In the Matter of John H. Gutfreund, et al.

Brief Fact Summary. It was discovered by three senior officers of Saloman Brothers, Inc. (Saloman) – Gutfreund, Strauss and Meriwether (Defendants) that the head of the firm’s Government Trading Desk, Mozer, had submitted a false bid of $3.15 billion, which Feuerstein (chief legal officer) informed them established a criminal act. The matter was not immediately reported by the officers and with no action being taken against Mozer for many months, he continued to violate the federal securities laws. Administrative proceedings were brought by the Securities and Exchange Commission (SEC) (Plaintiff) against the officers for failure to supervise, who settled. Feuerstein was not named by the SEC due to determining that he was not Mozer’s direct supervisor because he was chief legal counsel.

Synopsis of Rule of Law.  (1) The obligation of senior officers of a securities firm to reasonably supervise an employee is violated when they that they discover the employee has violated the securities laws but fail to conduct an investigation, fail to discipline and fail to limit the activities of said employee.
(2) For purposes of §§ 15(b)(4)(E) and 15(b)(6)  of the Securities Exchange Act of 1934, if a compliance or legal officer at a securities firm transitions into a “supervisor” is decided by the circumstances and facts per case, not just the officer’s position.

Facts. It was discovered by three senior officers of Saloman Brothers, Inc. (Saloman) – Gutfreund, Strauss and Meriwether (Defendants) that the head of the firm’s Government Trading Desk, Mozer, had submitted a false bid in a U.S. Treasury auction of $3.15 billion, which Feuerstein (chief legal officer) informed them established a criminal act. In early 1991, Mozer offered two false bids in the names of two customers, Mercury Asset Management (Mercury) and Quantum Fund, without them being aware of it and overriding Salomon’s regular procedures to keep his plan hidden.  One of Mercury’s affiliates, S.G. Warburg, was also a participant in the auction and was notified (along with Mozer) via letter by the Treasury Department that it would treat Mercury and S.G. Warburg as one entity for auction purposes.  Upon getting the letter in April 1991, Mozer told Mercury that the bid in Mercury’s name was a clerk’s mistake and would be corrected. The same day, Meriwether, Salomon’s Vice Chairman and Mozer’s supervisor was notified by Mozer ,of the letter and of his actions involving Mercury.Salomon’s president, Strauss, was made cognizant of the situation by Meriwether, who was surprised by Mozer’s behavior and informed by Mozer that he had not done anything similar to this before or since. The following week, Strauss, Meriwether and Feuerstein met with Salomon’s CEO and Chairman, Gutfreund, where Feuerstein determined that Mozer’s behavior was criminal and recommended reporting it to the government. It was determined that the Federal Reserve Bank of New York would was to be contacted regarding the matter, however, the four officers were vague when it came to how the report would be made. Due to each officer feeling that it was a different officer’s obligation to do so, at no point during this time was there ever a discussion about investigating Mozer’s actions, regarding discipline him or limiting his activities. During that timeframe, two additional unauthorized bids were submitted in the auctions of the U.S. Treasury by Mozer.  Also of note, even though Feuerstein repeatedly asked for a disclosure to be made to the government regarding Mozers employment being terminated in late 1991 due to an internal investigation was conducted by an external law firm revealing his wrongdoing in multiple auctions dating back to December of 1990.  The aforementioned information and the understanding that the officers were cognizant of the false February bid as early as April, were disclosed in press releases in August and later that month, all four officers resigned their positions. Then failure to supervise administrative proceedings were brought against Gutfreund, Strauss, and Meriwether by the SEC.

Issue. (1) Is the obligation of senior officers of a securities firm to reasonably supervise an employee is violated when they that they discover the employee has violated the securities laws but fail to conduct an investigation, fail to discipline and fail to limit the activities of said employee?
(2) For purposes of §§ 15(b)(4)(E) and 15(b)(6) of the Securities Exchange Act of 1934, does a compliance or legal officer at a securities firm transition into a “supervisor” because of their position?

Held. [Judge not stated in casebook excerpt.] (1) Yes. The obligation of senior officers of a securities firm to reasonably supervise an employee is violated when they that they discover the employee has violated the securities laws but fail to conduct an investigation, fail to discipline and fail to limit the activities of said employee.The SEC is authorized to impose sanctions against a broker-dealer, as perSection 1S(b)(4)(E) of the Securities Exchange Act of 1934 (Exchange Act), once the firm has “failed reasonably to supervise, with a view to preventing violations, another person who commits such a violation, if such person is subject to his supervision” and the SEC is authorized by Section 1S(b)(6) to enforce sanctions for failure to supervise on responsible individuals. A vigorous response is required by the supervisory obligations imposed on broker-dealers, even if simply an irregularity or “red flag” of any type appear. Satisfactory follow-up is required and if more than one supervisor is implicated, a clear explanation of the efforts taken is required, as is unambiguous assignment of those efforts to specific individuals. In this case, due to what the supervisors discovered, at the very least were required to investigate what happened and if other similar instances went unreported, seeing as Mozer was a high-level employee with considerable discretion. The four supervisors had an affirmative responsibility to begin a suitable query promptly and, pending the outcome of said investigation, to impose proper limitations on Mozer’s activities and to increase his supervision. Here, taking immediate action was even more essential seeing that the possible illegal conduct occurred in the U.S. Treasuries securities market and the integrity of said market is integral to worldwide and U.S. capital markets. The supervisors should have gone one step further than the aforementioned action by discussing among themselves, their fully defined individual obligations in response to Mozer’s behavior. Consequently, a severe breach of supervisory obligations was constituted by the supervisors failing to take action to investigate, to discipline Mozer, or to limit his activities. Gutfreund, as Chairman and CEO, had the lion’s share of responsibility for making certain that an immediate and comprehensive inquiry had begun and the Mozer was properly disciplined. Gutfreund failed to uphold that responsibility because he failed to make sure that the firm responded to the situation in a fashion that recognized the seriousness and urgency, and as President, Strauss needed to instruct Meriwether, Feuerstein and others to respond appropriately. Strauss should not have assumed that such action was being taken for he had a duty to ensure it had been taken so he also failed to uphold those obligations. As Mozer’s direct supervisor, Meriwether responded properly by reporting the situation to senior executives, however, had a continuing responsibility to supervise and monitor Mozer, so ultimately, his response was not satisfactory.
(2) Yes. For purposes of §§ 15(b)(4)(E) and 15(b)(6)  of the Securities Exchange Act of 1934, if a compliance or legal officer at a securities firm transitions into a “supervisor” is decided by the circumstances and facts per case, not just the officer’s position. Under the facts of the particular case, to discover if a person is deemed a “supervisor” is dependent upon if that individual has a necessary degree of responsibility, ability, or authority to affect the behavior of the employee whose behavior is of concern. In this case, due to Feuerstein’s position and influence at Salomon, he was required to share in the duty to use appropriate action in his response to misconduct. Under circumstances like that, such an individual is known as a “supervisor” and with the aide of other supervisors, is required to take reasonable and suitable action. Once included in expressing management’s response, that individual (Feuerstein) has a duty to take affirmative steps to address the misconduct with appropriate recourse and these responsibilities cannot be eluded because the individual failed to have previous direct supervisory obligations for the activities of the employee. Sanctions detailed in the Offers of Settlement are imposed.

Discussion. Aside from criminal activities, in this case the false bids, the SEC has brought failure to supervise actions for failing to properly review new hires, for failing to dismiss employees who have participated in misconduct, and also for not being properly responsive to “rogue” broker violations that include criminal acts. Once a violation has been discovered, a security firm may offer full disclosure and/or make restitution to customers and/or initiate special training, censure or supervision of employee or dismiss them.