FAILING TO SUPERVISE LARGE MUNICIPAL ACCOUNTS
A third settled administrative proceeding arising out of the churning of two Florida municipal accounts at First Allied Securities, Inc. was filed last week. This case was brought against the firm for failing to properly supervise the account executive. In the Matter of First Allied Securities, Inc., Adm. Pro. File No. 3-13808 (March 5, 2010). The earlier cases were filed against, respectively, the registered representative Harold Jaschke and his supervisor as discussed here.
Each case centers on trading conducted by Mr. Jaschke in the accounts of the City of Kissimmee, Florida and the Tohopekaliga Water Authority of Florida. Each municipality had ordinances which directed that it only make conservative investments designed to safeguard the principal. Mr. Jaschke developed an investment strategy based on trading STRIPS, a particular type of long term zero coupon Treasury Bond. While the bonds themselves are conservative investments, when traded they can be highly volatile and are sensitive to even small interest rate movements.
Over a three year period beginning in 2005, Mr. Jaschke made numerous unauthorized trades which were contrary to the policies of the two clients and which were not suitable. For Kissimee, he placed a total of 478 trades for $2.8 billion of STRIPS. This resulted in a profit of $4.3 million and commissions of $6.1 million. For the Water Authority, Mr. Jaschke placed 563 trades for $3.1 billion in purchases yielding $5.5 million in profits and $8.1 million in commissions. During the trading Mr. Jaschke, who had discretionary authority over the accounts, but failed to fully inform his clients about his actions, incorrectly told the two municipalities that account statements depicting his risky trading were wrong. The firm retained 10% of all the commissions. Throughout, the two clients relied on Mr. Jaschke.
According to the Order for Proceedings, the failure to supervise by First Allied hinged on the following:
• Ignoring “exceptions reports.” These are automated reports generated by Bear Stearns, the firm’s clearing agent, indicating the possibility of churning. When a report is generated, First Allied typically sent a “negative response letter” presenting the issue to the customer, but not requiring a response. In September and December 2006, exceptions reports were issued. After the June report, the firm chose not to send a letter based on the representations of Mr. Jaschke. Six months after the December report, a positive response letter (requiring a response) which also discussed other trading activity involving risky repos was sent to each client. Mr. Jaschke persuaded the clients to sign and return the letters. Nobody at the brokerage firm contacted either client before January 2008. This follow-up system was not reasonable, according to the Order.
• Use of personal e-mail/lack of record retention. Mr. Jaschke repeatedly used his personal e-mail account for business. Supervisors at the firm were aware of this use of personal e-mail. During a broker deal examination by the Commission staff, Mr. Jaschke’s use of personal e-mail was pointed out to the firm. The staff was assured that Mr. Jaschke’s personal e-mail was properly saved. In fact, it was not. Although the firm had a policy regarding the use of personal e-mail, it failed to monitor it and failed to ensure that the e-mail was properly maintained.
The Order for Proceedings charged the brokerage firm with failing to reasonably supervise Mr. Jaschke and to detect and prevent his violations of the antifraud provisions of the Securities Act and the Exchange Act.
To resolve the action, the firm consented to the entry of a cease and desist order. It also agreed to pay disgorgement of $1,224,606, pre-judgment interest of $233,699 and a civil penalty of $500,000. In addition, the firm will retain an Independent Consultant to review its written supervisory policies, prepare a report with recommendations for improvements and changes which the firm will adopt.