UNITED STATES OF AMERICA Before The SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 41036 / February 10, 1999 INVESTMENT ADVISERS ACT OF 1940 Release No. 1789 / February 10, 1999 ADMINISTRATIVE PROCEEDING File No. 3-9823 _____________________________ ) ORDER INSTITUTING PUBLIC In the Matter of ) PROCEEDINGS, MAKING FINDINGS, ) IMPOSING REMEDIAL SANCTIONS, ) AND ISSUING CEASE-AND-DESIST ) ORDERS REPUBLIC NEW YORK SECURITIES ) CORPORATION and JAMES ) EDWARD SWEENEY, ) ) Respondents. ) _____________________________ ) I. The Securities and Exchange Commission (the "Commission") deems it appropriate and in the public interest to institute public administrative and cease-and-desist proceedings pursuant to Section 15(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Section 203(k) of the Investment Advisers Act of 1940 ("Advisers Act"), to determine whether Republic New York Securities Corporation ("RNYSC") and James Edward Sweeney ("James Sweeney" or "Sweeney") willfully aided and abetted and caused violations of Sections 206(1) and 206(2) of the Advisers Act committed by a formerly registered investment adviser. In anticipation of the institution of these proceedings, RNYSC and James Sweeney (collectively, "Respondents") have submitted Offers of Settlement ("Offers") which 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 without admitting or denying the findings contained herein, except that Respondents admit the jurisdiction of the Commission over them and over the subject matter of these proceedings, Respondents consent to the issuance of this Order Instituting Public Proceedings, Making Findings, Imposing Remedial Sanctions, and Issuing Cease-and-Desist Orders ("Order"). Accordingly, IT IS ORDERED that administrative and cease- and-desist proceedings pursuant to Section 15(b) of the Exchange Act and Section 203(k) of the Advisers Act be, and hereby are, instituted. II. On the basis of this Order and the Respondents' Offers, the Commission makes the following findings:[1] A. NATURE OF PROCEEDING 1. This proceeding concerns a registered broker-dealer’s aiding and abetting and causing an investment adviser’s soft dollar fraud. Soft dollar practices are arrangements under which products or services other than the execution of securities transactions are obtained by an investment adviser from or through a broker-dealer in exchange for the direction by the adviser of client brokerage transactions to the broker- dealer. Soft dollars are benefits generated by such direction of brokerage. Because the advisory clients’ commissions dollars generate the soft dollars that pay for these goods and services, the soft dollars benefits are assets of the clients. 2. Section 28(e) of the Exchange Act provides a safe harbor that protects an investment adviser who uses soft dollars to obtain from or through a broker-dealer research and brokerage services (collectively, "research expenses"), and discloses such use (and complies with other requirements), from charges of breach of fiduciary duty for failing to obtain the lowest available commission rate. Research is generally defined as a product or service that provides lawful and appropriate assistance to a money manager in making investment decisions. The cost to an investment adviser of the research is referred to as "research expenses." 3. Between May 1994 and April 1995, Respondents RNYSC, a broker-dealer registered with the Commission, and James Sweeney, then RNYSC’s chief operating officer, paidrebated approximately $84,000 in soft dollar benefits to or on behalf of Sweeney Capital Management ("SCM"), an investment adviser.[2] During this period, SCM and its principals misappropriated soft dollars from their clients by purchasing and selling securities for their clients without disclosing their use of the clients' soft dollar benefits for their own personal expenses and business expenses unrelated to research.. 4. RNYSC and James Sweeney aided and abetted and caused SCM’s fraudulent conduct by processing SCM’s trades and paying its soft dollar invoices without inquiry in the face of indications, including the following facts, that SCM may have been engaged in a course of conduct that could violate the antifraud provisions of the securities laws: * Invoices Submitted to RNYSC Related to Non-Research Expenses. The invoices and paperwork provided by SCM to RNYSC requesting payment revealed on their face that the expenses were not for research or brokerage services and provided little or no direct benefit to SCM’s clients. Such payments are outside the safe harbor provided by Section 28(e) of the Exchange Act. In fact, more than 80% of the expenses submitted by SCM and paid by RNYSC were not related to research or brokerage within Section 28(e). * Payments Made Directly to Adviser. RNYSC forwarded all soft dollar payments directly to SCM. These payments included checks written by RNYSC and made payable to SCM’s soft dollar vendors as well as checks written by RNYSC made payable to SCM and SCM’s principals. RNYSC did not maintain contractual privity with SCM’s soft dollar vendors. The payments therefore were outside the safe harbor of Section 28(e) of the Exchange Act because the soft dollar products and services were not "provided by" RNYSC. * Invoices On Their Face Contained Indications of Fraud. SCM submitted soft dollar invoices that contained distinct indications that the invoices may have been fraudulent. For example, some of the invoices stated that an SCM principal had provided extensive research "consulting services," when RNYSC knew that this person was not a consultant and was instead an SCM vice-president and full-time employee of SCM and therefore should have known she was not a consultant to SCM. * Inadequate Documentation. RNYSC made many soft dollar payments on behalf of SCM to unfamiliar vendors and without receiving adequate documentation to establish that the expenses had actually been incurred by SCM. For example, RNYSC wrote purported reimbursement checks payable to SCM based only upon an invoice without proof that SCM had actually paid for the good or service. * 5. In early 1995, an attorney at RNYSC’s corporate parent told an RNYSC assistant vice-president that payment of an adviser’s non-research expenses with soft dollars could lead to potential aiding and abetting liability for RNYSC, and the assistant vice-president shared this information with others at the firm. 6. Despite the red flags described above and other facts that should have alerted RNYSC and Sweeney to SCM’s misconduct , RNYSC and Sweeney paid SCM’s expenses with client-owned soft dollars. RNYSC did not inquire about SCM’s authority to acquire products or services with client assets. It also did not inquire about SCM’s disclosures to its advisory clients and continued to process securities transactions and rebate soft dollar benefits to SCM. In fact, during the period when RNYSC paid SCM’s soft dollar invoices, SCM had failed to disclose to its advisory clients that it was receiving non-research soft dollar benefits. SCM’s disclosure concerning its soft dollar practices was inadequate. By continuing the soft dollar arrangement while ignoring the red flags described above and other facts, RNYSC aided and abetted participated in SCM’s misconduct. B. RESPONDENTS 7. Republic New York Securities Corporation is a Maryland corporation with its principal place of business in New York, New York. RNYSC is registered with the Commission as a broker-dealer pursuant to Section 15 of the Exchange Act and has engaged in the general business of a broker-dealer since approximately January 22, 1992. 8. James Edward Sweeney, age 50, is the President, Chief Executive Officer, and Chief Operating Officer of RNYSC. James Sweeney is registered with the NASD as a principal of RNYSC. Sweeney became RNYSC’s Chief Operating Officer in May 1994, its President in December 1994, and its Chief Executive Officer in June 1996. James Sweeney is not related to SCM or its president, Timothy Sweeney. C. RELATED ENTITY 9. Sweeney Capital Management, Inc., a California corporation located in San Francisco, was registered with the Commission as an investment adviser from March 1993 until its registration was withdrawn, effective July 1997. On March 10, 1998, the Commission filed a complaint in the Northern District of California against SCM and its principals alleging fraudulent misconduct, including fraud relating to its soft dollar operations. D. SCM DEFRAUDS ITS ADVISORY CLIENTS 10. Beginning in May 1994, SCM, aided and abetted by its two principals, willfully violated Sections 206(1) and 206(2) of the Advisers Act and other provisions of the securities laws. 11. SCM and its principals had discretionary management over SCM’s clients’ funds and executed its clients’ securities transactions through RNYSC. SCM, aided and abetted by its principals, misappropriated soft dollar benefits from their advisory clients by trading through RNYSC while failing to disclose to clients the use of soft dollar benefits for business and personal expenses. Among other things, SCM submitted to RNYSC fraudulent invoices as well as invoices for non-research related goods and services. RNYSC paid each invoice without question, despite the red flags indicated above that should have put RNYSC on notice of SCM’s possible misconduct. During its fiscal year ended December 31, 1994, SCM paid over 70% of its operating expenses with clients’ soft dollars, including rent, insurance, federal and state licensing fees, postage, accounting fees, telephone bills, client gifts, and satellite television installation. Without these soft dollar payments, SCM would have been insolvent during this period. E. RNYSC ESTABLISHES ITS SOFT DOLLAR BUSINESS 12. From its inception in late 1992, RNYSC designated soft dollars as one of its primary areas of operation and promoted its soft dollar services to money managers and investment advisers. By May 1994, RNYSC had approximately 80 soft dollar accounts and a soft dollar department consisting of about 15 employees. 13. Prior to May 1994, RNYSC operated its soft dollar business in such a manner as to stay within the safe harbor of Section 28(e). RNYSC paid only advisers’ research expenses, made soft dollar payments directly to vendors, did not reimburse advisers for previously paid expenses, and maintained contractual privity with soft dollar vendors. RNYSC also investigated unknown soft dollar vendors to ensure that their products and services qualified for the Section 28(e) safe harbor. 14. From 1992 through the time of the events discussed in this Order, RNYSC had no written policies or procedures relating to its soft dollar operations. F. RNYSC ELIMINATES ITS SOFT DOLLAR DEPARTMENT BUT CONTINUES ITS SOFT DOLLAR BUSINESS 15. RNYSC hired James Sweeney as a consultant in October 1993 to analyze certain profitability issues. While Sweeney had not previously been involved in soft dollar operations, he was experienced in the securities industry, familiar with soft dollars, and understood that soft dollars were assets of an investment adviser’s client. Partly as a result of Sweeney’s work, RNYSC reorganized its management structure and curtailed several areas of its business. On May 2, 1994, as part of this reorganization, RNYSC laid off its entire soft dollar department. At about the same time, RNYSC named James Sweeney as its Chief Operating Officer. 16. Although RNYSC eliminated its soft dollar department in May 1994, the firm reduced but did not eliminate its soft dollar operations. Soon after the layoffs, Sweeney determined that RNYSC needed to provide soft dollar services to certain existing customers for competitive purposes. After May 1994, RNYSC decided to maintain soft dollar arrangements with a small number of new brokerage customers and with selected investment advisers. 17. Prior to the May 1994 layoffs, RNYSC made no provision to transition the soft dollar business to employees who would remain at RNYSC. G. RNYSC BEGINS TO MAKE SOFT DOLLAR PAYMENTS FOR SCM 18. RNYSC and SCM reached an oral brokerage and soft dollar agreement shortly before May 2, 1994. Under this arrangement, SCM agreed to direct brokerage business to RNYSC. In return, RNYSC agreed to give SCM a soft dollar credit of $1.00 for every $1.75 of brokerage commissions generated by SCM's trades. 19. On May 12, 1994, less than two weeks after RNYSC’s elimination of its soft dollar department, SCM began to submit soft dollar invoices to RNYSC for payment. Over the next year, SCM and its principals misappropriated their clients’ soft dollars and failed to disclose to advisory clients that SCM was using soft dollars to pay for general business and personal expenses. 20. James Sweeney’s signature was required for payment of all invoices at RNYSC, including soft dollar invoices. No one else at RNYSC had the authority to approve soft dollar invoices. 21. After RNYSC eliminated its soft dollar department in May 1994, RNYSC had no formal procedures in place to ensure that soft dollar payments were in compliance with applicable securities laws. RNYSC and Sweeney did not assign responsibility to anyone to ensure that all soft dollar invoices were reviewed systematically prior to submission to Sweeney for approval. The soft dollar practices put into place by the firm’s former soft dollar department were discontinued. 22. SCM’s advisory clients were also RNYSC’s brokerage customers. RNYSC administered the soft dollar relationship by making trades and keeping books and records relating to soft dollars. H. RNYSC PERSONNEL ARE WARNED OF THAT A BROKER-DEALER MAY BE LIABLE FOR ASSISTING AN ADVISER’S SOFT DOLLAR MISCONDUCT 23. In December 1994, a RNYSC assistant vice-president involved with the processing of soft dollar payments expressed his concern that RNYSC conduct its soft dollar business in compliance with applicable rules and regulations. At Sweeney’s suggestion, he sought general legal information regarding soft dollars from a lawyer at RNYSC’s parent corporation ("RNYSC’s attorney") in January 1995. 24. RNYSC’s attorney cautioned in general terms that RNYSC should pay soft dollar invoices for investment advisers only if the expense aided the adviser’s investment decision- making process, such as research expenses. She said that RNYSC should not simply assume that an adviser was following applicable rules. She also said that RNYSC should not pay an adviser’s’ general administrative expenses, such as rent, computer hardware not used for research, and bookkeeping. Finally, RNYSC’s attorney noted that, under certain circumstances, RNYSC could be liable for aiding and abetting an adviser’s violation of its duties to the advisory clients. 25. Sometime in early 1995, soon after speaking with RNYSC’s attorney, the RNYSC assistant vice-president discussed this conversation with others at RNYSC who were involved with the payment of soft dollar invoices. The RNYSC assistant vice- president stated that he raised with James Sweeney the issue of RNYSC’s potential liability for advisers’ soft dollar misconduct; Sweeney denies that this issue was ever discussed in his presence. After these conversations, no firm-wide steps were taken to ensure that RNYSC’s soft dollar operations were appropriate. I. RNYSC AND JAMES SWEENEY ASSIST SCM’S MISCONDUCT 26. During the period that RNYSC paid SCM’s soft dollar invoices, RNYSC and James Sweeney were aware of significant red flags that should have alerted them that they may have been aiding and abettingparticipating a fraudulent course of conduct. Under these circumstances, James Sweeney and RNYSC should have inquired into SCM’s authority to engage in these types of soft dollar transactions but failed to do so. RNYSC and James Sweeney did not question or reject a single SCM soft dollar invoice or request for payment. SCM simply forwarded its requests to RNYSC, and James Sweeney continued to approve the payments using client-owned soft dollar benefits. No one at RNYSC raised the issue of whether the firm should cease paying soft dollars for SCM based on the following red flags. 27. Invoices Submitted to RNYSC Related to Non-Research Expenses. The invoices and paperwork provided by SCM to RNYSC requesting payment revealed on their face that the expenses were not for research or brokerage services and provided little or no direct benefit to SCM’s clients. In fact, over 80% of RNYSC’s approximately $84,000 in soft dollar benefit payments to SCM and its vendors were for non- research expenses outside Section 28(e). For example, RNYSC approved and paid invoices that stated that the expenses were for rent, insurance, federal and state licensing, postage, accounting fees, telephone bills, client gifts, and satellite television installation. The approximate percentage of research versus non-research expenses remained constant throughout the one year period. 28. Payments Made Directly to Adviser. RNYSC sent directly to SCM virtually all soft dollar payments made on SCM’s behalf. These payments included checks written by RNYSC and made payable to SCM’s soft dollar vendors; as well as as well as checks written by RNYSC made payable to SCM and SCM’s principals totaling approximately $8,000 (excluding the payments described in paragraph 29). Sweeney knew that at least some of the checks payable to vendors were being sent to SCM and he signed the checks payable to SCM and its principals. Because RNYSC did not maintain contractual privity with SCM’s soft dollar vendors, its soft dollars payments to or on behalf of SCM fell outside the safe harbor of Section 28(e). 29. Invoices On Their Face Contained Indications of Fraud. SCM provided invoices to RNYSC that stated that SCM’s vice- president had provided "consulting services" to SCM. The cover letters enclosing the invoices were typically addressed to RNYSC managers (not James Sweeney) who spoke with the vice-president frequently and knew that she was a full-time employee of SCM. RNYSC paid nine such invoices totaling $14,600 by checks made payable to the SCM vice- president, and sent directly to SCM. The soft dollars actually paid the vice-president’s salary. 30. Inadequate Documentation. In many instances, including those described below, RNYSC and Sweeney without inquiry approved checks payable to SCM and one of its principals without adequate documentation demonstrating that the submitted expense had actually been incurred. a) On approximately nine occasions, RNYSC reimbursed SCM or the principal based only upon an invoice submitted, with no canceled check to indicate that SCM or the principal had paid the invoice. Approximately twelve other times, RNYSC reimbursed SCM or the principal based only upon an invoice and a non-canceled check submitted by SCM as purported evidence that the expense had been incurred. On approximately seven occasions, RNYSC without inquiry made soft dollar payments to SCM and certain vendors without requiring SCM to furnish an invoice for the goods and services. b) RNYSC paid two false consulting invoices totaling $2,942.00 to the parents of an SCM principal. The parents never performed consulting services for SCM. The description on the invoices lacked any detail and simply read "for consulting services." The listed payee on the invoice was a fictitious entity. RNYSC wrote checks made payable to the purported vendor and sent them directly to SCM. No one at RNYSC inquired about this new vendor or the nature of the services purportedly rendered. c) RNYSC paid three false invoices totaling $3,383.94 for consulting services to an elderly advisory client of SCM. The invoices stated only that they were for "financial services." RNYSC wrote checks payable to the purported vendor, and sent the checks directly to SCM. No one at RNYSC inquired about this unfamiliar soft dollar vendor. Sweeney approved the invoices without question. 31. In addition, even after the RNYSC attorney stated that RNYSC should not pay for non-research items with soft dollars, RNYSC continued to pay for such products and services on behalf of SCM using the soft dollar assets of SCM’s advisory clients. Between February 22 and April 25, 1995, RNYSC paid without inquiry 31 invoices totaling nearly $8,000 in non- research expenses for SCM, including client gifts, rent, insurance, federal and state licensing fees, postage, accounting, an office water cooler, telephone bills, and satellite television installation. J. SUBSEQUENT EVENTS 32. In April 1995, RNYSC decided to stop paying SCM soft dollar invoices because SCM had accumulated a large soft dollar deficit. However, RNYSC paid one additional soft dollar invoice for SCM in August 1996. In approximately November 1996, RNYSC terminated the SCM accounts. 33. In 1997, RNYSC retained an outside consultant to evaluate its soft dollar practices and later adopted written policies and procedures concerning soft dollars. III. A. The Commission has stated that "conduct outside of the safe harbor of Section 28(e) may constitute a breach of fiduciary duty as well as a violation of specific provisions of the federal securities laws." Interpretive Release Concerning The Scope of Section 28(e) of the Securities Exchange Act of 1934, Exchange Act Release No. 23170 (April 30, 1986). B. The Commission previously put brokerage firms and associated persons on notice of their potential liability for an adviser’s misconduct relating to soft dollars. In a report pursuant to Section 21(a) of the Exchange Act, the Commission stated in the context of soft dollars that "[a] broker which causes or assists an institution to violate a duty to the investor may be aiding and abetting a fraudulent or deceptive act or practice." Report of Investigation in the Matter of Investment Information, Inc. Relating to the Activities of Certain Investment Advisers, Banks, and Broker-Dealers, Exchange Act Release No. 16679 (March 19, 1980) ("21(a) Report"). See also Confirmation of Transactions Under Fixed Commissions, Exchange Act Rel. No. 11629 (September 3, 1975) ("1975 Release"); Interpretation of Section 28(e) of the Securities Exchange Act of 1934; Use of Commission Payments by Fiduciaries, Exchange Act Release No. 12251 (March 24, 1976) ("1976 Release"). C. The Commission added that: "Brokers should recognize that compliance with any direction or suggestion by a fiduciary which would appear to involve a violation of the fiduciary’s duty to its beneficiaries could implicate them in a course of conduct violating the antifraud provisions.... Furthermore, a broker would have a duty to inquire with respect to his participation in a course of conduct which, to a reasonable person, would raise a question of fraudulent or deceptive acts or practices." 21(a) Report (quoting 1975 Release and 1976 Release). **FOOTNOTES** [1]: The findings herein are made pursuant to Respondents' Offers of Settlement and are not binding on any other person or entity in this or any other proceeding. [2]: Of the approximately $84,000 in soft dollar benefits, approximately $29,000 was paid in connection with trades done on behalf of SCM’s individual advisory clients and approximately $55,000 was paid in connection with trades done on behalf of a hedge fund for which SCM was the investment adviser and general partner. IV. Based on the foregoing, RNYSC and James Sweeney willfully aided and abetted and caused violations of Advisers Act Sections 206(1) and 206(2) by SCM by their knowing or reckless participation in a course of conduct that should have alerted them to the likelihood that SCM was violating its fiduciary obligations to its clients. V. In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions specified by RNYSC and James Sweeney in their Offers. Accordingly, IT IS ORDERED, that : A. RNYSC shall be, and hereby is, censured; B. Pursuant to Section 203(k) of the Advisers Act, RNYSC shall, effective immediately, cease and desist from committing or causing any violation and any future violation of Sections 206(1) and 206(2) of the Advisers Act; and C. RNYSC shall, within thirty (30) days of the date of this Order, pay a civil money penalty in the amount of $50,000 to the United States Treasury. 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 or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (4) submitted under cover letter which identifies RNYSC as a Respondent in these proceedings, and states the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to David B. Bayless, San Francisco District Office, Securities and Exchange Commission, 44 Montgomery Street, Suite 1100, San Francisco, CA 94104. IT IS FURTHER ORDERED that: A. James Sweeney shall be, and hereby is, censured; B. Pursuant to Section 203(k) of the Advisers Act, James Sweeney shall, effective immediately, cease and desist from committing or causing any violation and any future violation of Sections 206(1) and 206(2) of the Advisers Act; and C. James Sweeney shall, within thirty (30) days of the date of this Order, pay a civil money penalty in the amount of $25,000 to the United States Treasury. 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 or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (4) submitted under cover letter which identifies James Sweeney as a Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to David B. Bayless, San Francisco District Office, Securities and Exchange Commission, 44 Montgomery Street, Suite 1100, San Francisco, CA 94104. By the Commission. Jonathan G. Katz Secretary