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March 1, 2001

Another Regulatory Landmine for Traders: Clearing just became much more dangerous because of a con

By John A. Byrne

Also in this article

  • Another Regulatory Landmine for Traders: Clearing just became much more dangerous because of a con

Correspondent clearing firms, which settle trades for smaller broker dealers, are worried.

At issue is a decision in an arbitration case in Oregon filed by six investors of the failed brokerage, Duke & Company. The decision spelled trouble for clearing firms, while providing a victory for six investors of Duke, a controversial firm found guilty of securities fraud in 1999 by the Securities and Exchange Commission.

The decision, because it was made in arbitration, will not set a precedent in future cases. But it will likely act as a guideline in other arbitrations.

Broker dealers hoping to hitch their wagon to a correspondent clearing firm should be concerned that the decision could lead them to conduct overly conservative screenings of the introducing brokers, warns Michael Udoff, vice president and associate general counsel at the Securities Industry Association.

The Duke investors contend that Duke's clearing firm, Fiserv Correspondent Services of Denver, Co., materially assisted in the unlawful transactions conducted by Duke. The panel sided with the investors, awarding them $1.8 million. Duke is no longer in business so Fiserv was left to pick up to the multi-million dollar price tab.

Appeal Lodged

At press time, Fiserv had lodged an appeal with the federal district court to vacate the award. Officials of Fiserv were not available to answer questions about the case. But others in the clearing industry were uneasy about the decision. "It will certainly make clearing firms take a second look [at the introducing brokers they take in]," said Joseph Turk, vice president of sales and marketing at U.S. Clearing, a division of Fleet Securities.

The SIA, for its part, fired off a 25-page opinion, asking the district court that the award to be set aside.

The SIA argued that Fiserv acted only in an administrative capacity in clearing and processing Duke's trades, and could not be held accountable for the broker's actions.

"Duke would not have been able to effect those instructions if Fiserv had not executed trades on Duke's instructions," Udoff contended.

Udoff offered the example of a telephone scam to underline his point. A telephone company should not be held liable for fraud perpetrated on its system by an unethical customer.

For introducing brokers, such as smaller market makers who depend on larger, well-capitalized broker dealers to keep their costs down, the Oregon case is ominous.

The case, if it stands, could increase the overall costs of clearing as firms pass along expected legal costs, Udoff said. Alternatively, it could reduce the number of clearing firms available to introducing brokers.

The Fiserv case could go away. Nobody is betting on that course, however. The correspondent clearing business, like the rest of Wall Street, is populated with armies of hungry attorneys lusting for the next lucrative case.

"They use to chase ambulances. Now the attorneys are chasing broker dealers," said Patrick Ryan, president of a small market-making firm in McLean, Va., who is alarmed at the litigious nature of the industry. (Ryan's firm, Ryan, Lee & Co. clears through Fiserv, though he expressed confidence in the long-term future of his clearing partner.)