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“These violations, though diverse in nature, all point to a weakness of internal controls,” said Susan L. Merrill, chief of enforcement, NYSE Regulation. “Executives must understand that the cost of doing business always includes sufficient resources and personnel to fulfill operational and compliance requirements and also to remedy problems when they are uncovered.”
This disciplinary action concerned violations of NYSE Rule 80A, Rules 17a-3 and 17a-4 under the Securities Exchange Act of 1934 (the “Exchange Act”) and NYSE Rule 440, NYSE Rule 440B and Exchange Act Rule 10a-1, and NYSE Rules 342, 405 and 472.
Index Arbitrage Trading Violations
Bear Stearns was engaged in index arbitrage trading involving single transaction and basket trades of both NYSE and Nasdaq index products and employed hedging strategies involving these products. Using the NYSE’s SuperDot system to deliver these equities and derivatives trades to the NYSE Floor, on three separate dates—July 6, 2001, October 2, 2002 and May 30, 2003—the firm violated certain NYSE rules and Exchange Act rules in connection with its derivatives trading.
In response to the market breaks in October 1987 and October 1989, the NYSE instituted several circuit breakers to reduce market volatility and promote investor confidence. NYSE Rule 80A places tick restrictions (buy minus, sell plus) on certain index arbitrage trading when the NYSE Composite Index declines or advances 2% or more from its prior day's closing value.
On July 6, 2001, Bear Stearns transmitted nine agency index arbitrage sell programs on the firm’s automated system to the Floor of the NYSE over SuperDot without the required “sell plus” notation, when the tick restrictions set forth in Rule 80A were in place. Further, the firm’s books and records were insufficient, as they did not capture, with specificity, its index arbitrage trading and failed to timely report the trades. The Firm first provided data on these trades months later. On May 30, 2003, the firm again violated NYSE Rule 80A on two occasions when the firm permitted agency index arbitrage basket orders to be transmitted to and executed on the Floor of the NYSE without the “plus tick” notation required for arbitrage index trades when a collar was in place. The firm also engaged in index arbitrage trading without having a system to calculate, determine and inform its traders that a collar was in place and failed to have in place a system that would inhibit trades from being transmitted to the Floor of the NYSE when a Rule 80A restriction was in place without the appropriate tick indicators.
On October 2, 2002, the quantity of an index arbitrage order was misstated and a $4 billion rather than a $4 million dollar trade was transmitted for execution. Portions of the order violated NYSE Rule 440B (the “short sale” rule). The Firm’s Basket Trading System lacked a trade confirmation or “pop-up” feature for the trader to confirm the trade and lacked a feature (inhibitor) to prohibit the transmission of trades that exceeded the trading desk’s daily $2 billion limit.
Failure to Supervise Accounts with Suspicious Activity
During the period January 1998 through December 2002 the firm violated NYSE rules concerning the supervision of ten accounts controlled by a foreign customer (the “Customer.”) The firm also failed to use due diligence to learn essential facts relative to this Customer and his orders.
As early as 1995, the Customer was the subject of foreign news reports alleging fraud and financial improprieties at the bank where he was chairman. From January 1998 through December 2002, there were in excess of 20 wires into the Customer’s accounts totaling in excess of $20 million. On more than 95 occasions, funds totaling in excess of $18 million were wired from the accounts. On approximately 145 occasions a total in excess of $15 million was journaled between various accounts at the Firm. Many of the wires and/or journals noted above were processed without any underlying security transactions being effected in the accounts receiving the funds.
The frequency and size of the wires and journals involving the Customer’s accounts at the firm should have subjected them to further scrutiny and review by the firm and its supervisory personnel, at or around the time they occurred, particularly since several of these wires and/or journals coincided with suspicious investment activity.
During the relevant period, the firm had in place written policies and procedures that were designed to detect and prevent suspicious transactions of the type that occurred in the accounts. Despite having such policies and procedures in place, the firm permitted the suspicious activity discussed above to continue without making any reasonable inquiry into the transactions. Further, the firm failed to discuss with the registered representative the manner in which the accounts were being handled and it failed to learn the essential facts relative to orders the firm executed for the accounts.
On January 5, 2006, the Division of Enforcement issued charges against registered representative William Donald Redfern in connection with his handling of the Customer’s accounts, including failing to communicate to the firm information regarding allegations of fraud and financial improprieties involving the customer, and to use due diligence to learn essential facts relative to the Customer and the Customer’s accounts, in violation of NYSE Rules, including “Know Your Customer.”
Improper Communications by a Research Analyst
During the period April 26, 2003 through May 8, 2003, a video of a Bear Stearns research analyst appeared on an Internet road show for a public offering for which the firm was co-lead underwriter.
As one of the first road show events, Bear Stearns arranged for the company’s management to make a presentation to the firm’s sales staff at Bear Stearns’ headquarters in New York City on April 25, 2003. This presentation consisted of an introduction of the issuer and its management personnel by the analyst, a presentation by management and a question and answer period during which both the analyst and management responded to questions.
The analyst’s introductory remarks consisted entirely of his extremely favorable opinion of the issuer’s business, its management and his opinion that there would be an extraordinary return from an investment in the company. During the question and answer period, in response to a question posed to management, the analyst projected that the company would experience 20% internal growth in the coming year. Neither the analyst’s introduction nor any of his comments during the question and answer period included any discussions of risks associated with an investment in the company.
From April 28, 2003 through May 8, 2003, a videotape of this presentation, including the research analyst’s introductory remarks and the question and answer period, was made available to Bear Stearns’ customers and to potential investors via a password-protected website as the Internet road show for the IPO.
The firm did not have any policy or procedure to undertake a supervisory review of materials posted to the firm’s website as Internet road shows either before or after the Internet road shows were made available to its customers and potential investors. Neither the analyst’s introductory comments nor any of his other statements on this Internet road show presented fair and balanced information regarding the potential risks and rewards of an investment in the offering.
In settling these charges brought by NYSE Regulation, Bear, Stearns & Co. Inc. neither admitted nor denied the charges.
About NYSE Regulation
On December 17, 2003, the SEC approved a new governance structure for the NYSE. Under the new design, the NYSE Board of Directors is comprised solely of independent directors, except for the chief executive officer, who have no affiliation with any regulated member firm. A new position of chief regulatory officer was created and reports directly to the board of directors through a new Regulatory Oversight Committee. As a result, NYSE Regulation is insulated from potential influence from NYSE members and member firms, operates separately from the business side and is independent in its decision-making.
NYSE Regulation plays a critical role in monitoring and regulating the activities of its members, member firms and listed companies, as well as enforcing compliance with NYSE rules and federal securities laws. Nearly 400 of the largest securities firms in America are members of the New York Stock Exchange. These firms service 98 million customer accounts, or 84 percent of the total public customer accounts handled by broker-dealers, with total assets of over $4 trillion. They operate from 20,000 branch offices around the world and employ 144,000 registered personnel.
Nearly 700 employees, or more than 40 percent of the Exchange’s staff, work for NYSE Regulation, which consists of four divisions: Market Surveillance, Member Firm Regulation, Enforcement and Listed Company Compliance, as well as a Risk Assessment Unit and Dispute Resolution/Arbitration.
