Fidelity's regional managers, who were involved in the inspection preparation process, instructed branch managers to prepare for the inspections. The regional managers provided training for branch office managers using the previous year's inspection module. The training focused on preparing for internal inspections. Certain branch managers intended to use this training "to beat" the inspection rather than to comply with the Firm's record-keeping requirements. Regional managers instructed employees at branch offices that had already been inspected to share information about the inspections with employees at branch offices that had not yet been inspected. Regional managers also pressured branch office managers to have "no concerns" inspections and implied that they could be fired if there were more than a few inspection exceptions.

Unfortunately, Fidelity's Western Region managers pressured branch office employees to obtain "no concerns" reports at the conclusion of the inspections. To achieve such results, Western Region managers told its branch office employees when the inspections would occur, provided information and materials to branch office managers, and encouraged branch office managers to review applicable branch office documents in preparation for the inspection. Moreover, at least 62 employees  in at least 21 branch offices, primarily in the western region, discovered that some of the records maintained in the branch office omitted information or were not completed in accordance with Firm policies and procedures. These employees altered or destroyed new account applications, letters of authorization, and variable annuity forms maintained at Fidelity branch offices. Such conduct caused the Firm to maintain inaccurate or incomplete books and records.  

Heads Up  

The purpose of internal inspections should be to uncover compliance deficiencies and to subsequently confirm that the problems have been corrected and measures implemented to prevent any recurrences.  When firms send a heads-up to their branches as to the scope and dates of the surprise audits, the  examination becomes one of learning how to pass the test rather than learning the lessons.

When discovering that firms are sending warning flares about internal inspections, the regulators will frequently assume that brokerage staffs have engaged in some creative remedies just before and during the in-house inspections.  Expect to have the relevant client documentation scrutinized for back-dating, forgeries, etc.  

Yes, it's true that regulators will often give you some advance notice of an examination of your firm --- but you're still better off running a surprise in-house regimen.  At the very least, if you're a BD compliance professional you want to know what nonsense is going on in the branches.  Frankly, isn't that the whole point of internal inspections: to uncover misconduct before the regulators do?  Look at it this way, you want to know that the sprinklers aren't working before the fire starts.

In the Matter of Goldman, Sachs & Co., Exchange Act Release No. 33576, 1994 SEC Lexis 302 (February 3, 1994); 

In the Matter of Kirkpatrick, Pettis, Smith, Polian Inc., Peter N. Lahti And Gregory D. Adams, Admin. Proc. File No. 3-11328, Release No. 34-48748, 2003 SEC LEXIS 2661 (November 5, 2003) ("The Commission has long emphasized that the responsibility of broker-dealers to supervise their employees is a critical component of the federal regulatory scheme."), citing In the Matter of John H. Gutfreund, et al., 51 S.E.C. 93, 108 (1992).

In the Matter of Prudential Securities, Inc., Exchange Act Release No. 43896, 2001 SEC Lexis 155 (January 29, 2001).

Remedial Measures

Fidelity first learned about the matters described above in July 2002 when a registered representative reported concerns relating to the branch inspection at one branch office to the Firm's ethics office. Fidelity immediately conducted an internal investigation and disciplined those employees who were involved, including the termination of 13 branch employees, including three branch managers. The firm also replaced four members of the Western Regional management team and the region's compliance officer. In addition, Fidelity  contemporaneously shared its investigative findings and disciplinary actions with the SEC and the NYSE.   After its investigation, Fidelity developed and implemented enhancements to the Firm's branch inspection program and made improvements to various policies, procedures and controls.

SEC Settlement

Fidelity submitted an Offer of Settlement to the Securities and Exchange Commission ("SEC") that neither admitted or denied the findings made by the SEC, but nonetheless consented to the entry of the SEC's Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions Pursuant to Sections 15(b) and 21C of the Securities Exchange Act of 1934.  Fidelity also submitted a Stipulation of Facts and Consent to Penalty (SFC) to the New York Stock Exchange (NYSE), without admitting or denying guilt.

The SEC determined that certain Fidelity employees altered some of the records maintained in the branch offices such that they did not represent accurate records of the original communications; and, accordingly, as the altered records were maintained for regulatory purposes (i.e., to comply with Rule 17a-4), Fidelity willfully violated Section 17(a) of the Exchange Act and Rule 17a 4(b)(4) thereunder, and its employees aided and abetted these violations.  "Willfully" as used in this Offer means intentionally committing the act which constitutes the violation. There is no requirement that the actor also be aware that he is violating one of the Rules or Acts See, Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000); Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965). 

SEC Sanctions

In determining to accept the Offer, the SEC considered remedial acts promptly undertaken by Respondent and cooperation afforded the Commission staff.  As such Fidelity was 

1. censured;  
2. agreed to cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Exchange Act and Rule 17a 4 thereunder; and 
3. fined $1,000,000; and the SEC acknowledged that pursuant to Fidelity's agreement with the New York Stock Exchange in related proceedings, Fidelity will pay an additional fine in the amount of $1,000,000 to the New York Stock Exchange.

PRACTICE POINTER 

 I believe the SEC and the NYSE are using this case to send a clearer message as to what will constitute effective internal remedial measures for purposes of sanction mitigation.  Consequently, this case suggests the following steps:

1. Immediately conduct an internal investigation;

2. Promptly discipline those determined to have engaged in violative conduct;

3. Terminate those engaged in serious misconduct;

4. Terminate supervisors who furthered serious misconduct or who failed to reasonably prevent same;

5. Remove supervisors and compliance officers who knew or should have known of serious misconduct and failed to reasonably prevent same;

6. "Contemporaneously" contact regulators and inform them of the investigative findings and your disciplinary actions; and

7. Implement remedial measures designed to prevent a recurrence of the violations at issue.