UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 40459 / September 23, 1998 ADMINISTRATIVE PROCEEDING File No. 3-9712 _______________________________ : In the Matter of :ORDER INSTITUTING PROCEEDINGS :PURSUANT TO SECTIONS 15(b) AND NYLIFE SECURITIES INC., :19(h) OF THE SECURITIES :EXCHANGE ACT OF 1934, MAKING Respondent :FINDINGS AND IMPOSING REMEDIAL :SANCTIONS _______________________________: I. The Securities and Exchange Commission deems it appropriate and in the public interest that administrative proceedings be instituted pursuant to Sections 15(b) and 19(h) of the Securities Exchange Act of 1934 ("Exchange Act") against NYLIFE Securities Inc. ("NYLIFE Securities"), a broker-dealer registered with the Commission. II. In anticipation of the institution of these administrative proceedings, NYLIFE Securities has submitted an Offer of Settlement that the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, and prior to a hearing pursuant to the Commission's Rules of Practice, 17 C.F.R. 201.100 et seq., and without admitting or denying the findings, except those findings pertaining to the jurisdiction of the Commission over it and the subject matter of these proceedings, NYLIFE Securities by its Offer of Settlement consents to the entry of the findings and the imposition of the remedial sanctions set forth below. Accordingly, IT IS ORDERED that proceedings pursuant to Sections 15(b) and 19(h) of the Exchange Act be, and hereby are, instituted. III. On the basis of this Order and NYLIFE Securities' Offer of Settlement, the Commission makes the following findings:[1] A.THE RESPONDENT NYLIFE Securities, a broker-dealer registered with the Commission since 1970, is a wholly owned subsidiary of the New York Life Insurance Company ("New York Life"). New York Life currently employs approximately 11,000 insurance agents, of which approximately 6,300 are also registered representatives of NYLIFE Securities and are licensed to sell variable annuities and mutual funds. Approximately one-half of those registered representatives work in approximately 160 NYLIFE Securities branch offices. The remaining registered representatives work in off-site offices with fewer than five people. Some of the registered representatives are also separately registered with the Commission as investment advisers. In addition, some registered representatives, like the two former registered representatives discussed here, perform financial services through their own entities. A "Managing Partner" in each NYLIFE Securities branch office is required to supervise the activities of registered representatives who work in that branch office and registered representatives who work in off-site offices assigned to that branch office. B.SUMMARY This matter arises from NYLIFE Securities' failure reasonably to supervise two registered representatives - a registered representative in a one-person, off-site office in Worcester, Massachusetts ("the Worcester registered representative"), and a registered representative in a NYLIFE Securities branch office in Buffalo, New York ("the Buffalo registered representative") - with a view to preventing violations of Section 17(a) of the Securities Act of 1933 ("Securities Act"), Section 10(b) of the Exchange Act, Rule 10b-5 thereunder, and Sections 206(1) and (2) of the Investment Advisers Act of 1940 ("Advisers Act"). Over a seven-year period, they misappropriated approximately $4.5 million from their customers by convincing them to purchase securities and make checks payable to their own entities, and then depositing the customers' checks into their own accounts. NYLIFE Securities lacked adequate supervisory and compliance procedures. It failed to conduct unannounced inspections of its off-site registered representatives, failed adequately to review registered representatives' customer files, and lacked adequate procedures to ensure that the responsibility delegated to the Managing Partner of the Buffalo branch office was being diligently exercised. As a result, NYLIFE Securities failed reasonably to supervise the Worcester and Buffalo registered representatives. C.THE REGISTERED REPRESENTATIVES' VIOLATIONS The Worcester and Buffalo registered representatives used nearly identical schemes to embezzle approximately $4.5 million from their customers. They persuaded customers to purchase securities purportedly offered by NYLIFE Securities and instructed them to make checks payable to their own entities. Instead of using the funds to purchase securities offered by NYLIFE Securities, they deposited the checks into a bank account maintained in the name of their entities, and then used most of the funds for their personal benefit. Between November 1988 and November 1995, the Worcester registered representative misappropriated more than $2 million from approximately 23 customers. Between December 1991 and December 1996, the Buffalo registered representative misappropriated approximately $2.5 million from approximately 90 customers. As part of their schemes, the Worcester and Buffalo registered representatives sent their customers fictitious account statements, securities transaction confirmations, and correspondence that falsely represented the income earned on their "investment" and the balance in their investment account. In addition, in circumstances where the "investment" involved periodic payments, they sent checks to their customers, and falsely represented the checks to be interest, dividends or annuity payments. Copies of the falsified documents were maintained in their customer files. D.NYLIFE SECURITIES' FAILURE TO SUPERVISE During the relevant period, NYLIFE Securities' system for supervising registered representatives relied to a large extent on a semi-annual supervisory interview conducted by the Managing Partner or his designee. Inspections of registered representatives were conducted on as "as needed" basis. NYLIFE Securities also conducted annual inspections of branch offices. As described below, these procedures were inadequate to prevent and detect the fraudulent schemes committed by the Worcester and Buffalo registered representatives. Also, NYLIFE Securities lacked adequate procedures to ensure that enhanced supervisory procedures delegated to the Managing Partner of the Buffalo branch office were being diligently exercised. As a result of NYLIFE Securities' inadequate supervisory procedures, the violations by the Worcester and Buffalo registered representatives were not prevented or detected. 1.Inadequate Supervisory Interviews and Branch Office Inspections NYLIFE Securities' supervisory procedures required Managing Partners or their designees to conduct supervisory interviews of all registered representatives who they were responsible for supervising, including those who worked in off-site offices. Under this procedure, Managing Partners or their designees were required to ask the registered representative a series of questions that were designed to ensure that the registered representative understood NYLIFE Securities' policies and procedures, and to complete a checklist based on the registered representative's responses. In addition, Managing Partners or their designees were required to ascertain that the registered representative was using approved letterhead and business cards. These procedures did not, however, require a review of a sample of registered representatives' customer files to determine whether the registered representative was complying with NYLIFE Securities policies and procedures. In accordance with these procedures, NYLIFE Securities Managing Partners performed supervisory interviews of the Worcester and Buffalo registered representatives. The Managing Partners did not, however, review any of their customer files, which contained copies of fictitious account statements, confirmations, correspondence, and checks to and from customers.[2] Accordingly, the Managing Partners did not detect the registered representatives' violations. Therefore, NYLIFE Securities' procedures were not reasonably designed to prevent and detect the violations by the Worcester and Buffalo registered representatives. NYLIFE Securities' supervisory procedures also required an annual inspection of each branch office by a regional compliance officer. The inspection was a broad review of the procedures followed by the branch office concerning its securities operations. The inspection did not, however, require a review of a sample of registered representatives' customer files. NYLIFE Securities failed to inspect any of the customer files of the Worcester and Buffalo registered representatives as part of the annual inspection of branch offices. As a result, these procedures were not reasonably designed to prevent and detect their violations. 2.Failure to Conduct Unannounced Examinations NYLIFE Securities did not have a procedure to conduct unannounced examinations of off-site registered representatives.[3] This problem was of particular concern given the high number of registered representatives who worked in off-site offices. Between November 1988 and November 1995, while the Worcester registered representative was engaged in the fraud, NYLIFE Securities failed to conduct an unannounced examination of his office.[4] Accordingly, NYLIFE Securities' procedures were inadequate to prevent and detect the violations by the Worcester registered representative. A special compliance review of the Buffalo registered representative, conducted in September 1994 by the Corporate Compliance Department of New York Life, highlights the need for unannounced inspections.[5] The review included interviews with the Buffalo registered representative, his Managing Partner and Office Manager, and an announced inspection of forty-five customer files. Because the registered representative was told in advance that there would be an inspection of his customer files, he purged all evidence of his fraud from his files. In addition, because he did not want his administrative assistant to be questioned by the examiners, the Buffalo registered representative told her not to come to work on the days the review was to be conducted. 3.Failure to Follow Up and Review Additional Supervisory Procedures As a result of the September 1994 special compliance review, New York Life instructed the Managing Partner of the Buffalo branch office to more closely supervise the Buffalo registered representative by following additional supervisory procedures. Specifically, New York Life instructed the Managing Partner to contact the Buffalo registered representative's new customers on a quarterly basis, for a period of one year, to verify that they understood what they had purchased. New York Life also instructed the Managing Partner to randomly contact existing customers to discuss their level of satisfaction with the Buffalo registered representative's service. The Managing Partner, however, failed to adequately comply with these procedures. For example, he contacted only one of the Buffalo registered representative's 18 new customers during the one-year period. Among the 17 customers who the Managing Partner did not contact were two of the Buffalo registered representative's victims, who had complained to the Buffalo registered representative about not receiving the promised return on their "investment." Therefore, if the Managing Partner had complied with these procedures, he might have detected the Buffalo registered representative's violations. In accordance with his instructions from New York Life, the Managing Partner periodically sent a letter to a regional compliance officer of NYLIFE Securities, describing the status of his supervision of the Buffalo registered representative, including the substance of his conversations with the Buffalo registered representative's customers. NYLIFE Securities, however, failed to establish procedures to review the adequacy of the Managing Partner's supervision of the Buffalo registered representative. For example, although the Managing Partner reported that he had contacted one new customer, NYLIFE Securities failed to determine whether the Buffalo registered representative had other new customers that should have been contacted by the Managing Partner. Therefore, NYLIFE Securities had no system in place to ensure that the Managing Partner was diligently exercising his supervisory responsibilities.[6] E.LEGAL DISCUSSION Section 15(b)(4)(E) of the Exchange Act provides for the imposition of a sanction against a broker or dealer who "has failed reasonably to supervise, with a view to preventing violations of such statutes, rules, and regulations, another person who commits such a violation, if such other person is subject to his supervision." See In Re Smith Barney, Harris Upham & Co., Inc., Exchange Act Release No. 21,813, 32 SEC Docket 999, 1004 (March 5, 1985). Section 15(b)(4)(E) of the Exchange Act also provides that a broker or dealer has a statutory defense if it can be demonstrated that (1) 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 (2) 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. "It is not sufficient for a broker-dealer to establish a system of supervisory procedures which rely solely on supervision by branch managers." In the Matter of Prudential-Bache Securities, Inc., Exchange Act Release No. 22755, 48 S.E.C. 372, 400 (January 2, 1986). Broker-dealers must not only adopt effective procedures for supervision, but must also "provide effective staffing, sufficient resources and a system of follow up and review to determine that any responsibility to supervise delegated to compliance officers, branch managers and other personnel is being diligently exercised." In the Matter of Mabon, Nugent & Co., 47 S.E.C. 862, 867 (January 13, 1983). The system must provide sufficient checks "to insure that the first line of compliance, the branch manager, [is] functioning adequately." In the Matter of Shearson Lehman Brothers, Inc., Exchange Act Release No. 23640, 36 SEC Docket 1075, 1083 (September 24, 1986). Moreover, "[t]he need for central control increases, not decreases, as branch offices become more numerous, dispersed and distant." In the Matter of Shearson, Hamill & Co., Exchange Act Release No. 7743, 42 S.E.C. 811, 843 (November 12, 1965). Previously, the Commission has determined that firms with a high number of one or two person offices have not discharged their supervisory obligations where there were no surprise inspections. In the Matter of Royal Alliance Associates, Inc., Exchange Act Release No. 38174, 63 SEC Docket 1843 (January 15, 1997) (Broker- dealer's practice of conducting a pre-announced compliance examination of its off-site registered representatives only once a year was inadequate to satisfy its supervisory obligations); In the Matter of Consolidated Investment Services, Exchange Act Release No. 36687, 61 SEC Docket 20 (Jan 5, 1996) (Broker- dealer's supervision of a small office run by a single registered representative inadequate without surprise inspections, and annual compliance questionnaires inadequate substitute for on- site inspections). NYLIFE Securities' reliance on supervisory interviews of registered representatives and annual inspections of branch offices by regional compliance personnel without examining any customer files was inadequate to prevent and detect the Worcester and Buffalo registered representatives' violations. Moreover, NYLIFE Securities' failure to conduct any unannounced examination of the Worcester registered representative during a seven-year period was inadequate to satisfy its supervisory obligations, especially in light of the fact that approximately one-half of NYLIFE Securities' approximately 6,300 registered representatives work in off-site offices with fewer than five people. Therefore, NYLIFE Securities failed reasonably to supervise the Worcester and Buffalo registered representatives with a view toward preventing their violations of the securities laws because its procedures were inadequate to prevent and detect the violations. NYLIFE Securities' procedures were also inadequate because there was no system of follow up and review to determine that the responsibility delegated to the Managing Partner of the Buffalo branch office was being diligently exercised. The Managing Partner was instructed to more closely supervise the Buffalo registered representative by following additional supervisory procedures. If he had complied with those procedures, he might have detected the Buffalo registered representative's violations. The Managing Partner, however, failed to comply with those procedures, and there was no system in place to review the adequacy of his supervision to ensure that he was following the additional supervisory procedures. IV. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer of Settlement submitted by NYLIFE Securities and impose the sanctions specified therein. Accordingly, IT IS HEREBY ORDERED that: 1.NYLIFE Securities shall be, and hereby is, censured; 2.NYLIFE Securities shall, within ten (10) days of the entry of this Order, pay a civil money penalty in the amount of $200,000 to the United States Treasury. Such payment shall be: (A) made by United States postal money order, certified check, bank cashier's check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (D) submitted under cover letter that identifies NYLIFE Securities as a Respondent in these proceedings and the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Grant David Ward, Assistant District Administrator, Securities and Exchange Commission, Boston District Office, 73 Tremont Street, Suite 600, Boston, MA 02108; and 3.NYLIFE Securities shall comply with its undertakings described in footnote 6 above, implemented prior to the date of this Order, and those undertakings shall be maintained. By the Commission. _______________________________ Jonathan G. Katz Secretary **FOOTNOTES** [1]: The findings herein are made pursuant to NYLIFE Securities' Offer of Settlement and are not binding on any other person or entity in this or any other proceeding. [2]: In fact, the Worcester registered representative maintained documents relating to his fraudulent conduct in his customer files because he believed that his files would not be examined. [3]: NYLIFE Securities' supervisory procedures required inspections of its registered representatives, including a review of their customer files, only on an "as needed" basis. Factors that could prompt the inspection of a registered representative were a high volume of complaints, commission reversals, transaction reversals, redemptions, customer address changes and the use of unauthorized sales literature. [4]: The Worcester registered representative was not subjected to an "as needed" inspection prior to the discovery of his misappropriation scheme in November 1995. [5]: The review was conducted in response to a state insurance department inquiry concerning sales practices. The Buffalo registered representative was identified as one of a group of registered representatives that were subject to a high incidence of customer complaints. [6]: Prior to the date of this Order, NYLIFE Securities has undertaken to adopt procedures to enhance its supervisory procedures relating to the types of violations that gave rise to these proceedings and which are described in this Order.