Broker faces last SFA call

BURKHARD BRAUCH, the broker at the heart of a derivatives scandal at Morgan Stanley, will be judged in absentia by the Securities & Futures Authority if he fails to turn up for a tribunal hearing this month. He risks being banned from operating in the London markets if the regulator finds against him.

Mr Brauch faces disciplinary charges under the the provisions of the Financial Services Act over private client investment losses at Morgan Stanley, the US securities house, in 1992.

Morgan Stanley is suing him for pounds 20m, and he is counter-claiming for unfair dismissal and damages.

The SFA's judgement on Mr Brauch will bring to an end a saga that led to huge losses for five private clients of Morgan Stanley and to the highest fine ever imposed by the SFA. Last week Morgan Stanley agreed to pay pounds 240,000 in fines and admitted that internal controls in its private client division had been too lax. It has also reimbursed the five clients for their $30m (pounds 17m) losses.

The SFA imposed the fine after an inquiry lasting more than two years, which reached substantially the same conclusions as an earlier internal inquiry carried out by Morgan Stanley.

The story began when the five clients placed money under the control of Mr Brauch in the private client division. The clients included Robert Louis-Dreyfus, former chief executive of Saatchi & Saatchi and now chairman of Adidas, and Peter Ackerman, a director of a London consulting firm called Universal Consult.

Mr Brauch proceeded to invest the money in currency futures, particularly the lira. Moreover, he leveraged the investments in some cases by twice the amount allowed by his employers. The clients subsequently said they had not authorised such a speculative and risky investment strategy.

The strategy went wrong, and losses rapidly mounted into the millions. Months after investing $818,000, for example, Mr Ackerman was told by Morgan Stanley that he faced losses of $3.6m. Equally startling was the revelation that Mr Brauch had been "churning" the account - buying and selling investments with the sole aim of generating extra commission. His incentive for doing this was that he was paid partly according to the amount of commission he produced.

Morgan Stanley says it did not at first notice what was happening, because all the clients' money had been lumped into a single "omnibus account" that disguised individual dealings. The management relied on what Mr Brauch said about the performance of each client's investments, but had no way of checking whether he was telling the truth. In fact, the bank claims, Mr Brauch misled it. Nor did the bank know that he had failed to send proper notification of his dealings to the clients themselves.

The truth only came to light in the autumn of 1992 during a routine check within the bank. "The minute we knew exactly what was happening, we stopped it immediately. Brauch was suspended and then fired," said Amelia Fawcet, operations manager at Morgan Stanley. By then, however, the client losses had mounted to $30m.

Morgan Stanley agreed to reimburse four investors immediately, although Mr Ackerman decided not to settle until the SFA had completed its investigation. Morgan Stanley has also replaced the omnibus account system with individual accounts.

However, the bank continues to reward its brokers with a percentage of the commission income they generate on private client deals. It also refuses to comment on the fact that many of Mr Brauch's forward currency deals were carried out with Morgan Stanley itself, a practice which could give rise to conflicts of interest. The bank has not changed its rules on this, but Ms Fawcet denied it ever takes advantage of clients when it deals with them. "You cannot front-run your clients. Integrity is a fundamental value for us."

One of the more worrying features of the story, however, is how long it has taken the SFA to bring the case to a conclusion. It was called in by Morgan Stanley in 1992 and given the conclusions of the bank's own investigation. Nearly two and a half years later, the regulator has reached almost identical conclusions, yet has still not taken action against Mr Brauch.

"The case against the bank was settled some time ago," said David Jones, an SFA spokesman. "But we were not going to publish it until we had settled the matter with Brauch. Brauch, however, has not accepted our charges against him, so a tribunal is necessary." In the meantime, Mr Brauch is believed to have been operating in financial markets on the Continent.