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2004
CASE ANALYSIS

 In the Matter of FIDELITY BROKERAGE SERVICES, LLC. 
ORDER INSTITUTING ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS PURSUANT TO SECTIONS 15(b) AND 21C OF THE SECURITIES EXCHANGE ACT OF 1934
Securities Exchange Act of 1934 Release No. 50138, August 3, 2004
http://sec.gov/litigation/admin/34-50138.htm

In the Matter of Fidelity Brokerage Service, LLC.
NEW YORK STOCK EXCHANGE HEARING PANEL DECISION 04-110 July 8, 2004
http://www.nyse.com/pdfs/04-110.pdf

In the Matters of
ROBERT LARRY LOCKWOOD
SFC/HPD 04-107/July 7, 2004 
TYLER WAYNE OBRAY
SFC/HPD 04-109/July 7, 2004
STEPHANIE ARPIN-MEIER
SFC/HPD 04-103/July 7, 2004
ROBERT MICHAEL BIERMAN
 SFC/HPD 04-104/July 7, 2004 
ROBERT JUSTIN McDONALD
SFC/HPD 04-108/July 7, 2004
BRADLEY KEMP FISHER
SFC/HPD 04-105/July 7, 2004
JOHN A. LEONARD
SFC/HPD 04-106/July 7, 2004 

NOTE: New York Stock Exchange Hearing Panel Decisions (HPD) denoting Stipulation of Facts and Consent to Penalty (SFC) are entered into by Respondents without admitting or denying the allegations, but consent is given to the described sanctions and to the entry of findings.

Internal Inspections

Fidelity Brokerage Services, LLC ("Fidelity") is a New York Stock Exchange (NYSE) member firm and presently services more than 3.4 million clients.  Between January 2001 and July 2002, Fidelity had 88 branch offices, called "investor centers," throughout the United States. These offices maintained certain communications relating to customer accounts and the firm's practice was to produce branch office copies to the Securities and Exchange Commission ("SEC") and the New York Stock Exchange ("NYSE") staffs during on-site regulatory examinations.  Each branch office employed registered representatives who were supervised by an on-site branch office manager. Fidelity's branch offices in Arizona, California, Colorado, Oregon, Utah and Washington comprised its "Western Region," which was supervised by a team of managers in the region.  

Employees from Fidelity's internal inspection department conducted annual on-site internal inspections of branch offices. At the conclusion of an inspection, branch managers were provided with an Annual Compliance Examination Report. Items reflected as "concerns" required managers to provide written responses describing the actions taken (or to be taken) to address those issues. Items reflected in the report as "observations" required no response. 

Fidelity's regional managers, who were involved in the inspection preparation process, instructed branch managers to prepare for the inspections. The regional managers provided training for branch office managers using the previous year's inspection module. The training focused on preparing for internal inspections. Certain branch managers intended to use this training "to beat" the inspection rather than to comply with the Firm's record-keeping requirements. Regional managers instructed employees at branch offices that had already been inspected to share information about the inspections with employees at branch offices that had not yet been inspected. Regional managers also pressured branch office managers to have "no concerns" inspections and implied that they could be fired if there were more than a few inspection exceptions.

Unfortunately, Fidelity's Western Region managers pressured branch office employees to obtain "no concerns" reports at the conclusion of the inspections. To achieve such results, Western Region managers told its branch office employees when the inspections would occur, provided information and materials to branch office managers, and encouraged branch office managers to review applicable branch office documents in preparation for the inspection. Moreover, at least 62 employees  in at least 21 branch offices, primarily in the western region, discovered that some of the records maintained in the branch office omitted information or were not completed in accordance with Firm policies and procedures. These employees altered or destroyed new account applications, letters of authorization, and variable annuity forms maintained at Fidelity branch offices. Such conduct caused the Firm to maintain inaccurate or incomplete books and records.  

Heads Up  

The purpose of internal inspections should be to uncover compliance deficiencies and to subsequently confirm that the problems have been corrected and measures implemented to prevent any recurrences.  When firms send a heads-up to their branches as to the scope and dates of the surprise audits, the  examination becomes one of learning how to pass the test rather than learning the lessons.

When discovering that firms are sending warning flares about internal inspections, the regulators will frequently assume that brokerage staffs have engaged in some creative remedies just before and during the in-house inspections.  Expect to have the relevant client documentation scrutinized for back-dating, forgeries, etc.  

Yes, it's true that regulators will often give you some advance notice of an examination of your firm --- but you're still better off running a surprise in-house regimen.  At the very least, if you're a BD compliance professional you want to know what nonsense is going on in the branches.  Frankly, isn't that the whole point of internal inspections: to uncover misconduct before the regulators do?  Look at it this way, you want to know that the sprinklers aren't working before the fire starts.

Fidelity was unable to detect the conduct described above due to several factors related to inadequate supervisory procedures. These included 

(i) inadequate branch office procedures that, among other things, failed to address employees' handling of firm documents, such as new account applications, letters of authorization, and variable annuity forms; 

(ii) an inadequate system for implementing inspections; and 

(iii) a lack of adequate education provided to branch employees concerning the policies and procedures relating to the proper handling of branch office documents. 

Moreover, Western Region managers communicated with branch office managers in such a way that led some employees to believe that they should alter or destroy branch documents to achieve good inspection results. Thus, Fidelity had inadequate policies, procedures, and systems that would reasonably be expected to prevent and detect the improper alteration and destruction of documents, and therefore, failed reasonably to supervise its employees.  

Underlying Rules

Section 17(a)(1) of the Exchange Act Each member of a national securities exchange, broker, or dealer "shall make and keep for prescribed periods such records, furnish such copies thereof, and make and disseminate such reports as the Commission, by rule, prescribes as necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of this title." In the Matter of Deutsche Bank Securities, Inc., Goldman, Sachs & Co., Morgan Stanley & Co., Inc., Salomon Smith Barney, Inc., and U.S. Bancorp Piper Jaffray Inc., Exchange Act Release No. 46937, 2002 SEC Lexis 3083 (December 3, 2002).
Rule 17a-4(b)(4) of the Exchange Act Brokers and dealers shall preserve for a period of not less than three years, the first two years in an accessible place: "[o]riginals of all communications received and copies of all communications sent . . . by the member, broker or dealer (including inter-office memoranda and communications) relating to its business as such . . . ."  
Section 15(b)(4)(E) of the Exchange Act Authorizes the Commission to impose sanctions against a broker-dealer if the firm has "failed reasonably to supervise, with a view to preventing violations [of the federal securities laws], another person who commits such a violation, if such other person is subject to his supervision."  In the Matter of Smith Barney, Harris Upham & Co., Inc., Exchange Act Release No. 21813, 1985 SEC Lexis 2051 (March 5, 1985).

In the Matter of Goldman, Sachs & Co., Exchange Act Release No. 33576, 1994 SEC Lexis 302 (February 3, 1994); 

In the Matter of Kirkpatrick, Pettis, Smith, Polian Inc., Peter N. Lahti And Gregory D. Adams, Admin. Proc. File No. 3-11328, Release No. 34-48748, 2003 SEC LEXIS 2661 (November 5, 2003) ("The Commission has long emphasized that the responsibility of broker-dealers to supervise their employees is a critical component of the federal regulatory scheme."), citing In the Matter of John H. Gutfreund, et al., 51 S.E.C. 93, 108 (1992).

Section 15(b)(4)(E) of the Exchange Act No person shall be deemed to have failed reasonably to supervise any other person, if (i) there have been established procedures, and a system for applying such procedures, which would reasonably be expected to prevent and detect, insofar as practicable, any such violation by such other person, and (ii) such person has reasonably discharged the duties and obligations incumbent upon him by reason of such procedures and system without reasonable cause to believe that such procedures and system were not being complied with."  In the Matter of Goldman, Sachs & Co., Exchange Act Release No. 33576, 1994 SEC Lexis 302 (February 3, 1994); 

In the Matter of Prudential Securities, Inc., Exchange Act Release No. 43896, 2001 SEC Lexis 155 (January 29, 2001).

NYSE Rule 440 Requires that: “every member organization shall make and preserve books and records as the [NYSE] may prescribe and as prescribed by [SEC] Rule17a-3. The record keeping format, medium and retention period shall comply with Rule 17a-4 under the Securities Exchange Act of 1934.”  
NYSE Rule 342 NYSE Rule 342 requires member firms to provide for appropriate supervisory control
over its business activities to comply with federal securities laws and NYSE rules,
including a separate system of follow-up and review to determine that supervisory
authority and responsibility is properly exercised.
 

Remedial Measures

Fidelity first learned about the matters described above in July 2002 when a registered representative reported concerns relating to the branch inspection at one branch office to the Firm's ethics office. Fidelity immediately conducted an internal investigation and disciplined those employees who were involved, including the termination of 13 branch employees, including three branch managers. The firm also replaced four members of the Western Regional management team and the region's compliance officer. In addition, Fidelity  contemporaneously shared its investigative findings and disciplinary actions with the SEC and the NYSE.   After its investigation, Fidelity developed and implemented enhancements to the Firm's branch inspection program and made improvements to various policies, procedures and controls.

SEC Settlement


Fidelity submitted an Offer of Settlement to the Securities and Exchange Commission ("SEC") that neither admitted or denied the findings made by the SEC, but nonetheless consented to the entry of the SEC's Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions Pursuant to Sections 15(b) and 21C of the Securities Exchange Act of 1934.  Fidelity also submitted a Stipulation of Facts and Consent to Penalty (SFC) to the New York Stock Exchange (NYSE), without admitting or denying guilt.

The SEC determined that certain Fidelity employees altered some of the records maintained in the branch offices such that they did not represent accurate records of the original communications; and, accordingly, as the altered records were maintained for regulatory purposes (i.e., to comply with Rule 17a-4), Fidelity willfully violated Section 17(a) of the Exchange Act and Rule 17a 4(b)(4) thereunder, and its employees aided and abetted these violations.  "Willfully" as used in this Offer means intentionally committing the act which constitutes the violation. There is no requirement that the actor also be aware that he is violating one of the Rules or Acts See, Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000); Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965). 

SEC Sanctions

In determining to accept the Offer, the SEC considered remedial acts promptly undertaken by Respondent and cooperation afforded the Commission staff.  As such Fidelity was 

  1. censured;  
  2. agreed to cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Exchange Act and Rule 17a 4 thereunder; and 
  3. fined $1,000,000; and the SEC acknowledged that pursuant to Fidelity's agreement with the New York Stock Exchange in related proceedings, Fidelity will pay an additional fine in the amount of $1,000,000 to the New York Stock Exchange.

PRACTICE POINTER 

 I believe the SEC and the NYSE are using this case to send a clearer message as to what will constitute effective internal remedial measures for purposes of sanction mitigation.  Consequently, this case suggests the following steps:

1. Immediately conduct an internal investigation;

2. Promptly discipline those determined to have engaged in violative conduct;

3. Terminate those engaged in serious misconduct;

4. Terminate supervisors who furthered serious misconduct or who failed to reasonably prevent same;

5. Remove supervisors and compliance officers who knew or should have known of serious misconduct and failed to reasonably prevent same;

6. "Contemporaneously" contact regulators and inform them of the investigative findings and your disciplinary actions; and

7. Implement remedial measures designed to prevent a recurrence of the violations at issue.

NYSE Actions

Against Fidelity:

The NYSE accepted a Stipulation of Facts and Consent to Penalty from Fidelity and found the member violated 

  1. NYSE Rule 342 in that, in connection with its annual branch inspection process and the creation and maintenance of its books and records, the Firm failed to provide for appropriate supervisory control to comply with the federal securities laws and NYSE rules, including a separate system of follow-up and review; and
  2. NYSE Rule 440 and Section 17(a) of the Securities Exchange Act of 1934,and SEC Rule 17a-4 thereunder, by failing to preserve certain books and records and failing to preserve other books and records accurately.

The NYSE imposed  a censure and a penalty in the amount of $2,000,000. The amount to be paid to the NYSE as a fine to equal $1 million and $1 million to be paid to the U.S. Treasury as a civil monetary penalty.

Against Fidelity Employees:

The NYSE also found that seven Fidelity employees altered firm records by adding false information after the fact; and caused a violation of NYSE Rule 440 and Section 17(a) of the '34 Act, and Rule 17a-4 thereunder by causing the firm to preserve inaccurate books and records

LETTERS OF AUTHORIZATION/LETTERS OF INSTRUCTION 
These documents reflect certain customer instructions relating to transactions, including the transfer of assets.  The firm's policies and procedures required "signature guarantees" on certain of these letters.  Under the firm's internal policies, the employee who provided the signature guarantee was required to reflect  on the letter of authorization the customer’s driver’s license number and credit card information that had been used to identify the customer.

WHAT THEY DID

In preparation for the internal inspection, the Respondent and the other registered representatives in the Tigard Office were instructed by their BOM to ensure that any letters of authorization that they had “signature guaranteed” would appear to the inspectors to be complete. Respondent’s BOM discovered  letters of authorization for which Respondent had provided the “signature guarantee” that lacked the required customer identifying information.  Respondent added fictitious driver’s license and credit card data to  the letter of authorization so that they would appear to the internal inspectors to comply with the Firm’s policies and procedures.

Respondent 
 Number of LOAs Sanction
ROBERT LARRY LOCKWOOD
SFC/HPD 04-107/July 7, 2004 
Censure; 1 month suspension
TYLER WAYNE OBRAY
SFC/HPD 04-109/July 7, 2004 

2

Censure; 2 month bar
STEPHANIE ARPIN-MEIER
SFC/HPD 04-103/July 7, 2004 

3 Censure; 2 month bar
ROBERT MICHAEL BIERMAN SFC/HPD 04-104/July 7, 2004 
Censure; 2 month Bar
ROBERT JUSTIN McDONALD
SFC/HPD 04-108/July 7, 2004 
Censure; 3 month bar
BRADLEY KEMP FISHER
SFC/HPD 04-105/July 7, 2004 
10 Censure and 3 month bar

And finally, this last individual with a slightly different fact pattern, who was found to have concealed documents from his member firm employer during an internal inspection:
JOHN A. LEONARD
SFC/HPD 04-106/July 7, 2004
Leonard’s BOM discovered approximately 15 letters of authorization that were signature guaranteed by two persons who were not authorized by the Firm to do so. Leonard was aware that previous branch managers had concealed problematic branch documents from internal inspectors so as to achieve an acceptable inspection result. Shortly before the annual branch inspection, the BOM and Leonard agreed to conceal the problematic documents from the inspectors by having Leonard remove them temporarily from the branch office. Prior to the branch inspection, Leonard removed the problematic documents and took them home where they remained until the inspection was completed.

Censure, 2 month bar;and an undertaking that he cooperate with the Division of Enforcement and testify truthfully in connection with any disciplinary proceedings relating to matters set forth in the Stipulation and Consent.

 



RRBDLAW.COM AND SECURITIES INDUSTRY COMMENTATOR™ © 2004 BILL SINGER

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