As complaints against stockbrokers rise in a bad market, regulators say more must be done to protect consumers
Maryland Securities Commissioner Melanie Lubin said the state can order supervision for brokers have done 'questionable' things. She also would like her office to have more power to penalize rogue brokers.
Two firms dismissed stockbroker George L. Divel III.
The state of Maryland suspended him from the industry for three months.
The reason? Divel allegedly solicited elderly clients through cold calls and seminars and then made unauthorized trades worth hundreds of thousands of dollars in their accounts. He was also penalized for making stock trades in the accounts of two elderly sisters after they died, racking up $24,000 in fees.
Divel is now barred from soliciting any Maryland clients older than 65. But once the state suspension ended last year, he joined a new firm, Virginia’s Capitol Securities Management.
Divel’s new employer says the broker’s mistakes are behind him.
"He’s been exceptional since he’s been with us," President G. Mark Hamby said. "He’s been very clean. I’ll just leave it at that."
The complaints against Divel — and his quick return to practice — illustrate the risks of an industry where one bad decision can mean the difference between a customer’s secure retirement and the loss of a life’s savings.
A Baltimore Business Journal investigation examined Maryland Securities Division records for the 5,943 registered stockbrokers in Greater Baltimore as of March 2008 and found that 92 percent — or 5,443 — had clean records. Only 19 of the brokers had five or more disclosures on their record.
Though so-called "rogue" brokers aren’t typical in the industry, allegations of wrongdoing by customers are on the rise.
With the stock market at devastatingly low levels, the body that regulates stockbrokers expects a flood of unhappy customers seeking relief. Complaints against brokers typically climb when markets are on the rocks. The Financial Industry Regulatory Authority (FINRA), which oversees stockbrokers, received more than 4,600 new arbitration claims in 2008. That was a 54 percent increase from the previous year.
As customers try to sort out whether their portfolios’ problems stem from a down stock market or wrongdoing by a broker, they will encounter a regulatory system that provides extensive public data about brokers, down to bankruptcy filings and criminal charges. But despite all the regulation and public disclosure, some brokers with numerous customer complaints continue in the business. And brokers who have been suspended or even terminated from one firm for alleged wrongdoing may turn up at another.
Bad investment advice at all levels of the financial system played a key role in last year’s market meltdown, and many lawmakers and consumer advocates are calling for stricter regulation of the people who provide that advice.
Attorneys who represent investors in arbitration say that although firms are supposed to strictly supervise brokers who have incidents on their record, it often doesn’t happen.
"The obligation of the new brokerage firm is very clear, and seldom carried out," said one such attorney.
The regulators
When regulators and attorneys are determining whether a client’s losses were caused by a broker or the market, they often focus on whether a broker’s recommendations are appropriate for the client’s investment needs and tolerance for risk. For example, a broker putting a 75-year-old’s money into a risky startup technology stock might merit a second look.
In Divel’s case, four elderly clients filed arbitration complaints against him, claiming he made unsuitable and unauthorized trades in their accounts. An arbitration panel awarded one client $176,500; the other cases also settled for six-figure sums.
Divel declined to comment, referring questions to his attorney, who said she could not comment on client matters.
The investment products under the microscope vary. In 2008, FINRA — the brokerage industry’s self-regulatory body, financed by member fees — got 301 arbitration complaints dealing with auction-rate securities. The bonds’ interest rates reset regularly at auctions — until 2008, when the mortgage crisis sent buyers for the bonds scattering and left investors in the lurch.
"It follows logically that consumers might have more complaints or confusion about their brokers after the market has been through turmoil," said Travis Larson, a spokesman for the Securities Industry and Financial Markets Association, an industry trade group. "That may very well lead to increased filing of FINRA complaints but not necessarily mean an increase in bad behavior on the part of brokers."
Most brokers have clean FINRA records, available online through the regulator’s BrokerCheck system. Less than 7 percent of brokers have any discplinary disclosures on their record, said Maryland Securities Commissioner Melanie Lubin.
Lubin said she could not comment on any specific brokers’ records. In general, Lubin said brokers with disciplinary histories often move from firms with strict regulatory compliance programs to those with less strict programs. If the state finds compliance lacking at a brokerage, it will ask the firm to change its practices or bring in an independent consultant to do an overhaul, she said. The state works with firms to beef up their compliance in many ways, from flagging things for improvement in a routine audit to publicly sanctioning a company for violations.
Lubin said the state may order special supervision for brokers who have done things that are questionable but do not create legal grounds to bar them from the business. The state monitors those brokers and follows up on any complaints, she said.
But Lubin and her fellow state securities regulators want to do more.
The Madoff effect
In November, the North American Securities Administrators Association — which represents state securities regulators like Lubin — proposed guidelines for an overhaul of investment regulation. They include stronger rules, tougher penalties for those who violate them and holding brokers to a "fiduciary duty." Investment advisers are already held to the fiduciary standard, a legal duty to act in the best interest of the client.
"Without the fiduciary obligation, the broker may be interested in how the client fares, but he’s primarily working in his own best interest," NASAA spokesman Bob Webster said. The fiduciary duty "provides an extra layer of investor protection."
SIFMA’s Larson said the issue of the differing regulations for brokers and investment advisers came up during the hearings on the alleged $50 billion Ponzi scheme by Bernard Madoff, who was an investment adviser.
"I think the Madoff hearings could be a catalyst for Congress and the Treasury looking more closely at this issue," said Larson, whose group has both brokers and investment advisers as members.
In an October speech, then-FINRA CEO Mary Schapiro, who took over as head of the Securities and Exchange Commission in January, said financial regulation should provide investors with equal protection no matter what type of product or service they are buying.
That means customers of investment advisers, stockbrokers and insurance agents should all get the same safeguards, she said: "We cannot expect consumers to wade through a labyrinth of regulators or to decipher which product or service will afford the greatest protection."
‘Unacceptable risk’
Whether a "fiduciary duty" would stop bad behavior is up for debate.
Some risk-taking brokers don’t change their ways, even when they face disciplinary actions and fines. An outright ban in the securities industry is rare.
It happened in 2007, when Ferris Baker Watts stockbroker Brian J. Kelly got banned from the business.
FINRA’s enforcement division had filed a complaint against Kelly. When he worked for First Union Securities, Kelly allegedly racked up $33,000 in commissions on more than 500 trades in just over one year in the account of a 56-year-old Bethlehem Steel retiree.
A hearing panel said Kelly "took advantage of an unsophisticated investor who placed his trust in him." Allowing Kelly to keep working for a brokerage would create an "unacceptable risk" that he would break the law again, the panel said.
But when Kelly appealed the decision, he found a more sympathetic audience. In December, FINRA’s National Adjudicatory Council ruled that Kelly should pay a $118,000 fine and serve a two-year suspension from the business. He will be eligible to work as a stockbroker again in February 2011.
Kelly had seven customer disputes on his record and had been placed on special supervision because of problems with accounts he handled. Ferris had him on a short leash since hiring him in 2004, prohibiting him from making trades without his manager’s approval and requiring him to document every conversation with a client.
Similar measures hadn’t worked with Kelly before. The rapid trades in the Beth Steel retiree’s account started just months after First Union took Kelly off special scrutiny for mishandling an account at a previous firm, FINRA’s hearing panel said in its decision.
Ferris spokeswoman Robin Oegerle said the firm could not comment on Kelly’s case because it was a personnel matter. Kelly’s attorney, Kevin Arthur of Kramon & Graham, said neither he nor his client would comment.
Brokers on the books
Contracts between brokers and clients typically require disputes to go through FINRA’s arbitration system. Those disputes are included in brokers’s public records although there are some cases in which brokers can get customer disputes wiped off their record [See sidebar].
Securities laws also require brokers and their firms to disclose criminal convictions, bankruptcies, liens and many other legal matters. Being charged with possession of marijuana 40 years ago equals one disclosure. So does a verbal complaint by an investor who later recanted. So does a criminal conviction for embezzling $2 million from clients.
When the Baltimore Business Journal reviewed data from the Maryland Securities Division to see which Greater Baltimore stockbrokers had the most disclosures on their record, local brokerage Ferris Baker Watts was by far the firm most represented on the list.
Only 19 local brokers registered with the state in March 2008 had five or more disclosures. Of that group, nine worked for Ferris. Just one other firm, H. Beck Inc., had more than one broker among the 19. Some local brokers who have disciplinary histories were not on the list because they were not practicing at the time or because they were registered with an office outside Greater Baltimore.
For six of the Ferris brokers, all or most of the disclosures stemmed from class-action lawsuits filed in the early 1980s over sales of investments in limited partnerships. Another broker, Charles Wayne Shaeffer Jr., now employed at RBC, has seven such complaints on his record from his time at Ferris. Some of the brokers were named in those suits because they were partners in the firm.
Those lawsuits predated Ferris’ 1988 merger with Baker Watts & Co, said Oegerle: "That’s a Baker Watts issue. There are no records we’re going to dig up on the subject now."
Asked how investors should evaluate the lawsuits, which appear on the brokers’ records with FINRA, Oegerle said, "If they look at the date and see it as being 1984, that’s a long time ago."
Ferris hired two of the other brokers on the list, Gil Kuta and Thomas Charles O’Farrell, after they were terminated from other firms. Smith Barney Shearson allowed Kuta to resign in 1993, state records show. Kuta reported to FINRA that Smith Barney fired him because he reimbursed a customer for a stock that lost money.
In 1995, the New York Stock Exchange suspended Kuta from the business for a month for allegedly making unauthorized trades in customer accounts and sharing in a customer’s loss. When he applied to work at Ferris in 1994, Maryland and Virginia regulators ordered that he be placed under special supervision because of his disciplinary record. The supervision was later lifted.
Reached for comment, both Kuta and O’Farrell referred questions to Oegerle, who said the firm would not comment on the brokers’ disciplinary records because they are a personnel matter.
In a statement to FINRA on the suspension, Kuta wrote he believed the charges of unauthorized trading were unwarranted. "I acknowledge sharing in a single client’s nominal loss and it was uneconomic to contest all charges at issue," he wrote. Kuta has a radio show, "On the Money," that airs on 105.7-FM in Baltimore.
O’Farrell was terminated by Merrill Lynch in 1996. Merrill said he violated a firm policy on time and price discretion, when a client gives a broker permission to buy a certain amount of a security at a certain date.
O’Farrell said in his statement to FINRA on the termination that he did not know Merrill had a policy against use of time and price discretion. O’Farrell wrote that he believed he should not have to answer "yes" to the question of whether he had been terminated.
Such records are open to the public, but investors often have a tough time deciding whether a broker is dishonest or just unlucky.
"When people used to say, when you’re a kid and you get in trouble, ‘This is going to go on your permanent record’ — this is the closest thing I’ve found to almost a permanent record," said Maryland Securities Commissioner Lubin.
But she urges investors to evaluate the records carefully, accounting for how long ago incidents happened and what the broker’s record looks like since. It’s also important to assess whether the allegations stem from the broker’s actions or the sales practices of their firms, she said.
Customers were awarded damages in 42 percent of FINRA arbitrations in 2008. Including settlements and non-monetary awards like an injunction against a broker, that figure rose to 74 percent.
By law, certain things can disqualify someone from being a stockbroker — like a court injunction against them for illegal investing activity, or a felony conviction within the past 10 years. But if a firm wants to hire a broker with a potential disqualification, they can ask FINRA’s permission. FINRA requires firms to put such brokers under special supervision.
"The industry has long understood that if individuals with blemished records remain in the industry, they clearly need and require additional oversight," said Larson, of the Securities Industry and Financial Markets Association.
Losing money
Some investors will never feel safe in a system that is forgiving to its brokers. Their stories often go untold because settlements typically forbid customers from talking publicly about the case. But when FINRA arbitration panels award money to a client, those decisions become public.
That’s what happened to local investor John Rolph in 2006.
Rolph remembers the deal he made with stockbroker John Francis Means in the late 1990s: He would buy one stock from Means, and if that stock did well, he would invest a lot more.
A year passed, and the stock doubled, Rolph said. So Rolph, a 62-year-old Lutherville resident, invested a bigger chunk of money. But when the technology boom began to flag, Means allegedly began trading stocks rapidly in Rolph’s account, piling up commissions.
"I started getting three statements a day," Rolph said. "Red flags started to go up."
Rolph and about eight other Means clients who reported similar problems got together with a lawyer. They filed a FINRA arbitration complaint seeking $7 million from Means. Rolph’s case was separated from the others and an arbitration panel awarded him $35,000.
Rolph won’t say how much money he lost with Means, but he said the award only covered a portion of it.
Means has eight customer disputes on his record, according to data from the Maryland Securities Division. That’s more than all but three other stockbrokers who were registered in Greater Baltimore as of March 2008.
Most of the complaints were from when Means worked for First Union, which was bought by Wachovia Securities in 2001. Four of the complaints are still pending. Means, who has been in the business for 17 years, left Wachovia in 2004 and has worked at three firms since. He is now with Newbridge Securities in Towson.
Means said he could not comment on any specific cases. "Basically, the market fell apart in 2001 and 2002, and that was what happened," he said. "We were heavy into tech, and tech fell apart."
Wachovia spokesman Tony Mattera said the firm could not comment.
"It absolutely put me on guard," Rolph said of the experience. He hasn’t invested with a stockbroker since.
