Rules of SEC Work to Protect Investors
By Mitchell S. Ostwald
The Security Exchange Commission ("SEC") recently consented to the entry of an order that Richard Harriton, President of Bear Sterns Security Corp. ("BSSC") willfully violated various securities acts and ordered him to pay a civil penalty in the amount of $1 million dollars.
This marked the significant turning point in the way a clearinghouse firm has traditionally viewed itself in relation to small broker dealers who violate the law. BSSC is a wholly owned subsidiary of Bear Sterns & Co. , Inc, which is a wholly owned subsidiary of the Bear Stern Companies, Inc. BSSE cleared trades for AR Barron & Co. , Inc. ("Barron") who is registered as a broker dealer and was a member of the NASD. Clearing means that BSSC provides trade processing, clearance and other "back office" services to smaller, less capitalized brokers and dealers, called introducing firms.
Barron operated in a classic "boiler room" fashion. Barron officers and employees placed cheap securities into the hands of family members, favorite customers and nominees primarily through public offerings and private placements of the securities that it controlled, its so called "house stocks". Barron's retail sales force then ran up the prices of these securities by aggressively marketing them through the use of fraudulent, high-pressured sales tactics. Barron was able to control the overall market for each security through its market making activities.
Within the first two months of the clearing relationship, BSSC employees observed signs that Barron was engaged in fraudulent practices. BSSC employees became aware of the classic indications of unauthorized trading and parking - a high incidents of failures to pay for trade, excessive trade cancellations, corrections and credit extensions, numerous customer complaints against Barron, and a pattern of stock being sold to customers from Barron's inventory and then purchased back in the inventory by barring close to settlement at a loss. These complaints were reported to Harriton. Evidence showed that BSSC received over 50 complaints of sales practice abuses by Barron's sale force during the first three months.
Notwithstanding, Harriton, on behalf of BSSC, continued to allow Barron to operate. Ultimately, Barron filed for bankruptcy protection which caused investors to lose large amounts of money. When the SEC began its investigation, it determined (a) Harriton was a cause of Barron's violation of the Antifraud provisions, (b) Harriton aided and abetted Barron's violations of the net capital provisions, and (c) Harriton aided and abetted Barron's violation of section 15(c)(2) and rule 15(c)(2-4) of the Exchange Act.
Many industry observers believe this is a turning point in holding a clearing firm responsible for the acts of boiler room operations like Barron. The old defense of acting as merely a "clearing firm" while a small broker dealer continues its market abuses, undermines the creditability of all members of the NASD. While it remains a very lucrative business to act as a clearinghouse for smaller broker dealers, responsibility for their actions and adherence to the rules of the SEC and the NASD is paramount to the safety of all investors.
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