This article originally appeared in Bloomberg View on November 1st, 2012.

If regulators and brokerage firms are serious about restoring public confidence in the markets, they will have to do better than they did in the pathetic case of Mark C. Hotton.

Hotton is the 46-year-old former stockbroker who allegedly duped the producers of the Broadway musical “Rebecca” into believing he had lined up $4.5 million in financing. According to law enforcement officials, he even concocted a fictitious Australian guy, Paul Abrams, who would have been good for $2 million if only he hadn’t keeled over from malaria when it was time to write his check. While the clueless backers fell for his stories, Hotton pocketed finder’s fees. “Rebecca” has been “postponed indefinitely,” according to the show’s website.

It’s distressing, but it shouldn’t have come as much of a surprise from a man whose brokerage industry records since 1993 reveal a stolen-property charge, 16 customer disputes, a firing, a lien and a bankruptcy.

The real disgrace here isn’t Hotton, who is being held without bail after his arrest on two counts of fraud last month. The bigger scandal is trumped-up claims like this one:

“Ultimately, Hotton’s imagination was no match for the FBI, which uncovered, with lightning speed, his alleged financial misdeeds,” said Manhattan U.S. Attorney Preet Bharara in an Oct. 15 press release.

Lightning speed? Now that is what I would call a real whopper.

First Queries

I first began to contact Hotton’s lawyers a year ago this month when I saw that Hotton continued to work as a broker after filing for Chapter 7 bankruptcy, but they weren’t very talkative. Michael S. Finkelstein, a lawyer on Long Island, told me to call him back at 4 p.m. on Nov. 22, but didn’t answer that day, and never responded to voicemails. Similarly, voicemails and e-mails that I left with three other Hotton lawyers since Oct. 8 after the “Rebecca” flap erupted have gone unanswered. I couldn’t reach Hotton for comment.

Hotton has faced allegations of financial misdeeds as far back as 1990, yet moved on to work at six brokerage firms, including Ladenburg, Thalmann & Co. and Oppenheimer & Co. He was accused of fraud in multimillion-dollar lawsuits filed before anyone involved in “Rebecca” had ever heard of him. But there was nothing speedy about law enforcement’s response until the victims were attention-grabbing show-business types.

Hotton got a modest $60,000 from the producers of “Rebecca,” according to the U.S. attorney, and I suppose the crack investigators at the Federal Bureau of Investigation deserve credit for getting to the bottom of one of his punier swindles.

Anyone truly interested in watching out for the public might have started paying attention after Hotton bounced a check for $31,550 to Vilsmeier Auction Co. in Montgomeryville, Pennsylvania, on April 25, 1990. Hotton took possession of a 1985 Ford van and three other vehicles, thanks partly to a forged letter from a Westminster Bank officer assuring that his account had sufficient funds. Four months later, the real manager at the bank said in an affidavit that the letter was bogus and signed by a person who didn’t exist.

People who bounce checks and forge documents don’t belong in the securities business, but Hotton, who pleaded not guilty to two fraud counts last month, managed to get a broker’s license three years later anyway.

I asked Michelle Ong, a spokeswoman for the Financial Industry Regulatory Authority, how a broker like Hotton could stay in the business as long as he had. She said that before 2009, the complaints against Hotton had either been denied by his employers, or “settled for little money.” She says Finra began to investigate Hotton in 2009. That’s nice, I suppose, but three years later, Finra still has not announced any sanctions.

Finra Knew

Ong said that Finra knew Hotton had been convicted of criminal possession of stolen property, which apparently isn’t enough to convince regulators that a broker shouldn’t be in charge of other people’s money.

In the securities business, there is this brilliant idea that firms have a self-interest in tossing out bad guys. So I checked in with two firms that employed Hotton. I sent a list of 11 questions about Hotton’s criminal record and customer complaints to Paul Caminiti, a spokesman for Ladenburg, and all he had to say was that Hotton left the firm in 2005 to join Oppenheimer.

It gets worse.

On Oct. 15, the day Hotton was arrested, I called Noah Sorkin, a securities lawyer who worked at Oppenheimer when Hotton was there. Today, Sorkin is general counsel in New York at AIG Advisor Group, a network of independent brokers. “Lemme do this if it’s OK with you,” he said when I began to ask about Hotton. Sorkin said he would be happy to chat with me, but would first have to talk with lawyers at Oppenheimer. I’m still waiting for that call back.

An Oppenheimer spokesman, Brian Maddox, said this: “Investigations were conducted by both Oppenheimer and a securities regulator and no evidence of misconduct was uncovered. Any claims involving Mr. Hotton’s activities came to Oppenheimer’s attention after he left Oppenheimer.” He added that Oppenheimer employees who hired Hotton are no longer with the firm.

That probably would come as a surprise to Philip R. Schatz, a lawyer who filed an affirmation on June 25, 2010, in a multimillion-dollar lawsuit against Hotton while he was working at Oppenheimer, which wasn’t named as a defendant. Schatz said that, in previous lawsuits he had been involved with, Hotton’s actions at Oppenheimer and Ladenburg left him with serious reservations about the broker. In fact, he wrote that he had urged Sorkin in 2006 to investigate Hotton. “I told Mr. Sorkin that if I were in his position, as a matter of prudence, I would conduct a thorough review” of Hotton’s history, he wrote.

Yet for almost three more years, Hotton worked at Oppenheimer before moving to another firm. His story is but the latest example of the joke that securities regulation has become.

This article originally appeared in Bloomberg View on October 4th, 2012.

Financial pros have a long history of sneering at mom and pop investors as “the dumb money,” all the while cashing in on commissions each time a sucker sells at the bottom or buys at the top.

Now the U.S. Securities and Exchange Commission has made it official: The investing public doesn’t know what it is doing.

It took an act of Congress and 182 pages for the SEC in August to publish its “Study Regarding Financial Literacy Among Investors,” an exercise mandated by the Dodd-Frank Act of 2010. The study’s grim statistics showed that about half the investing public can’t read a stock trade confirmation and two-thirds can’t figure out how much their adviser would pocket on the sale of mutual-fund shares. After being shown documents for an account in which a customer’s broker used an outside custodial firm to hold the securities and issue the account statements, only a quarter could identify the custodian. There is more where that came from, but you get the idea.

Consider the profile of the 4,800 investors surveyed for the report, which concluded that they “lack basic financial literacy.” More than half had full-time jobs, 11 percent had part-time jobs, 70 percent had at least a two-year college degree and 63 percent had annual income of more than $50,000. We’re not talking about Mitt Romney’s indolent moochers here. The dumb money could be your neighbor. Or you.

Getting Taken

Of course, there’s ample evidence by now that you didn’t have to be Uncle Charlie in the nursing home to wind up parking your money with Bernard Madoff, or to sign up for designed-to-fail collateralized-debt obligations from Goldman Sachs. Smart money can be clueless, too.

For the moment though, let’s stick with investors who don’t work on Wall Street and don’t have an inkling that the worthwhile initial public offering is the one they will never be able to buy. So we have this new information about the public’s failure to understand finance. What do we do with it?

The report has been a jumping-off point for a lot of feel-good proposals that, sadly, are dead on arrival. The SEC says it got “many comment letters” advocating a “comprehensive financial literacy program in the United States that starts in elementary school.” Hey, a new education program sounds great. But try that one out on your strapped local school principal.

And maybe ask those principals how just plain old, non-financial literacy is working out. On Sept. 24, the College Board said reading scores on the SAT were the lowest in four decades. How do you teach people to read prospectuses when they have trouble reading at all?

The weird thing about the SEC’s comprehensive look at the failings of U.S. investors is that the effort comes even as a new law is about to unleash a flood of fresh hazards on the public. On April 5, President Barack Obama signed the Jumpstart Our Business Startups Act, a stunning piece of deregulation that will relax disclosure rules for some public companies and allow Internet stock offerings through what is known as crowd-funding.

So even as we learn that investors need more education about basics, we set them up as prey for a whole new genre of rip-offs.

There are some solutions here, and the quickest fixes are the ones that make investors smarter about fraud, not about computation of mutual fund fees:

Brokerages should be required to give customers a copy of an adviser’s regulatory record before they can open an account. Along with that, firms should reveal the number of times a broker has had a case expunged from his or her record (I’d look for a new broker if that number was more than one) and send a recap of every bankruptcy filing, every sanction by a professional organization and every lawsuit filed against the broker in state or federal court.

Head Scratching

I was heartened to see that 37 percent of the investors in the SEC study said they actually checked a broker’s records, but it was a head-scratcher that 21 percent didn’t consider “allegations or findings of serious misconduct” to be important. Get these facts under customers’ noses and make it hard for them to avoid considering them.

Firms also should explain in writing the terms of the relationship to new customers. I don’t mean boilerplate disclosures about the odious policy of mandatory arbitration that lets firms avoid court. There should be a statement in plain English saying what the firm promises. “Dear Mrs. Smith: We may say in our glossy ads that you are a valued customer, but we don’t have to put your interest before ours, and if you want to sue us, you will have to prove that we sold you something that wasn’t suitable, which is a lot harder than proving we weren’t working in your best interest.” OK, so the wording could be more delicate, but either way investors should get the broker’s commitment in writing.

Lazy investors (like the one who told the SEC, “If you can’t put it on a 4 x 5 card, I don’t want to deal with it”) should at least take smart shortcuts: First, go through the indecipherable documents your broker sent you and read the footnotes, which will at the very least arm you with material for your next cocktail party. After that, look for these words or terms: “certain proceedings,” “conflict of interest,” “fraud,” “Wells notice,” “litigation,” “Securities and Exchange Commission,” “cease and desist” and “not FDIC.” You will find all of them in the sections the smart money hopes you never read.

This article originally appeared in Bloomberg View on September 6th, 2012.

If there’s one thing we learned from Bernie Madoff, Allen Stanford and the countless perpetrators of the financial crisis, it’s that nobody’s word is worth trusting.

The parade of Ponzi guys and unindicted bankers of recent years has inspired a new enthusiasm for sleuthing by the public. There’s even a cottage industry of vetters willing to size up a broker if you aren’t inclined to do the work yourself.

The catch is, for all the new willingness of investors to ask questions before they hand over control of their nest eggs, what you discover in regulatory records may tell less than the whole story. As for the commercial websites that purport to know which advisers are good or bad, let’s put it this way: Most are free to investors, and there’s that issue of getting what you paid for.

Some investors go the do-it-yourself route and access BrokerCheck, a database operated by the Financial Industry Regulatory Authority, known as Finra, a self-regulatory organization financed by Wall Street. Others check websites with names like financialjoe.com and investorwatchdog.com that offer reviews of brokers and their firms.

Investorwatchdog.com, introduced in May, says its users “avoid costly mistakes, identify problems sooner and select advisors with the best qualifications.” Financialjoe.com says it “takes on Wall Street by empowering investors and allowing them to rate and monitor their financial advisors.”

Freebie Sleuths

Rely on the freebie sleuths at your own risk. If it were my money, I would be gathering facts from court and regulatory records, including Finra’s database. I will get back to those problematic broker-vetting websites in a bit. But it’s worth explaining that even BrokerCheck has shortcomings.

Finra does require disclosure of some red flags about a broker’s finances — liens and bankruptcies, for example.

It doesn’t, however, demand that brokers disclose if they were sued in a matter that isn’t investment-related. Thus, although 253 former brokers from the bankrupt Stanford Financial Group Co. — yes, that Stanford — have been sued by a court-appointed receiver, they have no obligation to report that to Finra.

Ralph Janvey, the receiver in the 2009 fraud case brought by the Securities and Exchange Commission, is trying to recoup money those brokers made while they peddled Stanford’s securities. If you were thinking about hiring one of the former Stanford guys, you might like to know if they are on Janvey’s list: The broker on the receiving end of a big court judgment might have a lot of motivation to raid your account.

Robert Cornish, a Washington attorney who represents four Stanford victims, analyzed records of all 253 brokers and discovered that only 18 disclosed the lawsuit, which seeks to collect about $177 million from the group Cornish checked.

So BrokerCheck paints only a partial picture of a broker’s record. But it offers more than some of the vetting Web pages.

Consider investorwatchdog.com, run by former broker Jack Waymire in Lincoln, California. I was curious that investorwatchdog says it could help investors pick financial advisers “with the best qualifications” while cautioning in the fine print that it doesn’t review compliance records. So I queried Waymire by e-mail. He responded that the terms of service I had read the previous day had “out-of-date information.” Sure enough, after getting his response, I saw that investorwatchdog’s terms of service were changed from the printout I had made of its disclosures.

Waymire says advisers — who pay to be featured — have to get a score of 90 or better on his proprietary algorithm before they can be featured, though he sometimes makes exceptions for advisers who he says have been subject to “frivolous” complaints. It is worth noting that he is willing to lose business from risky advisers: He says he kicked a guy off his site on Aug. 30 for having huge tax liens.

Background Checks

I noticed that the site featured a California broker whose record included a fine by a state insurance department, a customer complaint and a termination. Waymire responded that the adviser had acknowledged his mistake and reimbursed an investor in one instance 30 years ago, and hadn’t hurt investors in the two others. Personally, I would pass on someone like that.

BrightScope Advisor Pages, which says it helps consumers “conduct due diligence,” also gets revenue from financial advisers who pay to be highlighted. When I asked Mike Alfred, the firm’s chief executive officer, about a featured broker who had a criminal record, he said in an e-mail that BrightScope was in the business of making information easier to find and use, but that “We are not in the verification business.”

The operators of these sites themselves have blots on their records, ranging from a failure to meet a state’s net capital rules at a brokerage firm a quarter-century ago (Waymire); to two customer settlements, one for $35,000 and one that was confidential, for Shawn Tierney, founder of financialjoe.com.

Waymire said his firm ultimately met Florida’s requirements. Tierney said he was no longer handling the account in question when one of the complaints was filed, and that an investigation in the other determined he had done nothing wrong.

Then there is the million-dollar claim against Alfred, his brother Ryan, the president of BrightScope, and Axa Advisors LLC, one of their former employers. In a BrightScope blog posting on May 16, 2011, Ryan Alfred said “we were not required to pay any of the settlement.” Finra records for each Alfred, though, describe an “individual contribution amount” of $30,000 to the $135,000 agreement.

It took a world-rocking financial crisis to get the public to be more serious about checking the claims of brokers. Four years after the crisis began, there still is no substitute for using BrokerCheck or state regulatory records; Finra’s arbitration database; lawsuits and liens on pacer.gov; and LexisNexis’s SmartLinx for state courthouse actions. If that sounds like too much work and too much financial outlay — pacer and Lexis aren’t free — go ahead and peruse the new sleuthing sites. But don’t kid yourself about who their customers are.

This article originally appeared in Bloomberg View on August 2nd, 2012.

Let’s imagine the customers of a financial firm get word that more than a billion dollars of their money is missing. Then, less than a year later, customers of another firm learn that $200 million of their money is gone, too.

If such a sequence of events occurred, it’s likely that leaders from the industry would be called to appear before a government committee. And they would probably say something like:

Sorry, folks. But don’t try to slap us with expensive new rules.

Welcome to the era of financial regulation, cost-benefit style — emphasis on the costs, not the benefits.

Although it seems to have escaped the memories of the people in charge on Wall Street, the economy just about collapsed in 2008, and a lot of bad things followed. Credit froze, financial firms went under, and millions of people were thrown out of work as business owners lost their financing and their confidence.

Then, last October, that billion-dollars-gone-missing scenario came to pass. The commodities firm MF Global Holdings Ltd. declared bankruptcy after customer money got transferred to a corporate account and then disappeared. Last month, customers of an Iowa futures trading firm, Peregrine Financial Group Inc., found out they had lost $200 million after the firm’s chief executive officer said in a suicide note that he had been running a Ponzi scheme for 20 years.

Government Obligations

Which brings us to the obligatory government hearing.

Last month, the House Committee on Agriculture explored what it cryptically referred to as “Recent Events (that would be the lost customer money) and Impending Regulatory Reforms (which better not be too expensive).” Among those testifying were two futures industry leaders: Terrence A. Duffy, president of CME Group Inc., the world’s largest futures market, and Walter L. Lukken, CEO of the Futures Industry Association, a Washington-based trade group.

The two men made the requisite noises about ramping up the industry’s vigilance against fraud. Then both took the opportunity to get it on the record that there’s a more important agenda.

Duffy: “I would hate to see us get over-regulated to a point or have rules put upon us that put us in a very — a place that is very anti-competitive.” At a Senate hearing yesterday, he said he wasn’t opposed to an insurance fund for fraud victims “if people want to pay for it.”

Lukken: “It would be wise to carefully weigh the costs of any new regulatory mandates.” Some of the rules being proposed by the Commodity Futures Trading Commission could lead to market disruption, the exit of futures brokers from the business, and – – as if it were the customer we really cared about here — the limiting of customer choice, Lukken said.

There was a glimmer of hope after passage of the Dodd-Frank Act two years ago that lawmakers had put some measures in place to avert another financial disaster. To get the reforms up and running, though, government agencies first had to write rules that would execute the law’s objectives.

The financial industry has used many tactics to derail this process, but its standout victory was a 2010 lawsuit by the Business Roundtable and the U.S. Chamber of Commerce against the Securities and Exchange Commission, which had proposed a rule to make it easier for investors to oust corporate directors. The U.S. Court of Appeals in Washington said last July that the SEC hadn’t properly assessed the rule’s costs and benefits. It was “an aggressive stretch of the law” in the view of John Coffee, a securities law professor at Columbia University.

Getting Stuck

A stretch or not, it is what the SEC is stuck with for the moment, and it’s become “the cornerstone of the attack of regulatory reform in the courts,” according to an 82-page report released three days ago by the investor advocacy group Better Markets. Dodd-Frank was passed “to stop Wall Street from crashing the world again,” Dennis Kelleher, the group’s president, said in a telephone interview. “Now they’re saying they can’t do it if it costs them too much money.”

To get an idea of who has the upper hand in this fight, consider what it entails to be the chump who has to explain the “benefits” side of financial regulation. Costs can be easy to figure out. Say there’s a regulation that requires new compliance officers. Tally up the salaries. If there’s an assortment of new software you need to comply with Dodd-Frank’s reporting requirements, you call the computer vendors and get the numbers.

But how do you measure benefits, like the frauds that never happen because stricter rules are in place? Is there a dollar figure we can put on credit markets that don’t collapse? Or the elderly who don’t lose their life savings because regulators have cracked down on rip-off artists who troll retirement villages?

Those are important questions, but they aren’t the ones being asked at Washington hearings that have titles like “The SEC’s Aversion to Cost-Benefit Analysis,” which took place April 17 before the House Committee on Oversight and Government Reform.

One witness that day from the Cambridge, Massachusetts-based research group Committee on Capital Markets Regulation had this suggestion for financial regulators looking to get the cost-benefit equation right: If a regulator isn’t able to develop data for its cost-benefit analysis internally, it should get the numbers from third parties such as trade organizations. If that doesn’t work, the agency should try to get the information directly from the firms that will be affected by the regulations. (Whom I’m sure will be anxious to help the SEC get a new rule in place.) Inconveniencing financial firms with such requests, though, could be burdensome for the firms, the witness said, so overseers should make data requests “with an eye to minimizing the imposition on and disruption to” the firms they regulate.

See? Easy!

The object of this exercise, of course, is to swamp regulators with so much cost-benefit work that rule-making will be impossible.

To keep the SEC busy, one proponent of cost-benefit analysis showed up at that House Oversight hearing in April with a nifty checklist for the SEC. J.W. Verret, an assistant professor at George Mason University’s law school, said in his testimony that when the SEC proposes a rule, it should estimate the impact on job creation. And gross domestic product. And whether U.S. stock exchanges will lose listings to overseas rivals. While we’re at it, let’s just have the SEC “retract and re-propose” the Dodd-Frank rules the agency has completed, and start all over again with a new cost analysis, he said.

By the time the SEC is done with that, it should be time for a flash crash, a couple of London whale copycats, maybe another MF Global or two. Then we can start the whole re-regulation argument all over again, if there’s anything left to argue about.