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Industry Report Cards For Stockbrokers Questioned

Naples Daily News

All licensed stockbrokers have a report card of sorts.

In theory it’s supposed to give investors a place to go for some unvarnished background: criminal records, disciplinary infractions, firings, customer complaints, civil judgments and bankruptcies, to name a few.

A Naples investor gave his broker and firm a big black mark in July when an arbitration panel awarded him $2.66 million and agreed that his Wachovia Securities LLC stockbroker, George McMurray Walker, gave him bad financial advice.

More than six months later, that black mark – one of the biggest awards in Florida – still isn’t on the broker’s report card. Here’s what some observers find more shocking: Wachovia says under the industry reporting rules it doesn’t have to be.

Even as the industry has taken steps in recent months to clean up the tardy reporting of 8,000 broker infractions in four years, investor advocates still see a gaping loophole in the report card system – the Central Registration Depository that’s maintained by the brokerage industry’s self-policing organization, the National Association of Securities Dealers Inc. or NASD.

The unreported $2.66 million awarded to a Naples retiree is a glaring example. But it’s not an anomaly.

Around the country, attorneys who represent investors are complaining that the NASD – because of its interpretation of the reporting rules – is deceiving members of the investing public who want to check complaints against their stockbrokers.

Brokerages can choose not to report the transgressions of the people working for them if an investor sues the firm, not the individual stockbroker.

“Clearly it is a loophole,” said Phil Aidikoff, a securities attorney in California, who is on the board of the Public Investors Arbitration Bar Association, a group of attorneys who represent investors. “It should be closed. How can an investor rely on the accuracy of the CRD system if it doesn’t reflect wrongful activity?”

Naples attorney Chris Vernon, who won the $2.66 million award against Wachovia for Naples retiree John DeBoer, said the fact that Wachovia – with the NASD’s blessing under the rules – hasn’t reported the award on the broker’s CRD is disturbing.

Anyone can get a free copy of a stockbroker’s CRD on the NASD Regulation Web Site at, or in Florida by contacting the state Office of Financial Regulation in Tallahassee.

By telling investors they can rely on the accuracy of the CRD, the NASD is “essentially telling investors to rely on a document that’s suspect on its face,” Vernon said.

Vernon made his comments prior to the February settlement of a dispute between Wachovia and DeBoer over attorneys’ fees. That agreement gagged Vernon from speaking further to the press about the DeBoer case.

Officials from the federal Securities and Exchange Commission, who have ultimate oversight over the NASD, have recognized a disclosure gap, a spokesman acknowledged to the Daily News.

The gap has become apparent in recent years because investor attorneys are naming firms instead of individual brokers as part of their legal strategy. Not only do investors need to know about patterns of abusive activity by stockbrokers, regulators do too, SEC officials said.

“The regulators are looking at the issue,” SEC spokesman John Nester said of the SEC and a group of state regulators from around the country.

Herb Perone, a spokesman for NASD regulation, said a “working group” of regulators from the NASD, SEC and states met recently to examine the issue. Perone wouldn’t say specifically when the group met, only that it may have been in recent weeks or months. He declined to say who is in the group, or when it might complete a review.

“We have concerns about information of this kind not making it to investors through public disclosures,” Perone said.

Full disclosure

The rules governing the reporting system say a firm must report a customer complaint or arbitration claim involving a stockbroker within 30 days of receiving it.

DeBoer, a retired Waste Management Inc. executive, filed his arbitration claim involving his longtime Illinois broker, Walker, in November 2002. As of last week, there was no mention on Walker’s CRD report of DeBoer’s 2-year-old arbitration complaint – let alone his eventual $2.66 million award in July 2004.

In his claim, DeBoer, who sold his family’s trash disposal business to Waste Management Inc., contended Walker gave him unsuitable investment recommendations and mismanaged his nest egg. DeBoer had asked for $10.5 million in damages.

In a defense filing on behalf of Wachovia, the firm contended DeBoer knew the risks he was taking and that the investments were “reasonable, appropriate and suitable” for Walker to recommend. Ultimately, an arbitration panel found otherwise and agreed with DeBoer after a seven-day hearing in Tampa in 2004.

Although complaints about mismanagement of DeBoer’s portfolio were aimed at Walker, the party named as a defendant in the legal claim was Wachovia. DeBoer’s legal claim asserted the firm failed to supervise its employee.

The broker, Walker, wasn’t named as a defendant. So there is no mention of DeBoer’s complaint on Walker’s CRD.

So what is on Walker’s CRD?

It discloses that two Illinois investors filed a claim against him for $1.6 million and lost. Another client filed a claim for damages in excess of $5,000 and lost. Another client filed a claim seeking $3.8 million against Walker in March 2000 and the firm settled and paid $70,000.

Walker’s CRD even discloses a youthful indiscretion: He was charged with disorderly conduct in 1960 for possessing alcohol as a minor while he was an undergraduate at Princeton University in 1960.

While that minor charge is disclosed on Walker’s record, as of recently there still was no mention of DeBoer’s complaint and the $2.66 million award from Wachovia.

The award is on Wachovia’s CRD for the firm, but an investor would have to comb through more than 500 pages to find it. And the CRD makes no mention of the broker -Walker – involved.

That’s the rub for investors seeking complete information, investor attorneys say.

The broker “should be tagged because it’s the broker’s conduct that triggered the claim,” investor attorney Aidikoff said.

But that’s not what the NASD tells its member firms and brokers.

The rules instruct a stockbroker or firm to file a report if he or she is the subject of a customer complaint about a sales practice violation.

But NASD, in its guidance to its members on its Web site, instructs firms and brokers that only those named as defendants in an arbitration claim must report the complaint on a CRD report.

Vernon and many investor attorneys say they don’t always name the broker as a defendant for any number of strategic reasons.

“Brokers typically don’t have money and they don’t pay,” said Thomas Grady, a Naples attorney who represents investors.

Aidikoff relates a war story: In one claim he filed for a client, he named the firm and the broker as defendants. An arbitration panel found a fraud violation against the broker, but let the firm completely off the hook. The broker left the firm and Aidikoff’s client never got paid.

In that way, naming the broker as a defendant hurt his client.

“The broker is an employee. The firm is responsible for the conduct of the broker,” Aidikoff said.

Attorneys like Aidikoff say they have to use the legal strategy that’s best for their client, not necessarily what’s best for the general public under the current rules.

As Chuck Austin, an investor attorney from Virginia and former president of the investor attorneys’ association put it: “It’s not our job to clean up these idiot loopholes.”

Margaret Draper, a spokeswoman for the Securities Industry Association advocacy group that represents more than 600 brokerage firms, said if an investor attorney names the broker as a defendant, it goes on the CRD.

“That’s the plaintiff attorney’s decision,” Draper said.

She said the NASD’s rule ensures accuracy: For example the arbitration panel may only be considering the firm’s conduct in an award decision, not the conduct of the broker involved.

As it stands, the system is designed to report letters of complaint about a broker, not just legal claims for money and final outcomes.

The NASD’s Perone said investor attorneys could just copy and paste the allegations into a separate complaint letter, send it to the firm, and doing so would trigger the CRD reporting requirement.

“It’s a pretty simple matter to get the allegations about a broker’s conduct onto the CRD and into the public record,” Perone said.

But brokerage firms may not understand the rules that way.

Tony Mattera, spokesman for Wachovia Securities LLC, referred a Daily News reporter to the NASD’s guidance to members on its Web site and said the NASD rules “prohibit” the firm from noting the award on DeBoer’s CRD.

“The issue here is the firm, not the broker,” Mattera said.

Perone said sending a complaint by separate letter to a firm or the NASD will trigger a reporting requirement. However, that wasn’t the stance of the NASD’s district director in Atlanta in September 2002.

Investor attorney Grady sent a letter to attorneys for one brokerage asking why they hadn’t reported his separate complaint letter on the CRDs of two brokers. He copied the letter to Florida’s chief securities regulator, Don Saxon, and the NASD’s district office.

“We believe it is unwise and dangerous to fail to alert regulators and future potential employers or customers of these individuals about these prior complaints and claims,” Grady wrote in the Sept. 18, 2002, letter.

In a response letter, NASD District Director Alan Wolper wrote: “You suggest that even though you elected not to name either of the referenced individuals as respondents, the fact that your statements of claim ‘loudly complain of’ their activity makes the arbitration proceedings subject to mandatory disclosure (on the CRD). … I’m afraid I must disagree with your conclusion.”

Wolper went on to write that the NASD’s guidance to members on its Web site “addresses your concern squarely” and states: “Only persons who are named as respondents are required to report.”

Felix Lopez, a Miami attorney who represented First Montauk Securities Corp. at the time Grady made his complaint, said firms are going to follow the NASD’s guidance.

The NASD “is the one who dictates what needs to be reported,” Lopez said. “It’s a self-regulatory organization. If the industry or the public wants to change those rules, they’d have to lobby the NASD to change the rules.”

Pat Sadler, an Atlanta attorney and past president of the investor attorneys association, said it’s “a silly concept” if the NASD is saying an attorney or investor must only put a different format to their complaint to get it into the public disclosure system.

Sadler said he sees firms’ using the loophole to keep complaints away from the public.

Investor attorney Austin said firms are demanding that their brokers be dropped as defendants in cases where they are named.

“While they (firms) may be willing to pay, they don’t want it on the record,” Austin said.

Late disclosure?

The NASD has cracked down on firms in recent months to make sure its members promptly report broker infractions.

In November, NASD fined 29 member brokerages a total of $9.2 million for late reporting of stockbrokers’ bad grades. Collectively the firms failed to report more than 8,000 infractions in a timely way from January 2000 to March 2004. The action came after the NASD fined Morgan Stanley $2.2 million in July for late reporting of broker violations.

In announcing the sanctions, the NASD said investors and regulators rely heavily on the integrity of the CRD reporting system.

“The fact that so many firms failed in their obligation to report so much important information in a timely way is deeply troubling,” NASD Vice Chairman Mary L. Schapiro said in a statement announcing the fines.

Wachovia got the third largest fine, $650,000, of those handed down in November. The NASD said it discovered Wachovia had 610 late disclosures, or a rate of 32 percent of all the complaints filed by that firm over four years.

Merrill Lynch, Pierce, Fenner & Smith Inc. got the largest fine at $1.6 million for 1,420 late disclosures representing a rate of 30 percent. American Express Financial Advisors Inc. was fined $700,000 for 770 late disclosures, or 44 percent.

All of the 29 firms failed to report violations promptly in at least 25 percent of cases, and some had tardy rates of 70 percent, the NASD said. As part of the action taken in November, the firms – who neither admitted nor denied wrongdoing – agreed to conduct internal audits of their reporting compliance procedures and implement recommendations of the audits.

“We’ve taken an enforcement action that levies the largest fines for this type of violation,” Perone said at the time the fines were announced. “Each of the firms has had to make systemic changes.”

He said the fines send a clear and long signal to other firms to make sure they comply with the fundamental obligation to report broker infractions to the CRD system.

Investor attorneys are questioning whether the reporting procedure has a major loophole.

“It’s a fraud on the public,” investor attorney Sadler said.

Sadler said the NASD needs only to send a notice to its members changing the present rule interpretation to close the loophole.

Pam Epting, who heads stockbroker licensing for Florida’s Office of Financial Regulation, said Saxon wasn’t aware of the issue. Saxon was unavailable for an interview in recent weeks and ultimately referred questions from the Daily News to his subordinate, Epting.

“We would say that issue should be visited,” Epting said. “Our goal is investor protection. We want the information in the customers’ hands.”

Investor attorney Austin said the feds could act, thus pre-empting the need for the states to take action.

“The SEC is absolutely in a position to put an end to this, but hasn’t done so,” Austin said.

And while Sadler said he was pleased to hear that regulators are looking at the issue, he said investor attorneys have heard that response before about the loophole.

“The standard response is we need to look at it,” Sadler said. “But nothing ever happens.”