The Securities and Exchange Commission charged yesterday that Kidder, Peabody & Co., one of Wall Street's leading brokerage firms, improperly risked $145 million of its customers' securities for its own profit last year.
The SEC alleged that in March and April of 1984, Kidder pledged securities that belonged to its customers as collateral for loans that benefited the firm. The SEC also charged that from October 1983 to September 1984, Kidder failed to maintain accurate and detailed records describing these transactions.
Kidder vice president Hugh Covington denied the allegations yesterday. He said the SEC and Kidder simply have differing interpretations of "technical rules" governing the firm's bookkeeping practices.
"At no time were our customers inadequately protected against loss," Covington said. "We disagree with the SEC staff that our bookkeeping practices in March and April of last year violated these rules."
The SEC's charges against Kidder come amid continuing controversy surrounding cash-management practices at another well-known brokerage firm, E. F. Hutton & Co. SEC and congressional investigations into Hutton's aggressive overdrafting of bank accounts have not yet been completed, but on May 2, Hutton pleaded guilty and paid a $2 million fine, reimbursed the government for $750,000 in prosecution expenses, and agreed to make restitution to victimized banks.
The SEC allegations against Kidder mark the second time in less than two years that the firm has become involved in a major controversy. Two Kidder stockbrokers, Peter N. Brant and Kenneth Felis, were involved in a scheme to make money in the stock market by using information about future stories leaked by Wall Street Journal reporter R. Foster Winans. Winans and Felis were convicted of fraud charges. The Journal fired Winans.
SEC New York Regional Administrator Ira Lee Sorkin said yesterday that the SEC and Kidder will debate the allegation that Kidder improperly used its customers' securities for its own benefit at a hearing before an administrative law judge. The statute governing the SEC's charges would allow a judge to censure Kidder, suspend or revoke the firm's brokerage license or do nothing. Kidder will have the right to appeal the judge's ruling to the SEC's commissioners. The administrative hearing has not been scheduled.
While brokerage firms are allowed to use some of the securities they hold for their clients as collateral for loans, the SEC alleged yesterday that Kidder went $145 million beyond its legal limit and failed to keep accurate records. In addition to Kidder, the SEC named the firm's vice president and director of operations, Gerard A. Miller, as a codefendant in the proceeding.
Specifically, the SEC alleged that Kidder improperly pledged $55 million of its customers' securities as collateral for bank loans and $90 million as collateral for repurchase agreements in March and April of last year.
Although the SEC did not specify the exact nature of Kidder's repurchase agreements, these agreements probably resembled short-term loans in which a party with cash lent money to Kidder and took government securities from Kidder as collateral. As part of the agreement, Kidder probably agreed to buy back the securities at a higher price in the future. In the interim, Kidder would have been able to use the cash for other investments.
Repurchase agreements can be dangerous if the firm borrowing the cash invests the proceeds in risky transactions. They can also cause problems when the firm borrowing the money uses the same securities as collateral for multiple loans. The collapse of repurchase agreements was one of the catalysts that led to the Ohio savings and loan crisis earlier this year.
Brokerage firms are required to separate fully-paid-for securities that they hold for their customers from securities that the firms own themselves. The SEC's Sorkin said Kidder allegedly failed to separate its own securities from those belonging to its customers when borrowing money last year.
"We are alleging that they used customers' securities [as collateral for loans] that should have been segregated," Sorkin said. "They are also charged with failure to maintain accurate books and records for those dates."
The SEC also charged that Kidder failed to prepare and maintain a detailed description of the procedure it used to maintain physical possession or control of its customers' securities. The SEC charged that Kidder also failed accurately to compute on April 6, 1984, the amount of reserves required to be on deposit in a special bank account for the protection of customers. In addition, the SEC alleged that Kidder failed to keep accurate securities records on or about March 9, 16, 23, and 29 (1984) and April 6, 13, 19, and 26 (1984).
Firms charged with violations by the SEC frequently settle the cases to minimize the controversy that surrounds ongoing proceedings.