NASD Shows Signs of Life : Once Considered a Regulatory Joke, Agency Gets Serious About Going After Bad Brokers

After 13 years as a stockbroker, Cris David Sagnelli has a checkered professional history. Records show he has worked for at least 15 brokerage firms, including a string of controversial operations that were shut down or investigated by authorities.

Sagnelli, 35, also was the target of a complaint about unauthorized stock trading, filed by a client in Florida, a cease-and-desist order from a Kansas regulator and an arbitration claim alleging fraud that put him on the losing end of a $157,284 award in Georgia.

But none of that had jeopardized his ability to continue doing business as a stockbroker--until maybe now.

Thanks in part to changes at the National Assn. of Securities Dealers, an industry organization with quasi-governmental powers, Sagnelli and other possible troublemakers in the investment business are undergoing tougher scrutiny. Sagnelli has been prevented from taking a new job in the brokerage business since April, pending the outcome of an NASD review.

Just three years ago, the NASD, which helps police stockbrokers and brokerage firms, was severely censured by the Securities and Exchange Commission and accused of winking at abuse. But these days, it is showing signs of life as an investor-protection agency.

“It’s made great strides,” said Robert L.D. Colby, who oversees the NASD as the SEC’s deputy director for market regulation.

NASD regulators played a role in breaking up the alleged longtime collusion among dealers in the Nasdaq Stock Market that resulted in inflated trading costs for investors.

The NASD also increasingly has joined with other regulators and criminal prosecutors to drive out some of the boiler-room operations that bamboozled stock market investors through high-pressure telephone sales techniques.

And the organization apparently is keeping a closer eye on brokers with blemished backgrounds such as Sagnelli who once moved freely from one controversial firm to another. (Sagnelli, who lives in Savannah, Ga., did not respond to requests for an interview.)

The tale of how investor protection was kindled at the long-complacent NASD is testimony to the motivating power of government pressure, class-action litigation and media scrutiny.

Its reforms were dictated largely by its 1996 settlement with the SEC, which was negotiated to resolve charges that the NASD was derelict as a regulator. The NASD reaches a milestone next month when an independent consultant hired under the settlement is due to issue a final status report on the association’s regulatory efforts.

A Case Study in Organizational Reform

Even though observers say the NASD has yet to correct some serious shortcomings, what it has accomplished stands as a case study of an organizational overhaul. As part of its rehabilitation, it embarked on an array of fundamental management changes.

A crucial early step was establishing a stand-alone unit, NASD Regulation, to protect the organization’s regulatory officials from the meddling of securities industry power brokers. Next, the top jobs at NASD Regulation were filled with respected officials recruited from the SEC.

Those regulators, in turn, hired more personnel, invested in new technology to improve the organization’s sleuthing abilities and cultivated closer ties to other regulatory agencies and criminal prosecutors.

But tough challenges lie ahead for NASD regulators, including Internet-related investment scams and the prospect of extended stock-trading hours and overseas expansion by Nasdaq. What’s more, a number of the organization’s old failings persist.

Its regulators generally are considered less aggressive than their counterparts at the SEC and at many state securities agencies. They also continue to be faulted for acting too slowly to expel brokers with shady professional records. Officials with the NASD “are doing better, to a point,” said John P. Cione, a lawyer in the securities industry since 1962 who is based in Solana Beach. “Sometimes they chase the wrong people for too long, and then they let a bad guy get off with a small fine.”

Other critics maintain that the NASD’s arbitration program, the nation’s dominant forum for resolving claims brought by investors against brokers, is tilted in favor of the industry.

In addition, thriving Wall Street firms have hired away numerous NASD examiners, aggravating what some observers consider chronic staff shortages throughout the organization. The lack of experienced staff people has strained the NASD’s ability to, among other things, conduct routine audits of brokerage firms--a task designed to spot financial irregularities or sales practice problems before they mushroom into serious threats.

Amid the overlapping regulatory networks that police the U.S. securities industry, the Washington-based NASD is an important component. It is an unusual creation, an industry membership group that wields government-type powers while covering areas that fall below the radar screen of federal regulators at the SEC.

The NASD matters to investors because, for one thing, it often is the first line of defense against rogue stockbrokers and other scam artists.

Before brokers can get state licenses to sell securities, they must first register with, and be cleared by, the NASD. It conducts reviews of small brokerage firms--where some of the worst sales abuses tend to occur--across the country and helps the New York Stock Exchange in examining the biggest securities firms.

The NASD also is the parent of the nation’s highest-trading-volume stock market, Nasdaq, as well as the American Stock Exchange. As such, it is responsible for regulating those exchanges, along with other over-the-counter securities trading.

The NASD recently has talked about spinning off its regulatory operation and merging it with the regulatory arm of the New York Stock Exchange, a move that would enable it to oversee Big Board trading too.

Professors’ Study a Catalyst for Change

Until a few years ago, many of the NASD’s investor-protection efforts were considered a joke. The organization “was a ‘good ol’ boys’ club dominated by the big firms,” said Marc Beauchamp, a spokesman for the NASD in the mid-1990s who is now in charge of media relations for the North American Securities Administrators Assn., a group consisting mainly of state securities regulators.

One of the main catalysts for change was a 1994 study of Nasdaq stock trading by a pair of business school professors. The researchers found that trading costs were artificially high for Nasdaq stocks, a phenomenon that fattened market makers’ profits at the expense of investors. The only apparent explanation was collusion among the market makers, the Wall Street firms that maintain a market in particular stocks by both buying and selling their shares.

Subsequent investigations by the SEC and the Justice Department and, before that, a series by the Los Angeles Times, yielded extensive evidence of price-fixing and trading abuses on Nasdaq.

The SEC, in a scathing report three years ago, said the NASD received information about possible market manipulation beginning in 1990 and did nothing, ostensibly because it didn’t want to offend its market-maker members.

Without admitting wrongdoing, the NASD settled with the SEC. In a pair of related legal actions, major Wall Street market-maker firms accused of collusion in Nasdaq trading settled price-fixing charges with the Justice Department and agreed to pay investors $1.03 billion.

Amid all the legal pressure, the NASD started its overhaul.

Hired as president of newly created NASD Regulation was Mary L. Schapiro, 44, a well-liked, energetic administrator. Previously, she was chairwoman of the Commodity Futures Trading Commission and, before that, a commissioner of the SEC.

One of Schapiro’s key recruits was Barry R. Goldsmith, 49, as NASD Regulation’s executive vice president for enforcement. In his previous role as chief litigation counsel at the SEC, Goldsmith directed the agency’s securities fraud and insider-trading suits against Drexel Burnham Lambert, Michael Milken, Ivan Boesky and Dennis Levine.

Although boiler-room operations are widely believed to be less of a problem today than they were just a few years ago, the NASD is hardly the only group deserving credit. The industry’s two other main regulatory groups, the SEC and the state securities commissioners, have played pivotal roles. On top of that, criminal prosecutors, particularly in New York, have stepped up their pursuit of rogue brokers and other investment fraud artists.

Reforms Lead to 60% Cut in Trading Costs

But the NASD increasingly has gotten credit from prosecutors for helping out on important criminal investigations, particularly in cases against boiler-room operators.

“They’ve provided us with expertise that we don’t have,” said Daniel J. Castleman, investigation division chief for the Manhattan district attorney’s office.

NASD statistics provide evidence of tougher enforcement practices. Probably the most impressive indicator, though, comes from Nasdaq. Trading costs there have fallen by more than 60% over the last five years.

“It’s a tremendous improvement in terms of how the market operates,” said University of Notre Dame finance professor Paul H. Schultz, one of the authors of the 1994 study exposing the apparent collusion among market makers. “A lot of credit goes to external forces,” Schultz said, citing new SEC-imposed order-handling rules, increased competition and improved stock-trading technology. “But NASD Regulation also is involved.”

David K. Whitcomb, a finance professor at Rutgers University and president of a Charleston, S.C., trading firm named Automated Trading Desk, was more effusive. He credited NASD Regulation officials with taking legal action against rule-violating market makers--something, he said, that “they almost never did in the past. And they have succeeded in jawboning [other firms] to stop engaging in practices that are against the regulations or against the spirit of the regulations. . . . They’re doing their job.”

The stepped-up efforts also are reflected in the NASD’s regulatory annual budget, which has risen from $194.9 million in 1996 to $300.6 million this year.

Much of that money is going into technology. One of the most crucial developments is a vastly improved record-keeping system whose phase-in begins in August. The system, known as the Central Registration Depository, will track the disciplinary histories of the nation’s 600,000 registered securities brokers.

But despite the improvements, critics still wonder if the NASD has the will to crack down on rogue brokers as aggressively as it should.

The lack of experienced staff appears to be hindering the group. Along with the SEC, it has suffered an exodus of staff to higher-paying private industry. The NASD says the turnover rate among its examiners last year was 24%.

Even without that recent heavy turnover, some observers say, the NASD would be short on personnel. The independent consultant who has overseen the group since its 1996 settlement with the SEC, Frederick M. Werblow, wrote in his most recent report a year ago that “the greatest limitation on the surveillance, examination and enforcement process is the resources presently available” at the NASD.

Werblow, who generally has credited the NASD with making progress, declined to discuss the content of his final report due out next month.

Schapiro denies that examinations or other types of oversight have been lax, but she concedes that the high turnover has been a strain. Still, she pointed out, the NASD Regulation staff has grown to just over 1,700, up nearly 12% during the last three years.

Staffing levels, Schapiro said, are something “you always worry about as a regulator. . . . You always could do more.”

But she added: “You can only recruit and train and employ so many new people per year. I think we’ve pushed the envelope every year with our resource increases.”

Regulation of Problem Brokers Improving

Some of the severest criticism leveled at the NASD stems from its failure to act more swiftly to ban or suspend brokers with blemished records. In a December 1997 report, the New York state attorney general’s office said that “there are numerous examples of convicted felons, people with lengthy disciplinary histories and other unqualified individuals” approved for new registrations by the NASD.

But even in dealing with problem brokers, the NASD at long last is showing a measure of progress.

William H. Mohr, a deputy bureau chief in the New York attorney general’s office for investor protection and securities, said the NASD still doesn’t devote much scrutiny to brokers going through the registration process. On the other hand, he credits the organization in the last couple of years with stepping up investigations of and litigation against brokers with tainted records who have worked for brokerage firms that run afoul of regulators.

That is a departure, regulators said, from its past practice of focusing on the principals of the offending firms and letting the brokers slip away to new operations, where they sometimes got involved in similar scams.

This year through mid-July, the NASD has barred or revoked the registrations of 307 brokers, up from 227 in the same period of 1998. It suspended another 154, up from 123 a year ago.

In other cases, the NASD is clamping down on problematic brokers indirectly, by imposing extra supervisory requirements or business restrictions on their employers and other firms that raise warning flags.

“Where there are problem individuals involved, they [NASD officials] are not going to give them a free pass,” Mohr said.

In Sagnelli’s case, it’s not clear whether the NASD will take any disciplinary action after completing its current scrutiny of his record. NASD officials declined to discuss his status, citing the organization’s policy against disclosing information about an ongoing review.

Since a firm he was working for closed in April, however, Sagnelli’s career has stalled. Records show that two firms have taken preliminary steps to hire Sagnelli but that his clearance to resume work as a broker has been held up pending the NASD’s review.

The records show that Sagnelli and the first firm parted company but that the second firm, Orange County-based Equitrade Securities Corp., is continuing its efforts to get him registered again with the NASD as a broker. Equitrade officials declined to discuss Sagnelli’s professional record, saying they would make a final decision on whether to hire him after the NASD review is finished.

Earlier in his career, Sagnelli had little trouble getting work in the securities industry, even after suffering marks on his professional record.

In 1994, records show, Sagnelli was “permitted to resign” from a firm after being accused by a Florida client of unauthorized trading. A payment of $12,093 was made to settle the complaint and cover the client’s alleged losses.

Kansas securities officials issued a cease-and-desist order in 1996 against Sagnelli, saying he was doing business in the state without a license and selling an investment that wasn’t registered there.

Then in December 1997 came an Atlanta arbitration panel’s decision against Sagnelli. The panel found that Sagnelli defrauded a client, and it ordered him to pay $57,284 in compensatory damages and another $100,000 in punitive damages.

In coming years, the NASD will face a variety of growing challenges that will test its ability to stay on top of investor protection issues.

Topping the list are Internet-related scams. Even though some types of investment fraud have been tamed, other swindles are emerging online, posing a growing challenge to the NASD and federal and state regulators.

Demands on NASD regulators also would grow with extended stock-trading hours, which Nasdaq has talked about launching as early as this year. In another move that could mean even more work for NASD regulators, Nasdaq is looking to expand operations into Japan and other foreign markets.

Still, if the NASD has to take on greater regulatory responsibilities in coming years, experts say, it will be better able to handle the job.

Neal E. Sullivan, a Washington securities lawyer who was Massachusetts’ securities commissioner in the early 1990s, remembers when the SEC censured the group in 1996 and put it on course to turn itself around.

“There were many cynics who wondered if you could have a make-over of an institutional culture in 36 months, and perhaps I was one of them,” he says. “But I think the NASD has accomplished it.”

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Times staff writer Debora Vrana contributed to this report.

Coming Monday: The NASD is upgrading its antiquated computer system, adding new surveillance capabilities to help it track suspicious activity by brokers.

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More Spending, More Censure

Since the National Assn. of Securities Dealers in 1996 set up its NASD Regulation unit to handle regulatory tasks, the organization’s spending and staffing to police the brokerage industry have risen every year.