A Wall Street Case Study in Abuse, Light Punishment : Brokers: Lucrative office’s questionable tactics went unchecked. But managers cited in NYSE case stayed on.

At the big Lehman Division stock brokerage office at 55 Water St. in Manhattan, a good sales script was everything, and assistant branch manager Robert Tarlowe’s pitches were so good that they inspired even the office’s hardened veterans.

His brokers said Tarlowe would take command of the morning meeting of the office’s 130 brokers like a field general mapping out a battle plan. He would fire up the salesmen about a stock the firm was anxious to push that day, supplying them with the persuasive points they in turn would use on customers.

“When he gave a presentation, tape recorders would be going,” says one broker who recently moved to another firm. “When it was over, you couldn’t wait to get back to your desk and start making calls.”

Tarlowe’s way with words was one reason the office, part of American Express’ Shearson Lehman Bros., was a phenomenon. Its profits in many years exceeded that of entire brokerage firms, often approaching $100 million in annual commissions. Its success was based on “cold calling”--using lists of wealthy individuals in a wide region of the country and wearing down their resistance until they agreed to plunk down a minimum of $10,000 on a touted stock.

But not everything 55 Water St. customers were told was true. And many who put their trust in Water Street brokers ended up suffering for it.

“It was a cesspool,” says Caroline Baumel, who until her retirement in 1990 was the Shearson executive in charge of registering brokers with regulatory agencies. “There were all these shenanigans at 55 Water St., and everybody was shutting their eyes because big money was being made there.”

A Case Study

The mega-office in downtown Manhattan provides a case study of how unethical stock brokers are allowed to continue their practices unchecked, investors’ lawyers and former Water Street brokers say. And when finally caught, they often are given light punishment and allowed to stay on as brokers or managers.

Last summer, the New York Stock Exchange brought a little-publicized case against Shearson for wrongdoing at 55 Water St. during 1985 and 1986. Shearson agreed to pay a $750,000 fine, then the second-largest ever imposed by the NYSE. In the settlement, the firm agreed to the filing of certain charges without admitting or denying guilt. To date, three managers of the office, including Tarlowe and former branch manager Seymour Passman, have been penalized with censures, without admitting or denying guilt. Tarlowe and another manager also paid small fines.

But the few managers penalized have ended up well off despite the severe wrongdoing cited by the New York Stock Exchange.

Tarlowe, for example, went from being assistant branch manager to heading the entire Lehman retail division--a separate part of Shearson’s brokerage operations--before returning to become 55 Water St. branch manager in 1991, a position he still holds. Richard Baum, another assistant branch manager penalized by the exchange, also was promoted to become head of the Lehman retail office in Boston. Passman, although removed as a supervisor, stayed on with the firm and struck a lucrative arrangement in again becoming a stock broker.

The NYSE accused Shearson and the 55 Water office of gouging customers by charging fat, undisclosed commissions on sales of stock; rampant churning of accounts by making excessive trades to generate commissions; making trades customers had never authorized; touting risky stocks the firm’s own research department hadn’t approved; violating federal restrictions on margin accounts; illegally moving trades from one customer’s account to another’s, and failure by the office’s managers to carry out their basic duties as supervisors. Shearson was also penalized for failing to turn over numerous records requested by the exchange.

Extensive Problems

Shearson in a public statement said the events included in the NYSE charges took place nearly seven years ago. “Since the time of the settlement, the firm has taken a number of steps to address the issues raised by the stock exchange. Like all financial consultants (brokers) at the firm, those that work at the 55 Water St. branch are expected to perform according to high professional standards. Anyone who does not is disciplined accordingly.”

But documents and interviews show that the problems were more extensive than the incidents cited in the New York Stock Exchange charges. Many improper practices continued at least through 1990. In addition, NYSE investigators were aware of the continuing wrongdoing, according to confidential depositions. And testimony indicates senior executives were aware of the wrongdoing at least as early as 1987, although no one above the level of branch manager was penalized.

Among the findings of The Times’ investigation:

* The office and its brokers helped the firm sell off large blocks of stock from its own holdings even if the securities’ prospects were dubious. The brokers’ reward was large, secret commissions.

* The same kinds of wrongdoing occurred recently at another Lehman Division office, in Boston, involving individuals who used to work at 55 Water St.

* An entire area of highly irregular activity at 55 Water was never mentioned in the NYSE charges. Huge blocks of newly issued stock from many public offerings handled by Shearson were allocated to a group of favored accounts at 55 Water. The favored accounts got many thousands of shares while other Water Street clients who wanted them got none. The shares routinely were resold at a profit almost immediately, in apparent violation of Shearson policy. A small group of brokers close to Tarlowe, including his brother, shared in the enormous commissions generated by these accounts.

* More brokers were involved in wrongdoing than the NYSE charges indicated, and many of them are still at 55 Water St. or have moved on to other firms such as Salomon Bros., Smith Barney Harris Upham & Co., and Gruntal & Co.

Admits Misdeeds

Shearson Executive Vice President Peter T. Kujawski, the firm’s deputy director of branch services, acknowledges that wrongdoing occurred. But Kujawski maintains that the misdeeds were limited to 1985 and 1986, a transition period when Lehman was being absorbed into Shearson. And he says it involved “only a handful of salesmen” who were all forced to leave. Kujawski says that not only was the wrongdoing eradicated, but as an extra measure of caution, Shearson in 1991 appointed a lawyer with a reputation as a tough compliance officer at another brokerage to act as administrative manager at 55 Water. He says her job is to “review personally all legal and compliance issues that come up.”

Shearson acquired Lehman Brothers Kuhn Loeb in 1984, and with it came the Lehman retail division. The Lehman offices’ aggressive selling techniques often proved useful to Shearson. And the most aggressive office of all has long been 55 Water St.

Shearson brokers and lawyers who represented both brokers and investors describe 55 Water St. as having the feel of a “boiler room,” where fast-talking, high pressure salespeople use banks of phones to peddle securities or commodities, sometimes overstating their value or prospects.

Eugene L. Boyle III, who worked for a few months at 55 Water St. in 1988 before moving to the Lehman office on Madison Avenue in Manhattan, says that in hiring brokers: “They were looking for people who just wanted to sell without taking any prisoners.” He adds, “The guys I was exposed to there were pretty unsophisticated as far as their knowledge of securities went, but they were almost like pit bulldogs. As long as they had a client with money on the other end of the phone, they would just keep them on the phone and wear them down until they got what they wanted.”

The office’s brokers and managers enjoyed the accouterments of success normally associated with higher-ranking investment bankers in the 1980s. Tarlowe owned racehorses. One broker often gave two neighbors who worked in the office a lift to work in his Bentley. Others arrived at work in limousines. Many 55 Water brokers brought in about $1 million a year in commissions, far higher than the $280,000 average for Shearson brokers today.

The Lehman Formula

This dynamo of a brokerage office still sprawls across the 35th floor of a 1970s vintage concrete and glass shoe box, not far from Wall Street. The office has a view that sweeps across the upper reaches of New York Harbor from the Brooklyn Bridge to Governors Island. But when a reporter visits, no one is gazing out the window. More than 100 brokers and their sales assistants, mostly young and male, are constantly on telephone lines. Many wear telephone headsets to avoid neck strain from full days of cold calling. And neck strain is a definite risk: The office makes well over 100,000 cold calls a year.

The Lehman formula depends on lists of exclusive prospects who might have at least $100,000 available to invest. Compiled by outside firms, the lists included people who have Tiffany charge accounts, boats longer than 50 feet, or private planes (but only planes with at least two engines).

To cement a budding relationship, brokers mailed out packages that contained a free copy of a book on the world’s great merchant banking families. Brokers inserted their business cards as a bookmark, so that customers would open to a chapter headed “Lehman Bros., the Money Magicians.”

To close a sale, brokers commonly told customers that they had just emerged from an exclusive meeting with a top stock analyst and could make a recommendation normally available only to Shearson’s best institutional customers.

Corporate Stocks

The office had such prowess at selling stock that titans of industry, like Chrysler Chairman Lee A. Iacocca, made pilgrimages to 55 Water St. in hopes of persuading the office to push their companies’ stock.

The Water Street machine’s ability to sell huge amounts of stock to retail customers made it a vital adjunct of the firm’s activities on behalf of corporate clients. Shearson raised money for corporations by selling new issues of their stock, and supported those offerings by continuing to “make a market” in their shares. Shearson could buy large blocks of over-the-counter stock from its big, institutional customers who wanted to sell because the trading desk knew that the awesome Lehman retail sales force could get the risky stock position off the firm’s hands and push it out to retail customers.

“The trading desk knew that if they took it to 55 Water they could get the job done,” says one former Water Street broker.

The methods for doing so were often suspect, and often hurt retail clients.

One way 55 Water St. moved stock was with its so-called “specials.” Specials, according to Water Street alumni, were extra fat commissions paid secretly to brokers to sell a stock, even if it looked like a loser. Virtually all brokers in the office participated in the specials, ex-brokers say.

In 1986, for instance, Shearson took charge of an initial public offering of stock by Prospect Group Inc. Once the offering was completed, Shearson made a market for Prospect Group stock. On one day in late May, 1986, Shearson as a market maker sold 1.6 million Prospect Group shares. One million of those shares were sold by the 55 Water office alone, helping Shearson’s traders unload shares in their hands. But NYSE investigators found that the stock was sold at a higher price to nearly all of the 360 customers who bought it through the Water Street office than to customers of any other Shearson office that day. The NYSE said the office and its brokers profited from this secret markup, and illegally failed to disclose it to customers.

Shearson declined to comment on “specials” or to say if the practice has been stopped.

‘Herpes Warrants’

Former Water Street brokers still talk about “herpes warrants,” so-called because many of them turned out to be injurious to customers’ financial health. A warrant is the right to buy a share of stock at a specified price.

These were warrants issued by HPSC Inc., a small dental equipment leasing concern. Shearson made a market for the warrants from the time they were issued in 1984 until they expired in 1989. Market makers act as dealers, holding an inventory of a security and standing ready to buy or sell at publicly quoted prices. But price data shows that warrants sold at least from April, 1986, on were never profitable to exercise. And Dennis J. McMahon, HPSC’s controller, says all or nearly all of the warrants issued were never exercised and expired worthless.

The price of HPSC’s common stock plummeted steadily from late 1986 on, making the prospect of profitably exercising the warrants ever more remote. But records show that tens of thousands of the warrants continued to be traded every month. Former Water Street brokers say colleagues in the office continued to recommend the warrants to customers even though many of them harbored doubts about the company’s prospects. The former brokers, who declined to be identified, asserted that this was because Shearson paid an unusually generous sales credit to brokers for each warrant sold. Shearson declined to comment on the HPSC warrants, and refused to say how big a sales credit was paid to brokers.

Whatever the sales credits were on the warrants, however, the amount was small potatoes compared to the money a small corps of brokers was making from an irregular arrangement involving huge blocks of new stock marketed by Shearson.

Confidential NYSE depositions show that into 1990, there was a long-standing arrangement involving at least six veteran brokers close to Tarlowe, the assistant branch manager who for a time became head of the whole Lehman retail division. These brokers received huge allocations of highly sought-after shares, which they funneled into accounts held by a man described in deposition testimony as a lifelong acquaintance of Tarlowe’s. The acquaintance was New York real estate speculator Martin B. Tepper.

Seymour Passman, until 1991 the branch manager, testified behind closed doors in the NYSE investigation that the Tepper accounts were among the branch’s biggest.

Executives in the Shearson department that handled new stock offerings always gave 55 Water a big allocation of shares because they knew they could rely on the office to sell all the shares it received.

In a July, 1990, NYSE deposition, Passman confirmed that, in an extremely unusual arrangement that he said still existed as of his testimony, an inner circle of brokers favored by Tarlowe was permitted to sell many of the shares allocated to the branch into the Tepper accounts and receive steep commissions, even though they weren’t the designated brokers for the accounts. Sources say a similar arrangement also existed for several favored accounts not owned by Tepper.

The deposition also discloses that in 1988, the broker of record on the Tepper accounts, Arthur Robbins, relinquished the accounts so that Tarlowe’s younger brother, Stuart Tarlowe, could take over as the official broker. Stuart, a lawyer, was given a job as a broker in his brother’s office in 1985. He raised eyebrows within the office, former brokers said, when with less than three years of experience in the industry he was handed the huge Tepper accounts and was quickly able to earn hundreds of thousands of dollars in commissions.

Passman testified that even though he was the boss, and the Tepper accounts were among the office’s largest, he never personally supervised the accounts to make sure they were handled in compliance with regulations. He said Robert Tarlowe made the major decisions involving the accounts officially handled by his brother, even after Robert Tarlowe had been promoted to become head of the whole Lehman retail division.

Brokers would funnel all or most of their allocated shares into these accounts, sources say, despite strong demand for them by their other customers. The arrangement was unfair to other Shearson customers, because they were unable to get shares at the offering price and often had to pay more for them later. In at least several cases, Tepper immediately resold the stock at a profit through the same brokers to other 55 Water St. customers. Tepper typically resold the stock almost immediately, reaping a profit because the price frequently went up just after an offering.

Former Shearson executives say the firm’s policy was to strongly discourage rapid sale of newly issued stock, and to cut off the supply to customers who did such trading. Shearson declined to answer questions about the Tepper accounts. Spokesman Steven H. Faigen said: “It is inappropriate for the firm to discuss client trading activities.”

The Tarlowe brothers have declined to answer questions about the accounts. The Times repeatedly called Tepper’s offices for comment on the accounts beginning in May, and posed questions to his lawyer, Ilyne R. Mendelson. Neither Tepper nor the lawyer responded. The Times faxed written questions to Mendelson last week. Mendelson said Tepper was traveling in Europe and hadn’t received the written questions. But she confirmed that she had spoken by phone to Tepper after receiving the questions, and said he wouldn’t be able to comment at least until he returns to the United States next week.

Shares from new public offerings of stock paid higher commissions to brokers than ordinary stock sales, often $1 a share. The sought-after shares in new offerings were allocated by Shearson according to brokers’ past performances in selling shares from offerings. But Tarlowe’s inner core was assured of a steady supply because they could count on selling all of their shares into the Tepper and other favored accounts.

Edward Kwalwasser, the NYSE’s executive vice president for regulation, declined to say what potential rule violations the exchange was looking into in connection with the Tepper accounts, or to say if the inquiry has been closed. To date no charges have been filed relating to those accounts.

Passman, branch manager at the time, declines to comment on anything that happened at 55 Water. In hundreds of pages of depositions taken in 1989 and 1990, Passman repeatedly testified that he couldn’t remember why certain things were done, or said he could only speculate on the reasons. He confirmed having discussions with Shearson higher-ups after an NYSE audit turned up improprieties in 1986, but said he couldn’t specifically recall what was discussed.

When the NYSE charges were filed last summer, Passman was the only 55 Water manager who was demoted. Although he went back to being a broker, Shearson arranged for the transition to be a comfortable one.

He was allowed to move to the Shearson office in Boca Raton, Fla., where he had already built a lavish home. He was given what was described in testimony in an arbitration case as a “consulting agreement” for two years, whereby he was guaranteed $125,000 a year over and above anything he earned as a broker. (A Shearson spokesman denies that the agreement is a consulting agreement and says that Passman has done no consulting for the firm.)

And his earnings as a broker likely are considerable. He was given an extremely lucrative “book” of customers that once belonged to William E. Welsh, who had built Lehman’s retail division. Shearson declined to comment on the Welsh list. And for his first two years as a broker, Passman was allowed to keep 60% of the commissions he generated. Forty percent is more common among brokers.

Asked why Shearson didn’t fire Passman for allowing numerous serious violations of securities regulations to go on in his office, Joseph J. Plumeri II, president of Shearson’s retail unit, says: “Whatever transgressions the New York Stock Exchange thought he committed were in a supervisory capacity.” Plumeri said Passman had been punished enough and erroneously stated that the stock exchange had fined Passman. In fact, his only punishment was a censure and four months suspension from acting as a supervisor. Plumeri said that since Passman was no longer in a supervisory role at 55 Water, “we felt satisfied that he was in a good position to do what was right for the rest of his life.”

Management Aware

Passman’s memory lapses may have been fortunate for some of his superiors. Baumel, the former Shearson compliance executive, contends in an interview that Shearson’s top management was repeatedly made aware of wrongdoing at 55 Water St., but gave orders to do nothing about it. “I remember one year we were complaining to management about what was going on. They said, ‘You have to understand that this branch made $100 million this year, more than 10 other branches combined were making. So we can’t clamp down on them.’ ”

Baumel says she faults former Shearson Chief Executive Peter Cohen, even though she says she has no firsthand knowledge that he was aware of the specific problems at Water Street. Cohen, she notes, engineered Shearson’s acquisition of Lehman Brothers Kuhn Loeb in 1984. “He brought them in so he favored them. When anybody would speak out against what’s going on there, he would pooh-pooh it.”

Cohen denies knowledge of serious problems at 55 Water St. “We were not aware of sales practice abuses at 55 Water out of the ordinary,” he says. “And when we did become aware of them, we saw that the salesmen were terminated, as we did anywhere in the (Shearson) system.”

In his depositions, Passman testified that he discussed the wrongdoing found in the NYSE’s 1986 audit with higher-ups, including Shearson’s head of compliance, Joseph A. DelDuca. Passman said he couldn’t recall them ordering any remedial action. A Shearson spokesman said DelDuca had no comment.

Although Shearson executives said in interviews that all of the 55 Water brokers involved in wrongdoing had long ago been booted out, additional NYSE charges made public in March, 1992, establish that this isn’t so. The exchange disclosed that its board of directors upheld an October, 1990, NYSE disciplinary panel finding against Water Street broker Anthony Tricarico.

For activity in 1985-86, the exchange censured Tricarico and ordered him suspended for nine months. Tricarico is appealing the suspension to the Securities and Exchange Commission, and meanwhile is still at his desk. The exchange in essence found that Tricarico had carried the idea of not taking no for an answer to a new extreme. The disciplinary panel found that at least four times, when customers he had called turned him down, he opened accounts in their names anyway. He then sold the customers stock they never asked for and sent them the bill. Tricarico and his lawyer declined to comment on the charges.

At least one other 55 Water customer claims to have been victimized more recently by Tricarico while the NYSE investigation dragged on.

Kenneth Greenway, whose family owns restaurants around Shreveport, La., says Tricarico cold called him in 1987 and persuaded him to pull much of his money out of bank certificates of deposit to open a stock trading account at 55 Water St. Greenway charged in a formal arbitration complaint that Tricarico heavily churned the account over the course of a year, wiping out much of his investment. Shearson paid Greenway $20,000 in settlement. “That I’d fall for someone like Anthony is embarrassing,” Greenway says. “But he’s probably one of the smoothest people I’ve ever dealt with.”

Shearson declined to comment on the cases involving Tricarico or say why the firm decided to let him remain on while he appeals the stock exchange decision.

Records of other arbitration cases show that 55 Water St. brokers other than those who have been named in NYSE charges were involved in garden-variety churning and making unauthorized trades.

Retired steel company executive Irving Kurtz recovered $213,000 in an arbitration award after accusing Water Street broker Michael Tierney of churning his account from 1985-88. The average value of the account was $410,501, but Tierney made rapid purchases and sales of securities so that total purchases amounted to over $9.7 million, generating commissions to Tierney and the firm of over $285,000. Kurtz’s out-of-pocket losses allegedly amounted to $249,000.

Tierney has since left Water Street to join Salomon Bros. Inc., where a spokesman says he is a broker in good standing. Tierney, reached by phone, declined to comment.

What’s more, customers recently claimed to have been victimized in the Lehman retail office in Boston, where Richard Baum, a former Water Street assistant branch manager who was penalized by the exchange, now presides. At least five former customers of broker Chester J. Dudzik Jr. claim that while he was with Lehman’s Boston office, he abused their trust through churning and buying risky stocks for their accounts that paid him steep commissions.

Dudzik is a former 55 Water broker who joined Shearson in Boston after a stint at Drexel Burnham Lambert. Dudzik left Shearson a few weeks ago, after The Times posed questions with Shearson’s management about trading records The Times had obtained. A Shearson spokesman said Dudzik “was permitted to resign,” but declined to elaborate. Dudzik said his departure was voluntary but declined to say why he left. He now works in the Sudbury, Mass., office of brokerage firm Portfolio Asset Management, an executive there confirmed.

One of Dudzik’s customers in the Boston office was Victor Lo, an owner of two Chinese restaurants in Bangor, Me., who recovered $100,000 in an arbitration case after claiming to have lost more than that in an account Dudzik allegedly churned. Records show that Lo acquiesced to unusual trading advice from Dudzik to sell his blue-chip stocks and instead concentrate his holdings in certain over-the-counter stocks for which Shearson was a market maker. Lo says Dudzik never told him that the broker was receiving large sales credits for selling the stock, which in accordance with Shearson’s practice aren’t disclosed on customers’ confirmation slips or account statements.

Shearson spokesman Faigen said Shearson wouldn’t comment on Dudzik’s accounts “other than to say the system for processing and handling OTC stocks are in full compliance with all regulatory guidelines and procedures.”

In a short interview, Dudzik noted that under existing regulations he wasn’t required to disclose the sales credits to customers. He said customer complaints about him were “purely allegations.”

Today, Shearson executives say they are satisfied with the way the Lehman division is operating. They say they have no plans to change its fundamental mode of doing business--cold calling, or as some Shearson executives prefer to call it, “telemarketing.”

Former brokers say that in the 1980s, that approach often brought the Lehman offices perilously close to violating the “know your customer” regulations. Brokers are required to know details of their clients’ financial resources, their level of sophistication as investors and their financial goals. They aren’t allowed to recommend stocks that have a higher degree of risk than a client can reasonably afford, and can’t push securities that are inconsistent with their clients’ investment objectives.

“They didn’t want you to know your customer at all,” former broker Boyle says. “Time was too valuable.”

Next in Business: Getting accurate information on brokers’ records is more difficult than regulators think.