Rogue Broker at Stephens Inc. Caused Penalty, $1.9M Claim

by George Waldon  on Monday, Feb. 17, 2014 12:00 am  

Stephens Building (Photo by Mauren Kennedy)

Lost in the political fracas between the Arkansas Securities Department and Stephens Inc. is the event that started it all: a customer complaint against a former Stephens stockbroker, William Wayne LaRue.

Along the way, Stephens paid $475,000 in September to settle a $1.9 million claim by an unidentified LaRue client in an arbitration case. LaRue worked for Stephens in its Conway office from October 1998 until August 2011.

His regulatory troubles led to the ASD’s Aug. 22 consent order against his former employer and the $25,000 fine that has provided legislative grist in the conflict between Stephens and ASD Commissioner Heath Abshure.

The consent order ended an amazing 33-year run of sanction-free business in Arkansas for Stephens.

Individual Stephens employees have had brushes with state securities officials over the years, but the company itself had avoided being fined by the Arkansas Securities Department since 1980. (See Previous Consent Orders.)

The regulatory wheels that ended the streak were set in motion in early 2012.

That’s when the ASD received a complaint from an investor who claimed LaRue had made a series of unauthorized trades on her account before he left Stephens a few months earlier.

That lone complaint mushroomed into an investigation that uncovered other LaRue clients with similar experiences. Digging deeper, the agency discovered other violations.

“The unauthorized trading was occurring in margin accounts,” said Scott Freydl, staff attorney with the Arkansas Securities Department. “In looking at this, we saw there were leveraged and inverse exchange traded funds [ETFs]. That’s when the issue of suitability came up.”

According to documents filed by Stephens in its grievance against Abshure, the LaRue clients afflicted by unauthorized trading and/or unsuitable investments included Diana Kirkland, David Branscum, Ray and Donna Hambuchen, Bobby Spradlin and Doug and Andrea McConnell.

LaRue made unauthorized trades in the ultra-short-term investments designed to be held for one day that were instead held for days, weeks and even months in some of his clients’ margin accounts, according to the ASD findings.

In one instance outlined in the consent order against LaRue, he bought and sold speculative, short-term ETFs in July 2009 for a client account with an investment objective listed as “long-term growth with greater risk.”

LaRue was sanctioned in October by both the ASD and the Financial Industry Regulatory Authority, the investment in-dustry’s self-regulating organization.

He was fined $10,000 each by the ASD and FINRA, and both agencies suspended his securities trading privileges for four months. The ASD suspension ends on Friday, and the fine is due by April 21. The four-month FINRA suspension ends March 3.

LaRue also is required to retake and pass the Series 7 and 63 or 66 exams to regain his stockbroker license.

After leaving Stephens, he worked in the Conway offices of Morgan Keegan & Co. and its acquirer, Raymond James & Associates, from September 2011 until his regulatory suspension in October.

LaRue has worked in the securities business almost continuously since he passed his Series 7 exam in March 1985 and started his career at A.G. Edwards & Sons.

When the new Stephens location in Conway opened in 2001, LaRue was described as a vice president and manager of the office.

Widespread Problem

Ultimately, Stephens wasn’t penalized by the ASD for lack of supervision regarding LaRue’s unauthorized trading. The ASD staff determined the company had sufficient policies in place and took action once it learned of the problem in September 2011, a month after LaRue left the firm.

However, the ASD staff did believe Stephens had to answer for allowing LaRue to buy and sell unsuitable investments, specifically the leveraged and inverse ETFs. (See What Are Leveraged and Inverse ETFs?)

“Stephens had no customer complaints about the sale of ETFs by Wayne LaRue, and ETF sales had nothing to do with LaRue’s departure from the firm,” said Frank Thomas, spokesman for Stephens Inc.

“Beyond that, we have no additional comment.”

The February 2012 complaint that resulted in the $475,000 arbitration settlement with Stephens was portrayed as a case of churning, in which LaRue made questionable trades to generate commissions at the expense of the client.

ETF trades were part of that unauthorized trading activity, according to ASD officials.

The ASD findings reported that until Aug. 7, 2009, Stephens had no written compliance policy that specifically addressed transactions in inverse or leveraged ETFs. Months after that, the Stephens internal computer system was unable to track the sale of leveraged and/or inverse ETFs and enforce the written policy.

LaRue traded the unsuitable ETFs before and after Aug. 7, 2009.

The lack of internal policies regarding ETFs and monitoring ETF trading wasn’t peculiar to Stephens.

“Stephens was not alone,” Freydl said. “It was a widespread industry problem.”

In October 2012, 10 months before Stephens was fined, the ASD fined Morgan Keegan & Co. $15,000 for one broker’s unsuitable ETF trades involving one client.

Stephens argued unsuccessfully that it should have re-ceived a comparable fine, even though LaRue’s infractions involved multiple clients.

And unlike Morgan Keegan, according to the ASD, Stephens didn’t have any ETF policies in place when LaRue’s infractions began and later had a monitoring system in place that didn’t work.

Stephens executives be-grudgingly agreed to the $25,000 fine, but in November, its general counsel, David Knight, filed an ethics complaint against Abshure. Among other things Stephens claimed the fine was increased because the firm refused to make a donation to the North American Securities Administrators Association in lieu of a fine.

Abshure was last year’s president of the NASAA, an organization that has opposed some national legislation advocated by Stephens CEO Warren Stephens.

After the economic downturn in 2008, securities officials began seeing more and more trading in the exotic ETFs.

“We saw an explosion of non-traditional investments,” Abshure said. “Instead of sophisticated investors, we started seeing Ma and Pa buy.

“It’s common to push non-traditional investments during times of market fears. Sometimes it’s customer-driven; sometimes it’s broker-driven.”

Concerns about the proliferation of ETF trading outside the normal investor pool prompted the Securities & Exchange Commission and FINRA to issue a joint alert on Aug. 18, 2009.

“The SEC staff and FINRA are issuing this Alert because we believe individual investors may be confused about the performance objectives of leveraged and inverse exchange-traded funds (ETFs). Leveraged and inverse ETFs typically are designed to achieve their stated performance objectives on a daily basis.

“Some investors might invest in these ETFs with the expectation that the ETFs may meet their stated daily performance objectives over the long term as well.

“Investors should be aware that performance of these ETFs over a period longer than one day can differ significantly from their stated daily performance objectives.”

The ASD consent order with Stephens gave the firm the benefit of the doubt that the ETF problem was isolated to LaRue and not widespread.

“We decided we wouldn’t do further investigation,” Abshure said. “Had we not done that, it would’ve been a potential violation for every agent who sold ETFs over there. It might be that no agents were selling ETFs [inappropriately].”

Stephens General Counsel David Knight has characterized the choice of settling or undergoing further investigation as a threat.

Previous Consent Orders

The Aug. 22, 2013, consent order with Stephens Inc. marks only the third time the Arkansas Securities Department has fined the Little Rock firm since 1976.

Feb. 8, 1980: Stephens Inc. was fined $357 as part of a consent order settlement agreement.

The company was ordered to improve certain supervisory procedures in connection with a separate ASD order entered against a former salesman and in connection with the review of securities registration and exemption procedures.

The odd dollar value rounded out $19,643 Stephens voluntarily paid to reimburse a client of the company’s former employee, William Luplow III.

The offending investment was described as “evidences of indebtedness as investment securities of Stephens Inc., Real Properties Inc. or any other subsidiary.”

The securities commissioner back then was Harvey L. Bell.

Oct. 24, 1976: Stephens Inc. was fined $1,000 for failing to reasonably supervise its agent who was found to have transacted business in the state without being registered under the Arkansas Securities Act.

What Are Leveraged and Inverse ETFs?
Source: Financial Industry Regulatory Authority

Leveraged Exchange Traded Funds seek to deliver multiples of the performance of the index or benchmark they track. Inverse ETFs (also called “short” funds) seek to deliver the opposite of the performance of the index or benchmark they track.

Like traditional ETFs, some leveraged and inverse ETFs track broad indices, some are sector-specific and others are linked to commodities, currencies or some other benchmark.

Inverse ETFs often are marketed as a way for investors to profit from, or at least hedge their exposure to, downward moving markets.

Leveraged inverse ETFs (also known as “ultra short” funds) seek to achieve a return that is a multiple of the inverse performance of the underlying index.

An inverse ETF that tracks a particular index, for example, seeks to deliver the inverse of the performance of that index, while a 2x (two times) leveraged inverse ETF seeks to deliver double the opposite of that index’s performance.

To accomplish their objectives, leveraged and inverse ETFs pursue a range of investment strategies through the use of swaps, futures contracts and other derivative instruments.

Most leveraged and inverse ETFs “reset” daily, meaning that they are designed to achieve their stated objectives on a daily basis.

Their performance over longer periods of time — over weeks or months or years — can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time.

This effect can be magnified in volatile markets.



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