Securities Probe Focuses on Clearing Agent Role; Could These Low-Profile Middlemen Help Police Trading Abuses by Their Customers?

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Securities Probe Focuses on Clearing Agent Role

Could These Low-Profile Middlemen Help Police Trading Abuses by Their Customers?

Federal regulators, as part of their larger inquiry into the recent wave of securities dealer failures, say they are focusing on the role of clearing agents in the U.S. government securities market.

A key question under study is whether those agents could help prevent fraudulent transactions, including misuse of collateral, by maintaining an independent record of the dealers' transactions with customers.

The inquiry has turned a spotlight on the otherwise low-profile middlemen in securities trading--the agents that hold and transfer securities on behalf of dealers. The unusual attention has sullied the reputations of two premier banking organizations. Security Pacific Corp. and Fidata Corp., whose subsidiaries served as clearing agents for the two largest government securities dealers to collapse.

Without accusing the clearing agents of any wrongdoing, Chairman John S.R. Shad of the Securities and Exchange Commission told Congress this week that one focus of his agency's inquiry is on the activities of Fidata's clearing unit.

Some officials investigating the recent failures of the E.S.M. Government Securities Corp. and Bevill, Bresler & Schulman Asset Management Corp. say the clearing agents must have been aware of the dealers' fraudulent activities.

In both cases, "it is hard to believe that the pattern of such activities was not known or could not have been discovered by the clearing agent,' Saul S. Cohen, the New York attorney acting as Bevill's bankruptcy law trustee, said in congressional testimony earlier this week.

Mr. Cohen said he felt the failure of the clearing agents to blow the whistle on the fraud was comparable to a similar failure on the part of the dealers' independent auditors.

But officials for the clearing agents, Security Pacific Clearing & Services Corp. and Fidata's Bradford Trust Co., say that Mr. Cohen and other critics do not understand their role. As clearing agents, the firms say, they have no knowledge of transactions between dealers and their customers.

The market's lack of understanding of the clearing agent business, in fact, is also reflected in a number of the complaints voiced by victims of the fraud, the clearing agents say.

In a business that is based on transaction fees, generally ranging from $5 to $30 per transaction, a typical clearing agent may process as many as 15,000 trades a day, Security Pacific officials said. Most clearing agents also are subsidiaries of national banks, giving them access to the Federal Reserve's wire transfer network--on which almost all U.S. Treasury securities are traded.

Security Pacific is a relative newcomer to the government securities clearing business. Larger forces in the business include subsidiaries of Morgan Guaranty Trust Co., Manufacturers Hanover Trust Co., Irving Trust Co., Bankers Trust Co., Bank of New York, and Chemical Bank.

Pivotal, Two-Part Role

Clearing agents perform two key functions that facilitate the massive trading volume and feverish pace of the U.S. government securities market. In both capacities, they act only on the instructions of their client brokers or dealers.

In one role, the clearing agent uses a safekeeping, or segregated, account to store securities that were fully paid for by a dealer's customer. The clearing agent also transfers securities in and out of the dealer's active clearing account, which is used for trading purposes.

The need for swift settlement of government securities trades has also thrust the clearing agent into the role of a lender--financing securities purchases for their client dealers.

Because the clearing agent plays such a pivotal role in the market, it is often viewed by investors as the villain in the failure of a government securities firm. …