## Facts

- A registered broker-dealer acquired a retail brokerage business and installed the acquired firm’s Cleveland branch manager as the new Cleveland branch-office manager.
- The branch manager was a “producing” manager who both supervised the branch and serviced his own retail customers.
- Over many years, the manager misappropriated customer funds and sent falsified account documents that materially overstated account values, using new deposits and unauthorized withdrawals to satisfy customer requests.
- At the firm, the manager had influence over the compensation and continued employment of personnel responsible for reviewing correspondence and approving certain disbursements.
- The manager maintained channels and tools that bypassed ordinary firm controls, including: a fax machine restricted to him and his assistants, a non-networked personal computer used to generate false statements, and access to secure mailing infrastructure used to send falsified documents.
- Customer address information was manipulated so that authentic firm statements were diverted while customers received falsified documents from the manager.
- After roughly fifteen months at the firm, the manager disappeared and confessed to law enforcement; he later surrendered and pled guilty to securities- and mail-fraud offenses.
- The SEC instituted a settled administrative proceeding alleging the firm failed reasonably to supervise the manager with a view to preventing and detecting violations of the federal securities laws; the firm consented without admitting or denying the findings.

## Issues

1. Whether the broker-dealer failed reasonably to supervise the branch manager, within the meaning of Exchange Act § 15(b)(4)(E), with a view to preventing and detecting his securities-law violations.
2. What remedial sanctions and investor redress measures were appropriate in light of customer harm caused by the misconduct.

## Decision

- The SEC found the firm failed reasonably to supervise the branch manager under Exchange Act § 15(b)(4)(E).
- The SEC ordered the firm to cease and desist from committing or causing future supervisory violations.
- The SEC required remedial undertakings to strengthen supervisory policies and procedures, including controls over correspondence, communications channels, disbursements, and oversight of producing branch managers.
- The SEC ordered participation in a voluntary, special NYSE arbitration process for qualifying customers; the firm was responsible for arbitration awards tied to misconduct occurring during a defined period of the manager’s employment at the firm, with allocation rules for conduct spanning a transition window.

## Legal Principles

- A broker-dealer violates Exchange Act § 15(b)(4)(E) if it fails reasonably to supervise an associated person subject to its supervision with a view to preventing and detecting securities-law violations.
- “Reasonable supervision” requires supervisory structures and procedures reasonably designed and implemented to prevent and detect misconduct, including independent review where conflicts arise from a producing supervisor’s dual role.
- Supervisory systems must control and monitor customer communications, record generation, address changes, and outgoing mail to prevent off-system document creation and diversion of authentic account statements.
- A firm’s lack of effective controls over disbursements and correspondence review, especially where the wrongdoer can influence the reviewers’ employment or compensation, supports a finding of unreasonable supervision.
- The SEC may impose cease-and-desist relief, undertakings to reform supervisory procedures, and customer redress mechanisms (including special arbitration) as remedial sanctions in supervisory-failure proceedings.

## Conclusion

The SEC concluded that the broker-dealer’s branch structure and control weaknesses allowed a producing branch manager to bypass review and continue a large customer-fraud scheme, warranting cease-and-desist relief, mandated supervisory reforms, and a special arbitration process to facilitate customer recovery.


In re Lehman Bros., Inc., Exchange Act Release No. 48336 (Aug. 12, 2003)