In a report that caps nearly two years of investigation, the Securities and Exchange Commission concludes that some of Wall Street's biggest investment houses have failed to weed out brokers who habitually defraud customers, according to a copy obtained by The Times.
The report on rogue brokers, due to be made public today, calls for much tougher regulation of both brokerages and brokers. It discloses that the SEC has launched disciplinary cases involving fully a quarter of the 161 branch offices it inspected.
The illegal activities included making unauthorized trades, excessive trading to generate commissions for brokers, putting customers into unsuitably risky securities and improperly switching customers from one mutual fund to another.
The SEC review focused on the nine Wall Street brokerages that do the most business with individual investors. Three of the firms accounted for 88% of the improprieties found.
While the report did not identify the three, sources have said one is PaineWebber Inc. Officials of PaineWebber could not immediately be reached for comment late Wednesday. But top executives have denied that the firm has any systemic problem with brokers and said PaineWebber has recently adopted advanced computer systems to ferret out fraud.
The SEC report concludes that the number of dishonest brokers is probably small. But "the fact that 25% of the branch office examinations conducted in this project resulted in referrals for enforcement investigation and possible disciplinary action," it said, suggests that firms are not adequately supervising brokers.
That finding also shows the need for stronger sanctions by the SEC and stock exchanges, the report concludes. Among its recommendations: Give enforcement authorities the right to ban brokers from the industry for life, with no right to reapply.
The SEC investigation was launched in response to a Times series on rogue brokers published in July, 1992. It also followed questions to the SEC from Rep. Edward J. Markey (D-Mass.), chairman of the House Subcommittee on Telecommunications and Finance. A parallel inquiry is being conducted by the General Accounting Office, and Markey's subcommittee is due to hold hearings on the issue this summer.
The Times series reported that PaineWebber, Prudential Securities and several other well-known Wall Street firms hired and kept on brokers who had long records of lawsuits, arbitration cases, customer complaints and disciplinary action. The series noted that the SEC itself seldom brought cases against brokers and firms for cheating individual investors. The Times found that inquiries conducted by the New York Stock Exchange, the National Assn. of Securities Dealers and other exchanges were extremely slow and shrouded in secrecy.
Brokers kicked out of one firm for unethical behavior often had no trouble finding jobs at other firms, the series reported--a finding the SEC report confirms. But the commission said that only a few of the bad brokers it identified were among their firms' 50 top producers.
The controversy over rogue brokers prompted the NYSE and NASD for the first time to make disciplinary cases public as soon as charges are filed, instead of only after all appeals are exhausted. It led to an overhaul of an NASD investors hot line that had been withholding information about brokers' disciplinary records.
In a speech he is scheduled to deliver today in Washington, SEC Chairman Arthur Levitt Jr. is expected to emphasize that the problems are not endemic to the brokerage business. Nonetheless, he will call for greatly enhanced enforcement measures--including, if necessary, steps against the firms' top executives.
Since his appointment last year by President Clinton, Levitt has focused on beefing up protections for individual investors.
The SEC found that many firms had failed to institute hiring and supervisory practices to screen out bad brokers. The report says that some branch office managers did not take routine steps required by regulations to weed out dishonest conduct by brokers and that compliance officers who objected to the hiring of brokers were often overruled by others at their firms.
The recommendations include:
* Using more inspectors and stepping up the frequency of routine inspections by the SEC and stock exchange examiners.
* Implementing new regulations to make clear that top management at firms, and the firms themselves, will be held accountable for employing brokers who have "a history of regulatory problems."
* Requiring tougher penalties against brokers, including longer suspensions and, for severe violations, permanent bans from the industry without the right to reapply. Currently, most who are banned for life are allowed to reapply eventually.
* Giving firms' compliance officials more say in firing brokers who break the rules. The report says that firms' top executives should be held accountable when they overrule a compliance officer's recommendation not to hire a broker or to fire someone who has drawn customer complaints.
* Increasing continuing education for brokers, especially about "new and exotic" investment products firms are selling.
The firms included in the SEC investigation were PaineWebber, Prudential Securities, Merrill Lynch, Dean Witter Reynolds, Kidder Peabody, A.G. Edwards and Kemper Securities, as well as Shearson Lehman Bros. and Smith Barney, which have merged since the investigation began.
The SEC noted that because the investigation focused only on the nine big firms, the report does not draw any conclusions about how widespread the problem may be in the securities industry as a whole, which includes hundreds of brokerages throughout the country.
The inquiry focused on a sample of 268 brokers who had records of customer complaints, arbitration cases and disciplinary action.
But the report notes that when examiners visited the branches where these brokers worked, they often found other brokers in the same offices who appeared to have committed serious violations.
The SEC also found that some firms were not complying with requirements to promptly report complaints filed against brokers.