Taking Stock of your broker Dishonest ones can slip through cracks, going from firm to firm ruining accounts

April 24, 1994|By David Conn | David Conn,Sun Staff Writer

When Charles Knell retired a decade ago with a $350,000 nest egg, he and his wife entrusted their money to D. Jeffrey Rice, the son of the Knells' best friends and a broker at Alex. Brown & Sons.

Their goal was not to get rich, but merely to provide for a quiet lifestyle in southern Florida. Who better to leave their money with than Alex. Brown, Baltimore's pre-eminent investment banker, and Mr. Rice, a respected friend of the family?

The mistake was costly. Within five years, nearly three-quarters of their money was gone. The Knells, with just $100,000 in their account, were stunned. They filed a complaint, charging Mr. Rice with mismanaging the account and trading just to generate commissions for himself. The couple, now in their early 70s, settled the case with Alex. Brown for $150,000 in 1992.

The bitter story ended there for Charles and Jeanne Knell -- but not for Mr. Rice.

With two large settlements already behind him, the former Gilman School senior class president left Alex. Brown in 1990 just as the Knells discovered their losses. Hired by PaineWebber Inc., he began again -- with a new employer and new customers unaware of all his past problems.

The result: PaineWebber last fall fired Mr. Rice for allegedly stealing $3 million from 25 customers over the past three years.

Mr. Rice's track record does more then tell an unfortunate and costly tale of the dangers of the market in general, and the role of brokers in particular. It is equally illuminating and profoundly disturbing for the industry as a whole.

Mr. Rice and others like him, referred to in the industry as "rogue brokers," have been targeted by industry leaders, regulators and lawmakers as the biggest threat to maintaining public faith in the nation's securities industry.

Although relatively few, these brokers are able to wreak damages, both to their customers' finances and to the industry's reputation, far beyond their numbers. Just a few well-publicized cases can involve millions of lost dollars and sully the reputations the nation's largest brokerage houses.

But many tales remain unreported, private losses that pit the small investor against the numerous failings and conflicts inherent in the self-policed brokerage business. What these investors have learned so painfully is the safety of their money can be placed at severe risk by simply opening an account to buy or sell securities.

Among the problems:

* Brokers are paid to make trades, not to make profits, and they rarely inform customers about the incentives that drive them to buy and sell.

* Brokerage firms, driven by high costs and intense competition, are hesitant to crack down on productive salesmen, regardless of their disciplinary records.

* Problem brokers with big client lists find it easy to jump from firm to firm, aided by employers who are reluctant to say anything bad about a former employee.

* Disciplinary proceedings are shrouded in secrecy that can protect these rogue brokers for years.

* The general lack of public disclosure of disciplinary actions makes it nearly impossible for investors to discover the truth about their brokers.

"It's the retail customer who believes that all this protection is in place, when in fact there is a nationwide, low-level buzzing of anarchy," says Patrick G. Finegan Jr., a Washington securities attorney and former in-house brokerage lawyer.

"Regulation is a myth," he maintains. "It is a destructive, fraudulent myth."

The problem has become so pervasive that the Securities and Exchange Commission, which supervises the brokerage industry, and Congress have responded with a torrent of speeches, hearings and studies in the past six months. The SEC and the National Association of Securities Dealers (NASD) last -- month announced that everyone in the industry who deals with customers will have to take consumer education and ethics courses.

Regulators say they recognize the severity of the problem, which has taken on added importance recently as a new generation of unsophisticated investors, repelled by low interest rates at banks and lured by booming Wall Street markets, turned to stockbrokers.

But some downplay the scope of the problem, arguing that the few chronic abusers are quickly caught and banished from the industry.

"We are satisfied with [the regulatory system]," says Joseph R. Hardiman, president and chief executive of the NASD, which is both the brokerage industry's largest trade association and, because of the authority given to it by the SEC, its chief regulator. "Is it perfect? No. But we are generally satisfied with it."

Misplaced confidence, trust

It is unlikely that the clients of Mr. Rice would agree.

Although the parties involved declined to discuss the case at length, details of their story came from allegations against him by PaineWebber, the Knells, and others, as well as publicly available documents, and from some of the Knells' friends.

The Knells had every reason to believe their money was safe with Mr. Rice.

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