Acting as Rocky Mountain Securities & Investments Inc.'s (RMSI) President, Director, Registered Financial and Operations Principal (FINOP), and Compliance Officer, Stephen J. Horning was a jack-of-all-trades — unfortunately, he appeared not to be a master of any. Horning was solely responsible for supervision of the Trading Department as well as the three-person Operations Department, which was run by a high-school graduate who had no registrations and had failed the Series 7. In 2001, the Securities and Exchange Commission (SEC) conducted a routine examination of RMSI and discovered that the Head Trader had accumulated over $600,000 in unreported trading losses in unrecorded accounts. Although RMSI's Operations Manager and its Assistant Director of Compliance knew about the unrecorded trades from clearing house data, neither employee notified Horning. The SEC issued a deficiency letter citing net capital, books and records, and inadequate written supervisory procedures.
Under Control
In responding to the SEC, Horning claimed to have remedied all the problems, and argued that “the differences were detected [but] they were then ignored … [in the] hope that the market would recover and help alleviate some of these problems.” Separately, Horning told the NASD that he was implementing procedures to prevent a recurrence of the Head Trader's misconduct. In spite of everything, Horning decided that the Head Trader, Operations Manager, and Assistant Director of Compliance were trustworthy and deserved a second chance. He did not fire or fine them, and did not make them repay the losses.
Crash And Burn
Horning's abiding faith in redemption was not rewarded. From April 2002 through January 2003, the Head Trader incurred approximately $6.5 million in losses in RMSI's proprietary accounts. The Head Trader concealed those losses by entering fictitious profitable trades in RMSI's computer system and omitting losing trades. He also entered fictitious trades in the personal accounts of RMSI's registered representatives. The Operations Manager used approximately $4.5 million of customer and firm funds to pay for the trading losses and further the cover-up. The scheme did not work, and in 2003, RMSI underwent an SIPC liquidation.
On February 20, 2007, the Operations Manager pled guilty to wire fraud, and was sentenced to a 24-month imprisonment, three years supervised release, and was ordered to make restitution in the amount of just over $6.9 million. See United States v. Andrade, (No. 06-CR-00196/D. Colo. 2006). On September 4, 2007, the Head Trader pled guilty to wire fraud, was sentenced to a 54-month imprisonment, three years supervised release, and was ordered to make restitution in the amount of just over $6.9 million. See United States v. Clarke, (No. 06-CR-00333/D. Colo. 2006).
Out To Lunch
In The Matter of Stephen J. Horning (1934 Rel. No. 56886 / http://sec.gov/litigation/opini0ons/2007/34-56886.pdf/ December 3, 2007), the SEC found that Horning had failed to reasonably supervise the Head Trader and Operations Manager; and had permitted net capital, customer reserve, and books and records violations. The SEC barred Horning in any supervisory capacity, and suspended him in all capacities for 12 months.
The SEC found that Horning failed to institute any adequate reconciliation procedure. Even after an auditor warned him to ensure adequate separation of cash receipt and disbursement duties, Horning failed to implement remedial procedures. Moreover, Horning did not put an operations manual in place for the Operations Department, and he lacked accurate information about the duties performed by that three-person department.
Although Horning claimed that he reasonably relied upon the Head Trader's and Operations Manager's assurances, the SEC admonished that where subordinates have committed misconduct in the past, it is inappropriate for supervisors to rely on unverified representations.
Writer's BIO: Bill Singer practices law at Stark &Stark, and is the publisher of RRBDLAW.com