SEC SENDS SALES PRACTICES MESSAGE TO INDUSTRY
OLDE PART 2:
COMPENSATION PRACTICES

Olde referred to stocks followed by its research department and published on a specific recommended list as special venture stocks, which numbered approximately 200 exchange-listed and NASDAQ stocks, the majority of which were speculative or growth investments. Olde's brochures stated that the firm's research department believed special venture provided the customer the best chance for maximum return if held between two and four years. The firm refers collectively to all the securities it recommends as special products, which include stocks, investment grade fixed income securities, mutual funds, preferred stock, and unit investment trusts.

The SEC examined Olde's compensation, production and training practices and concluded that they fostered deceptive and fraudulent practices. In particular, the SEC was highly critical of Olde's:

• undue emphasis of its special venture stocks;
• substantially higher payouts for the sale of special venture stocks than for all other stocks;
• production requirements and position quotas motivating RRs to concentrate their selling efforts on special venture stocks
• sales credits (from the spread on that stock) to RRs prompting them to recommend higher payout special venture stocks; and
• practice of training its RRs in high pressure sales techniques.

Olde RRs received a salary of $1,200 per month; the remainder of their monthly income was primarily dependent on sales of securities to the firm's customers. An RR's "special products gross" was the monthly total of any markups, markdowns, or commissions charged to the customer, sales loads on fund products, and a share of the spread on his or her special venture stock trades.

• RRs who generated $10,000 or less in monthly "special products gross" received 20% of the gross figure as their monthly payout.
• RRs who generated monthly special products gross of more than $10,000, the payout on the total gross figure increased to 33%.

Before Olde RRs could earn commissions from non-special products trades, they were required to generate monthly gross commissions from such trades of $5,000, at which point they received 5% of that gross amount. During the relevant period, an RR received 0% payout on monthly gross commissions of less than $5,000.

At $10,000 in monthly gross commissions from non-special products trades, an RR would earn 10% of the gross amount. RRs, however, found it difficult to reach the $5,000 level because commissions on such trades were based on the firm's discounted commission schedule.

Newly licensed Olde RRs were required to generate special products gross of at least $15,000 for a minimum of two consecutive months before being considered for commission privileges under the formula described above. At that point, the firm's National Sales Department considered whether to grant the RR commission privileges. The factors Olde considered as relevant to that determination [an RR's success in servicing the firm's agency trade business was not a factor] included the ability to

sell special products,
persuade previously inactive customers to buy special products, and
prospect for new customers.

Once RRs earned commission privileges they were required to generate $10,000 each month in special products gross and sell an additional $100,000 per week in fixed income products or mutual funds. In order to maintain commission privileges, Olde RRs were required to build an average of two special venture stock positions per day worth at least $20,000 in the aggregate.

Money line market valuewas the aggregate value of all customer accounts.

Building a position meant making a new investment in a special venture stock not already in a customer's account.

Those RRs who exceeded the quotas required to maintain commission privileges could achievesuperbroker status within Olde and qualify for sales assistants by achieving the following gross production levels:

$15,000 in special products for three consecutive months and averaging a minimum net gain in special venture moneyline market value of $400,000 per month earned one sales assistant;

$30,000 in monthly special products gross earned a second assistant; and

$45,000 and $60,000 in monthly special products gross earned a third and fourth sales assistant, respectively.

New branch office managers were selected from among the ranks of the superbrokers. While the typical Olde branch office is small, elevation to management did not bring with it a reduction in the sales production expected of the new manager, whose sales production continued undiminished while he was expected to perform the added supervisory responsibilities of a branch office manager. Above the branch office manager level, district managers were also required to continue selling, as were the regional managers above them.

Additional Ways to Get the SEC Upset

Olde calculated the number of positions built by an RR on any day as a net function, i.e., it subtracted any positions sold that day. Further, the net gain of two stock positions had to add at least $20,000 to the RR's moneyline market value to maintain commission privileges.
PROBLEM: This practice has the effect of discouraging customer sales and promotes no-sell policies.

Olde required that its RRs generate at least $15,000 in special products gross in two consecutive months in order to earn commission privileges.
PROBLEM: This practice placed its newly hired and licensed RRs in an atmosphere in which instances of churning and unsuitable recommendations could and did occur.

Olde required that its RRs build positions in special venture stocks or run the risk of termination or a lower commission payout.
PROBLEM: This do-it-or-else threat virtually ensured that RRs would aggressively attempt to induce customer purchases in special venture stocks, regardless of the customer's best interest. Olde's policies created an environment in which the pressure for production overshadowed suitability determinations.

Olde use a customer preference profile ("CPP"), which consisted of information extracted from the account opening form, which the customer signs, regarding the customer's investment experience, investment goals, and risk tolerance. The information from the account opening form was put into Olde's computer system, making it accessible firmwide.
PROBLEM: Certain Olde RRs ensured that the CPP was consistent with the trading activity in the account. Given the progressive levels of sales incentives, supervisors adequately pursue questions concerning excessive uniformity among CPPs or to investigate questionable new account information. WORSE: Olde RRs could change CPP information by filling out a "CPP Update Form," which did not require a customer signature. Updates were often entered without the customer's prior knowledge or consent, and with the apparent intent to conform the stated investment objectives to the aggressive manner in which the RRs were trading the accounts.

Olde's traders set and frequently changed the sales credits, designating a portion of the spread as the credit (ranging from $.0625 to over $1.00 per share for the purchase of different special venture stocks) by posting them on its firm-wide computer system. Every RR had a computer terminal on his or her desk and could access the credit screen instantaneously: the firm flagged high credits by placing exclamation points or asterisks on either side of those credit figures. Traders also telephoned RRs to alert them to stocks paying high credits.
PROBLEM: With the sales credits coming from the spread, stocks with large spreads tended to have larger credits, with the highest credits tending to be more speculative securities. An RR's selection of which special products to recommend had a direct impact on the RR's monthly special products gross, and therefore monthly income. Consequently, Olde's sales credits established an unacceptable system that appealed to the RR's self interest to generate more income by selling speculative securities, which earned higher payouts. In similar fashion, when Olde traders needed to purchase a particular stock but could not find it in the market, at times, they offered "sell-side" credits to Olde's RRs, some of whom would then attempt to convince their customers to sell the stock. Such sell recommendations were often not prompted by the customer's best interests but by the opportunity to obtain the sell-side credit.