==========================================START OF PAGE 1====== UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7279 / April 9, 1996 SECURITIES EXCHANGE ACT OF 1934 Release No. 37085 / April 9, 1996 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 771 / April 9, 1996 ADMINISTRATIVE PROCEEDING File No. 3-8984 ______________________________ : In the Matter of : : ORDER INSTITUTING GRUNTAL & CO., INCORPORATED : PUBLIC ADMINISTRATIVE : PROCEEDINGS, MAKING and : FINDINGS, IMPOSING : REMEDIAL SANCTIONS, AND GRUNTAL FINANCIAL CORP., : ISSUING CEASE AND : DESIST ORDER Respondents. : ______________________________: 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") and Sections 15(b)(4) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") and against Gruntal Financial Corp. ("Gruntal Financial") pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act. In anticipation of the institution of these administrative proceedings, Gruntal and Gruntal Financial have submitted Offers 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 and Gruntal Financial, by their Offers of Settlement, prior to a hearing pursuant to the Commission's Rules of Practice and without admitting or denying the findings set forth herein, consent to the entry of this Order ==========================================START OF PAGE 2====== Instituting Public Administrative Proceedings, Making Findings, Imposing Remedial Sanctions, and Issuing Cease and Desist Order ("Order"). II. Accordingly, IT IS HEREBY ORDERED that proceedings pursuant to Section 8A of the Securities Act and Sections 15(b)(4) and 21C of the Exchange Act be, and hereby are, instituted. III. The Commission makes the following findings:-[1]- A. RESPONDENTS 1. Gruntal At all times from December 15, 1983 to the present, Gruntal has been a broker-dealer registered with the Commission pursuant to Section 15(b) of the Exchange 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. ("NASD"). As a broker-dealer, Gruntal provides a full range of securities brokerage and trading services, as well as related financial services. From 1983 to June 1990, Gruntal conducted its back office operations through a wholly owned subsidiary, Regional Clearing Corp. ("Regional Clearing"). In June 1990, Regional Clearing was merged into Gruntal. As used in this Order, the term "Gruntal" refers, as the context requires, to Gruntal and/or Regional Clearing. 2. Gruntal Financial From December 15, 1983 to the present, Gruntal Financial has been a Delaware corporation operating a securities brokerage business through Gruntal, its wholly owned subsidiary. For the period December 1983 to August 1987, Gruntal Financial was a publicly traded corporation with its securities registered pursuant to Section 12(b) of the Exchange Act and listed on the NYSE. From December 1983 to August 1987, Gruntal Financial was ---------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====== required to file periodic reports with the Commission pursuant to Section 13 of the Exchange Act. In June 1986, Gruntal Financial conducted an offering of 7 1/2% Convertible Subordinated Debentures due 2011. In August 1987, Gruntal Financial was acquired by The Home Group, Inc., a public corporation whose securities were registered pursuant to Section 12(b) of the Exchange Act. Gruntal Financial was held as a subsidiary of The Home Insurance Company, a wholly owned subsidiary of The Home Group, Inc. In May 1989, The Home Group, Inc. changed its name to AmBase Corporation. In February 1991, The Home Insurance Company was acquired by Home Holdings Inc., a public corporation with its securities registered pursuant to Section 12(b) of the Exchange Act. Home Holdings Inc. went private in mid-1995. B. OTHER RELEVANT PERSON Edward E. Bao Edward E. Bao was Gruntal's Executive Vice President for Operations and Administration. Bao also held the same position at Gruntal Financial. Bao's employment at Gruntal and Gruntal Financial was terminated on December 16, 1994. C. SUMMARY This proceeding involves conduct in two areas. The first, and principal, area involves violations of the antifraud, reporting, and record-keeping provisions of the federal securities laws in connection with three separate schemes to divert assets that occurred between 1984 and 1994 and that were instituted by certain members of Gruntal senior management (who left the firm subsequent to the conduct discussed herein). In those schemes, securities and funds totalling over $11 million were diverted intentionally from customer accounts, dividend "overages,"-[2]- customer and vendor checks, and other ---------FOOTNOTES---------- -[2]- Dividend "overages" resulted at Gruntal when the firm received stock dividends, cash dividends, or interest accrued on debt securities from issuing corporations in excess of those that its books showed were due to customer or proprietary accounts. See Edward C. Jaegerman, 46 SEC 706, 708 (1976). For example, Gruntal received such dividends when its customers sold securities between their record dates and their payment dates. Those dividends did not belong to Gruntal; instead, Gruntal held them as a "debtor," with a "duty" to transmit the unclaimed dividends to their beneficial owners. See Delaware v. New York, 113 S. Ct. 1550, 1559 (1993). ==========================================START OF PAGE 4====== sources at Gruntal. Approximately $5 million of the diverted assets were moved to fictitious customer accounts and then transferred to Gruntal profit and loss ("P&L") accounts or used to make off-books payments of Gruntal expenses. Thus, Gruntal used these diverted assets artificially to inflate its income or reduce its expenses. The remaining $6 million of the diverted assets were embezzled by certain members of Gruntal management implementing the schemes. In furtherance of these schemes, the Gruntal officers and managers implementing the diversions falsified Gruntal's books and records. To carry out and conceal the diversions, they created fictitious customer accounts. Other books and records, although not intentionally falsified, were based upon information contained in the falsified records and therefore were inaccurate. The diversions were instituted originally to inflate Gruntal's income. As a result of the diversions, Gruntal filed periodic FOCUS reports that overstated firm income, and Gruntal Financial filed periodic reports that mischaracterized the diverted assets and misstated Gruntal Financial's income. These reports also failed to disclose the diversion of customer and other third party funds to income and the involvement of certain officers and managers in those activities. The second area involves Gruntal's execution and reporting of certain Over-the-Counter ("OTC") trades. In mid-1995, NASD reports indicated that Gruntal's late reported OTC trades exceeded the industry average. Gruntal subsequently reviewed a sample of such trades and found that, in a limited number of instances, customers were financially disadvantaged in connection with these practices. D. THE MISAPPROPRIATION SCHEMES 1. Gruntal Misappropriates Assets to Increase Its Income a. Sources of Diverted Assets Beginning in 1984, Bao and certain senior managers under his control identified various assets that could be diverted and, ultimately, misappropriated for Gruntal's benefit. At Bao's direction, this process was conducted initially by three members of Gruntal's senior management: its Director of Operations, its Manager of Internal Audit, and the Executive Cashier (hereinafter "Certain Senior Managers").-[3]- By 1984, these managers ---------FOOTNOTES---------- -[3]- The misappropriation schemes came to light after the Executive Cashier's sudden, unexpected death on October 16, 1994. In November 1994, Gruntal terminated the employment of the (continued...) ==========================================START OF PAGE 5====== realized that hundreds of thousands of dollars worth of overages had accrued in Gruntal dividend payable accounts.-[4]- At the behest of Bao -- the number two officer at Gruntal -- Certain Senior Managers undertook to ascertain to whom the overages belonged and the likelihood that Gruntal might yet receive claims for them. Overages that were unlikely to be claimed became candidates for diversion. The overages were potentially escheatable property. Thus, if they had remained unclaimed, Gruntal should have eventually escheated them to the states. Instead, Bao and Certain Senior Managers diverted unclaimed overages out of the dividend accounts. In about 1987 or 1988, Bao and Certain Senior Managers realized that Gruntal's bank reconciliation accounts held stale or outstanding customer and vendor checks that Gruntal could misappropriate. Gruntal's normal procedures required it to notify its customers of the checks. If the checks remained unclaimed after such notification, Gruntal was required eventually to pay them to the appropriate states. Gruntal did abide by these procedures for checks of smaller denominations; however, larger checks were diverted out of the bank reconciliation accounts.-[5]- In addition, Gruntal, acting through Bao and Certain Senior Managers, diverted assets from dormant customer accounts. Securities and customer money balances were transferred out of customer accounts that were inactive or for which mailed account statements had been returned. b. Fictitious Accounts and Falsified Records Hide the Diverted Assets ---------FOOTNOTES---------- -[3]-(...continued) Director of Operations and the Manager of Internal Audit. Both of those individuals subsequently have pleaded guilty to a two- count criminal information filed by the United States Attorney's Office for the Southern District of New York. -[4]- Gruntal used these accounts to receive, hold, and disburse the stock dividends, cash dividends, and accrued interest that it received from issuing corporations. -[5]- Notification of customers who had "stale" checks was more than a mere pro forma procedure. In many cases, these checks did belong to present, living customers. In fact, during the course of the diversions, Certain Senior Managers were forced to re-credit to customers over $700,000 for previously diverted checks when customers contacted Gruntal inquiring about their money. ==========================================START OF PAGE 6====== Beginning in 1984, Bao and Certain Senior Managers opened securities accounts at Gruntal under fictitious customer names. These accounts were given numbers purporting to identify them as customer accounts. From 1984 and continuing for a decade, dividend overages, stale checks, and other assets targeted for diversion were transferred into these fictitious customer accounts. To avoid detection and to obscure the true nature of the assets, these transfers often were made by means of complex, multiple-step transactions that utilized otherwise legitimate Gruntal operational or suspense accounts as interim stopping points. From fictitious customer accounts, diverted assets were transferred into the firm's P&L accounts and falsely credited as income.-[6]- These transfers tended to coincide with downturns in Gruntal's monthly income. Sometimes the diverted assets were used to make off-books payments of firm expenses, thereby reducing Gruntal's liabilities. In carrying out the scheme, Gruntal, acting through Bao and Certain Senior Managers, created, or caused to be created, numerous fictitious and false books and records, including account opening documents, account statement entries, debit and credit memos, dividend claim forms, and accounting and journal entries.-[7]- In addition, to avoid detection, Bao and Certain Senior Managers periodically closed the fictitious customer accounts and opened new accounts to take their place, utilizing a number of fictitious accounts over time. Finally, Gruntal, through Bao and Certain Senior Managers, circumvented and disregarded certain procedures and internal controls, in particular those relating to opening new accounts and the proper handling of abandoned and/or escheatable property. 2. Embezzlement of Diverted Assets a. Certain Senior Managers Divert Assets for Their Own Benefit In about 1987, Certain Senior Managers began to divert assets for their own benefit. Their scheme drew on the same sources of assets utilized in the original diversions and largely used the same methods for diverting those assets. For their ---------FOOTNOTES---------- -[6]- In some instances, the diversions bypassed the fictitious customer accounts, and items were moved from their sources to operational or suspense accounts and from those accounts directly to Gruntal's P&L. -[7]- The implementation and concealment of the scheme was effectively assisted -- knowingly, recklessly, or inadvertently - - by individuals from several departments at Gruntal, including bank reconciliation, abandoned property, internal audit, accounting, and the back office. ==========================================START OF PAGE 7====== scheme also, Certain Senior Managers created, or caused to be created, fictitious or false records. However, this second scheme largely avoided the fictitious customer accounts, and the assets diverted under this scheme ultimately left the firm -- without the authorization of other officers at Gruntal. b. Executive Cashier Diverts Assets for His Own Use A third diversion scheme developed when the Executive Cashier began an embezzlement on his own behalf. The Executive Cashier implemented a scheme based primarily on the creation of debits in Gruntal's reorganization account and which ultimately involved the creation, in some instances, of false "fails to deliver."-[8]- He then directed the alteration and falsification of Gruntal's corresponding records. Only a small portion of the assets the Executive Cashier embezzled came from the sources of assets used in the other diversion schemes. The Executive Cashier's scheme was conducted without the authorization of other officers at Gruntal. E. FALSE FILINGS 1. Gruntal Financial From 1985 through mid-1987, Gruntal Financial filed with the Commission false and misleading periodic reports and a false and misleading registration statement. Those reports, including the financial statements contained therein, were misstated because they failed to reflect, disclose, or correctly characterize the amounts and uses of the diverted assets. As a result, Gruntal Financial's income was overstated. Because a large number of Gruntal Financial's books and records were falsified, it is not always possible to quantify the precise impact of the diversions on income during this period. Nevertheless, for some periods, the misstatement of income can be clearly ascertained. For example, as a result of the diversions, Gruntal Financial's annual report on Form 10-K for fiscal year 1985 overstated its pre-tax income by approximately 15%. In addition, Gruntal Financial's periodic reports and registration statement failed to disclose the diversion of customer and other third party funds to income and management's role in those activities. ---------FOOTNOTES---------- -[8]- A fail to deliver occurs when the selling broker- dealer, in this case Gruntal, has failed to deliver securities to the buying broker-dealer. The selling broker-dealer will not receive payment as long as the fail continues. Thus, the creation of a false fail to deliver created the appearance that monies actually missing were merely monies that were owed to, and had not yet been received by, Gruntal. ==========================================START OF PAGE 8====== The false and misleading Gruntal Financial filings include: (1) A registration statement on Form S-1, filed on June 2, 1986, and Amendment No. 1 thereto, filed on June 18, 1986, both filed in connection with Gruntal Financial's offering of 7 1/2% Convertible Subordinated Debentures due June 15, 2011; (2) Annual reports on Form 10-K for the years 1985 and 1986; and (3) A quarterly report on Form 10-Q for the third quarter of fiscal year 1987. 2. Gruntal Between 1985 and 1994, Gruntal filed false and misleading FOCUS reports with the Commission and with the NYSE. These reports, including the income statements contained therein, overstated Gruntal's income. Because Bao and Certain Senior Managers falsified a large number of Gruntal's books and records, it is not always possible to quantify the precise impact of the diversions on the firm's income during this period. Nevertheless, for some periods, the misstatement can be clearly ascertained. For example, by diverting assets to income, Gruntal falsely overstated its pre-tax income by approximately 13% on its 1985 annual FOCUS report. Similarly, Gruntal's quarterly FOCUS report on Form X-17A-5 for the quarter ended June 28, 1991, overstated pre-tax income by approximately 130%. The false Gruntal filings include: (1) Annual FOCUS reports for fiscal years 1985 through 1994; (2) Certain quarterly FOCUS reports on Form X-17A-5 from second quarter 1986 through fourth quarter 1994; and (3) Certain monthly FOCUS reports on Form X-17A-5 for months from April 1986 through October 1994. F. LATE REPORTING AND ORDER EXECUTION PRACTICES In mid-1995, NASD reports issued to Gruntal indicated that Gruntal's late reported OTC trades exceeded the industry average. In November 1995, Gruntal undertook a study aimed at finding the reasons for the late reported trades. As part of that study, Gruntal examined a random sample of those trades. Gruntal found that, in a limited number of instances, customers had been financially disadvantaged by Gruntal's trading practices. For example, Gruntal identified two instances in which a customer placed an order to buy a particular OTC stock, but the order was not executed in a timely manner. Gruntal's trading desk, which ==========================================START OF PAGE 9====== had started the day flat with regard to that particular stock, subsequently built a position in it. Once that position was built, the customer's order was filled from the position, to the customer's detriment. Gruntal has repaid those disadvantaged customers that it has identified to date. A broker-dealer which fails to transmit promptly information required by an effective transaction reporting plan with respect to a reported security violates Section 11A(a)(2) of the Exchange Act and Rule 11Aa3-1(c) thereunder. A broker-dealer which fails to execute a customer's order promptly in accordance with the customer's instructions without disclosure violates the antifraud provisions, including Sections 10(b) and 15(c) of the Exchange Act and Rules 10b-5 and 15c2-1 thereunder and Section 17(a) of the Securities Act. As set forth below in Section VI.F.2. of this Order, an Independent Consultant acceptable to the Commission's staff will investigate the OTC order execution and reporting practices set forth above and, among other things, will direct Gruntal to reimburse any customers who have been financially harmed in connection with Gruntal's processing of OTC trades. IV. A. VIOLATIONS OF THE ANTIFRAUD PROVISIONS Section 17(a) of the Securities Act proscribes fraud in connection with the "offer or sale" of securities. Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit fraud in connection with the purchase or sale of a security. Section 15(c)(1) of the Exchange Act prohibits a broker-dealer from effecting transactions in securities, otherwise than on a national securities exchange of which it is a member, by means of any manipulative, deceptive, or fraudulent device or contrivance. A broker-dealer is entrusted with the funds and securities of its customers. Customers rely upon their brokerage. But, from 1984 through 1994, Bao and Certain Senior Managers took assets in the form of customer securities and balances, stale customer and vendor checks, and unclaimed dividends. They took pains to hide their actions. A broker-dealer's misappropriation of customer securities is a violation of the antifraud provisions of the federal securities laws. Donald T. Sheldon, 51 SEC 59, 62-63 & n.11 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995). "'[I]t is a fraudulent and deceptive act, practice, and course of business, which operates as a fraud and deceit on a customer, for a broker-dealer to . . . convert to his own use customers' funds or fully-paid for securities of customers held by the broker-dealer for safe- keeping.'" Sheldon, 51 SEC at 62 n.10 (quoting Ezra Weiss, ==========================================START OF PAGE 10====== Registration and Regulation of Brokers and Dealers 181 (1965)). At Gruntal, a substantial amount of customer funds and securities were converted for the broker-dealer's use. Gruntal also violated the antifraud provisions when it misappropriated unclaimed dividend overages held in its dividend accounts and converted the dividends for firm use. Edward C. Jaegerman, 46 SEC 706, 708-09 (1976). The "in connection with" requirement of the antifraud provisions "is met if the fraud alleged 'somehow touches upon' or has 'some nexus' with 'any securities transaction.'" SEC v. Rana Research, Inc., 8 F.3d 1358, 1362 (9th Cir. 1993) (quoting SEC v. Clark, 915 F.2d 439, 449 (9th Cir. 1990)).-[9]- Transactions in securities were integral to the fraudulent activities at Gruntal. Gruntal officers and managers removed balances and securities from customers' securities accounts, purchased securities with the stolen balances, sold customers' securities, took customer checks representing proceeds of securities transactions, and misappropriated dividends payable to contra-brokers, institutional investors, and Gruntal's customers. To violate Section 17(a)(1), Section 10(b), or Rule 10b-5, a defendant must act with scienter. Aaron v. SEC, 446 U.S. 680, 701-02 (1980). Bao and Certain Senior Managers at Gruntal and Gruntal Financial knowingly instituted and condoned the diversions. Gruntal and Gruntal Financial are chargeable with their employees' state of mind. See SEC v. Manor Nursing Ctrs., Inc., 458 F.2d 1082, 1089 n.3 (2d Cir. 1972). From 1985 through mid-1987, Gruntal Financial itself violated the antifraud provisions by filing certain materially false and misleading reports. Gruntal Financial was a holding company conducting its business through Gruntal. The original diversion scheme was instituted by Gruntal to inflate its income. As a result of Gruntal's overstated income, Gruntal Financial's income was also inflated, and Gruntal Financial filed with the Commission periodic reports and a registration statement that were materially misstated -- mischaracterizing the diverted assets and overstating income.-[10]- Gruntal Financial's ---------FOOTNOTES---------- -[9]- Although the courts are in some disagreement over the contours of the "in connection with" requirement for a private plaintiff, "its meaning in SEC actions remains as broad and flexible as is necessary to accomplish the statute's purpose of protecting investors." Rana Research, 8 F.3d at 1362 (discussing requirement in context of case brought under Section 10(b)). -[10]- A fact is material if there is a substantial likelihood that a reasonable investor would consider the information to be important. Basic Inc. v. Levinson, 485 U.S. (continued...) ==========================================START OF PAGE 11====== filings were also made materially misleading by their failure to disclose the diversions at Gruntal or the involvement of certain members of senior management. See SEC v. Kalvex Inc., 425 F. Supp. 310, 315-16 (S.D.N.Y. 1975); cf. SEC v. Scott, 565 F. Supp. 1513, 1527 (S.D.N.Y. 1983) (stating that failure to disclose kickback scheme involving principal obviously material), aff'd sub nom. SEC v. Cayman Islands Reinsurance Corp., 734 F.2d 118 (2d Cir. 1984). During this period, Gruntal Financial securities were listed and traded on the NYSE, and, in June 1986, Gruntal Financial conducted an offering of Convertible Subordinated Debentures. In order to establish liability for aiding and abetting, the Commission must establish (1) the existence of a primary violation, (2) that the aider or abettor had a general awareness that his role was part of an overall activity that was improper, and (3) that the aider or abettor knowingly and substantially assisted the principal violation. Dominick & Dominick, Inc., 50 SEC 571, 577 (1991). Gruntal willfully aided, abetted, and caused Gruntal Financial's violations of the antifraud provisions. Gruntal, acting through Bao and Certain Senior Managers, knowingly implemented and condoned a scheme by which assets were transferred fraudulently and Gruntal's income was artificially inflated. As a result of that scheme, Gruntal Financial filed with the Commission materially misstated reports. For the foregoing reasons, Gruntal willfully violated Section 17(a) of the Securities Act, Sections 10(b) and 15(c)(1) of the Exchange Act, and Rule 10b-5 thereunder by fraudulent transactions and practices, and Gruntal Financial violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by material misrepresentations and omissions in its periodic reports and registration statement. Moreover, Gruntal willfully aided, abetted, and caused Gruntal Financial's violations. B. GRUNTAL FINANCIAL'S VIOLATIONS OF EXCHANGE ACT REPORTING AND RECORD-KEEPING PROVISIONS Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder require issuers with securities registered under Section 12 of the Exchange Act to file annual and quarterly reports with the Commission and to keep this information current. ---------FOOTNOTES---------- -[10]-(...continued) 224, 231-32 (1988). Information regarding a company's income is among the most important information for making an investment decision. ==========================================START OF PAGE 12====== The obligation to file such reports embodies the requirement that they be true and correct. See, e.g., SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). Exchange Act Rule 12b-20 further requires the inclusion of any additional material information that is necessary to make required statements, in light of the circumstances under which they were made, not misleading. Information regarding the financial condition of a company is presumptively material. SEC v. Blavin, 760 F.2d 706, 711 (6th Cir. 1985). As discussed above, from 1985 through mid-1987 Gruntal Financial filed certain false and misleading periodic reports with the Commission that mischaracterized the diverted assets, misstated Gruntal Financial's income, and failed to disclose management's role in the diversion of customer and other third party funds to income. Section 13(b)(2)(A) of the Exchange Act requires Section 12 registrants to make and keep books, records, and accounts accurately reflecting transactions involving their assets. Section 13(b)(5) of the Exchange Act provides that no person shall knowingly falsify any such book, record, or account or circumvent internal controls. Rule 13b2-1 also prohibits the falsification of any book, record, or account subject to Section 13(b)(2)(A). From 1984 through mid-1987, Gruntal Financial's books and records reflecting transactions in its assets were not merely inaccurate, they were intentionally falsified. Its internal accounting controls were intentionally circumvented. For the foregoing reasons, Gruntal Financial violated Section 13(a), 13(b)(2)(A), and 13(b)(5) and Rules 12b-20, 13a-1, 13a-13, and 13b2-1. By engaging in the conduct described above, Gruntal willfully aided, abetted, and caused Gruntal Financial's violations of Section 13(a), 13(b)(2)(A), and 13(b)(5) and Rules 12b-20, 13a-1, 13a-13, and 13b2-1. C. GRUNTAL'S VIOLATIONS OF BROKER-DEALER REPORTING AND RECORD-KEEPING PROVISIONS Section 17(a) of the Exchange Act and Rules 17a-3 and 17a-4 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). Rule 17a-11(d) requires a broker- dealer to notify the Commission and its principal self-regulatory organization the same day that it fails to meet the requirements of Rule 17a-3. ==========================================START OF PAGE 13====== 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). Bao and Certain Senior Managers went to great lengths to hide their actions, including the intentional falsification of numerous books and records. Other books and records, although not intentionally falsified, were based upon information contained in the falsified records and therefore are also inaccurate. Books and records specifically required by Section 17(a) and Rule 17a-3, but which were falsified or inaccurate at Gruntal, include the following: (1) blotters containing an itemized daily record reflecting, among other things, all receipts and disbursements of cash and other debits and credits, and the account for which each such transaction was effected (17a-3(a)(1)); (2) ledgers reflecting all assets and liabilities, income and expense and capital accounts (17a-3(a)(2)); (3) ledger accounts itemizing separately as to each cash and margin account of every customer, among other things, all debits and credits to that account (17a-3(a)(3)); (4) ledgers reflecting dividends and interest received and securities failed to receive and failed to deliver (17a-3(a)(4)); (5) records with respect to each cash and margin account, indicating the name and address of the beneficial owner of such account (17a-3(a)(9)); and (6) a record of the proof of money balances of all ledger accounts in the form of trial balances (17a-3(a)(11)). Gruntal failed to give the Commission or the NYSE the lack of compliance notice required by Rule 17a-11(d). Section 17(a) and (e) of the Exchange Act and Rule 17a-5(d) require registered broker-dealers to file with the Commission annual FOCUS reports. Section 17(a) and Rule 17a-5(a) require registered broker-dealers to file monthly and quarterly FOCUS reports on Form X-17A-5. Implicit in these provisions is the requirement that the information be accurate. See In the Matter of Nikko Sec. Co. Int'l, Exchange Act Release No. 32331 (May 19, 1993). As a result of the diversions, Gruntal's annual FOCUS reports and monthly and quarterly FOCUS reports misstated Gruntal's income. For the foregoing reasons, Gruntal willfully violated Section 17(a) and (e) and Rules 17a-3, 17a-4, 17a-5(a), 17a-5(d), and 17a-11(d) thereunder. V. Based on the foregoing, the Commission finds that: ==========================================START OF PAGE 14====== A. Gruntal Financial violated Section 17(a) of the Securities Act and Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(5) of the Exchange Act and Rules 10b-5, 12b- 20, 13a-1, 13a-13, and 13b2-1 thereunder; B. Gruntal willfully violated Section 17(a) of the Securities Act and Sections 10(b), 15(c)(1), 17(a), and 17(e) of the Exchange Act and Rules 10b-5, 17a-3, 17a- 4, 17a-5(a), 17a-5(d), and 17a-11(d) thereunder; and C. Gruntal willfully aided, abetted, and caused Gruntal Financial's violations of Section 17(a) of the Securities Act and Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(5) of the Exchange Act and Rules 10b-5, 12b- 20, 13a-1, 13a-13, and 13b2-1 thereunder. VI. In view of the foregoing, it is in the public interest to impose the sanctions specified in the Offers of Settlement. In determining to accept the Offers, the Commission considered remedial acts undertaken by Gruntal and Gruntal Financial and cooperation afforded the Commission staff. Accordingly, IT IS HEREBY ORDERED that: A. Gruntal be, and hereby is, censured; B. Gruntal, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange 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), 13(a), 13(b)(2)(A), 13(b)(5), 15(c)(1), 17(a), and 17(e) of the Exchange Act, and Rules 10b-5, 12b-20, 13a-1, 13a-13, 13b2-1, 17a-3, 17a- 4, 17a-5(a), 17a-5(d), and 17a-11(d) thereunder; C. Gruntal Financial, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange 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), 13(a), 13(b)(2)(A), and 13(b)(5) of the Exchange Act, and Rules 10b-5, 12b-20, 13a-1, 13a-13, and 13b2-1 thereunder; D. Gruntal shall pay a civil money penalty in the amount of $4 million pursuant to Section 21B of the Exchange 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 ==========================================START OF PAGE 15====== 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 (HO-2997), a copy of which shall be sent to Thomas C. Newkirk, Associate Director, Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop 4-1, Washington D.C. 20549; E. Gruntal and Gruntal Financial (collectively "Respondents"), pursuant to Section 8A of the Securities Act and Sections 21B and 21C of the Exchange Act, shall pay an aggregate of $5.5 million in disgorgement and prejudgment interest for the benefit of customers, states, and other third parties that are identified as due funds from Respondents as a result of the diversions of assets between 1984 and 1994 as described in this Order, in the manner set forth below; F. Respondents shall comply with the following undertakings: 1. To implement the above ordered disgorgement: a. within ten business days of the date of this Order, Respondents shall deposit $5.5 million in a Court Registry Investment System ("CRIS") account (the "Fund") to be established in accordance with the Commission's petition in the District Court pursuant to Section 20(c) of the Securities Act and Section 21(e) of the Exchange Act ("Petition"); b. within 30 days of the date of this Order, at Respondents' expense, Respondents shall retain the independent Fund Administrator ("Fund Administrator") appointed and approved by the District Court upon the Commission's recommendation and with the consent of the Respondents, which consent shall not be unreasonably withheld, who will: i. have all appropriate powers and authority to perform his or her duties as set forth in this Order, including, without limitation, the powers to hire such persons as are reasonably necessary to perform his or her duties as set forth in this Order; ii. file tax returns on behalf of the Fund; iii. conduct such investigation, research, and review as is necessary and practicable to: (A) verify Gruntal's representation to the Commission that it has repaid, recredited, escheated, or properly segregated and scheduled for escheatment $6.7 million which it has identified as escheatable, or presently believes to be escheatable, or has identified as belonging to customers, contra-parties, vendors, and other third parties, in connection with the conduct described in this Order, and (B) ==========================================START OF PAGE 16====== where practical, identify the type (e.g., dividends), ownership (e.g., customer), and nature (e.g., escheatable) of the assets diverted in connection with the diversions of assets between 1984 and 1994 as described in this Order, which are presently so unidentified; iv. following such investigation and research, but in any event no later than one year after the date of this Order, submit to the District Court, the Director of the Division of Enforcement of the Commission, and Respondents: (A) a report of his or her findings, and (B) a Plan of Distribution to disburse the Fund in accordance with this Order; v. after an opportunity for interested parties to be heard, and upon approval of the Plan of Distribution by the District Court, the Fund Administrator shall disburse the Fund in accordance with the Plan of Distribution; vi. 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, Gruntal's Operations Division, and Gruntal's Operations Control Group; and vii. be entitled, to the extent that he or she deems appropriate, to require Gruntal to continue the engagement of D&T and to maintain resources within its Operations Control Group to support the efforts of the Fund Administrator; c. in the event that the Fund Administrator determines, pursuant to Section VI.F.1.b.iii.(A) above, that Gruntal has not repaid, recredited, escheated, or properly segregated and scheduled for escheatment $6.7 million in connection with the conduct described in this Order, Gruntal shall disgorge into the Fund the difference between $6.7 million and the amount the Fund Administrator determines that Gruntal has actually repaid, recredited, escheated, or properly segregated and scheduled for escheatment in connection with the conduct described in this Order. Such additional disgorgement shall be distributed pursuant to the terms of this Order that govern disbursements from the Fund; d. if, as a result of research by Respondents or by the Fund Administrator, any of the amount referred to in Section VI.F.1.b.iii.(A) above which is segregated and scheduled for escheatment is determined not to be escheatable and is determined to belong to customers, contra-parties, vendors, or other third parties, then Respondents shall pay such monies to the parties to whom they belong. If at any time any of the amount referred to in Section VI.F.1.b.iii.(A) above which is segregated and scheduled for escheatment is determined not to be escheatable and not to be owed to customers, contra-parties, vendors, or other third parties, then Respondents shall pay such monies into the ==========================================START OF PAGE 17====== Fund and such monies shall be disbursed pursuant to the terms of this Order that govern disbursements from the Fund; e. the Fund shall be used for the benefit of customers, contra-parties, vendors, states, and other third parties that are identified by the Fund Administrator as due funds from Respondents as a result of the diversions of assets between 1984 and 1994. The Fund is to be disbursed as follows: i. first, to pay any taxes on the income earned on the Fund, ii. second, to repay to customers such monies identified as owing to them, iii. third, to repay to vendors, contra-parties, and other third parties such monies identified as owing to them, iv. fourth, to escheat to the proper state(s) such monies identified as presently escheatable, v. fifth, to have assets identified as potentially escheatable, but not yet ripe for escheatment, properly maintained in segregated accounts until escheated, and vi. sixth, to pay any residual balance into the United States Treasury; f. Respondents shall indemnify, defend, and hold harmless the Fund Administrator and his or her agents and attorneys from and against all liabilities, claims, and demands arising from or relating to any act or omission to act in the course of performing his or her duties, except to the extent that the District Court finds that such person acted in bad faith, gross negligence, reckless disregard of his or her duties, or in a manner that he or she knew was contrary to the terms of this Order; and g. in the event that the Commission's Petition is not granted by the District Court, (i) any monies that would have been transferred to the CRIS account under control of the Fund Administrator and subject to the jurisdiction of the District Court shall instead be transferred to an appropriate account under the control of the Fund Administrator, subject to the jurisdiction of the Commission, (ii) the Fund Administrator shall be selected by the Commission with the consent of Respondents, which consent shall not be unreasonably withheld, and (iii) the Plan of Distribution proposed by the Fund Administrator shall be subject to approval by the Commission after an opportunity for interested parties to be heard; provided ==========================================START OF PAGE 18====== however, that if Respondents and the Commission agree, they may jointly move a United States District Court for approval and implementation of any such Plan of Distribution; 2. Respondents shall retain within 45 days of the date of this Order, at Respondents' expense, an Independent Consultant, acceptable to the Commission's staff, to: a. conduct a comprehensive review of Gruntal's policies and procedures concerning: (i) operations (back office), including but not limited to the cashier's department; (ii) the bank reconciliation department; (iii) the accounting department; (iv) dormant, abandoned, stale, unidentified, or escheatable assets; (v) suspense accounts, operations area accounts, and other accounts of a similar nature; (vi) the creation and maintenance of accurate books and records with respect to the foregoing; (vii) the internal audit department and functions; (viii) OTC trading; and (ix) compliance, in determining whether and to what extent there is a need for additional policies and procedures designed reasonably to prevent and detect, insofar as practicable, violations of the federal securities laws; b. conduct a comprehensive investigation of The facts and circumstances surrounding Gruntal's execution and reporting practices for OTC trades as described in this Order. Such investigation shall include, among other things: (i) the accuracy and timeliness of Gruntal's reporting of OTC trades and the manner in which Gruntal processed OTC market orders and OTC limit orders; (ii) the cause(s) of inaccurately or untimely reported OTC trades or improperly processed OTC trades; (iii) the persons responsible for the practices; (iv) the knowledge of management, if any, of the practices; (v) the financial harm to customers resulting from the practices; (vi) the identities of customers harmed; (vii) the amount by which each such customer was harmed; and (viii) the amount, if any, by which Gruntal was unjustly enriched as a result of such practices; c. review the 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 practicable, violations of the federal securities laws; d. recommend policies and procedures (or amendments to existing policies and procedures) designed reasonably to prevent and detect, insofar as practicable, violations of the federal securities laws; ==========================================START OF PAGE 19====== e. be entitled, to the extent that he or she deems appropriate, to rely upon work performed or to be performed by E&Y, D&T, Gruntal's Quality Assurance Task Force, Gruntal's Operations Division, and Gruntal's Operations Control Group; f. 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; g. 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 to comment on the Independent Consultant's review and recommendations; h. 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 Director of the Division of Enforcement of the Commission and such other persons or entities as may be proposed by any governmental, regulatory, or self- regulatory body; i. 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 Sections VI.F.2.a., c., and d. above, and the policies and procedures adopted pursuant to the Independent Consultant's recommendations, to ensure compliance 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 Sections VI.F.2.a., c., and d. above; and j. report to the Director of the Division of Enforcement of the Commission and Respondents: (i) any material failure to comply with the procedures and system for applying those procedures, described in Sections VI.F.2.a., c., and d. above, and the policies and procedures adopted pursuant to the Independent Consultant's recommendations; (ii) any other material failure by Respondents to comply with this Order; and (iii) any violation of the federal securities laws; 3. Respondents 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 ==========================================START OF PAGE 20====== 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; 4. Respondents shall pay to each customer identified by the Independent Consultant's report as having been financially harmed in connection with Gruntal's reporting or processing of OTC trades, 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 customer was harmed, plus accrued interest thereon calculated at the rate utilized by the Commission in cases involving disgorgement. If it is not possible or is impractical to make such payments to each customer 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 reporting or processing of OTC trades; 5. Respondents shall cooperate fully with the Fund Administrator and the Independent Consultant, including using all reasonable efforts to obtain the cooperation of Respondents' employees or other persons under their control, including E&Y and D&T, and giving the Fund Administrator and the Independent Consultant full access to all documents and premises under Respondents' control; 6. To ensure the independence of the Fund Administrator and the Independent Consultant, Respondents: a. shall not have the authority to terminate the Independent Consultant, or the Fund Administrator if selected by the Commission pursuant to Section VI.F.1.g. above, without the prior written approval of the Director of the Division of Enforcement of the Commission; b. shall compensate the Fund Administrator, the Independent Consultant, and persons engaged to assist the Fund Administrator and Independent Consultant, for services rendered pursuant to this Order at their reasonable and customary rates; c. shall not, without the prior written consent of the Director of the Division of Enforcement of the Commission, enter into any legal, business, or other financial relationship with the Fund Administrator, Independent Consultant, any firm with which the foregoing are affiliated or of which they are a member, or any person engaged by the Fund Administrator or the ==========================================START OF PAGE 21====== Independent Consultant to assist the Fund Administrator or Independent Consultant in the performance of their 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 Fund Administrator or Independent Consultant and shall not seek to invoke the attorney-client or any other doctrine or privilege to prevent the Fund Administrator or Independent Consultant from transmitting any information, reports, or documents to the District Court, the Commission, or its staff; 7. If the Fund Administrator resigns or is otherwise unable to serve, a successor shall be appointed and approved by the District Court upon the Commission's recommendation and with the consent of the Respondents, which consent shall not be unreasonably withheld. Respondents shall retain such successor, at Respondents' expense, within 30 days after the successor's appointment and approval by the District Court. If the Fund Administrator is selected by the Commission pursuant to Section VI.F.1.g. above and resigns or is otherwise unable to serve, a successor shall be selected by the Commission with the consent of the Respondents, which consent shall not be unreasonably withheld. Respondents shall retain such successor, at Respondents' expense, within 30 days after the Commission's selection. If the Independent Consultant resigns or is otherwise unable to serve, Respondents shall retain a successor within 30 days, at Respondents' expense, acceptable to the Commission's staff. All provisions in this Order that apply to the Fund Administrator or the Independent Consultant shall apply to any successor; 8. 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) review policy relating to the achievement of compliance with applicable federal securities laws and the rules and regulations of the Municipal Securities Rulemaking Board or of any national securities exchange or self- regulatory organization ("SRO") of which Gruntal is a member ("applicable rules and regulations"); (b) 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 Sections VI.F.2.a., c., and d. above; and (c) monitor Gruntal's efforts to detect, correct, and prevent failures to comply with applicable rules and regulations. The Committee shall require the General Counsel of Gruntal to submit quarterly to the Committee a written report which shall include a summary of: government and SRO ==========================================START OF PAGE 22====== investigations involving Gruntal or its employees; internal disciplinary actions; employee terminations for cause; and any material deficiencies in policies or procedures identified in any internal audit at Gruntal. In addition, 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 9. Respondents 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 government agencies, securities exchanges, or SROs arising from or relating to the conduct described in this Order; and G. Under no circumstances shall any of the assets referred to in Section VI. of this Order be paid to or revert to Respondents, their assigns, subsidiaries, or shareholder(s). By the Commission. Jonathan G. Katz Secretary