Study of the Effect of Industry Hiring Practices
and SRO Agent Licensing on Connecticut Investor Protection

Issued July 1999

[ Executive Summary ]

BACKGROUND AND OVERVIEW

The Securities Industry Association (the "SIA") recently proposed that the anticipated Securities Markets Enhancement Act of 1999 ("SMEA") include a provision that would cede a state's authority to license out-of-state agents. The SIA suggested that agents who are registered with the National Association of Securities Dealers (the "NASD") and with the state from which they conduct business should not be subject to other states' review. Of the approximately 103,000 broker-dealer agents registered with the Securities and Business Investments Division of the Connecticut Department of Banking (the "Division"), close to 90% are located out-of-state. These agents would not be subject to our review if the SIA proposal is enacted.

In carrying out its oversight responsibilities under the Connecticut Uniform Securities Act, the Division examines the disciplinary histories of thousands of individuals who apply for registration in Connecticut. This report focuses on 20 individuals that were selected as representing a fair cross-section of applicants with disciplinary histories.

The following summaries chronicle the type of proceedings involved (arbitrations, complaints, criminal convictions, state regulatory actions), the amount of damages alleged, sums paid to settle investor complaints and the agent's registration status with the NASD. Also included, where applicable, is information on whether the agent experienced additional regulatory problems following the withdrawal of his or her application from further Connecticut review. Although some agents mentioned in this report are not presently associated with a broker-dealer, our experience shows that they often resurface in the future.

This report presents a unique inside look at agent licensing from a state regulatory perspective.

AGENT SUMMARIES

Agent 1
This agent had eight disciplinary items including three criminal charges, three state denials and one NASD censure, fine and bar. On September 5, 1989, he plead guilty to attempted criminal possession of a forged instrument in the second degree (a Class E felony) and attempted robbery in the first degree (a Class C felony). He was sentenced to a maximum of 7 ½ years in state prison. After a 2 ½ year period of incarceration, he was paroled in February 1995. The NASD registered Agent 1 in June 1996. Based on the felony convictions, Agent 1 was denied registration in the State of Connecticut on June 13, 1997. Subsequently, on April 5, 1999 the NASD censured, fined and barred Agent 1 from association with any member in any capacity.

Agent 2
Agent 2 had four disciplinary items. In the first two incidents, the customers rescinded their complaints after the agent's employing broker-dealer reversed the trades. The third incident was an arbitration alleging omission of facts, unauthorized trading, suitability and breach of fiduciary duty. The arbitration was settled in July 1998. Settlement for these three incidents totaled $65,000. Agent 2 violated Connecticut law by attempting to transact business in Connecticut at a time when he was not registered. In settlement of the Connecticut matter, Agent 2 entered into a consent order with the Division on June 1, 1998 that required him to cease and desist from regulatory violations, pay a fine and not reapply as an agent for three years. In June 1999, the U.S. Department of Justice indicted this individual along with 54 other defendants in a criminal matter. The defendants were charged with securities fraud, mail and wire fraud, money laundering and obstruction of justice. In his six year tenure in the business, Agent 2 was registered by the NASD 11 times with 11 different broker-dealers. The NASD licensed Agent 2 as recently as January 1999.

Agent 3
This agent's record consisted of 35 disciplinary incidents, including a March 8, 1999 Connecticut Consent Order compelling him to forfeit his agent registration. Agent 3's disciplinary history included claims that he engaged in fraud and misrepresentation, violated suitability standards, traded without customer authorization and failed to follow customer instructions. Alleged damages by his customers (including treble and punitive elements) totaled close to $5,000,000. This agent's employing broker-dealers paid out over $200,000 to settle customer complaints against him. Notwithstanding his extensive disciplinary history, including pending administrative actions in two states and a three-year bar in another state, he remains registered with the NASD.

Agent 4
Agent 4's disciplinary history indicated that he was convicted of attempted murder (a Class B felony), attempted assault, disorderly conduct and first degree robbery. He was sentenced to eight to 25 years and served time in prison. The agent's two attempts to register in Connecticut were unsuccessful. The NASD approved Agent 4 on five separate occasions between 1996 and 1998. This agent was approved in only one state whose laws automatically registered any agent approved by the NASD.

Agent 5
Agent 5 had nine disciplinary items. Over a five-year period, the agent was named in seven separate NASD proceedings that included the following findings: failure to pay an arbitration award, failure to maintain complete, current and accurate books and records, filing false and inaccurate financial reports, acting as a financial and operations principal without being licensed as such, and failure to establish, maintain and enforce written supervisory procedures. As a result of the NASD proceedings, Agent 5 was subject to the following disciplinary actions: seven censures, one six-month suspension from acting in a principal capacity, a one-year prohibition from effecting any principal transactions and a bar from association with any broker-dealer as a financial and operations principal. Fines levied by the NASD against the agent totaled $58,750. Despite his lengthy disciplinary record, the NASD registered Agent 5 when he transferred to a new broker-dealer. Connecticut terminated its review of Agent 5's application on September 9, 1998 without registering him. Subsequently, Agent 5 was named in a NASD arbitration alleging unauthorized trading and remains registered.

Agent 6
At the time of his application, this agent had 10 reported disciplinary incidents, including a state revocation of his license and an administrative action by the NASD. Arbitrations filed against this agent alleged unauthorized trading, unsuitability, failure to supervise, high-pressure sales tactics, misrepresentation, omission of material facts, fraudulent inducement and breach of fiduciary duty. Total alleged damages approximated $187,000 of which $100,000 had already been paid. During his nine-year tenure in the securities industry, the agent was employed by 11 firms. Agent 6 failed to respond to the Division's request for additional information and his application was terminated without registration on May 24, 1999. Agent 6 remains registered with the NASD.

Agent 7
Agent 7 was employed by a New York Stock Exchange ("NYSE") member firm. During his tenure at this firm, Agent 7 was the subject of two arbitrations and one administrative action. In one arbitration, the agent was accused of churning, misrepresentation and omission of material facts. Alleged damages were in excess of $2.5 million. The matter was settled by Agent 7's employing broker-dealer for $955,000. The agent was not asked to contribute any money toward the settlement. In the second arbitration, the agent was accused of churning, unauthorized trading, breach of fiduciary duty and negligence. This case was settled by the agent's employing broker-dealer for $80,000. On November 12, 1997, Agent 7 was censured and fined $12,000 by the Chicago Board Options Exchange for effecting numerous stock and options transactions on a discretionary basis without prior written authorization from the customer or the firm. In addition, the agent effected numerous options transactions that were excessive in size and frequency. The NASD reviewed and registered Agent 7 in 1995 when he applied for registration at a new firm. His application was terminated without registration in Connecticut.

Agent 8
The Division investigated the circumstances surrounding this agent's recent criminal conviction for assaulting his former branch manager. Despite being charged with and convicted of assault, the agent found employment with a new broker-dealer. Connecticut issued a final order denying his registration on November 24, 1998. The agent remained licensed with both the firm that filed on his behalf as well as the appropriate self-regulatory body until May 1999 when he voluntarily left the securities business.

Agent 9
Agent 9 was the subject of five arbitrations alleging unsuitability, misrepresentation, omission of material facts, unauthorized trading, breach of contract and manipulation. From 1996 through 1998 the Division chose not to register this agent despite requests by three different employing broker-dealers. On May 27, 1999 Agent 9, his prior employing broker-dealer and 12 other individuals at that firm were named in an SEC action alleging that they systematically defrauded investors and used fraudulent boiler-room sales practices to induce investors to purchase highly speculative securities. Since 1985, Agent 9 has been approved by the NASD nine times at eight different broker-dealers; the most recent approval on April 11, 1999.

Agent 10
This agent's disciplinary record was of the "patterned" variety (i.e., the allegations in the complaints were strikingly similar) - six of the seven reported complaints alleged unauthorized trading. In addition, Agent 10 was also the subject of three arbitrations and a discharge from employment. The similarity of the allegations and the $678,938 in alleged damages prompted Connecticut to investigate further. To avoid scrutiny, Agent 10 elected to withdraw his Connecticut application on September 25, 1998 - the same day the NASD approved him. Since the withdrawal of his application in Connecticut, a former customer has filed an arbitration against Agent 10 alleging fraud, misrepresentation, breach of fiduciary duty and suitability. Alleged damages in connection with this arbitration total $56,000.

Agent 11
This agent was the subject of 15 reported disciplinary events consisting of 11 arbitrations and four customer complaints. The claims included misrepresentation, fraud and market manipulation. Total alleged damages exceeded $2.7 million. To date, 13 of the complaints and arbitrations have been settled by the agent's employing firm, with Agent 11 contributing only $32,000 to settle one of the cases. This agent was permitted to withdraw his Connecticut application on August 4, 1997. Following his withdrawal in Connecticut, nine additional disciplinary incidents appeared on his record. The NASD terminated Agent 11's registration on July 30, 1998, almost a year after his Connecticut withdrawal.

Agent 12
This agent had 30 reported disciplinary incidents consisting of 25 arbitrations and complaints and four non-securities matters. Ten additional incidents were removed from his Central Registration Depository ("CRD") record without explanation. The arbitrations and customer complaints alleged approximately $1.8 million in damages. The claims included churning, unauthorized trading, high-pressure sales tactics, breach of contract, breach of fiduciary duty, failure to execute trades and failure to observe suitability standards. The agent's employing firm paid the settlement in eight of the resolved arbitration or complaint proceedings. Agent 12 contributed $22,000 to settle two additional proceedings. On September 2, 1997 Connecticut terminated its review of Agent 12's application without registration. Subsequently, three additional disciplinary incidents appeared on his record. From 1992 to 1999, this individual was registered with nine different firms. Each time he received self-regulatory approval. Agent 12 was approved in only one state whose laws automatically registered an agent approved by the NASD.

Agent 13
This agent's disciplinary history contained 32 reported incidents including 26 arbitrations and complaints alleging damages in excess of $2 million, a pending NASD investigation, a civil action (settled by Agent 13's employing firm for $10,000), a 1992 NYSE letter of admonition, a state administrative action and a bankruptcy filing. Agent 13's employing firm assumed the costs of settlement in nine of twelve resolved arbitrations. The agent contributed $13,650 in the aggregate to the remaining three resolved arbitrations. Common claims in the arbitrations included churning, unauthorized trading, unauthorized use of margin, violation of suitability standards, failure to follow customer instructions and misrepresentation. This agent filed for registration in Connecticut on November 9, 1998 after receiving self-regulatory organization clearance. When he left the securities business in March 1999, he had not yet been granted Connecticut registration.

Agent 14
Agent 14's disciplinary record was marked by 12 arbitrations and complaints focusing primarily on delays in executing trades and, to a lesser extent, on unauthorized trading. The claimants alleged damages of $379,500. Only one claim was dismissed. The others remain pending or were either settled or resolved. The pattern of execution delays caused Connecticut to raise its concerns to Agent 14's employing firm. The firm opted to withdraw Agent 14's application on September 25, 1997. Agent 14 left the securities industry two months later. During his eight-year tenure in the business, this agent transferred employment 13 times to 11 different broker-dealers, each time receiving the appropriate self-regulatory approval.

Agent 15
Agent 15 sought employment with 22 different firms during his 11 years in the securities business. The agent was the subject of 13 disciplinary incidents at the time of his last application to register as an agent in Connecticut. Agent 15's disciplinary record included five arbitrations, five customer complaints and two administrative actions. The customer complaints and arbitrations included six separate allegations of unauthorized trading as well as allegations of misrepresentation, omission of material facts, suitability, failure to execute customer orders and negligence. The customer complaints and arbitrations were settled by Agent 15's employing broker-dealers either through reimbursement to the customers or by reversing the trades in question. Agent 15 did not contribute any money in connection with the settlements. Two firms terminated this individual for unauthorized trading. A third terminated Agent 15 for not following employee guidelines. The Division chose not to register Agent 15 despite requests from his last five employing broker-dealers. The NASD registered Agent 15 as recently as October 5, 1998.

Agent 16
This agent was subject to 17 customer complaints and two arbitrations alleging misappropriation of funds, misrepresentation, unauthorized trading and unsuitability. In addition, he was the subject of several administrative sanctions including one from the Commodities Futures Trading Commission for failure to inform a client of the status of his account and a censure and fine from the NASD for the purchase of securities for a client without having reasonable grounds to believe that such purchases were suitable. Agent 16 received a letter of admonishment from the NYSE for participating in a nonpublic offering of stock without the consent of his employer. He was also terminated by one of his employers for falsifying new account documents. Alleged damages during this agent's lengthy tenure in the securities industry approximated $2,500,000. Half of the disciplinary incidents occurred while he was employed at several NYSE member firms. On January 20, 1999 he sought registration in Connecticut after a six-year hiatus. The Division terminated his application without registration on March 17, 1999.

Agent 17
This agent was the subject of nine arbitrations and two customer complaints. Allegations included negligence, lack of supervision, misrepresentation, unsuitability, breach of contract and breach of fiduciary duty. Agent 17 was also named in three class action lawsuits. Outstanding damages alleged totaled $750,000. Damages already awarded exceeded $2,000,000. The Division became aware of six additional disciplinary incidents that were filed against this agent when he reapplied for registration at a new firm. Despite the additional allegations against him, the NASD approved Agent 17 on January 8, 1999. His application in Connecticut was terminated without registration on February 10, 1999.

Agent 18
Agent 18 had five disciplinary incidents on his record, all involving criminal charges. On February 21, 1991, Agent 18 was arrested on several charges that included the receipt of stolen property. In June 1993, Agent 18 was involved in the illegal discharge of a firearm from a car in a grossly negligent manner and served two months in jail. He plead guilty to battery in 1998 and served 10 days of community service. Several other criminal charges were dropped. Connecticut did not register Agent 18. The NASD approved his registration on April 28, 1999.

Agent 19
This agent's history revealed a pattern of improper conduct. He was subject to seven disciplinary incidents (four arbitrations, two regulatory actions and an internal review). Allegations included unsuitability, excessive markups, churning and negligence. In his 14 years in the securities industry, Agent 19 was hired by nine different broker-dealers. He received approval from the appropriate self-regulatory organization each time. This agent withdrew his application for registration in Connecticut on March 1, 1999. Subsequent to March 1, 1999, the agent was named in two additional arbitrations, one of which was settled and resulted in a payment of $250,000 to the complainant.

Agent 20
The agent was named in six disciplinary events: two regulatory actions, three customer complaints and one arbitration. Damages already paid equaled $597,322 with additional claims outstanding. Based on its investigation, the Division filed a notice of intent to deny this agent on November 22, 1996 alleging that he made false and misleading statements to his employing broker-dealer and that he used client funds without their authorization. The order was made permanent on February 22, 1997. More than one year later, the NASD barred the agent from association with any member firm and fined him $1,000,000 for misappropriating client funds. The State of Connecticut brought criminal charges against this agent alleging one count of first degree larceny and 17 counts of second degree forgery.

Pending Agents

Each year the Division reviews approximately 36,000 applications for registration. Some of these individuals are applying for agent registration for the first time while others are seeking to be relicensed in Connecticut, the NASD and a new employing broker-dealer. Roughly 15%, or 5,400 of these applicants will have at least one disciplinary incident. Approximately 1,500 of these individuals will have disciplinary history significant enough to warrant special supervision.

The information requested of the applicants with more serious disciplinary incidents includes a statement from the applicant that they have not conducted business with Connecticut residents absent registration. Such conduct is illegal under Connecticut law. Rather than respond to the Division's request for confirmation of compliance with Connecticut law and/or placement of an agent under special supervision requirements, one-third of employing broker-dealers seek withdrawal of their agents' applications.

The following two examples are representative of many agents with disciplinary history that are currently under review by the Division. A request for additional information concerning the disciplinary history of these individuals has already been forwarded to their respective employers. In addition, the Division has communicated its concerns regarding the manner and depth of the firm's supervision to be exercised over these individuals.

Agent A
Agent A's disciplinary history indicated several 1997 criminal charges, including sexual abuse (a felony), unlawful imprisonment, endangering the welfare of a child and petty larceny. The sexual abuse charge was later dismissed. Agent A was convicted on the charge of unlawful imprisonment and was sentenced to three years probation. The Division requested additional information including a statement attesting as to whether the agent conducted business in Connecticut while unlicensed. Agent A's application is currently pending with the Division. The NASD approved agent A on June 22, 1999.

Agent B
On June 26, 1991 Agent B was charged with harassment and intimidating and trying to influence a juror. Agent B served 51 days in jail and received three years probation. He violated his probation in 1992 by failing to make a court-ordered payment to the probation department. The NASD approved his registration on May 7, 1999. Agent B's application is currently pending in Connecticut.

FINDINGS

A number of findings relating to agent registration were made during the preparation of this report. Consider the following:

• Notwithstanding repeated customer complaints and arbitrations of a similar nature, broker-dealers choose to continue an agent's association without placing any additional supervisory conditions on such agents. This counters the argument from the SIA that the securities industry is self-policing.

• Broker-dealers tend to pay the entire settlement amount for arbitrations and complaints filed against their agents. The Division believes that agents have very little incentive to adhere to regulatory standards of conduct knowing that the firm will pay the regulatory costs incurred as a result of the agent's dishonest or unethical conduct.

• Some CRD records have incidents that were deleted by the NASD without explanation. Although it is possible that such incidents were purged because they are no longer reportable, the editing of an information base by the NASD demonstrates the perils of allowing an industry self-regulatory organization to control data.

• A number of broker-dealers fail to file a Form U-5, the uniform form to report a termination of an agent's employment. Form U-5 is the broker-dealer's version of events that lead to an agent's termination. Information on the Form U-5 often conflicts with the agent's often self-serving version of events that is filed when he transfers to a new firm.

• The self-regulatory organizations rarely take action to bar an individual from the securities industry, even when that agent has engaged in egregious conduct.

• An agent with a pattern of arbitrations or complaints usually is the subject of additional incidents in the future.

• Many agents have a history of criminal conduct including attempted murder, assault, drug possession, theft and other offenses that would disqualify other professionals from pursuing their vocation (e.g., attorneys).

• Given the advances in technology, an agent located in New York City can easily transact business in California. Our study indicates that there is no direct and consistent correlation between an agent's place of employment and the jurisdiction that takes disciplinary action.

• Generally, it may take up to two years from the date an agent committed a violation to the date the incident is reported on the CRD. During this time, an agent may automatically transfer from one firm to another.
  
  

CONCLUSION

We are troubled that the SIA, a member association composed of a large and important part of the securities industry, opposes or would limit the authority of a state to review and/or take action against agents that have disciplinary histories. We are also disturbed that broker-dealers continue to hire agents with known significant customer complaints and arbitrations. The only reason we can determine for this practice is that a number of broker-dealers care less about regulatory standards than they do about the profits these agents generate.

Our experience indicates that the number of investor complaints received by regulatory authorities or reflected on an agent's disciplinary record is significantly under-reported. For every written complaint that is received, many others are not filed because the investor is overcome by a sense of embarrassment and helplessness. It is not uncommon for broker-dealers and their agents to dismiss or otherwise explain away customer concerns that may lead to formal complaints. In addition, customer complaints are under-reported because the CRD automatically deletes complaints that remain pending over a certain period. Some broker-dealers neglect to report customer complaints in the first place.

During the last two years, the Division received 72,000 agent applications of which 69,000 were registered within 24 hours. As mentioned earlier, roughly 15% of these applicants have at least one incident under the category of disciplinary. Approximately 3,000 of these individuals will have disciplinary history significant enough to warrant special supervision. These figures counter the securities industry's argument that states unnecessarily delay agent registration. The only agents not approved within 24 hours are those with significant disciplinary incidents.

As demonstrated in this report, the agent licensing standards of the NASD are inadequate. Out of 600,000 registered agents, the NASD brought a mere 307 actions against agents to bar or revoke their registrations during the first six months of 1999. Based on our observations, self-regulatory organization actions are initiated after an agent is no longer in the securities industry. Since the NASD is an industry-controlled, soon to be publicly held, self-regulatory organization, its standards do not rise to the level that would ensure investor protection within our borders. The securities industry has no incentive for a self-regulatory organization to strengthen its licensing requirements for agents.

By removing state registration requirements and ceding agent registration standards solely to the NASD, state legislatures will be stripped of their historic obligation to regulate occupational licensing for the protection of their residents. The SIA's proposal suggests that broker-dealer agents should be treated more leniently than plumbers, electricians, applicants for liquor permits or any other professionals that are licensed by the state. Since broker-dealer agents generally help investors meet financial goals, including saving for college tuition, retirement and medical needs, it is imperative that these individuals be held to the highest professional and ethical standards as determined by a state.