2 Investors Sue Glendale-Based Otra Securities Over Annual Fees
Two investors have sued Glendale-based Otra Securities Group, which runs a clearing service for brokerage houses, charging that the company defrauded them and more than 100,000 other investors of up to $5 million in allegedly illegal annual maintenance fees.
The suit, filed July 11 in U. S. District Court in Utah, comes amid a proliferation of new fees charged by securities brokers to boost revenues. Beginning next month, Merrill Lynch plans to charge investors $15 for a stock certificate, and most Wall Street brokerage houses have raised commission rates and handling charges to cope with the securities industry slump brought on by the stock market crash of 1987.
Charging fees may be commonplace among brokerage houses, but Otra appears to be one of the only clearinghouses to have taken up the practice, industry sources said. Clearing services are hired by brokerage houses to “clear,” or process, stock trades, as well as to confirm and settle the securities trades.
Spokesmen for two of the nation’s biggest clearinghouses, the Pershing Division of Donaldson, Lufkin & Jenrette in New Jersey and Broadcort Capital Corp. in New York, a Merrill Lynch subsidiary, said they do not bill investors for clearing services.
“The customers really are not Pershing’s customers,” DLJ spokeswoman Catherine Conroy said. “Those are customers of our 650 brokerage firms who have hired Pershing to provide clearing services.”
The Utah suit accuses Otra and its subsidiary, Otra Clearing Inc., of mail, wire and securities fraud in an alleged scheme to collect fees by, among other things, liquidating a portion of investors’ stock without their permission and billing them to close accounts.
“It’s kind of like having a checking account and the bank saying, ‘Before you can take any of your money out, we’re going to charge you a fee, and if you take it out, we’re going to charge you a fee to take it out,’ ” said John Michael Coombs, one of two Salt Lake City attorneys representing New Jersey investors William and Naomi Herron in the lawsuit.
Otra’s Salt Lake City attorney, Scott Monson, denied that the fees were improper. He said fewer than a dozen people complained about the new $25 annual maintenance fee, which went into effect for all account holders in September, and he knew of no similar lawsuits against Otra.
Coombs, however, said about 30 people have called him complaining about Otra’s fees since the suit was first publicized last week.
The suit, which seeks class-action status, asks for out-of-pocket damages of as much as $50 for each class member, collective treble damages of $6 million to $15 million, and punitive and exemplary damages of at least $20 million. Coombs said the case was filed in Utah because Otra Securities Group is incorporated there.
Whether or not the fees hold up in court, they have paid off handsomely for Otra.
Otra’s profit jumped sevenfold last year to $1.55 million from 1989, thanks primarily to the $2 million in maintenance fees it collected. Overall, the company’s revenues increased 20%, from $10.45 million to $12.6 million.
Most of Otra’s broker-customers specialize in thinly traded “penny stocks” that normally trade for less than $5 a share. By contrast, big brokerage houses such as Merrill Lynch have their own back-office operations for clearing transactions.
In the suit, the Herrons say Otra imposed the $25 fee without giving investors a grace period to close or transfer accounts at no charge. Those who did close their accounts were slapped with additional processing fees, the suit charges.
“They’re being paid already for safekeeping and maintaining” by brokerage houses, Coombs said. “Then to turn around and charge the customer directly is . . . double dipping.”
When the Herrons failed to pay the fee, Otra transferred $25 worth of stock from the their account into Otra’s own trading account and charged an additional $25 “processing fee” to complete the transfer, for a total charge of $50. Otra stood to profit if the stock rose in value before it was traded, Coombs said.
But Monson said investors had ample time to close their accounts if they didn’t want to pay the fee.
He said Otra notified investors in late July, 1990, that the fees would take effect on Sept. 1. The letter did not list any alternatives to paying the fee, but Monson said the Herrons were aware of the options because they wrote to Otra on Aug. 12 asking that their accounts be closed.
“Obviously, an account with a total value of approximately $200 is not worth a $25 fee and is not worth your handling either,” William Herron wrote in the letter.
Otra then asked Herron to pay $30 ($15 for each of his two stocks) to close the account, or to send $20 to liquidate the account as a tax loss, the suit said. According to Monson, such “transaction fees” had been in place since Otra started business in 1986. In some cases, such fees are paid by the brokerage houses themselves, Otra spokeswoman Bernadette McLaughlin said, but Otra billed the Herrons directly because their broker, P. B. Jameson of Salt Lake City, had left the securities business.
“They are claiming now in the suit that you couldn’t get out one door and not out the other . . . but they knew very well what were their options,” McLaughlin said.
Otra says the fee is necessary to cover its costs of holding stock certificates for investors, sending them quarterly financial statements and providing other services.
“The maintenance fee was to help defray the costs of operation that the brokers aren’t covering,” Monson said.
Otra is not the only firm that has arrived at that conclusion.
In the past five years, Merrill Lynch, PaineWebber and Smith Barney, Harris Upham & Co. have all begun charging fees on inactive accounts. Merrill Lynch charges $40 annually and the other two charge $50. Shearson Lehman recently raised its annual fee to $50 from $30.
At the same time, Shearson, Dean Witter and PaineWebber began charging “processing and handling” fees ranging from $2.30 to $2.85 per transaction. Merrill Lynch and Smith Barney recently doubled their transaction fees.
Unlike Otra, however, Merrill Lynch does not charge a fee for closing or transferring accounts, spokesman Fred Yager said.
And some brokerage houses, such as discount broker Charles Schwab & Co. Inc. and A. G. Edwards & Sons in St. Louis, still do not charge fees. “We don’t have research analysts,” Schwab spokesman Tom Taggart said. “We keep our costs down.”
Otra attorneys questioned the motivation behind the lawsuit.
Monson said Coombs’ co-counsel in the case, Richard Leedy, represents a Salt Lake City chiropractor suing Otra in U. S. District Court in connection with an alleged stock fraud. Otra in January filed a countersuit contending that Leedy himself participated in the fraud, a charge Leedy denies.
“Otra is certainly not a stranger to the two attorneys who filed the complaint” on behalf of the Herrons, McLaughlin said.
