Several of Wall Street's biggest firms risked financial disaster during the collapse of the silver market in 1980 because they did too much business with the billionaire Hunt family of Texas, Securities and Exchange Commission investigators said yesterday.
The SEC staff urged the commission to limit the amount of business stock brokers can do with any one customer, in the same way that banks are limited in the amount they can lend to a single borrower.
Based on a 2 1/2-year investigation of the silver market collapse, the SEC staff severely criticized the New York Stock Exchange for the way it regulates brokers and complained that investors were not warned of the precarious finances of several brokerage houses.
The SEC report disclosed for the first time that Bache Halsey Stuart Shields Inc. was censured by the New York Stock Exchange and fined $400,000 for violations of exchange rules that contributed to the silver crisis. The fine was levied in July and made public yesterday. Bache agreed to pay the fine without admitting it had violated stock market rules.
The SEC said Bache "created the potential for a material adverse impact on its financial condition" by not only handling huge Hunt orders for silver futures contracts, but also by lending the Hunts $80 million to buy silver.
When silver prices hit bottom on March 27, 1980, the Hunts had $184 million in past due debts to Bache, which at that time had only $52 million of its own money available to cover the deficit, the SEC investigators found. Bache's true financial status was not disclosed at that time, however, because the firm--along with others in the industry--used an accounting method that vastly overstated the value of silver futures contracts held by the Hunts, the SEC said.
The SEC staff study is the most complete picture yet painted of the role played by Wall Street in the inflation and collapse of the silver bubble in 1979 and 1980. In less than a year the price of silver soared from under $10 an ounce to $50 then plunged back to $10.80.
Members of the Hunt family and their associates, who the SEC says controlled 195 million ounces of silver, lost hundreds of millions of dollars when silver sank and had to obtain the approval of Federal Reserve Board Chairman Paul A. Volcker for a $1.1 billion bank loan to cover their debts.
The staff study said the incident "provides a valuable lesson in the fragility and interdependence of the financial structure and challenges both the private sector and government to respond."
Though Bache is singled out for criticism in the SEC study, five other Wall Street firms were also at risk because of their dealings with the Hunts, the report said. They include Merrill Lynch Pierce Fenner & Smith, the nation's biggest investment broker; Dean Witter Reynolds, the brokerage now owned by Sears, Roebuck & Co.; E.F. Hutton; Paine Webber Jackson & Curtis Inc. and A.G. Edwards & Sons. The six firms faced huge -- and in some cases potentially fatal -- losses when the Hunts were unable to pay their silver debts, the SEC staff concluded.
The study blames "decisions by senior management in these firms" which it said "created the potential that default by this single group of customers could jeopardize entire firms." Without naming names, the SEC points a finger at the top executives on Wall Street saying, "the decision to assume the risks associated with such substantial holdings was made at the executive committee level or higher."
The New York Stock Exchange declined to comment on the SEC report. Merrill Lynch issued a statement saying the firm "was at no time in financial difficulty." Bache did not comment on the SEC report, but said it paid the $400,000 fine "rather than continuing to fight past wars, [because] we felt it was better for the firm to put the issue behind us."
The brokers got in trouble, the SEC investigators said, because they did not bother to check the financial references of the Hunts, who are generally regarded as the richest family in America. Wall Street firms let family members run up millions of dollars in debts "based on a general belief concerning the extent of the Hunts' financial resources, but without detailed or current information concerning those resources," the report says.
Faulting the brokers for violating stock exchange requirements to "know your customer," the SEC staff urged the commission to set limits on the amount of business a brokerage does with a single customer. Banks are permitted to loan no more than 10 percent of their assets to one customer and a similar rule ought to apply to brokers, the staff suggested, without recommending a specific limit. The staff also recommended changes in accounting rules, capital requirements for brokers and closer monitoring of the self-regulator actions of the New York Stock Exchange.
The study criticized the nation's most prestigious financial market for what staff members called its "failure to identify an impending crisis and its consequent failure to take appropriate prophylactic action."
The breakdown in measures to protect the public, the study added, "was due to the fact that the Exchange based its surveillance of Exchange members dealing in silver on a belief that the members would provide candid, accurate and complete information to the exchange staff, promptly and spontaneously. As outlined above, this assumption proved false."