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In Olde Broker’s tale, a note of caution for ambitious discounters: Blurring lines can smear anyone’s reputation

Beware of the company that bills itself as a full-service discount broker.

As the lines blur between what are traditionally considered discount operations and full-service brokerages, these “discount” firms are sure to trip up on compliance, say lawyers and compliance consultants. Case in point: Detroit-based Olde Discount Corp., which since the 1980s has been calling itself “America’s full-service discount broker.”

Earlier this month the firm settled a stock fraud suit that regulators say is unprecedented in a case of its kind for the size of the fines –$7 million — and unusual because penalties were imposed on its chairman personally. Ernest J. Olde agreed to fines of more than $1 million and an 18-month suspension from securities dealings.

Two other executives at the firm were fined lesser amounts and barred from the industry with a chance to reapply in five years. Olde Discount Corp. and the three individuals neither confirmed nor denied the allegations, and Mr. Olde, who has a residence in the Cayman Islands, was out of the country at press time and unavailable for comment.

A spokesman, noting that the case stems from incidents occurring between 1992 and 1995, says the company has been undergoing changes in management and compensation structure over the past three years that it began on its own. The changes, he says, are too numerous “for me to detail them; it’s an extremely exhaustive list of items.”

Still, lawyers and compliance consultants point to the firm’s tribulations as a cautionary tale for the discount brokerage industry.

“Discount firms are going to have to evaluate themselves as they expand, and they will have to read that case carefully,” warns Betty Santangelo, a securities lawyer at New York’s Schulte Roth & Zabel.

Olde was ahead of its peers in realizing that discount brokerages, in order to compete, can’t remain mere order takers for do-it-yourself investors who go to them for fear of being ripped off by commission-driven stockbrokers. Founded in 1971, Olde in the 1980s began offering stock research and hiring brokers to pitch stock recommendations.

Today discount brokerages talk a lot about their full-service approach.

Most notably Charles Schwab & Co., the nation’s largest discount brokerage, states publicly its competitive strategy going forward is to look more like a full-service firm offering, if not specific recommendations, help on picking mutual funds and referring clients to a network of independent financial advisers.

The San Francisco firm is not alone. New York’s Quick & Reilly, which is owned by Fleet Financial Group Inc., has been training its “order takers” to find other sales opportunities when investors call to purchase a stock or mutual fund. And other firms offer a variety of services approaching those available from a traditional broker.

What would drive a discount broker to commit offenses such as those alleged in the Olde case? Heady competition among discount shops — along with technological advances that facilitated brokerage transactions — has forced down the price for brokerage services, says Vincent J. Bencivenga, managing director in the San Francisco office of PricewaterhouseCoopers LLP’s regulatory compliance consulting group.

Speaking of the SEC and NASD’s fining Olde and its chairman, Mr. Bencivenga says: “When they do this, it makes every chief executive officer in America twitch.”

And regulators are quite aware that in their frenzy to compete, discount brokerages are adding services they don’t necessarily have any experience in, such as recommending stocks, offering research or providing online transactions.

“Every day they read about a competitor doing something new,” says Mr. Bencivenga, “and they say, ‘Hey, we need to do this,’ and they get into a service so quickly they go past their compliance department.”

To be fair to the brokerage industry, though, Olde is somewhat of an anomaly. It has had a history of complaints from investors dating back to its first decade.

Extra-credit projects

Regulators alleged that Mr. Olde had tried to stonewall their investigations too. He allegedly walked out in the midst of testifying before regulators and canceled another scheduled appearance at the last minute, saying he had a nosebleed.

According to regulators, Olde went astray when the full-service approach spawned rapid growth. Operating much like penny-stock brokerages or rogue brokers at traditional firms, Olde had instituted a program called “special ventures,” which were small company stocks in which the firm was making a market. To encourage its brokers to sell these stocks over others, Olde offered them an “extra credit” on top of the traditional commission: the spread between the purchase and ask prices. But, regulators allege, brokers would only get the credit if no price-limit order was imposed. For that alleged procedure, the Securities and Exchange Commission fined the firm.

“The size of the fine signifies that the commission views this as a serious case, and that they (discount brokers) should go back and examine their policies and procedures,” says Richard Murphy, a senior trial counsel in the SEC’s Atlanta office.

The industry’s self-regulatory body, the National Association of Securities Dealers, fined Olde for another reason. It alleged the firm misrepresented itself in advertising, calling itself “commission-free,” without markups.

Can the firm survive in light of the size of the settlement and the attendant publicity?

The Olde spokesman would not comment about the impact the settlement might have on the firm’s bottom line, and insists that it intends to remain a full-service brokerage.