Probe Targets the Hiring of Problem Brokers : Several Leading Firms Use Them, SEC Says

A major inquiry by the Securities and Exchange Commission has yielded information confirming that several of Wall Street’s leading brokerage firms have knowingly employed significant numbers of brokers with long records of cheating customers, sources said.

The SEC began its wide-ranging review last July, demanding voluminous data from a dozen of Wall Street’s top firms in response to a series of investigative stories in The Times.

Because the information is still being reviewed, SEC officials so far have declined to make any public statement on the findings.

But sources familiar with the data said it shows a wide disparity among the brokerages. Some firms appeared to have few problems; others seemed to consistently hire and retain brokers with multiple formal complaints against them and records of disciplinary action.

Firms asked to turn over information to the SEC included Shearson Lehman Bros.; PaineWebber; Prudential Securities; Merrill Lynch; Kidder, Peabody, and Smith Barney, Harris Upham.

Sources declined to say which firms had the worst problems or divulge any statistics on the extent of those problems. But one official said: “There is definitely cause for concern,” adding that the data shows “clear problems” in hiring and disciplining brokers at certain firms.

The firms with the worst problems, according to one source, appeared to be those that “value big producers above all else.” In Wall Street jargon, “big producers” are ones who generate heavy commission income for their firms.

The related problems include violations such as making trades customers never authorized, forging customer signatures on account documents, excessively trading accounts solely to bring in commissions and deliberately putting customers into unsuitably risky investments.

The SEC staff is expected to formulate a general response to the inquiry early next year. Sources said it will include proposals for industry rule changes and may also include a wave of cases by the SEC’s enforcement division.

Several firms confirmed that they had turned over information requested by the SEC but declined further comment because the inquiry is pending.

Merrill Lynch, saying that it complied fully with the SEC request, issued this statement: “We are extremely proud of our compliance record, which is due to the fact that we deal quickly and definitively when such action is necessary.”

The Times series reported that some of Wall Street’s best-known firms employed brokers with long records of formal customer complaints, arbitration awards and civil judgments against them, as well as disciplinary records.

It also reported that the industry’s system of self-regulation--which delegates much rule enforcement to the stock exchanges and the National Assn. of Securities Dealers--had been ineffective at weeding out brokers and supervisors who allowed improper activities to occur.

The SEC sent letters to the dozen brokerages in July, requesting extensive information on hiring practices and on brokers who had records of formal action resulting from multiple customer complaints. Firms turned over the information by early October.

SEC Commissioner Mary L. Schapiro said she couldn’t comment on the inquiry itself. But Schapiro said she and several other commissioners have become convinced that the ease with which brokers who have records of cheating small investors move from one big firm to another poses a serious problem.

“We have been sitting in enforcement meetings and just been disgusted that we see these people go from firm to firm, getting increasing amounts of money each time,” said Schapiro, who has been mentioned as a possible candidate to succeed SEC Chairman Richard Breeden. “The firms appear to make a calculation that the commission business these people can bring in is worth the risk.”

Although the SEC is still deciding on a general response, disclosures of wrongdoing by firms and brokerage managers already have resulted in action:

* The SEC enforcement division has begun a formal investigation of Shearson Lehman Bros., with emphasis on sales abuses and other problems at the firm’s huge, highly profitable retail branch office at 55 Water St. in Manhattan, individuals with direct knowledge of the investigation said.

The Times reported that a number of practices--churning customer accounts to generate big commissions, using high-pressure sales tactics to sell unsuitable securities and making trades customers never requested--had been endemic in the office and that wrongdoing had been at least tacitly encouraged by supervisors.

A Shearson spokesman said the firm had no comment on the SEC investigation.

* Shearson has carried out a major shake-up of its retail division, including the removal or demotion of the heads of several Shearson retail offices--among them Robert Tarlowe, who had been the branch manager at 55 Water St.

A Shearson spokesman has denied any link between the personnel changes and the SEC inquiry or Times articles. But other sources at the firm contend that the changes were directly linked to the disclosures and to intense scrutiny of the firm’s retail operations by the SEC.

* The SEC has launched or stepped up several other enforcement investigations involving the retail sales practices of major brokerage firms. In addition, the commission in November approved rules changes requiring firms to disclose more information about brokers’ disciplinary records.

* In response to data collected in the inquiry, the SEC has begun formal examinations at several firms--probes in which SEC examiners conduct a formal review of records and procedures.

Until the SEC inquiry began, the agency had opened few enforcement investigations in recent years involving the major Wall Street firms’ retail brokerages, leaving most enforcement to the New York Stock Exchange and NASD. Instead, the agency focused on insider trading and securities fraud violations involving top investment banking officials, as well as violations by smaller penny stock firms.

* At least one federal criminal investigation of alleged wrongdoing in the retail brokerage industry is pending.

The U.S. attorney’s office in Manhattan is investigating an alleged forgery of a customer’s signature on a document on which the customer, Carole W. Davis, appeared to acknowledge that she was aware of and approved unusually heavy trading in her account by Charles M. Lewis, a Shearson broker cited in The Times series, two sources with knowledge of the investigation said.

Both Shearson and Lewis declined to comment on the case. Lewis has denied any wrongdoing in dealings with customers.