NYSE Sanction Highlights Remarkable Failure To Supervise Abusive Sales Practices in Customers' Accounts

ecurities regulators regularly censure, suspend and even bar securities professionals for sales practices violations. Sometimes the disciplinary matters are so egregious that they deserve further attention. That is the case with a recent New York Stock Exchange (NYSE) disciplinary matter involving a regional manager of A.G. Edwards & Sons, Inc. in connection with his failure to supervise the sales activities of one of the firm's branch office managers.

The case involved regional manager Earl Duncan Laing, who entered into a "Stipulation of Facts and Consent to Penalty." A separate disciplinary matter related to the sanctions imposed on the branch manager, William Floyd Gibbs. Although A.G. Edwards was not named, the firm has received approximately 144 customer complaints about William Gibbs and, according to the NYSE, has settled the majority of them for over $30 million.

The Sales Abuses

Cleverly, Mr. Gibbs promoted a relatively well-known investment strategy known as the "Dow Strategy". That strategy involved buying either the ten highest yielding stocks of the Dow Jones 30 Industrials or the five lowest priced of the ten highest yielding Dow stocks, and holding them for one year. But Mr. Gibbs did not stop there. He modified the Dow Strategy so that he would purchase a technology stock as a "kicker". He also modified the Dow Strategy by trading the Dow stocks more than once a year. He euphemistically referred to this as "active management."

Of course, the retirees did not suspect this scheme, having limited education and investment experience. Their goal was to generate consistent income from their retirement savings in "growth-conservative" investments. It was stipulated that Mr. Gibbs employed his strategy without consideration of whether the trades were suitable and traded without the customers' prior authorization.

In March, 2000, Mr. Gibbs began a new scheme. He contacted many of the retirees and solicited $100,000 minimum investments for what he called a "short term trading program." The program involved purchasing and trading aggressive risk technology stocks. The NYSE found that Gibbs failed to explain the risks of his program.

A third scheme began in early 2001, when Mr. Gibbs began an options trading program. His strategy was to purchase calls on the stocks that the retirees already owned (known as covered calls). The NYSE found that the strategy "subjected customers to the risk that their stock could be called away, removing assets from their accounts which had already lost much of their value." The NYSE found this to be unsuitable.

The Failure to Supervise

The NYSE found that Mr. Laing failed to supervise Mr. Gibbs, including for example, by failing to attend one of Gibbs' seminars, failing to review written information disseminated at Gibbs' seminars, spending only about one-half hour per week reviewing daily trade reports and other materials relating to Gibbs' trading in his customer accounts, failing to discuss the accounts with Mr. Gibbs, and failing to review any of the accounts when he visited the branch office.

Most remarkable is that Mr. Laing failed to adequately supervise despite receiving warnings from others at A.G. Edwards. In early 1998, the firm's compliance department alerted him that while Mr. Gibbs' documents relating to the retiree accounts consistently mentioned the Dow Strategy, the activity in the accounts differed from the Dow Strategy. The compliance department also noted that the Dow Strategy was not, by its nature, the conservative-growth strategy that the retirees desired. The compliance department requested that Mr. Laing evaluate suitability, review this information with Mr. Gibbs, document his supervisory actions and contact the compliance department to verify his review. Mr. Laing did none of that.

Additionally, in late 1998, Mr. Laing received two additional warnings but, effectively, did nothing. One of the warnings came in a conversation with another A.G. Edwards branch manager, who had learned from an A.G. Edwards broker what Mr. Gibbs was telling seminar attendees. The broker reported that Gibbs had told seminar attendees that they should "concentrate their investments in five stocks" and that asset allocation was a "waste of time" and "ineffective". In response, all that Mr. Laing did to supervise was to make a note of the word "dangerous" in his conversation notes with the branch manager.

The NYSE details other warnings that Mr. Laing ignored. In sum, the NYSE found that "Laing had a policy of allowing Gibbs to supervise himself, relied on Gibbs' representations regarding customer accounts and failed to contact customers upon being alerted to potential misconduct in their accounts." The NYSE sanction against Mr. Laing is a censure, two-year bar from supervision and a requirement that he retake supervisory examinations prior to resuming employment in any supervisory capacity.

For investors, the Laing case should send a warning that no one can assume that financial services firms are adequately supervising their employees.

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James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.