December 19, 2005

Arbitrators to Weigh Two Cases Over Responsibility for Trades; Victories Are Tough for Plaintiffs

By SUSANNE CRAIG
Staff Reporter of THE WALL STREET JOURNAL

After Deborah Loeffler's sister was killed in the World Trade Center bombings in 2001, the former model entrusted the money she inherited from the tragedy to the family friend who was there to console her -- stockbroker and former financial-television personality Todd Eberhard.

Today, Mr. Eberhard, her former best friend's husband, is serving 13 years in prison for defrauding clients including Ms. Loeffler out of at least $20 million. In Ms. Loeffler's case, she says her broker forged her signature and transferred her money out of her account without authorization, causing her $2.6 million in losses.

But she isn't just blaming the broker. The firms that processed, or "cleared," the trades for Mr. Eberhard, the former majority owner of Park South Securities, turned a blind eye to his behavior, she says.

Winning damages from clearing firms on Wall Street isn't always easy. But earlier this month, a National Association of Securities Dealers arbitration panel agreed to hear Ms. Loeffler's claim along with a similar claim from Robert Pellegrini, who says he lost $8.4 million because of Mr. Eberhard's mismanagement.

The two argue that Pershing LLC and Correspondent Services Corp., the clearing firms that processed Mr. Eberhard's trades, should have spotted his shenanigans.
Clearing firms typically maintain things like client records and send out trade confirmations for firms that don't have the size or capital to do so, often earning big returns in the process.

A spokesman for Bank of New York Co., which owns Pershing LLC, said the arbitration case is without merit. A spokesman for UBS AG, which owned CSC when it cleared for Mr. Eberhard, says CSC wasn't responsible for Mr. Eberhard's conduct, was also deceived by him and plans to defend itself vigorously against this latest arbitration claim.

What is the responsibility of Wall Street firms when they clear trades for brokers like Mr. Eberhard? That is the key to the Loeffler and Pellegrini cases. Going after clearing firms is often difficult because current regulations require them to spell out their role in advance, often limiting their liability to only those specific functions.

Yet the issue of clearing-firm accountability is not new: For years customers like Ms. Loeffler, 41 years old, have been trying to hold clearing firms accountable when the trades they process turn out to be problematic.

Last week, Bear Stearns Cos. announced that it has agreed to pay regulators $250 million to settle charges of improper trading in mutual funds by some of its employees in its clearing division. As well, an independent consultant will review aspects of its mutual-fund trading and clearing operations. The substantial fine was seen by many as a signal that firms with clearing practices like Bear must pay more attention for signs of wrongdoing by their clients.

In perhaps the best-known case against a firm, Bear in 1999 settled civil regulatory charges that it ignored signs of fraud by one of its clearing customers, A.R. Baron & Co., in the form of customer complaints. Without admitting or denying wrongdoing, Bear agreed to pay about $38 million in fines and restitution. In 1999, in a move prompted by the Bear case, the New York Stock Exchange beefed up requirements for clearing brokers, for example requiring clearing firms to forward customer complaints to regulators.

Still, there have been relatively few successful investor claims against clearing firms, in large part because their limited liability is so clearly spelled out. And despite a few changes over the year, Wall Street has long tried to keep more stringent rule-making of these often very profitable divisions at bay, arguing firms like Pershing will simply stop clearing if they are held accountable for the actions of the brokers they clear for.

Jake Zamansky, a high-profile plaintiff lawyer, is representing Ms. Loeffler and Mr. Pellegrini, 66. An often outspoken advocate for his clients, Mr. Zamansky is perhaps best-known in legal circles for suing Merrill Lynch & Co. in 2001 for issuing tainted stock research in an attempt to win more lucrative investment-banking business. That issue mushroomed, ending with 10 securities firms, without admitting or denying guilt, paying $1.4 billion to settle like charges by regulators.

Mr. Zamansky says he plans to lobby regulators to beef up the rule-making and regulation of clearing brokers. For instance, clearing firms currently are required to notify only the brokerage firm they are clearing for if they detect suspicious activity in accounts. Those reports, Mr. Zamansky says, should also be sent to the client, and in some cases even regulators. As well, he believes regulators should be more aggressive in holding clearing firms responsible if there is strong evidence they knew of a fraud and did nothing.

In Ms. Loeffler's case, Mr. Zamansky says both Pershing and CSC were aware of a formal NASD investigation into Mr. Eberhard's behavior yet continued to do business with him. "They knew about the fraud, continued to execute his trades and profit from them," he said. Both Pershing and UBS maintain the arbitration claim is without merit.

Unlike court decisions, arbitration cases don't create precedents; each case is argued on its own merits so even if Mr. Zamansky prevails it will be hard to immediately measure the impact of his case. If he wins the case, it will almost surely be appealed. Still, a win could encourage others with similar claims to cite the case.

His quest for changes at clearing firms will face a serious challenge from Wall Street. "These firms are paid to clear trades, not to watch customers. Clearing firms will charge more or consider leaving the business if they are asked to police sales practices and that will end up hurting the average customer," says Sidley Austin Brown & Wood lawyer Henry Minnerop, who has represented most of Wall Street's clearing firms over the years.

However, despite the obstacles there have been a handful of victories against clearing firms over the past several years. In 2001, NASD arbitrators in Oregon ordered Denver-based Fiserv Correspondent Services to pay $1.8 million to six investors defrauded by brokerage firm Duke & Co.

The ruling was upheld by the Ninth U.S. Circuit Court of Appeals in Seattle in 2002 and the firm has since paid the award, says Bob Banks, the plaintiff lawyer who took on Fiserv. "Despite the award, I believe it's tough to win these cases," he said. "For me to take on a clearing firm case I need to be convinced there was wrongdoing on the part of the introducing broker and the clearing firm knew of the wrongdoing and allowed it to continue."

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