A mallet stands out among the clutter on a desktop in Mesirow Financial's offices in Chicago. Is this for Thomas Avgeris, a big man never afraid of strangers in the Windy City?
No, Avgeris needs the mallet to hammer home one of the attributes some say has made Mesirow an important name in the scrappy business of correspondent clearing: good quality control.
That's right, quality control. And it was scrawled in big letters across the mallet crashing down on the desk.
Quality control, repeated Avgeris, a managing director at Mesirow's North Clark Street offices in the Windy City. "When in doubt, bring it out," he said, giving the desk another rap. "Quality control."
Soon the laughter was actually rattling the room. But this was no laughing matter. Mesirow, which has 125 corespondents, likes to rank quality control among the top reasons an introducing broker, or a smaller broker dealer, selects Mesirow to execute, clear and settle its equity transactions.
"We are an extension of the introduction broker, as it were," Avgeris said.
Symbolic Reminder
The mallet, of course, is much more than a symbolic reminder of how important quality of service is at Mesirow. The mallet is a good way to begin any article in 1998 about the correspondent-clearing business.
After all, the industry is now awaiting Securities and Exchange Commission approval on new clearing rules that could utterly change the relationship among clearing firms, their correspondents, the correspondents' customers the ultimate customer, actually as well as the regulators.
The objective is to enhance existing levels of quality control in a business that has not always demonstrated a sterling reputation.
The rules were submitted to the SEC in response to several highly-publicized cases of alleged investor fraud by broker dealers that use other broker dealers or correspondent-clearing firms to clear and settle their business.
In particular, regulators stepped up their demands for stricter clearing rules in the wake of the collapse of New York-based A.R. Baron & Co. Last year, a state grand jury indicted A.R. Baron and 13 former employees on charges of bilking investors of more than $70 million. The firm filed for bankruptcy in 1996.
Bear Stearns & Co., which processed A.R. Baron's business and wins high praise from many of its correspondents for running a good ship was questioned by the SEC, and separately, by the Manhattan district attorney's office about its role in the collapse of A.R. Baron.
At issue was the role of Bear Stearns, passive or otherwise, in the alleged wrongdoings of a correspondent.
Bear Stearns defended its role in the A.R. Baron debacle, pointing out, for instance, that it represented only a small fraction of its total clearing business. (Bear Stearns processes an estimated 12 percent of the volume on the New York Stock Exchange cleared through the National Securities Clearing Corp.)
Moreover, Bear Stearns stressed that customers make it clear in customer agreements they are aware that the firm acts as the backoffice provider that gives them investment advice.
Regulators, however, are not convinced that current clearing-firm rules are adequate. The National Association of Securities Dealers, in its proposed rule filing with the SEC, said that "concerns about questionable sales practices and potentially fraudulent activity by certain introducing firms, and the handling of customer complaints about those firms by their clearing firms, caused the staffs of NASD Regulation and the NYSE to examine the relationship between clearing firms and their client-introducing firms.
"The examination resulted in proposals to amend the NASD's and the NYSE's rules relating to the content and approval of clearing agreements to specify requirements for handling customer complaints."
Utmost Importance
The new rules that finally emerge from the SEC could be of the utmost importance to equity traders, particularly Nasdaq market makers. That's because the new rules, as proposed, would require clearing firms to file complaints against an introducing broker to self-regulatory organizations and to the correspondents themselves.
That, of course, may ultimately ensure a greater degree of investor protection than ever before, but could unfairly impugn some trading desks, compliance experts fret.
"Some customers could abuse this provision recklessly," one compliance expert said. "Suppose they had an unwarranted gripe, maybe it was something personal, they could make life miserable for the desk writing a complaint to the desk's clearing broker."
Another hot issue is whether the SEC will require clearing firms to inform a correspondent's customer, on receipt of a complaint from the customer, that the customer retains the right to transfer his account to another broker dealer.
Some top correspondent clearing-firm executives are worried. "It is scary what they are talking about," said an executive at a Jersey City-based clearing broker. "Will the rules also require us to furnish compliance data on the correspondent directly to the SEC? That would upset a lot of people."
Another executive, Frank Colella, director of marketing at New York-based BHF Securities, said an introducing broker may be required to send more compliance data directly to the clearing broker, or else risk having the firm not process the correspondent's business. BHF, which clears for 40 correspondents, typically institutional agency brokers, did not outline its own plans.
Avgeris has another view, pointing out that Mesirow, like other clearing brokers, now passes along complaints to the appropriate regulatory authorities. However, he draws a line separating the clearing broker from ultimate responsibility for policing the correspondents.
"That's up to the regulators and the correspondents' compliance officers," he said.
More Selective
One inescapable fact is that clearing firms have become more selective about their roster of correspondents. With small-cap fraud making headlines, more clearing firms are distancing themselves from firms specializing in the business be it market making or retail distribution.
That, unfortunately, hurts the majority of businesses in the small-cap area that run legitimate operations. And that's the unavoidable price for investor protection, compliance experts say.
There are other regulatory issues equally as breathtaking as the clearing-firm rules. For one thing, many clearing firms may have to step in and assist small to medium-sized Nasdaq trading desks to comply with the parameters of the NASD's pending Order Audit Trail System, or OATS.
Many of these desks do not have the systems capability or the budget to pull off the requirements for OATS compliance (mandated by regulators in the wake of the SEC's settlement with Nasdaq about two years ago). The system, as envisaged, would capture up to 25 trade details from the point of order entry to execution.
Another issue is Year-2000 compliance. But the man with the mallet had a word of comfort for his introducing brokers. "It's our job to worry about the Year 2000," Averis said. "All of our systems, including order routing, record keeping and clearing, have to be ready. That'll take some of the pressure off the introducing brokers."
