Wall Street Ineffective Policing Abuse By Brokerages Survey Shows Repeat Offenders Continue To Beat The System
America’s fever for three-strikesand-you’re-out penalties has not spread to the bastion of pinstripes: Wall Street.
When the largest brokerages or their workers are caught cheating, they usually pay less in fines than the firms spend to throw the office picnic and softball game.
An Associated Press study shows a handful of firms and brokers have committed serious violations over and over again in a system where they are largely responsible for disciplining themselves. The study included enforcement records of the 20 biggest brokerage firms from 1981 to 1994.
Year after year, thousands of investors call the cops on their brokers who may buy stocks without permission or pilfer accounts.
Despite increased enforcement and some high-profile fines of $1 million or more, the typical financial penalties are only a few thousand dollars per violation. That’s less than a broker spends to park a car for a year in a Wall Street garage.
The most egregious cases of repeat offenders have been well publicized, such as Prudential Securities Inc.’s troubles in the late 1980s. Yet a review of enforcement records shows five firms had an average two or more serious violations per year: Prudential Securities, a total 77 cases; Paine Webber Group Inc., 48; Merrill Lynch & Co., 46; the former Shearson Lehman Brothers, 42; and Dean Witter Reynolds Inc., 36.
Some large firms had less than half as many: the former Kidder Peabody & Co. Inc., 16; Smith Barney Inc., 14; and A.G. Edwards & Sons Inc., 11.
These serious violations range from insider trading and unauthorized trading to excessively trading a customer’s account. Most were related to sales practices.
While regulators defend current enforcement, other regulators, brokers and consumer advocates say more could be done to deter the recurrent fraud and carelessness that could ruin any investor.
“When you have 5,000 brokers and you get a $10,000 fine, that’s like shooting a pea at Godzilla,” said Alan Davidson, former member of an industry self-policing panel and now president of Zeus Securities, a Jericho, N.Y., investment firm.
More Americans are entrusting their savings to brokers, hoping that purchases of stocks, bonds and mutual funds will provide better returns than simple bank accounts. One out of three U.S. families has an investment in the markets - and many new investors could be prey for unscrupulous brokers.
“A lot of those people are just not as informed as they should be,” said Securities and Exchange Commission Chairman Arthur Levitt Jr., the nation’s top financial-market law enforcer.
Bettylou Horn is better informed than she used to be. The Houston widow said she lost about $15,000 when her Dean Witter Reynolds broker, Steven E. Johnston, engaged in unauthorized stock options trading in the early 1980s. The broker was fired and banned from the industry.
“Because I was extremely naive, I sat back, well OK, here’s my money, take it and do something for me and let me know when I get rich,” Horn said. “And I should have, of course, paid more attention to it. And, of course, I am doing that now.”
Longtime investors aren’t necessarily insulated from abuse either. For Isadore and Bernice Fendelman, owners of a wholesale candy business in St. Louis, it meant the loss of their $200,000 life’s savings following the 1987 stock market crash. They blamed the loss on Jerry Stein, a broker who managed their portfolio for 15 years while at several brokerage firms.
Regulators barred Stein and fined him more than $200,000. Stein denies wrongdoing and is contesting the penalty.
The AP study found financial penalties amounted to $1.37 billion, less than 5 percent of the $29 billion these firms made over a period when the number of enforcement cases was rising continuously.
“I certainly think there’s more money to be gained by defrauding people than there is to be lost by legal penalties at this time,” said Leonard B. Simon, a San Diego attorney who has represented victimized investors.
Many professionals and government regulators argue the industry has cleaned itself up. One study by the General Accounting Office, the investigative arm of Congress, said only 2 percent of brokers have a disciplinary record.
Defenders also argue that total financial penalties have risen sharply in recent years, evidence that it’s harder for wrongdoers to go unpunished. Moreover, financial penalties aren’t the only enforcement weapon - suspensions, temporary shutdowns of brokerages and the negative publicity are considered a more severe punishment.
“There are certainly violations that we don’t catch and people we don’t catch,” said William McLucas, SEC chief of enforcement. “But we probably do a better job, the whole system does I think, than what you would be led to infer” from the AP study.
Indeed, the SEC, National Association of Securities Dealers Inc., and New York Stock Exchange receive generally good marks from academics and congressional overseers for improving enforcement work in recent years.
Nonetheless, records reviewed by the AP show some firms flouted laws they previously had been penalized for breaking.
Prudential Securities and its brokers, for example, were cited 24 times and ordered to pay $1.6 million in cases concerning unsuitable investments in the early 1980s. Later, the brokerage was hit with nearly $1 billion in fines and settlements for the same infraction, this time over risky investments known as limited partnerships, purchased by thousands of unwitting investors in one of Wall Street’s worst scandals.
In 1988, Paine Webber Group Inc. and two employees were fined $41,900 for unsuitable trades in a customer account. One employee was barred and the other reprimanded. In ensuing years, Paine Webber or its brokers were cited 13 times for the same violation and ordered to pay $1.4 million.
“Do the fines and suspensions serve their desired purpose of preventing future abuses? I think the answer to that is clearly no,” said Barbara Roper, a securities industry expert for the Consumer Federation of America, a Washington advocacy group.
Both Prudential and Paine Webber say they’ve strengthened oversight of brokers by hiring new compliance staff and scrapping financial incentives that tend to put a broker’s own financial interest ahead of a client’s.
Even where penalties have been strengthened, violations haven’t necessarily dropped.
Consider insider trading, or illegal use of secret information to profit in the stock market, a crime made famous by the Ivan Boesky scandal of the 1980s. The number of insider trading cases has remained high - the SEC brought a record number of insider trading cases last year - even though Congress gave the SEC expanded powers to levy fines in 1984.
Critics of the system, including some regulators themselves, say penalties must rise drastically.
Wayne Klein, state securities regulator for Idaho, said “Fines are a cost of doing business. We have to make it more expensive for the firms to violate the law than to comply with the law.”
SEC penalties have risen in recent years, partly reflecting the agency’s strengthened enforcement powers. The SEC alone imposed fines and settlements of $340 million against the 20 firms and their brokers since 1990, for example, but that didn’t seem to dent its caseload.
The agency handled an average 19 cases per year against the 20 firms since 1991, up from an average 9.4 cases prior to 1991.
The SEC itself, in a study of enforcement problems at nine major firms last year, concluded penalties need strengthening. The General Accounting Office also recommended stiffer fines in a 1994 report that described “shortcomings in the detection and discipline of unscrupulous brokers.”
Brokerages say financial penalties alone distort their commitment to investor protection.
At Merrill Lynch, compliance director O. Ray Vass said its selfpolicing department has grown by 70 percent to 465 people since 1981. Financial penalties levied against brokerages, Vass said, are minuscule in “contrast to what we spend to try to prevent problems.”
John Pinto, executive vice president of the NASD, a self-policing trade group, said the most powerful enforcement weapons are suspensions and banishment, which do far more financial harm to a brokerage than fines.
The AP study examined suspensions and found regulators handed down more than 109 years’ worth of suspensions and criminal terms while barring 83 brokers.
But the AP study showed a suspension’s financial impact was limited. Revenues lost from suspended brokers, as measured by a typical broker’s production in 1993, totaled $35 million.