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In Focus #70: June 9, 2009


Financial Advisers in Motion; A Primer On the Employment Issues Facing Those in Transition


Retirement Income: Repairing the Damage to Assure the Flow


Train Wrecks of Estate Planning


A Complex Game: The Life Settlement Process
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Be Alert for For Telephone Calls and Letters from the Brokerage Firm's Branch Office Manager


ost brokerage firm customers never hear from their stockbroker's boss, the branch office manager at the brokerage firm. Those who do should pay close attention. Preliminarily, one should know that the securities laws require brokerage firms to have a compliance system. In this compliance system, brokerage firms must:
Establish procedures reasonably designed to detect and prevent violations of the securities laws

Establish a system to apply and enforce such procedures, and

Identify the persons responsible for discharging the obligations that the procedures impose
The Securities and Exchange Commissions (SEC) believes that the position of branch office manager is the most critical because it is where customer protection truly begins. In fact, branch office managers frequently are named in regulatory and arbitration matters because they allegedly failed to adequately supervise the brokers under their supervision.

There are several areas of supervision where branch office managers commonly fall short. These areas include:
Failure to review trading activity, and

Failure to follow the firm's own internal procedures
Another deficiency is common even though it is easy to avoid -- the manager's failure to contact customers directly to discuss their accounts. In fact, numerous disciplinary decisions have found this failure even when branch office managers knew or suspected that their brokers had been treating customers inappropriately, based upon the managers' reviews of new account applications, order tickets and account activity (computer surveillance) reports.

Comfort Letters

Let's examine some scenarios where the SEC found that the branch office manager should have done more. One disciplinary action, where the branch office manager was suspended and fined, involved failure to adequately supervise a broker who actively had traded certain customer accounts. While the accounts were losing money, they were generating high commissions and margin interest. As a result, these accounts appeared on the manager's monthly account activity reports. Nonetheless, the branch office manager chose not to immediately telephone the customers. He chose not to provide them substantive information about their account and to verify that the high activity was, in fact, what they wanted. He should have done so.

Instead of calling the customers, the branch office manager simply mailed them letters, in industry parlance referred to as "Comfort Letters" or "Happiness Letters". The SEC faulted the content of these letters, finding that they did not confirm that the accounts were losing money or provide any other substantive details, including the amount of commissions being generated.

In another disciplinary action barring the branch office manager from the securities industry, the brokerage firm provided to managers no less than seven form Happiness Letters. The purpose was to give managers a choice as to which one to use, depending upon the degree of caution which he sought to convey to customers. In this case, the branch office manager was aware of numerous "Red Flags" of customer abuse which appeared on the account activity (computer surveillance) reports. Nevertheless, he was content repeatedly to send the most basic form letter of those seven forms that the firm provided. That particular form letter did not alert customers to any problems in their accounts. It simply thanked customers for their business and invited them to discuss "any problems or difficulties" that they might have.

These cases illustrate the resistance on the part of many branch office managers to send anything but the most basic, uninformative letters to customers. So, when a customer does, in fact, receive a letter from the firm's branch office manager, it is a significant event. In response, customers should respond to the letter by contacting the manager to ask questions. For example, ask the branch office manager:
What prompted you to send me this highly unusual letter?

What is it about my investments that cause you to have concern?

Am I losing too much money?

Am I trading too much?

Am I paying too much in commissions?

Am I paying too much in margin interest and is my margin balance too high?

Is the firm or a regulatory agency investigating my broker?

Are you contacting the broker's other customers?

Do you believe that all of the account activity is consistent with the investment objectives stated in the firm's records? What do your records show as being my investment objectives?
No matter what answers the manager provides, customers should record those answers in writing and should seek legal counsel immediately for a "second opinion".

Telephone Calls

Likewise, What should a customer do if she receives a telephone call from the branch office manager? Let's examine some other scenarios where the SEC found that the branch office manager should have done more.

In one disciplinary action involving unauthorized trading, the branch office manager sent uninformative comfort letters but also telephoned to discuss the accounts. The SEC criticized the branch office manager for not having a substantive conversation with the customers. Key facts to discuss, the SEC found, would have been the amount of commissions, the amount of margin interest, and the losses in the account.

In a separate disciplinary action, the branch office manager's telephone calls were limited to an invitation to the customer that, if he ever had questions, she should "call … and ask them". This discussion was found to be insufficient. The SEC requires meaningful, informative contact.

Whatever the content of these telephone conversations, customers must know that it is highly unusual to receive any telephone calls from their broker's boss, no matter how benign the content may appear. Accordingly, ask the same types of questions that I list above, record the manager's answers in writing and seek legal counsel immediately for a second opinion.



Sponsored by James J. Eccleston. This Web site contains material of general interest. It is neither intended to, nor constitutes, either legal advice or investment advice.
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