The Hot Line That Isn’t : For Checking Out Brokers, It May Be Worse Than No Data at All

Getting accurate public information on unscrupulous stock brokers is more difficult than some regulators seem to believe.

William McLucas, the Securities and Exchange Commission’s enforcement chief, claims that investors can help protect themselves from brokers with long histories of customer complaints just by taking the trouble to check out a broker’s record before investing.

He recommends calling a toll-free hot line set up last October by the National Assn. of Securities Dealers in Washington. The hot line was mandated by a new federal law.

But an investigation by The Times shows that the NASD’s 800 number is often worse than no information at all. Operators routinely give out false or misleading information, giving a clean bill of health to brokers who have records of judgments against them for harming customers, as well as numerous customer complaints and settlements. The NASD, an industry organization whose members are securities firms, as a matter of policy also does not disclose pending disciplinary charges against brokers.

The result is that small investors who make diligent efforts to check up on brokers may still fall into the hands of salesmen with established records of defrauding customers.

On several occasions, NASD operators gave out patently false information when a Times reporter, identifying himself only as a private individual, called to inquire about individual brokers. On May 11, for example, a reporter called the toll-free number, 1-800-289-9999, and asked about Charles M. Lewis, a Shearson Lehman Bros. broker in New York. The operator checked the computer and said: “No disciplinary information exists for this individual.”

The reporter then asked specifically if Lewis had a record of any arbitration cases decided against him. The operator, who identified himself as Duane, said there were no arbitration awards on Lewis’ record. “None at all?” the reporter asked. “That’s right--there’s nothing,” the operator said.

In fact, Lewis’ record, obtained by The Times from the same NASD computer database that supplies information to the hot line, shows three big awards since 1990 in cases brought by customers. The awards total more than $288,000, assessed jointly against Lewis and Shearson. Allegations in the cases included fraud, unauthorized trading and “churning” customer accounts--rapidly buying and selling stocks just to generate brokerage commissions.

Lewis declined to comment on the arbitration awards. Shearson says that despite the awards, it still disputes the allegations.

On April 22, the hot line gave a similar report on Boston-based Shearson broker Stephen H. Karelitz. The operator said Karelitz had a clean record. Asked if there had been any arbitration awards against him, she replied: “No.” In fact, the NASD database shows a $10,000 arbitration award to a customer in 1982. The hot line also did not disclose that complaints against Karelitz and lawsuits in which he was one of several defendants resulted in the firm paying settlements to customers totaling $695,000 from 1984-1991. In settlements, including this one, firms typically neither admit nor deny wrongdoing.

Karelitz said the arbitration award hinged on “a technicality.” He says he was unfairly named as a defendant in the lawsuits and says there was no legal finding that he had done anything unethical.

Sometimes, the hot line says it needs to review its records, and then sends a written report to callers. It did so in response to an inquiry about Randall R. Bryan Jr., a Shearson broker in Atlanta. Bryan since 1988 has had two arbitration cases decided against him with exceptionally big awards to clients, totaling $674,000. In one, an arbitration panel took the unusual step of awarding punitive damages in a case involving unauthorized trading in a customer’s account.

But the NASD report on Bryan says in full: “Final disciplinary actions: None. Criminal convictions: None.”

Shearson says it disputes most of the allegations against Bryan and calls the cases “isolated incidents.”

Lionel Glancy, a Beverly Hills lawyer who specializes in representing investors in securities cases, says of the NASD 800 number: “It’s an absolute joke.”

Mary Calhoun, a former stock broker who now serves as a consultant in Boston to lawyers in securities cases, says that the hot line is “worse than having nothing” because it gives investors a false sense of security.

The hot line’s failure to give out complete and accurate information raises questions about the SEC, which under the Penny Stock Reform Act of 1990 is supposed to supervise the NASD’s implementation of the hot line.

NASD officials readily acknowledge that as a matter of policy the hot line does not give out many types of information. Enno Hobbing, who just retired as NASD spokesman, said before he stepped down that the NASD will give out only final disciplinary actions, which he defines as final actions taken by the NASD, stock exchanges, the SEC or state regulators, and records of criminal convictions. The NASD will not give out information on settlements of lawsuits or arbitration cases, private censures imposed by the NASD or stock exchanges, or any pending disciplinary charges.

Hobbing said the NASD is justified in withholding the information because it may give an unfairly negative impression to customers.

But interviews with SEC officials show that they are not aware of how the hot line is actually operating. The SEC, for example, apparently is not aware that the NASD refuses to disclose arbitration awards against brokers and that it sometimes falsely states that there are none.

Mark D. Fitterman, the SEC’s associate director of market regulation, says that under the penny stock law, the NASD is definitely required to disclose final judgments in arbitration cases. “If there’s an arbitration award, yes, it should be disclosed,” Fitterman says.

Experts say arbitration cases are a crucial indicator of a broker’s trustworthiness. They say that while a broker in business for a long time may have a couple of customer complaints against him, multiple arbitration awards and settlements are often a reliable sign of problems. Because of a 1988 Supreme Court ruling, nearly all disputes between customers and brokers now go to arbitration.

Hobbing said the reason the NASD does not give out information on arbitration awards is that the awards do not fit within the NASD’s narrow definition of final disciplinary action. That definition is set by the NASD’s board of directors, whose members are brokerage firm executives.

To investors weighing whether to trust a broker who has contacted them and is urgently pressuring them to open an account, the issue can be vitally important. Actual disciplinary action, such as fines and suspensions, are rare. Even when the stock exchanges launch investigations and start disciplinary action, it typically takes years before the action is finalized and made public. But there are many brokers who have long records of customer complaints, judgments in civil suits and arbitration awards, in which panels of arbitrators found that brokers committed wrongdoing.

The NASD’s database, known as the Central Registration Depository, contains information on the disciplinary history of every broker in the country. The data includes customer complaints, arbitration awards, civil judgments, bankruptcies and actions by state regulators.

The telephone hot line was mandated by Congress in 1990 to replace a cumbersome system under which investors had to write in and formally request information from the NASD. The law was passed mainly in response to abuses by small brokerage firms that ran “boiler room” operations, victimizing investors by manipulating the market for low-priced over-the-counter stocks. Although the law left many details to be worked out between the SEC and NASD, it required the NASD to give out more information than it had under the old system.

The Times was able to check the hot line’s information against the brokers’ NASD database records by obtaining the full records from helpful state regulators. All state securities regulators have access to the database. Some states--such as Florida, Arizona, Missouri and Virginia--will give out over the phone or by mail the complete, uncensored record on a broker to state residents who ask for it.

But California residents aren’t so lucky. The state Department of Corporations does not take requests by phone. California residents wanting to inquire about a broker must send a written request to the corporations commission and wait two weeks or more for an answer. And the California regulators censor the NASD data--to a lesser extent than the NASD does, but still eliminating references to any pending disciplinary charges or customer complaints, arbitrations or lawsuits.

“I think you have to be fair to people. We’re not in the business of regulation by defamation,” says Bill McDonald, head of the Department of Corporations’ enforcement division.

But investor advocates say there are good reasons to disclose pending complaints.

“If an investor looks at the file of someone who has been a broker for 10 or 20 years and sees that there’s one complaint against them, that’s all right,” says Calhoun, the consultant in Boston. “People know that if you’re in the business for a long period of time, there’s bound to be one or two complaints. But patterns of conduct that generate lots and lots of complaints are significant. The more complaints there are, the likelihood that they’re all frivolous goes way down.”

NEXT: Allegations that brokers forged customers’ signatures on account documents are widespread.