SECURITIES AND EXCHANGE COMMISSION Washington D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 41007 / February 1, 1999 Admin. Proc. File No. 3-9046 ____________________________________________ : In the Matter of : : JAMES HARVEY THORNTON : : and : : PAYNE & THORNTON, INC., : d/b/a RETIREMENT INVESTMENT GROUP : ____________________________________________: OPINION OF THE COMMISSION BROKER-DEALER PROCEEDINGS Ground for Remedial Action Failure to Supervise Registered broker-dealer and its president failed reasonably to supervise registered representative with a view to preventing representative's violations of antifraud provisions of the securities laws. Held, in the public interest to order the broker-dealer to pay a $50,000 penalty and to revoke its registration and to order president to pay a $5,000 penalty and to bar him in all capacities from association with any broker-dealer with a right to reapply in non-proprietary and non-supervisory capacity after three years. APPEARANCES: Christopher A. Colvert, for James Harvey Thornton and Payne & Thornton, Inc., d/b/a Retirement Investment Group. Christian R. Bartholomew, for the Division of Enforcement. Appeal filed: April 15, 1997 Last brief filed: August 7, 1997 I. Payne & Thornton, Inc., d/b/a Retirement Investment Group ("Retirement" or the "Firm"), a registered broker-dealer, and James Harvey Thornton, its president, general securities principal, financial and operations principal, and compliance officer, (collectively, "Applicants") appeal from the decision of an administrative law judge. The law judge found that, between July 25, 1991, and November 1991, Applicants failed reasonably to supervise a registered representative, Gail Griseuk, with a view to preventing her violations of Section 17(a) of the Securities Act of 1933 ("Securities Act") and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder. The law judge revoked the Firm's broker-dealer registration and imposed on the Firm a $50,000 penalty. The law judge also barred Thornton from association with any broker-dealer or member of a national securities exchange or registered securities association, barred him from participating in any offering of penny stock, and ordered him to pay a $5,000 penalty. We base our findings on an independent review of the record, except with respect to those findings not challenged on appeal. II. This case concerns the Applicants' alleged failure to supervise Griseuk between July 25, 1991, and November 1991, during which time she committed securities fraud. Griseuk's Fraud Griseuk consented, without admitting or denying any wrongdoing, to the entry of an Order finding that, while she was a registered representative with Retirement, she violated Securities Act Section 17(a) and Exchange Act Section 10(b) and Rule 10b-5 thereunder by making false and misleading statements and material omissions regarding the risk, safety, and liquidity of certain securities, as well as making false statements about the compensation she earned from selling those securities. [1] We ordered that Griseuk (1) cease and desist from further violating the securities laws and regulations that she was found to have violated, (2) be barred from association with any broker, dealer, municipal securities dealer, investment company, or investment adviser, and (3) disgorge $370,786, plus interest, all but $20,000 of which amount we waived because of Griseuk's inability to pay. Applicants admit that between July 25, 1991, and November 1991, Griseuk violated Securities Act Section 17(a) and Exchange Act Section 10(b) and Rule 10b-5 thereunder in connection with the sale of approximately $325,000 of limited partnership interests. Retirement's Organization Between July 25, 1991, and November 1991, Retirement, headquartered in Houston, Texas, had between forty and fifty registered representatives in five to six states. The Firm provided these registered representatives with investment research and certain administrative services (e.g., supervision), but did not pay any of their expenses. In return, the representatives paid to Retirement between ten and twenty percent of the commissions that they generated. During this period of time, Thornton was the Firm's president and was responsible for supervising all of these representatives. Red Flags and Warnings The Firm hired Griseuk as a registered representative on June 1, 1988. Griseuk operated out of offices in Florida. Her agreement with Retirement set her compensation at ninety percent of all commissions that she generated. She quickly became Retirement's most productive salesperson, and, by the time she left the Firm in late 1991, she was responsible for generating as much as 50 percent of Retirement’s revenues. When she was hired by Retirement, Griseuk stated on her Form U-4 that she had never been the subject of an "investment- related, customer-initiated complaint or proceeding that . . . alleged compensatory damages of $10,000 or more, fraud or wrongful taking of property." At the time of her hiring, however, Griseuk was in fact the subject of two separate customer complaints alleging that she had placed her customers in unsuitable investments. These complaints were disclosed to the Firm soon after its hiring of Griseuk, through a Form U-5 filed by Griseuk's former employer, Birchtree Financial Services, Inc. ("Birchtree") and through a Form U-4 Disclosure Reporting Page ("DRP") filed by Griseuk. The first of these complaints was filed January 16, 1987. In July 1988, Griseuk offered to settle this complaint by buying back the limited partnership investments that were the subject of the complaint. The Florida Division of Securities and Investor Protection investigated this complaint, but declined to find that Griseuk had violated Florida securities law. Griseuk reported on a Form U-4 Disclosure Reporting Page that the second complaint, filed June 21, 1987, was submitted to arbitration and later was dismissed. On June 2, 1988 (one day after Griseuk joined the Firm), a customer suitability lawsuit naming Griseuk as a defendant was filed in a Florida state court, and was disclosed to Retirement through a Form U-5 filed the same day by Birchtree. In May 1989, judgment was entered by default against Griseuk in this lawsuit, and she was ordered to pay $742,528, plus $156,000 in attorney’s fees and prejudgment interest, forcing her and two firms with which she was associated, Griseuk Realty and Griseuk Associates, to file for protection from their creditors under Chapter 11 of the federal Bankruptcy Code. In February 1989, a class action lawsuit was filed against Griseuk. Thirty-two plaintiffs alleged that Griseuk had placed them in unsuitable investments. This lawsuit was disclosed to Retirement soon after its filing. Griseuk reported on a Form U-4 DRP that this class action lawsuit was dismissed in September 1990. In early July 1991, Cullen Baker, a former employee of Griseuk's who recently had resigned from her organization, alerted Thornton that Retirement "could very easily have a major compliance problem [regarding the] suitability" of certain investment recommendations made by Griseuk. Although he was notified of these lawsuits, bankruptcies and customer complaints and had received the warning from Baker, Thornton made no meaningful effort to supervise Griseuk. He testified that he received the Forms U-4 and U-5, but that he did not read them very carefully, "missed" the information on them pertaining to Griseuk's disciplinary history, and that he "absolutely blew it." Thornton also never audited Griseuk's client accounts, inspected her offices, interviewed her employees and salespeople, contacted her clients, or otherwise inquired concerning the suitability of her investment recommendations. While Thornton claims to have visited Griseuk's office between three and five times during her three and one-half year tenure with Retirement, he concedes that he announced these alleged visits to Griseuk in advance. In any event, only one of these visits is confirmed by the record. A Griseuk employee present at that one meeting stated that it was a "non-event," that the office was not inspected, and that compliance issues were not discussed. "Griseuk Amendments" In late August and early September 1991, Thornton "by accident" contacted two Griseuk clients who informed him of certain of Griseuk's "unacceptable" sales tactics. In response, Thornton modified Retirement's procedures and supervisory policies in an effort to protect client liquidity and combat high-pressure sales tactics by registered representatives. Thornton testified that these modifications were "laughingly" referred to by him and his staff as the "Griseuk Amendments." Specifically, Thornton required registered representatives to (1) send sales proceeds directly to customers, rather than to a firm known as Southwest Securities for future investment (Thornton feared that this practice was confusing to customers); (2) maintain lists of "products" sold to each client and send the lists to Retirement at the end of each quarter, noting the customer's net worth on the bottom of the list; and (3) notify and discuss with Retirement if a customer was expected to exceed "fifty percent non-liquidity" in his portfolio (a "non-liquid product" was defined by Thornton as a financial instrument "that cannot be easily turned into equivalent cash"). The record does not reflect whether Applicants enforced these modified policies. Griseuk's Employment is Terminated On September 27, 1991, Thornton gave investigative testimony to the Division of Enforcement ("Division") in connection with its investigation of Griseuk. After that testimony, Thornton claims that he paid his first and only "surprise" (i.e., unannounced) visit to Griseuk's offices in Florida. Following this visit, Thornton determined that the Firm would not renew Griseuk's registration for calendar year 1992, thereby forcing Griseuk to seek employment with another broker-dealer. Accordingly, on December 30, 1991, Griseuk voluntarily terminated her association with the Firm. III. This Commission may censure, suspend, limit the activities of, or revoke the registration of, any broker or dealer if we find that (1) such sanction is in the public interest and (2) the broker or dealer "failed reasonably to supervise, with a view to preventing [securities] violations . . ., another person who commits such a violation, if such other person is subject to his supervision." [2] We also may sanction any natural person associated with a broker or dealer if we find that such individual has failed to supervise, [3] and may impose money penalties upon firms and individuals for failure to supervise, as long as such monetary sanction is "in the public interest." [4] No firm or individual shall be disciplined for failure to supervise, however, if (1) there were in place "procedures, and a system for applying such procedures, which would reasonably be expected to prevent and detect" the securities violation in question, and (2) the person responsible for administering such procedures and system "reasonably discharged [his] duties and obligations . . . without reasonable cause to believe that such procedures and system were not being complied with." [5] Applicants admit that Griseuk committed securities fraud and that they were responsible for supervising her. They further admit that they failed to supervise her by failing (1) to observe certain of Retirement's own internal supervisory procedures, (2) to implement additional supervisory procedures once they were on notice of possible securities law violations by Griseuk, and (3) to increase their supervision of Griseuk, given her disciplinary history. In this appeal, they do not challenge the law judge's findings of violation, but ask for a reduction of the sanctions imposed. On the basis of Applicants' admission of wrongdoing and our independent review of the record we find that Retirement, acting through Thornton, failed reasonably to supervise Griseuk. We further find that Thornton individually failed reasonably to supervise Griseuk. We discuss our findings briefly to provide a basis for our sanctions. Thornton did not review Griseuk's customer accounts pursuant to Retirement's internal supervisory procedures. Many, if not all, of Griseuk's customers were elderly persons on fixed incomes. She invested their money in risky and illiquid partnership interests. Had Thornton performed the rudimentary supervisory duty of reviewing Griseuk's customer accounts, the lack of suitability of these investments would have been clear. Applicants responded inadequately and belatedly to signs of Griseuk's possible misconduct. The July 1991 warning from Cullen Baker, Griseuk's former employee, of potential "compliance problems" with Griseuk's organization required Thornton, as a part of his supervisory obligations, to investigate further but Thornton did not take any responsive action. [6] Only after his "accidental" contact in September 1991 with two Griseuk customers did Thornton eventually implement the so-called "Griseuk Amendments." Applicants' knowledge of Griseuk's past conduct (i.e., the two customer complaints against Griseuk, the two lawsuits naming Griseuk as a defendant, and Griseuk's bankruptcy filing) imposed on them additional obligations to insure that rules and procedures were in place to supervise Griseuk properly. [7] Applicants also were obligated to enforce such rules and procedures. [8] Nevertheless, Applicants' supervisory policies made no provision for heightened supervision of a registered representative with a disciplinary history. At the very least, Applicants should have conducted on-site compliance audits and unannounced inspections of Griseuk's offices. This Commission and the National Association of Securities Dealers, Inc. ("NASD") have underscored the challenge of effectively supervising registered representatives in remote locations and often have stated the importance of conducting such audits and inspections frequently, particularly in the case of personnel who work a substantial distance from any supervisory or compliance officers. [9] Retirement's supervisory procedures did not require such audits and inspections. Had Thornton made a timely effort to conduct an on-site audit of Griseuk's business, inspect her office, speak with her employees and salespersons, or contact her customers, it would have been readily apparent that her sales tactics were inappropriate, as is evidenced by Thornton's perceived need to implement the "Griseuk Amendments" after interviewing only two Griseuk customers. Applicants argue that the NASD's "system" failed by allowing Griseuk to retain her registration, in spite of these "red flags." That the NASD permitted Griseuk to become associated with Retirement, however, does not relieve Applicants of their supervisory responsibilities. [10] IV. Thornton has been licensed as a registered representative in the securities industry since 1969. The NASD and state securities regulators have disciplined Thornton a total of eight times in his capacity as a supervisor or a principal of a firm, but have never disciplined him for his conduct as a registered representative. Based upon our findings of violation and this disciplinary history, a permanent bar in a supervisory capacity is warranted. [11] We also find it in the public interest to bar Thornton from association with a broker-dealer with the right to reapply, in a non-supervisory and non-proprietary capacity, after three years. Barring Thornton from participation in a penny stock offering is not appropriate in this instance. Congress amended the Exchange Act in 1990 to authorize this Commission to impose such a "penny stock bar," [12] with the intent of preventing unscrupulous securities professionals who have committed penny stock fraud from becoming consultants to or promoters of penny stock issuers after being otherwise banned from the securities industry. [13] Griseuk's fraud was in connection with the sale of partnership interests, not penny stocks, and Thornton's failure to supervise also did not involve penny stock fraud. Moreover, it does not appear that Thornton is likely to commit penny stock fraud, or even to enter the penny stock industry, in the future. In addition to barring Thornton, we revoke Retirement's registration and fine Retirement and Thornton $50,000 and $5,000, respectively, the maximum "first tier" penalty which we may impose pursuant to Exchange Act Section 21B(b). Exchange Act Section 21B(b) prescribes penalties which we may impose in instances of failures to supervise. The law judge found that a first tier penalty was appropriate under these circumstances, and we concur. While it is unusual for us to revoke a firm's registration for failure to supervise, Retirement serves few of the traditional purposes of a securities firm. It is so thinly structured that it will effectively cease to exist after our bar of Thornton, its sole principal; it offers minimal support to its registered representatives, who remit to it as little as ten percent of their commission income; and it has made essentially no effort to supervise its registered representatives or perform its other basic administrative functions. An appropriate order will issue. [14] By the Commission (Chairman LEVITT and Commissioner JOHNSON); Commissioner UNGER concurring separately; Commissioners HUNT and CAREY not participating. Jonathan G. Katz Secretary Commissioner UNGER, concurring: The Commission has recognized that substantial and affirmative responsibilities are placed on those who have a duty to supervise. [1] However, Exchange Act Section 15(b)(4)(E) provides that no person shall be held liable for deficient supervision if he "reasonably discharged the duties and obligations incumbent upon him by reason of [his firm's] procedures and system." [2] As we have noted before, "different supervisors may have different responsibilities depending on how each firm devises its compliance program." [3] Our prior decisions have been careful not to substitute the knowledge, gleaned with hindsight, of actual wrongdoing by someone under a supervisor's control for an assessment of whether the supervisor's conduct was proper under the circumstances. [4] Instead, we have applied the standard that a manager "must respond reasonably when confronted with indications of wrongdoing." [5] Thornton did not even come close to meeting the terms of the statute. Greed made him turn a blind eye to the problems of his most productive salesperson and caused him to fail to perform the most rudimentary oversight, even when he was specifically alerted of lawsuits, bankruptcies, and customer complaints against her. The "Griseuk Amendments," his belated attempt at imposing some controls on Griseuk, were a mockery. It is safe to say that the firm's procedures were wholly inadequate to provide supervisory oversight of operations, and that Thornton failed to apply the few procedures that were in place in any meaningful way. He also failed to respond adequately to numerous red flags, including specific warnings. Having been disciplined eight previous times by the NASD and state securities regulators, Thornton has shown repeatedly an utter lack of even the most rudimentary grasp of what it means to supervise reasonably. In fact, Thornton's significant and continuing errors in judgment as a supervisor call into question his ability to be in the securities industry in any capacity. For these reasons, I am confident that the Commission's disciplinary sanction imposed today is an appropriate remedy and is not the result of the Commission substituting its knowledge gleaned with hindsight for an assessment of the reasonableness of Thornton's judgements made at the time. Thornton's judgements, on the basis of information available to him at the time, were not reasonable. I wish to emphasize, however, that I view the record of Thornton's handling of his subordinate Griseuk quite differently from those situations where a supervisor either fails to uncover misconduct despite the proper discharge of his supervisory duties, or uncovers misconduct and takes quick, effective action to remedy the situation. The duty to exercise reasonable, effective supervision has never been construed to be an absolute guarantee against every malfeasance by errant subordinates. Rather, the Commission has always viewed the disposition of failure-to-supervise charges as requiring a fact-specific inquiry, and the identification of specific lapses in supervision. [6] I believe the Commission must exercise continuing vigilance to resist the pitfall of mistaking the cleverness of a wrongdoer in eluding appropriate supervisory measures for a failure at the supervisory level. Such a practice would only serve as a deterrent to supervisors who are inclined to "do the right thing" by alerting regulators when misconduct is detected. **FOOTNOTES** [1]: Gail G. Griseuk, Securities Act Rel. No. 7161 (Apr. 18, 1995), 59 SEC Docket 318. Our findings here with respect to Griseuk are made solely for the purpose of this proceeding. [2]:Exchange Act § 15(b)(4)(E). [3]:Exchange Act § 15(b)(6). [4]:Exchange Act § 21B. [5]:Exchange Act § 15(b)(4)(E). [6]:See Consolidated Investment Services, Exchange Act Rel. No. 36687 (Jan. 5, 1996); 61 SEC Docket 20, 29 ("Any indication of irregularity brought to a supervisor's attention must be treated with the utmost vigilance."). [7]:Id., 61 SEC Docket at 28 (citing Frank J. Custable, Jr., 51 S.E.C. 855, 860 (1993)) [8]:See Consolidated Investment Services, 61 SEC Docket at 30 (holding that a "registered representative who has previously evidenced misconduct can be retained only if he subsequently is subjected to a commensurately higher level of supervision") (citing Dan A. Druz, Exchange Rel No. 35203 (January 9, 1995), 58 SEC Docket 1621, 1627; Frank J. Custable, Jr., 51 S.E.C. at 861; Donald T. Sheldon, 51 S.E.C. 59, 82 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995)). [9]:See Consolidated Investment Services, 61 SEC Docket at 26-27. See also NASD Notice to Members 86-65, "Compliance with the NASD Rules of Fair Practice in the Employment and Supervision of Off-Site Personnel" (Sept. 12, 1986). [10]:Frank J. Custable, 51 S.E.C. 855, 860 n.14 (1993). [11]:See Consolidated Investment Services, 61 SEC Docket at 34 (stating that "prior disciplinary history is to be considered in fashioning a sanction," because it "provides evidence of whether an applicant's misconduct is isolated, the sincerity of the applicant's assurance that he will not commit future violations and/or the egregiousness of the applicant's misconduct") (citing Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff’d, 450 U.S. 91 (1981)). [12]:Penny Stock Reform Act of 1990, Pub. L. No. 101-492, § 504, 104 Stat. 931, 952 (1990) (codified at 15 U.S.C. § 78o). [13]:See 15 U.S.C. § 78o note (1994) ("Current practices do not adequately regulate the role of ’promoters’ and ’consultants’ in the penny stock market, and many professionals who have been banned from the securities markets have ended up in promoter and consultant roles, contributing substantially to fraudulent and abusive schemes."); H.R. Rep. No. 101-617, at 20-22 (1990), reprinted in 1990 U.S.C.C.A.N. 1408, 1422-24 (noting that the "penny stock industry is now fraught with repeat offenders" and that the penny stock bar is intended to "expand the [Commission’s] barring authority to include a broad range of persons as promoters, consultants, agents or in any number of other guises"). [14]:All of the arguments advanced by the parties have been considered. They are rejected or sustained to the extent that they are inconsistent or in accord with the views expressed herein. [1]:See, e.g., Arthur James Huff, 50 S.E.C. 524, 531 (1991) (concurring opinion of Commissioners Lochner and Schapiro). [2]:15 U.S.C. § 78o(b)(4)(E). [3]:Huff, 50 S.E.C. at 528. [4]:See, e.g., Louis R. Trujillo, 50 S.E.C. 1106 (1989) (proceedings dismissed where evidence did not support charge that supervisor failed to exercise reasonable supervision over salesman with a view to preventing his violations of antifraud provisions). [5]:William L. Vieira, 50 S.E.C. 1091, 1097 (1989). [6]:See Huff, 50 S.E.C. at 528. See also generally, Conrad C. Lysiak, 51 S.E.C. 841 (1993); Trujillo, supra; and Wedbush Securities, Inc., 48 S.E.C. 963 (1988). UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. Admin. Proc. File No. 3-9046 ____________________________________________ In the Matter of : : JAMES HARVEY THORNTON : : and : : PAYNE & THORNTON, INC., : d/b/a RETIREMENT INVESTMENT GROUP : ____________________________________________: ORDER IMPOSING REMEDIAL SANCTIONS On the basis of the Commission's opinion issued this day, it is ORDERED that Payne & Thornton, Inc., d/b/a Retirement Investment Group, be, and it hereby is, assessed a penalty of $50,000, and that its registration be, and it hereby is, revoked, and it is further ORDERED that James Harvey Thornton be, and he hereby is, assessed a penalty of $5,000, and barred in all capacities from association with any broker-dealer with a right to reapply to the appropriate self-regulatory organization to become so associated in a non-supervisory and non-proprietary capacity after three years. By the Commission. Jonathan G. Katz Secretary