NEW YORK (Dow Jones)–New details in the Brookstreet Securities Corp. case support investor advocates’ calls for lifting the curtain higher on details of brokers’ transactions, particularly how brokers are compensated and their use of margin accounts.
The Securities and Exchange Commission on Thursday filed fraud charges against 10 former brokers for Brookstreet, an Irvine, Calif., brokerage that collapsed in scandal in 2007. It said the brokers falsely marketed investments in derivatives of mortgage-backed securitiesas safe and appropriate for investors with conservative goals, including retirees. In many cases, they allegedly told investors the securities were backed by the U.S. government. The Financial Industry Regulatory Authority, or Finra, also charged six Brookstreet brokers in a parallel enforcement action.
The brokers raked in more than $16 million in commissions between 2004 and 2007, the SEC says, while their clients collectively hemorrhaged almost $40 million in margin account deficits. Some of the brokers told clients that margin would be used sparingly, and with little or no risk to their principal, according to the SEC complaint.
Stuart D. Meissner represented three investors in arbitrations against two of the brokers. He says investors who purchase certain bondsor exotic instruments are often unaware of markups, which is the difference between what the broker pays for the security and what the investor pays.
Many investors only learn of the markup much too late – when filing an arbitration claim.
“It’s certainly something that one is entitled to know, especially if it’s not a traditional investment,” says Meissner.
Furthermore, being told about the markup may not mean understanding it, notes Theodore G. Eppenstein, a New York-based attorney who represents investors in securities arbitrations. “You need a forensic accountant to take apart the statements. Even a sophisticated investor can’t figure it out,” he says.
Deborah Meshulam, a former SEC assistant chief litigation counsel who now chairs DLA Piper’s SEC practice in Washington, says brokerages typically comply with securities laws that require disclosure of their compensation and conflicts of interest – but the catch is whether the disclosure is adequate.
The Brookstreet brokers misrepresented how margin accounts would be used, the SEC says, and some told clients that they would be taken off margin but weren’t. Many investors aren’t even candidates for margin accounts – particularly if their goals are conservative.
Jill I. Gross, director of the Investor Rights Clinic at Pace Law School in New York, says that, during the last two decades, margin accounts have been extended to customers who lack the financial sophistication to use them prudently. Regulators, she says, should consider imposing requirements for margin accounts, such as standards for net worth or knowledge level.
Some investor advocates say that compensating brokers based on the performance of client portfolios would prevent misconduct. But Philip M. Aidikoff, a Los Angeles-based securities attorney, is concerned the model would push brokers toward high-risk strategies. “A broker who isn’t making anything on the portfolio may figure he has nothing to lose,” he says.