SEC backing off on B share cases?

IRVINE, Calif. — Regulators are backing off their aggressive pursuit of B share cases.
In the clearest indication yet that enforcers have changed their tune, the SEC late last month dropped a prominent B share case against former Prudential Securities Inc. broker Robert Ostrowski.
Since the original charges were filed in 2003, “there have been significant changes in both the law and related circumstances that make it advisable for the [charges] to be dismissed,” SEC officials said.
That is the SEC’s way of acknowledging that B shares are not always more expensive than A shares in amounts up to $250,000, lawyers said.
That was the conclusion from a similar case the SEC dismissed last year. “When circumstances change … it would be unfair to the defendant for us to proceed,” said Dan Hawke, district administrator of the SEC’s Philadelphia office, which filed the case against Mr. Ostrowski.
The SEC “had [the Ostrowski case] teed up as a pretty big case,” said Terry Lister, chief regulatory officer for Waddell & Reed Inc. of Overland Park, Kan. “So for them to drop it, it’s pretty amazing.”
The case never went to a hearing.
The dismissal may portend an end to a string of cases that in the past few years have given the industry much grief.
The SEC has nailed a number of firms for failing to tell clients that A shares are cheaper than B shares.
Citigroup Global Markets Inc. of New York paid $20 million in March 2005, and Morgan Stanley DW Inc. also of New York was hit for $50 million in November 2003. The cases involved other alleged mutual fund violations, as well.
Last year, NASD fined several major firms more than $40 million for improper sale of B and C shares.
Washington-based NASD was not yet able to comment on the Ostrowski dismissal, said spokesman Herb Perone.
Case goes wrong
But now, the SEC has acknowledged that a key legal argument it used is gone.
The SEC was “assuming just on the basis [of cost] that A shares were always better than B shares,” said Richard Kraut, an attorney in the Washington office of Dilworth Paxson LLP of Philadelphia, who represented Mr. Ostrowski.
“But you just can’t say that,” Mr. Kraut said.
Legal observers say the commission’s dismissal of the Ostrowski matter was in reaction to a setback that SEC enforcers suffered last year in a similar B share case, against IFG Network Securities Inc. of Atlanta, now part of ING Advisors Network Inc., also based in Atlanta. Three IFG brokers and the firm’s president also were charged in that case.
The full commission dismissed the charges against IFG and three of the individuals after an SEC administrative law judge had earlier ruled that A shares were not always cheaper at the $250,000 level, as enforcers had alleged.
In another case, NASD enforcers were rebuffed in March 2005 when a hearing panel dismissed charges against an unnamed broker who had invested $360,000 of a client’s assets in B shares, using six different fund companies for diversification and performance reasons.
NASD said that the broker should have put the client in A shares from one fund family.
But the panel rejected the notion that cost alone was the only factor to consider in making investment recommendations.
Brokers aren’t off the hook yet.
The vague language in the Ostrowski dismissal order isn’t enough “to claim a victory for the industry,” said David Bellaire, general counsel at the Financial Services Institute Inc. in Atlanta, which represents independent-contractor firms.
The SEC’s Mr. Hawke said that the dismissal does not mean enforcers are backing off. “In the right set of circumstances, we would look hard [to see] if there were federal securities law violations involving B shares,” he said.
The SEC may have to back off fraud charges in particular, lawyers said, but NASD can file cases based on unsuitability, which is easier to prove.
Plaintiff’s lawyers also can file B share cases for suitability as well as state law violations, said Steven Caruso, president of the Public Investors Arbitration Bar Association of Norman, Okla., and an attorney at Maddox Hargett & Caruso PC in New York.
Nevertheless, industry observers say that the bulk of B share and related cases may have run their course since the industry in the past few years has limited B share sales to $50,000.
Sales of B shares have fallen to about 3% of the market in 2006, down from 10% in 2001, according to Financial Research Corp. in Boston.
Issue ‘fading away’
Mr. Ostrowski, for one, is glad the B share issue may be fading away.
“Until something like this happens to you, you don’t realize what it’s like,” said Mr. Ostrowski, 70, who now is retired.
All his B share sales were in relatively low-cost bond funds and suitable for the clients, he said.
Mr. Ostrowski of Kingston, Pa., sued Prudential when it fired him in 2001 and refused to turn over $1.65 million in deferred compensation. In October 2005, a New York Stock Exchange arbitration panel ordered the firm to pay him the money, plus attorneys’ fees.
“It all turned out great,” Mr. Ostrowski said.
He was fortunate that he could afford to retire — and spend nearly $400,000 in legal fees to clear his name, he added.
In 2003, Prudential paid a $382,000 fine to settle SEC charges in the case. The firm admitted to no wrongdoing.