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Olde Discount Fined $5 Million As SEC Finds Nationwide Pattern Of Customer Abuse
EC Chairman Arthur Levitt did not mince words: "The abuses the SEC found were egregious and well outside the industry's 'best practices'.... This case should send a very strong message that abusive sales practices will be vigorously punished and that officials at all levels will be held accountable" (SEC News Release, 9/10/98)
Olde Discount and three senior officials settled with the SEC, agreeing to more than a $5 million fine. In addition to paying $1 million of that fine, the firm's founder and chairman, Ernest J. Olde, was suspended for 12 months. The firm's former director of national sales (Stanley A. Snider) and its former regional manager (Daniel D. Katzman) were fined and barred for 5 years.
Importantly, customers can file arbitration claims against Olde Discount to recover their investment losses due to unsuitable investments, excessive trading, unauthorized trading, misrepresentation and margin abuse. As part of its settlement with the SEC, Olde Discount has agreed that it will waive certain defenses in these customer arbitrations.
Let's review 10 abuses that the SEC found at Olde Discount relating to its broker compensation, sales production, broker hiring and broker training policies.
1. Different Sales Commission Payouts for Different Investment Products
The SEC found that for typical "agency trades", the brokers' commission payout was "relatively insignificant" compared to the "generous" commission payout received from Olde Discount's "special products" (mostly small, unknown stocks, known as "Special Venture" stocks in which Olde made a market and traded from inventory). The SEC concluded that "the compensation system at Olde, which provided for generous rewards to [brokers] for the sale of special venture stocks relative to other trades, jeopardized the provision of unbiased investment advice and provided an inducement for [brokers] to recommend transactions in which they had the greatest financial interest."
2. Burdensome Sales Production Quotas that Promote One Product Over Another
The SEC found that Olde's production requirements and position quotas emphasized the sale of special venture stocks. The reason? To even be considered for "commission privileges", newly licensed brokers had to earn at least $15,000 in special products gross commissions for at least two months. Agency trades did not count. Thereafter, to continue receiving commissions, brokers had to meet several requirements. First, generate $10,000 each month in special products gross commission. Second, sell an additional $100,000 per week in fixed income products or mutual funds. Third, convince clients to purchase an aggregate $20,000 of special venture stocks per day (subtracting any client sales!).
3. Changes Made to Clients' Investment Objectives Without Discussion and Disclosure
The SEC found that Olde's policies created an environment in which the pressure for production overshadowed suitability determinations. Certain brokers, the SEC found, used an internal investment objective update form, not requiring a customer's signature, to change investment objectives and to portray customers as more aggressive than they had indicated.
4. Use of Sales Credits To Entice Conflicts of Interest
Olde Discount's traders offered every broker $.0625 to $1.00 per share (!) to push certain Special Venture stocks. This often comprised the largest portion of the broker's gross, and some brokers, the SEC found, earned their living "credit shopping". Through publication on computer screens (with asterisks and exclamation points) as well as by telephone, Olde traders flagged stocks with high credits. The list changed frequently, and the prize of many brokers was to earn a "stick" ($1.00 per share). Customers were unaware of this practice given that the "credit" was built into the spread, by way of the mark-up or mark-down charged to customers.
5. Enforce Customer Forfeiture Rules for Lack of Continuous Sales of Special Products
Olde Discount required its brokers to convince each one of their customers to buy a special product every six months. If he/she failed to do so, the customer was forfeited. Olde reclassified the customer's account as a "house account", thereby giving all brokers access to solicit purchases.
6. Hire Neophytes and Teach Them Mostly High Pressure Sales Tactics
The SEC found that many of Olde's brokers were recent college graduates with no experience. There were three stages of training. First, new brokers participated in an apprenticeship program, where they cold called from a call center in addition to studying to pass an exam to sell municipal securities. Second, if the broker passed the municipal securities exam, he/she studied for the general securities exam. However, at the same time, Olde Discount required these trainees to meet a sales production quota of 20 new accounts and $500,000 gross sales production within 5 months of entering the program. Third, newly licensed general securities apprentices traveled to Detroit for 2 weeks of classroom training. Nonetheless, the SEC found that this training "focused primarily on intensive sales training", including distributing sales scripts, practicing selling techniques on each other in role-playing sessions, and, with Olde officials (such as Stanley Snider ) or superbrokers monitoring, overcoming all conceivable customer objections to the "close".
7. Use of a Cross-Selling Directory
Olde brokers were provided with cross-selling directories that juxtaposed agency (and often well-known) stocks with Olde Discount's Special Venture stocks (where Olde had a conflict of interest) in the same general industry groups. As discussed above, brokers made relatively insignificant compensation selling agency stocks. The SEC found "significant numbers" of Olde brokers viewed "aggressive cross-selling as necessary to survive at Olde". And the firm promoted that view. As Daniel Katzman allegedly said at the 2 week training course, "Why let someone buy a stock you're not going to get paid on?"
8. Lying to Customers
Olde's primary sales tool was known as "Three Bullets and a Close". In sales scripts, Olde brokers were taught to deliver 3 positive facts, taken from Olde research reports on the Special Venture stocks. Brokers were instructed to "create a sense of urgency" by delivering those facts in rapid succession, and follow that by immediately urging a purchase with Olde-provided closing scripts. The closing script might represent, "I'm buying it for all my customers", or "The stock is going up". Another abuse was the "Take Away Close". The Olde sales manual told brokers to say, "If you don't buy today, you won't be able to get the product tomorrow or be able to buy the stock at the same price". Finally, the sales manual instructed brokers to solicit new customers quickly and aggressively: "Remember, the romance of a relationship is much stronger in the first two weeks. Build positions in many different issues during this time".
Nonetheless, Olde's former director of national sales, Daniel Katzman, made it well known that he did not want brokers talking to customers for an extended period of time. To remind brokers of this fact, he even distributed 3 minute egg timers to hundreds of brokers.
The SEC particularly condemned Olde's sales scripts addressing customer objections to purchasing Olde's Special Venture stocks. Brokers were instructed to tell objecting customers that, "I have been watching this stock for 2 years. This is the time to buy 1,000 shares". However, the SEC found that: "Given the high turnover at Olde, the majority of its [brokers] had not been in the securities industry for two years, much less following a particular stock for two years". Likewise, if a customer stated that he/she did not accept stock recommendations, the script called for the broker to respond, "I spend 60 to 80 hours per week analyzing and researching investments. We are highly qualified to give recommendations". In fact, the SEC learned from former Olde brokers that the only "analyzing" they did was to read Olde's own research reports in order to extract "bullets" for their sales pitches.
9. Excessive Use and Abuse of Margin Loans to Customers
Olde trained its brokers to routinely recommend that customers use margin loans to purchase stocks. This is an aggressive strategy that exposes investors to substantial losses. The customer must repay the loan. Moreover, if the price of the stock falls, the customer must ensure that there is sufficient "equity" (collateral) in the account to cover the loss. If the stock price falls to certain levels, the customer must deposit additional cash or securities to avoid involuntary liquidation and a lawsuit for collection.
Instead of emphasizing the high risk nature of buying stocks on margin, Olde Discount's sales manual touted margin use as a way that brokers could increase their own compensation. The sales manual gave mathematical examples of this, and wrote (in capital letters and underlined): "THINK BIG!!! Additionally, the SEC found that some customers did not even know that they had opened a margin account, given that Olde's standard new account form included a margin account agreement.
10. Mislead Customers with the Claim that Trading is Commission-Free
The cornerstone of Olde's marketing and advertising campaign, according to the SEC, was the Smart Trade and Smart Trading programs. The SEC faulted Olde for misleading customers who asked how the firm makes money. It found that certain senior sales officials instructed brokers to not disclose that Olde made money on the spread. Instead, brokers were told to say that Olde "hoped to make money on other trades or on margin interest", which was highly misleading.
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