Brokerage Firms Were Repeatedly Disciplined Despite Costly Sanctions, They Overlooked Scams
March 3, 2002
By Teresa Dixon Murray
The Plain Dealer
Cleveland, OH — Corrections and clarifications: The following clarification appeared on March 15, 2002: A March 3 story on Page A1 said federal agents had subpoenaed records from lawyer Dominic Perry in the investigation of stockbroker Frank Gruttadauria. Perry’s lawyer says no subpoena was issued to his client. Federal authorities declined to comment.
The brokerage firms where Frank Gruttadauria worked can’t say they hadn’t been warned.
Lehman Brothers Inc. and SG Cowen Corp., which employed the Gates Mills broker in Cleveland, both have been repeatedly disciplined by stock-market regulators to deter lapses and swindles such as the one Gruttadauria admitted to.
Eleven years ago, Lehman, its Cleveland branch manager and a Cleveland broker were each indicted by a Cuyahoga County grand jury on 42 counts of fraud in a scandal that cost investors millions of dollars.
Regulators cited the firm for not supervising a broker who did as he pleased with customer accounts.
That was nine years before Gruttadauria began working for Lehman.
Three years ago, regulators fined and chastised Cowen for several counts of improper trading and for failing “to establish, maintain and/or enforce adequate supervisory procedures” in seven areas, the National Association of Securities Dealers said.
And the same year, the SEC fined Lehman, Cowen and 26 other brokerages a total of $27 million for manipulating the NASDAQ stock market, pocketing illegal profits and failing to properly supervise their brokers. Cowen was fined $1.3 million; Lehman was fined $212,500.
Lehman, in fact, has been sanctioned by regulators some 220 times in the last quarter-century. In 57 of the cases, Lehman was cited for not properly supervising brokers. Its file also includes 980 formal customer complaints.
Cowen has been sanctioned at least 37 times in the last decade; in about a quarter of the cases, regulators said Cowen wasn’t properly supervising brokers. It has had 30 formal customer complaints.
“How many times do you have to get hit in the head before you realize it hurts?” asked Rocky River securities attorney and former broker Brian Biggins.
Even Gruttadauria admitted astonishment that he still got away with wholesale fraud for 15 years, and did it right under the noses of the two firms.
“I can hardly believe I could have done this without detection for so long,” the 44-year-old broker wrote in a note to the FBI before he vanished in January and spent a month on the run.
Authorities say Gruttadauria faked spectacular returns for some clients to lure more investors. Then, investigators say, he used shell corporations, forged signatures and outright theft to defraud them out of roughly $125 million they invested and some $150 million more that he led them to believe they had.
He worked for Lehman since October 2000, and for a decade before that at Cowen.
Gruttadauria so far is charged with “massive fraud” in a civil suit from the U.S. Securities and Exchange Commission and with a criminal charge of lying to a bank to get a loan. He is in jail without bond.
Now, six weeks after his scheme came to light, Gruttadauria’s good fortune in a career of misappropriating others’ fortunes is looking even more remarkable, particularly given the discipline his employers suffered.
And yet the system failed spectacularly. Indeed, no one caught Gruttadauria. His antics didn’t come to light until he sent a written confession to the FBI in January.
Said SEC spokesman John Nester: “It’s kind of like the Enron deal, where the analysts, the accountants – no one – caught on. Everyone just missed it.”
Among the things they missed:
Gruttadauria’s practice of sending phony account-activity statements to clients and diverting their genuine statements to keep clients from seeing them. Authorities say Gruttadauria forged signatures for more than 50 people on forms authorizing the brokerage firms to mail statements to post-office boxes he controlled, and to two of his business associates, instead of to clients’ homes or businesses.
Brokerages shouldn’t allow address-switching so easily, said Lawrence Klayman , a former broker and NASD employee. He’s now a securities lawyer in Florida who represents both investors and brokerages.
Firms should confirm a new address with a phone call or a letter to the client’s home address, Klayman said. And Lehman and Cowen should have programmed their computers to flag peculiarities, such as mail for more than 50 clients going to the same post office box, Klayman said.
Lehman spokesman William Ahearn insisted that none of the address changes occurred after Lehman bought Cowen’s investor business in October 2000 and brought Gruttadauria into the Lehman fold. But all of Cowen’s clients had to fill out new account application forms when their accounts moved from Cowen to Lehman, and yet the misdirected mailings continued; some now allege that Gruttadauria must have forged those documents during the transition.
Cowen spokesman Don Nathan said it would be premature to comment on specifics during the ongoing investigation.
Gruttadauria’s own computer, which he kept on his desk alongside his company-issued computer but not hooked up to the office network.
Authorities say Gruttadauria used it to keep his own set of books with false, inflated client account information. Nearly all brokerages prohibit personal equipment – even Palm Pilots – unless they’re connected to the company network, so that co-workers and auditors have access.
Gruttadauria’s pattern of steering huge amounts of money from client accounts to into his accounts at Cowen and Lehman.
Even though the transfers may have looked legitimate at a glance (clients now say their signatures were forged), someone should have noticed, said David Axelrod, a former federal prosecutor who recently served as a special prosecutor in Ohio’s largest-ever securities case. The Columbus lawyer specializes in white-collar crime and money-laundering cases.
The sheer volume of money transfers into any single person’s account should have been a flag, Axelrod said. “If you just saw that pattern, you’d say, what the heck is this?”
Brokerage procedures also normally call for any account controlled by a broker to be scrutinized with a fine-tooth comb “because the possibilities are so rife,” said Allan Fedor of Florida, a 22-year veteran of securities law.
The account balances of dozens of rich customers in the “high- net-worth” client group shrinking from tens of millions of dollars to near zero.
Brokerages are supposed to occasionally conduct a sort of “customer service check,” said Pat Sadler of Atlanta, president- elect of the Public Investors Arbitration Bar Association.
“Every legitimate compliance program calls for the firm to contact the customers at some point,” he said, typically by both phone and letter for wealthy clients.
Lack of oversight
With questions such as these now being examined, investor advocates say the two firms’ regulatory records should have pushed them to shape up long before Gruttadauria. Indeed, last week four Gruttadauria clients filed two separate suits against Lehman and Cowen in federal court here, accusing them of negligent oversight.
The 260 regulatory actions and nearly 1,000 customer complaints against Lehman in the last 25 years compare with 64 actions and six complaints in the last 15 years against Goldman Sachs & Co., the brokerage firm closest in size to Lehman. While Cowen has had fewer sanctions, it too has been cited repeatedly for sloppy procedures and supervision, as have all notable investment firms.
Lehman and Cowen almost certainly will be sanctioned again by regulators in the Gruttadauria case.
Other eyes didn’t see
Authorities are also questioning co-workers and others who perhaps could have realized things seemed odd in Gruttadauria’s brokerage world.
(SEE CLARIFICATION NOTE)Federal agents have subpoenaed some records from local accountant Joseph DeGrandis and lawyer Dominic Perry – the two business associates who were getting legitimate account statements in the mail from Lehman that were supposed to be going to Gruttadauria clients.
DeGrandis got statements for 10 to 15 Gruttadauria clients. DeGrandis’ attorney, Ralph Cascarilla, said about half of the named addressees were DeGrandis’ clients and he did their tax returns. With the others, Cascarilla said, DeGrandis got the statements for more than a year because he hoped to be their accountant someday.
Perry said he received “a couple” of statements addressed to his clients. Authorities say one was Andrew Rayburn, a Moreland Hills businessman who lost roughly $70 million.
Rayburn told investigators he had no idea his statements were going to Perry and that Perry wasn’t his lawyer – the only legal work Perry ever did for him was some estate planning years ago.
DeGrandis and Perry have not been accused of any violation of criminal or civil law. But some authorities and former clients wonder if Gruttadauria’s scheme could have fallen apart sooner if those two had rattled him or his employer with questions about the misdirected mailings.
In any case, DeGrandis should never have accepted non clients’ statements without objection, said Clarke Price, spokesman for the Ohio Society of Certified Public Accountants. “That’s common sense,” he said. “To say, ‘This could be a client someday’ – that sounds a little strange. It doesn’t even begin to pass the smell test.”
Investor lawsuits and the SEC have also challenged Lehman’s and Cowen’s scrutiny from within the Cleveland office. Like nearly all brokerages, Cowen and Lehman employed an on-site “compliance director,” whose job is to make sure brokers follow securities laws. Plaintiffs’ lawsuits contend that job clearly didn’t get done.
The Cleveland office’s compliance director for the last decade was Robert Semenak of Euclid. His boss: Frank Gruttadauria.
Last month, Lehman fired Semenak, along with co-workers Melinda Trocano and William Kall and Laurie Kacludis English, Gruttadauria’s longtime assistant and former lover.
Karl May, Semenak’s attorney, declined to comment.
‘Remain ever vigilant’
All of the misplays in the Gruttadauria case would be comical if so many people hadn’t lost their life savings, said Tracy Pride Stoneman of Colorado, a director with the Public Investors Arbitration Bar Association. She said the Gruttadauria case should send a strong message to the firms involved and all investment companies.
Despite the Gruttadauria case and all of its warts, people should still have confidence in the regulation of the brokerage industry, said the SEC’s Nester. He said the United States has “the world’s strongest enforcement system.”
Dennis Ginty, spokesman for the Ohio Division of Securities, which oversees brokers in Ohio, agreed. “But unfortunately, there will be always will be a new twist to an old plot that con artists will devise.” So regulators must keep up with the latest shenanigans, and investors must “remain ever vigilant,” he said.
Brian Ochs, assistant director of enforcement for the SEC, said the Gruttadauria case is a fluke.
“There are always going to be people out there who are waiting to steal your money,” Ochs said. “But I don’t think there’s any reason to panic and start putting your money under the mattress. If cases like the Gruttadauria one were a common occurrence, it wouldn’t have generated so much interest.”