How some big brokerages cash in on customers' cash

Robberies of banks and other savings institutions now occur with such frequency that they may not even make the headlines unless the heists are particularly large, involve bloodshed, or both. Yet several of the nation's leading stock brokerage houses (dealers) quietly relieve their own customers of many millions of dollars annually -- without atttracting much public attention -- by engaging in practices the Securities and Exchange itself regards as being at least unethical.

Largely on the basis of complaints lodged by victims and near-victims of such dealer malpractices, the SEC has succeeded in stamping out many and reducing the frequency of others. The commission's functions, however, are primarily "to ensure the maintenance of fair . . . markets for securities and the protection of investors. . . . While the Federal securities laws provide investors with recovery rights if they have been defrauded, the SEC is not authorized to act as a 'collection agency' on behalf of investors who have suffered losses. . . . If you have been defrauded, you must seek redress privately -- either infromally or through a court suit" ("Information for Investors," SEC, February 1980). Most investors nevertheless feel that their interests are adequately protected if they deal with any of the country's largest and best-known dealers.

Has it ever occurred to you, however, that (1) your own dealer, possibly one of the leading and best known, might be borrowing money from you (and perhaps from your bank as well) without having received consent to do so, and without paying or pledging any interest for the use of the "borrowed" funds; that (2) your dealer might remit most payments due you by checks mailed from its home office (which might be in a city distant from where you live) and drawn on out-of-town banks (thus prolonging its interest-free use of your funds); that (3 ) your dealer might delay making payments to you when due, going so far as to remit payments of dividents and interest only on a monthly basis rather than "immediately" as each becomes due, and engage in this practice without even having sought your consent; that (4) your dealer might increase commission rates without giving adequate notice, thus denying you an opportunity to "shop around" for lower rates (many cut-rate dealers charge commissions as much as 50 percent or more lower than those charged by most "full service" dealers; that (5) your dealer would impose "custodial fees" on "inactive accounts" without giving adequate notice that would enable you to transfer or close your account; and that (6) your dealer would fail to transfer your account promptly to another dealer upon your request, thus causing you inconvenience and possibly some additional expense as well?

All these practices have for years been the subjects of continuing investigation by the Securities and Exchange Commission; it issued an interim report on the subject on Sept. 28, 1978, Release No. 15194. The commission summarized its findings in that report with the observation that some of the leading dealers, "in addition to violating standards of fairdealing," engage in other conduct "inconsistent with just and equitable principles of trade" and in some instances "appear to violate antifraud provisions of the federal securities laws." The commission noted further that many of these practices "appear not to be isolated occurrences but instead to reflect established policies of several of the nation's lead ing broker-dealers." The commission admonished that "action to correct these abuses is overdue and should be undertaken promptly."

The only near-rebuttal of the SEC's charges was made by Edward I. O'Brien, president of the Securities Industry Association. He said: "There isn't any fraud intended or practiced by any broker-dealer in any of these practices."

The press took note of the SEC's charges but tended rather to underplay their importance. A typical headline was: "Leading Brokerage Firms Accused of Petty Larcenty." Had prime interest rates been as high then as tehy are now, the headline-writer might have chosen a more somber qualification than "petty."

SEC has made considerable progress in eliminating some of the most serious of these abuses. It has, for example, greatly reduced the more brazen "remote checking" abuses. No longer do any of the dealers with head offices in New York City dispatch checks from their offices there to customers in, say, Boston or Miami but drawn on banks in California. Dealers, however, are still left free to make considerable profit out of such remote checking as is not forbidden.

The most serious abuse cited by the SEC was the practice of "disbursing dividents and interest payments monthly rather than promptly upon receipt of the funds and . . . without notifying their customers in advance and offering them the alternative of immediate payments." However, the SEC did not direct these dealers to reinstate "immediate" payments, and it is doubtful that any has done so of its own accord.

Dealers now generally discourage requests for "immediate" payments by, for example, requiring that individual requests be made for each such payment shortly before it becomes due. Once payments have been started on a monthly basis, however, customers tend to "elect" to continue receiving them on that basis, rather than confront the inconvenience of requesting a return to "immediate" payments on whatever terms they are available.

The extent to which a customer forgoes income by receiving monthly rather than "immediate" payments varies somewhat with how far he resides from his dealer's main office from which checks are generally dispatched. A resident of Boston, for example, now typically receives payments from most leading dealers by checks mailed from their New York offices, and drawn on banks in the same city.

When "immediate" payments are made by mail-delivered checks, a Boston customer of any of the leading broker-dealers ordinarily forgoes the use of his funds for two to six days, and the dealer has the interest-free-use of them for that period, plus an additional day or two: at the expense of the customer's bank!m When such payments are made on a monthly basis, the customer is obliged to forgo the use of his funds for two days to about five weeks, and the dealer has the interest-free use of them for three days to more than five weeks.

Customers who receive payments on a monthly basis, rather than "immediately," forgo, or "lose," anywhere from 0 percent (for those who would deposit the funds in their checking accounts) to as much as 24 percent (or even more) for those who would use the funds to pay off credit-card indebtedness. The return that dealers earn on the funds supplied them interest-free by their customers (and unwittingly in token amounts also by their customers' banks) is probably close to the prime rates charged by most commercial banks (currently 20 percents).

To date, however, not even the SEC has been able to devise any practicable program for preventing some of the nation's leading broker-dealers from reaping enormous windfall gains from the interest-free use of their customers' funds!