Tip for Stock Investors: Beware of Watchdogs : Regulation: Brokers police themselves in a process that moves with glacial slowness while hiding wrongdoing for years. Higher-ups typically escape tough punishment.
As branch manager of PaineWebber’s Santa Barbara office, David W. Stanger is supposed to supervise his stockbrokers so closely that he is required to examine and initial every trade they’ve made.
A few years back, however, Stanger detected nothing amiss when his top-producing broker linked up with a convicted felon and aggressively sold grossly overvalued stock in three small, related companies to unsuspecting customers. The companies made claims worthy of medieval alchemists: One falsely told investors that it had discovered the means to extract vast amounts of gold from the black sand beaches of Costa Rica; another that it could cheaply extract platinum from used automobile catalytic converters.
Stanger allowed the broker to load up customers’ accounts with the stock of the three companies, Goldcor, S. Taylor Cos. and Noble Metal Recovery. Other brokers in the office also sold shares of the stock. But none of the stocks were legally registered for sale in California. And when a February, 1988, article in Barron’s disclosed that all three companies had vastly overstated their financial prospects, the stock prices collapsed. Customers of Stanger’s branch lost well over $1 million.
Donald Balch, a former broker in the office whose wife invested in the stocks, recalls that the Santa Barbara branch was used to show slide presentations to customers touting the securities and showing pictures of gold mines.
Although Alan Goldman, the broker who heavily promoted the stocks, was fired, Stanger is still the Santa Barbara branch manager. And when the New York Stock Exchange got around to penalizing Stanger in January--more than four years after the trading had occurred--for failing to properly supervise his office, his punishment was a three-week suspension as a supervisor, and a $15,000 fine that PaineWebber paid.
“It’s preposterous,” says John R. DeLoreto, a Santa Barbara lawyer who represented victimized customers. “The penalties are nothing.”
Stanger declines to comment on the case.
When it comes to the biggest Wall Street firms, regulatory authorities often go easy on supervisors and higher executives who allow wrongdoing to go on or who fail to exercise sufficient vigilance in detecting or preventing wrongdoing. The Times’ examination of several recent big cases brought by the NYSE against major firms shows that low-level managers received mild punishment and more senior executives weren’t penalized at all despite evidence that they knew of the wrongdoing and allowed it to go on.
Mild penalties and the slowness of the New York Stock Exchange to act, critics say, is symptomatic of a system in which the securities industry is largely left to regulate itself. They say the result is an atmosphere in which supervisors remain more worried about profits than about protecting unsophisticated investors from being cheated.
Lawyers for investors say that enforcement should be stricter and that the Securities and Exchange Commission should more closely supervise the enforcement efforts of the stock exchanges.
Federal securities laws and regulations, in fact, are strict and explicit, charging brokers with a “fiduciary” responsibility to their customers. By law, they are forbidden to engage in what are called abusive sales practices, such as excessively trading accounts solely to generate commissions.
But in practice, government regulators most often stay in the background. The SEC delegates much regulatory responsibility to “self-regulatory organizations,” or SROs. These include the National Assn. of Securities Dealers and the stock and options exchanges. They are all organizations whose members are the securities firms.
“The SEC very rarely brings broker-dealer cases,” says Edward Kwalwasser, the NYSE’s executive vice president for regulation. “Almost all cases come from the SROs, and once we have a case, we don’t (like to) give it up.”
But it is an arrangement that even top industry executives acknowledge is unusual. The industry’s marketplaces--the stock exchanges, whose members are the brokerage firms--are also supposed to be the industry’s watchdogs. “I don’t know of any other business where the marketplaces are your regulators and you have this self-regulatory control,” says O. Ray Vass, director of compliance at Merrill Lynch & Co.
The SEC maintains that the system works well. Mark D. Fitterman, the SEC’s associate director of market regulation, describes recent cases brought by the NYSE against member firms as “very big cases” with “very large fines in relation to the historical precedent.” NYSE is the main regulatory authority for the biggest Wall Street firms. Fitterman says, “I think it’s fair to say that the New York Stock Exchange has upped the ante.”
SEC officials say the agency doesn’t have the money or staff to take over more of the regulatory responsibilities from the self-regulatory organizations. William R. McLucas, the SEC’s enforcement chief, says investors must accept that despite current enforcement efforts there will continue to be dishonest brokers and managers.
“There will be an acceptable level of miscreants in the system,” McLucas says. “It’s just a fact of life, unless you want to spend so much money that you would put a federal enforcement officer in every firm to clear out the bad apples from the good.”
But lawyers who represent customers say that in practice the system often amounts to letting the fox guard the chicken coop. “The SROs are really too close to the firms they regulate,” says New York securities lawyer John Halebian. “It’s a tremendous conflict.”
At the NYSE, disciplinary procedures are cloaked in secrecy and move with glacial slowness. Even when investigators discover that a brokerage office is victimizing customers on a continuing basis, the NYSE doesn’t publicly disclose its charges until its entire judicial process is completed. This can take more than five years. Even once a NYSE disciplinary hearing panel finds a broker or firm guilty, the charges aren’t made public until after NYSE’s board rules on a final appeal.
NYSE officials say this procedure is necessary to preserve the reputations of brokers or firms who may ultimately be found not guilty. But lawyers for brokerage clients say the investing public should at least be warned once a disciplinary panel rules. They say keeping the case confidential until the appeal is exhausted is analogous to keeping the existence of a criminal case secret until after the Supreme Court rules on a final appeal.
Although SEC officials say the Big Board has become a much tougher cop lately, an analysis of two of the NYSE’s recent biggest cases shows that the penalties were extremely mild compared to the level of wrongdoing found.
One case involved PaineWebber, the other a huge Shearson Lehman Brothers retail brokerage office in Manhattan. The Big Board didn’t make public its charges until years after finding serious violations of securities laws.
The exchange did not charge anyone above the lowest levels of supervisors, even though there was strong evidence that senior executives must have known of the misdeeds. In the PaineWebber case, the exchange found that top executives failed to take any action even after exchange examiners presented them with reports detailing sales practice violations, such as concentrating customers’ investments in unsuitably risky securities.
For example, the charges involving PaineWebber’s Santa Barbara office were part of a case extraordinary in scope that was filed in January by the NYSE against the brokerage. PaineWebber was allowed to negotiate a settlement and neither admitted nor denied guilt. Even so, the NYSE charges made public indicated systemic wrongdoing at PaineWebber.
The charges included churning, manipulating options trades at customers’ expense, as well as criminal activity such as multiple instances of direct theft of customers’ funds. And the wrongdoing occurred from coast to coast: The NYSE charges involved nine PaineWebber branch offices across the country, from Springfield, Mass., to Santa Barbara.
Stock exchange investigators found a firm-wide pattern of wrongdoing, including failure by PaineWebber managers to monitor how their biggest producing brokers were earning their commissions. The NYSE found that many profited personally while cheating their customers. The NYSE charges stated that the firm’s “supervision of certain of its largest producers was inadequate to prevent continuing misconduct over long periods of time.”
The alleged violations cost PaineWebber’s customers, many of them smaller investors, millions.
The NYSE heralded the action against PaineWebber, the nation’s fifth largest retail brokerage, as a major case. Fines totaling $900,000 were the second-largest amount ever imposed by the exchange.
But most of the specific instances of alleged wrongdoing took place from 1984-88, and the NYSE case wasn’t publicly disclosed until 1992. The firm claimed that all of the wrongdoing was history, involving brokers who long ago had been fired. However, arbitration and court records show that a number of current and recently departed PaineWebber brokers have long records of customer complaints, disciplinary action and arbitration and court cases against them.
The executives who were penalized were given only brief suspensions from supervisory duties--the longest suspension was three weeks--and fines that the firm paid for them. Although the $900,000 was large, PaineWebber officials acknowledge that it will have no significant impact on the firm, which in 1991 earned a profit of $150 million. And even though the NYSE found systemic compliance problems throughout PaineWebber and the wrongdoing took place in offices across the country, the only executives penalized were the lowest level managers--seven branch office managers and two regional managers, one of whom was no longer with the firm.
In the example of PaineWebber’s Santa Barbara office, records show that not only did the firm fail to closely examine the financial prospects of the three companies, but senior executives in New York authorized PaineWebber’s trading desk to make a market in the stocks. A market maker acts as a dealer and stands ready to buy or sell a stock at publicly quoted prices. The decision facilitated sales of the stock to PaineWebber customers.
PaineWebber General Counsel Robert M. Berson confirmed that the decision for the firm’s trading desk to make a market could only have been made by senior executives at PaineWebber’s New York headquarters. And records obtained by The Times show that the decision was made after Santa Barbara broker Goldman sent a four-page memo to PaineWebber President Paul B. Guenther. The memo extolled the stocks and praised Carl Martin, the promoter of the companies who was later discovered to be a convicted felon.
Berson said Guenther declined to comment. Berson said the firm couldn’t comment on the case because of a pending arbitration in which ex-broker Goldman is seeking money from the firm. He declined to say if Guenther knew anything about Martin’s record or if senior executives closely looked into the three companies. Berson wouldn’t say if it was Guenther who authorized the trading desk to make a market in the stocks.
What’s more, NYSE documents charged that PaineWebber violated exchange rules that require annual supervisory inspections of branch offices. NYSE examiners throughout the late 1980s found that scores of PaineWebber offices hadn’t been visited by supervisors in more than 18 months. Some of them had never been visited at all until NYSE officials repeatedly called PaineWebber’s attention to the problem.
Critics charge that the NYSE’s response to massive wrongdoing found at the huge Shearson retail office at 55 Water St. in Manhattan was equally tepid.
Jonathan Kord Lagemann, a former supervisor of litigation at the brokerage firm Thomson McKinnon and now a private attorney representing a former 55 Water St. customer, says of the Water St. penalties, “Shearson in my view paid money to resolve a problem that, if you’re serious about enforcement, should have required some bars (from the industry) for life. A lot of them.”
The NYSE fined Shearson $750,000 for widespread wrongdoing that NYSE auditors had turned up in 1986. Shearson neither admitted nor denied guilt, and now says the problems occurred years ago and have since been remedied. Investigators found heavy churning of customer accounts to generate commissions, trades being illicitly moved from one customer’s account to another and brokers illegally taking big, secret commissions.
It wasn’t until August, 1991, however, that charges were publicly disclosed. In the meantime, there was no warning to investors of serious violations of securities laws at 55 Water, and other customers were victimized while the NYSE disciplinary process played out.
The NYSE allowed Shearson to negotiate a settlement under which the firm consented to charges being filed that applied only to activity in 1985-86, even though investigators had found wrongdoing continuing well after that. The only rank-and-file brokers named in the negotiated settlement were ones who had already left the firm, even though brokers still there had also participated in the wrongdoing.
The NYSE took even longer--until March, 1992--to announce action against a 55 Water St. broker who remained at the firm, Anthony Tricarico, for wrongdoing committed in 1985. NYSE auditors found that Tricarico had fraudulently opened accounts for individuals who hadn’t asked for them and made unauthorized sales of stock into the accounts. In the meantime, Tricarico continued to do business at the office, and at least one customer in the late 1980s received a settlement from Shearson after formally complaining that Tricarico had churned his account.
Asked why it took the exchange seven years to announce action against the broker, David Doherty, NYSE’s enforcement director, said the Tricarico case was part of the larger, complicated 55 Water St. case. “Complicated investigations take a long time,” he says.
The NYSE’s Kwalwasser strongly defends the penalties in the PaineWebber and 55 Water St cases. The penalties “seemed to us big,” he says. “We have no reticence in bringing proceedings against any member firm if we believe they violated the rules.”
Kwalwasser says the facts in the recent cases didn’t justify going after high-level executives. “You can’t expect the chief operating officer to supervise a salesman,” he says. And he notes that there have been other cases in which the most senior managers have been penalized.
For example, Frederick Joseph, the former chief executive of Drexel Burnham Lambert, was recently censured and temporarily barred from association with a member firm. (The action against Joseph, however, didn’t come until long after Joseph’s firm had pleaded guilty to six felony counts and collapsed into bankruptcy proceedings.)
Significantly, when the NYSE enforcement staff brings a case against a firm or its employees, guilt or innocence and the size of any penalty are not decided by the exchange itself. Instead, brokerage firm executives have a deciding vote in every case. Two of the three members of every disciplinary hearing panel are brokerage firm executives. (The third is an officer of the exchange.) The result, critics say, is that the NYSE rarely imposes severe penalties on managers or high-level executives of established firms.
Kwalwasser defends NYSE penalties as tough and appropriate to the level of wrongdoing investigators find. But he acknowledges that there are practical limits on penalties, even though NYSE rules set no limit on the size of fines. Asked why the exchange hasn’t pressed for tougher penalties and action against high-ranking executives in some recent cases, Kwalwasser says, “You have to figure out what you can get from a panel. We have to go for what we can get.”
An analysis of the disciplinary decisions that the NYSE publishes every month shows that the panels often reject charges NYSE investigators recommended. In Tricarico’s case, the enforcement staff had also recommended charges for heavily churning a customer’s account to generate commissions and causing customers to concentrate their investments in highly risky, unsuitable securities. The disciplinary panel rejected these charges on the ground that the customers were sophisticated enough about investments that they should have detected and stopped the trading themselves.
Tricarico and his lawyer declined to comment on his case, which is being appealed to the SEC.
The NYSE’s judicial process is so secretive that the exchange doesn’t even make public the names of industry executives who serve on disciplinary panels--so that, in effect, even the identity of the judges is secret.
The Big Board turned down a request from The Times for the names of executives who have served on panels in recent years. But The Times has obtained transcripts of sworn testimony showing that one individual who served on NYSE disciplinary hearing panels for 20 years was Seymour Passman, the former 55 Water St. branch manager who presided over that office throughout the time the wrongdoing occurred and who was censured by the exchange.
NYSE spokesman Raymond Pellecchia says that once panel members are formally designated as targets of NYSE investigations, they aren’t allowed to continue serving on disciplinary panels. He declined to say if either of the two other Water St. executives who were censured have ever served on disciplinary panels.
The names of the panel members are disclosed to the firms who are targets of investigations, NYSE officials say, but the names aren’t made public. The officials say the secrecy about panel members’ identity is necessary to prevent retaliation against them by their employers, or other firms, for the decisions they make. The officials said that even though the names of panel members are disclosed to targets, the exchange expects the targets to keep the names confidential.
The exchange also heavily censors its published disciplinary decisions. In actions against individual brokers, it routinely edits out the branch office they worked for, as well as the names of stocks involved in the brokers’ wrongdoing, and the identity of victims. Customers’ lawyers claim that the heavy editing protects firms from new claims by individuals who might discover from the NYSE reports that they too had been victimized. NYSE officials say the secrecy protects innocent parties from unnecessary publicity.
State regulators and securities lawyers also complain that other key elements of the industry’s self-regulatory system are inefficient and heavily biased toward the industry. For example, state regulators such as Debra M. Bollinger, director of the South Dakota division of securities, complain that the largest self-regulatory organization, the National Assn. of Securities Dealers, also may be too sympathetic to the concerns of the member firms it regulates. The NASD is a Washington-based industry organization that oversees much of the over-the-counter stock market.
The NASD’s role is crucial because it maintains a vast computer database, known as the Central Registration Depository, that contains disciplinary information on virtually every firm and broker in the country. It is the main database that state regulators rely on to enforce securities laws in their states, and brokerage firms rely on the accuracy of the data when making hiring decisions. Yet the records are filled with gaps, leaving out major arbitration awards and other serious action against brokers.
The NASD rarely takes action against firms for failing to file accurate reports, and interviews with industry executives indicate that there is much confusion about what they are required to file, and with whom.
In 1990, a NYSE arbitration panel awarded Shearson customer Donald Sillaro $106,390 in an arbitration case against Shearson broker Henry Boulbol for losses caused by putting much of Sillaro’s savings into highly risky options purchases. There is no record of the award, however, in Boulbol’s CRD file.
Shearson insists that it made all necessary filings with the NASD. NASD officials deny that they are responsible for the gaps in the brokers’ records. So it is impossible to determine whom to blame.
State regulators rely heavily on the database, as do the Wall Street firms themselves when they are considering hiring a broker from another firm. Yet the gaps and inaccuracies mean that users of the database often get an incomplete account of complaints and disciplinary actions against brokers.
State regulators have other complaints about the NASD:
Bollinger complains that the NASD often does nothing when NASD examiners turn up violations of state securities laws, including instances of brokers doing business in states where they aren’t licensed. The NASD confirms that it normally doesn’t report such violations to the states and says it can’t afford to have its examiners worry about widely diverse state laws.
* The NASD won’t open an enforcement case if a dispute between a broker and customer is pending in an arbitration case before the NASD. Signs of severe wrongdoing at firms often emerge first when customers bring complaints to arbitration. But John E. Pinto Jr., NASD executive vice president for compliance, says that except in rare circumstances, it’s against NASD policy to open an investigation until an arbitration case has been completed, a process that can take years.
* Even though NASD arbitrators have the authority when they issue their decisions to refer cases they find egregious for disciplinary investigation, they seldom do. Deborah Masucci, the NASD vice president for arbitration, estimated that arbitrators refer only a dozen cases for disciplinary investigations out of the approximately 1,400 cases decided each year. She says under NASD policy arbitrators aren’t specifically encouraged to do so.
The SEC’s division of market regulation is responsible for supervising the self-regulatory organizations such as the NASD and the NYSE. But over the years the SEC has seldom taken action against any of them. The SEC’s Fitterman says that the commission has done so only three times since the agency was created in 1934.
But Kenneth Greenway, a Shreveport, La., resident, disagrees with SEC officials’ claims that they’re already doing enough to police the industry. In a formal complaint that led to a settlement by Shearson, Greenway claimed he lost thousands of dollars when 55 Water St. broker Tricarico churned his account to generate commissions--abuses that occurred well after the long NYSE investigation of Tricarico had begun.
“Something needs to be done about it,” Greenway says. “The regulators need to look at what’s going on at these firms. The government isn’t doing its job.”
