfillment of its responsibilities under this Order; and 8. Gruntal shall cooperate, and use all reasonable efforts to cause its present or former officers, directors, agents, servants, employees, attorneys-in-fact, assigns, and all persons in active concert and participation with them to cooperate, with investigations, administrative proceedings, and litigation conducted by the Commission, other ==========================================START OF PAGE 14====== government agencies, securities exchanges, or SROs arising from or relating to the conduct described in this Order. By the Commission. Jonathan G. Katz Secretary