A mallet stands out among the clutter on a desktop in Mesirow Financial's offices in Chicago. Is this for Thomas Avgeris, a big man never afraid of strangers in the Windy City?

No, Avgeris needs the mallet to hammer home one of the attributes some say has made Mesirow an important name in the scrappy business of correspondent clearing: good quality control.

That's right, quality control. And it was scrawled in big letters across the mallet crashing down on the desk.

Quality control, repeated Avgeris, a managing director at Mesirow's North Clark Street offices in the Windy City. "When in doubt, bring it out," he said, giving the desk another rap. "Quality control."

Soon the laughter was actually rattling the room. But this was no laughing matter. Mesirow, which has 125 corespondents, likes to rank quality control among the top reasons an introducing broker, or a smaller broker dealer, selects Mesirow to execute, clear and settle its equity transactions.

"We are an extension of the introduction broker, as it were," Avgeris said.

Symbolic Reminder

The mallet, of course, is much more than a symbolic reminder of how important quality of service is at Mesirow. The mallet is a good way to begin any article in 1998 about the correspondent-clearing business.

After all, the industry is now awaiting Securities and Exchange Commission approval on new clearing rules that could utterly change the relationship among clearing firms, their correspondents, the correspondents' customers the ultimate customer, actually as well as the regulators.

The objective is to enhance existing levels of quality control in a business that has not always demonstrated a sterling reputation.

The rules were submitted to the SEC in response to several highly-publicized cases of alleged investor fraud by broker dealers that use other broker dealers or correspondent-clearing firms to clear and settle their business.

In particular, regulators stepped up their demands for stricter clearing rules in the wake of the collapse of New York-based A.R. Baron & Co. Last year, a state grand jury indicted A.R. Baron and 13 former employees on charges of bilking investors of more than $70 million. The firm filed for bankruptcy in 1996.

Bear Stearns & Co., which processed A.R. Baron's business and wins high praise from many of its correspondents for running a good ship was questioned by the SEC, and separately, by the Manhattan district attorney's office about its role in the collapse of A.R. Baron.

At issue was the role of Bear Stearns, passive or otherwise, in the alleged wrongdoings of a correspondent.

Bear Stearns defended its role in the A.R. Baron debacle, pointing out, for instance, that it represented only a small fraction of its total clearing business. (Bear Stearns processes an estimated 12 percent of the volume on the New York Stock Exchange cleared through the National Securities Clearing Corp.)

Moreover, Bear Stearns stressed that customers make it clear in customer agreements they are aware that the firm acts as the backoffice provider that gives them investment advice.

Regulators, however, are not convinced that current clearing-firm rules are adequate. The National Association of Securities Dealers, in its proposed rule filing with the SEC, said that "concerns about questionable sales practices and potentially fraudulent activity by certain introducing firms, and the handling of customer complaints about those firms by their clearing firms, caused the staffs of NASD Regulation and the NYSE to examine the relationship between clearing firms and their client-introducing firms.

"The examination resulted in proposals to amend the NASD's and the NYSE's rules relating to the content and approval of clearing agreements to specify requirements for handling customer complaints."

Utmost Importance

The new rules that finally emerge from the SEC could be of the utmost importance to equity traders, particularly Nasdaq market makers. That's because the new rules, as proposed, would require clearing firms to file complaints against an introducing broker to self-regulatory organizations and to the correspondents themselves.

That, of course, may ultimately ensure a greater degree of investor protection than ever before, but could unfairly impugn some trading desks, compliance experts fret.

"Some customers could abuse this provision recklessly," one compliance expert said. "Suppose they had an unwarranted gripe, maybe it was something personal, they could make life miserable for the desk writing a complaint to the desk's clearing broker."

Another hot issue is whether the SEC will require clearing firms to inform a correspondent's customer, on receipt of a complaint from the customer, that the customer retains the right to transfer his account to another broker dealer.

Some top correspondent clearing-firm executives are worried. "It is scary what they are talking about," said an executive at a Jersey City-based clearing broker. "Will the rules also require us to furnish compliance data on the correspondent directly to the SEC? That would upset a lot of people."

Another executive, Frank Colella, director of marketing at New York-based BHF Securities, said an introducing broker may be required to send more compliance data directly to the clearing broker, or else risk having the firm not process the correspondent's business. BHF, which clears for 40 correspondents, typically institutional agency brokers, did not outline its own plans.

Avgeris has another view, pointing out that Mesirow, like other clearing brokers, now passes along complaints to the appropriate regulatory authorities. However, he draws a line separating the clearing broker from ultimate responsibility for policing the correspondents.

"That's up to the regulators and the correspondents' compliance officers," he said.

More Selective

One inescapable fact is that clearing firms have become more selective about their roster of correspondents. With small-cap fraud making headlines, more clearing firms are distancing themselves from firms specializing in the business be it market making or retail distribution.

That, unfortunately, hurts the majority of businesses in the small-cap area that run legitimate operations. And that's the unavoidable price for investor protection, compliance experts say.

There are other regulatory issues equally as breathtaking as the clearing-firm rules. For one thing, many clearing firms may have to step in and assist small to medium-sized Nasdaq trading desks to comply with the parameters of the NASD's pending Order Audit Trail System, or OATS.

Many of these desks do not have the systems capability or the budget to pull off the requirements for OATS compliance (mandated by regulators in the wake of the SEC's settlement with Nasdaq about two years ago). The system, as envisaged, would capture up to 25 trade details from the point of order entry to execution.

Another issue is Year-2000 compliance. But the man with the mallet had a word of comfort for his introducing brokers. "It's our job to worry about the Year 2000," Averis said. "All of our systems, including order routing, record keeping and clearing, have to be ready. That'll take some of the pressure off the introducing brokers."

ABN AMRO Chicago Corp. is stepping up its grab for more introducing brokers, hoping to join the major-league players in the correspondent-clearing business.

"There is nothing to say that we won't go out and acquire another clearing firm," said Joseph Oliva, a senior official who heads up marketing at the Chicago-based clearing unit of ABN AMRO.

Oliva's feisty talk is spurred, in part, by the transformation of the former Chicago Corp. from a regional investment bank into a global powerhouse.

Oliva, a veteran of the Chicago Corp.'s clearing business, now heads up a reenergized clearing unit on the wing of ABN AMRO Holding NV., the Dutch-based investment bank that dipped into its deep pockets to acquire the Chicago-based Chicago Corp. in September 1995.

With $50 million in capital (and the clout of the parent's much larger capital cushion), 50 fully-disclosed clearing correspondents, an even larger number of execution and omnibus accounts and up to 400 staffers dedicated to clearing, Oliva is not shy talking business.

"We want to be considered one of major clearings firms, like Bear Stearns & Co. and Pershing [Division of Donaldson, Lufkin & Jenrette], and we want to be in their arena," he said.

"In the past," Oliva added, "we were selective. Now, with up to $50 million in capital, we can go after firms that are major clearing candidates. We can consider firms with $50 million, $100 million or $200 million in margin debits."

Oliva stressed, however, that ABN AMRO is not prepared to do a reckless highwire act. "We have the same capital requirements as the major clearing brokers. We won't talk to any firm that does not bring certain levels of revenue to us and has less than $100,000 in net capital."

"Day trading is interesting but we'll only do it selectively," Oliva added. "We'll look suspiciously on firms doing a lot of penny-stock deals. What we want is well-rounded organizations not weighted 100 percent or 70 percent in any one area."

One good sign of the times, he said, is the inquiries his clearing business is now receiving. "We're getting calls from major firms that like what we do. They know we don't chase tickets, though tickets are nice, of course. They know we want quality business."

Every investigation by the National Association of Securities Dealers carries the risk of fines and sanctions. A single sanctionable event can cost a dealer $20,000.

A penalty depends largely on how well the dealer responds to accusations. However, traders too often adopt the attitude that they have done no wrong, and choose to leave the trading practices in place.

Written responses are defensive and simplistic, leaving the NASD with little choice but to impose a significant fine or sanction against the firm. Second offenses carry even larger fines and sanctions.

Compliance Consultants

Compliance consultants can reverse the risk of regulatory fines and sanctions. Some trading desks turn to these consultants, my firm included, for help.

First, we represent and protect market makers in their dealings with NASD Regulation. Second, we learn about their business, help to remedy their deficiencies and make them more aware of compliance. Third, we fill the information void with answers to everyday questions.

We encourage traders to accept that deficiencies do exist and should be corrected. We bridge the communications gap between NASD expectations and trading realities, with carefully-prepared responses to NASD accusations of apparent rule violations and trading deficiencies that are both fair and effective.

Our responses put flesh and blood on the NASD Regulation staff's cold facts and statistics, introduce mitigating circumstances and account for supervisory procedures that firms may not have realized they were doing.

The NASD welcomes such an approach, and their initial reactions have been quite positive.

Scheduled Reviews

Whether or not your firm is the target of an NASD Regulation investigation, regularly scheduled reviews of compliance practices for trading and trade processing should be conducted. What worked in the past may no longer be sufficient. Compliance consultants can plan a tailored, comprehensive analysis that will reveal what supervisory and operational compliance procedures you are doing right, doing wrong and should be doing but are not.

As deficiencies are discovered, corrective action should be taken. Head traders should promote compliance awareness on the trading desk so that problems are resolved as they occur. Handling everyday compliance issues may not only save you money, it should promote a better working relationship between your traders and the regulators.

Compliance consultants can also help with everyday compliance issues. Even with new and improved compliance practices in place, traders will have problems staying on top of the issues and developments. Many are overwhelmed by the steady stream of correspondence from Nasdaq and the NASD, and they are struggling to comply with the rules. Compliance consultants can sort through the pronouncements and help fill the gaps left open by trader uncertainties.

Howard L. Haykin, CPA, is president of Compliance Solutions, a New York-based specialist in regulatory compliance for broker dealers and investment advisers.

Like the common cold, compliance problems are easy to contract but difficult to get rid of. Perhaps the following checklists for broker dealers and the NASD may be just the right medicine.

Broker-Dealer Checklist

1.) Plan ahead. A strong offense is always the best defense.

2.) Learn the rules, and get a grip on best execution. Familiarize yourself with trading rules and National Association of Securities Dealers interpretations.

3.) Beef up your compliance practice. Hire a full-time compliance officer or supplement your existing staff with the services of an independent compliance consultant. Perform mock examinations. Prepare checklists for daily and periodic supervisory reviews of trading activity.

4.) Update your Written Supervisory Procedures Manual, remembering to answer these four questions for each trading issue: who, what, when and how.

5.) Approach each NASD Regulation examination, review or inquiry as an opportunity to correct what you're doing wrong, or not doing but should be doing. By correcting known deficiencies, intentional or not, you will reduce the number of sanctionable events and eliminate unnecessary disruptions to your business.

6.) Relate more closely with the NASD Regulation staff. Create a dialogue and see where they are coming from. When dealing with staff members who have limited trading experience, add some flesh and blood to the cold facts and statistics they are compiling from transaction reports and trade documentation.

Finally, respond immediately to NASD Regulation findings. It is in your best interest to correct any problems and thereby minimize the impact of trailing fines or sanctions.

7.) Respond to customer limit orders within 30 seconds, and don't forget about your Manning obligations on customer limit orders that are routed to other broker dealers.

8.) Develop compliance awareness. Your traders should establish informal trader networks to learn what's hot and how others are handling the rules.

9.) Inform other firms about who at your firm is responsible for handling and resolving trade disputes. This may reduce the likelihood of backing-away charges.

10.) Understand the value of the Continuing Education Program and the Annual Compliance Program. Develop comprehensive written plans that result in programs tailored for your traders. Go through the compliance history of your firm, identify soft spots and ask your traders about their unanswered compliance questions. Keep a file of all training materials, including handouts. Most importantly, conduct training programs more than once a year.

NASD Checklist

1.) Provide more timely guidance to market makers. Why has the NASD never released its sample Written Supervisory Procedures Manual, which was substantially completed by the summer of 1996? In the same vein, why did it take the NASD nine months to release its first interpretation of traders' best-execution obligations (Notice to Member 97-57)?

2.) Control the pace of self-regulatory surveillance over trading desks. In 1997, many market makers were receiving weekly correspondence from NASD Market Regulation on concurrent examinations, reviews and inquiries. Some of these inquiries involved single trades dating back to early 1996.

3.) Dispel the perception that the record fines and sanctions against market makers were intended solely to finance the association's operating budget. If perception is reality, the NASD might follow the lead of the Internal Revenue Service, which recently issued a detailed confession that its management had become overly obsessed with boosting tax-collection efficiency in recent years at the expense of treating taxpayers properly.

4.) Limit your "zero-tolerance" standards to the discovery of trading violations and deficiencies; apply market conditions, traders' intentions and patterns of deficient trading practices before deciding on disciplinary sanctions. Fines and sanctions for isolated or unintentional rule violations simply do not match their crimes.

5.) Drop the double standard. When Nasdaq and ACT, Nasdaq's Automated Confirmation Transaction trade-reporting system, went down on Oct. 27, 1997, volume overload was an acceptable excuse. Why then should market makers, who are human, be held to a higher standard for occasionally reporting trades late or handling customer limit orders in a less than timely fashion, particularly when operating under similar circumstances?

6.) Help level off the playing field between market makers and institutions in the Nasdaq market. While these participants compete in the same market, institutions have the advantage of operating without self-regulatory oversight and are able to use SelectNet to broadcast anonymous orders. It is unlikely that the Securities Exchange Commission would agree to major changes, but clearly some form of compromise is needed.

7.) Work with Nasdaq traders to correct onerous fees imposed on transactions. It has been estimated that since January 1997, Section 31(a) fees have generated more than $150 million, all of which has been earmarked to fund the SEC's budget. Nice work if you can get it.

8.) Visit broker dealers more often, and reduce the scope of routine and other examinations. This will lead to more interaction with members and help provide better accomodation for traders' schedules.

On Monday morning, Beverly York was tired. She had spent the weekend trying to keep up with her spirited two-year-old granddaughter. While most of Seattle slept early that March Monday, she awoke in the dark at 4 a.m. and then walked her two dogs before the 20-mile drive to work.

"These early hours still bother me," York sighed. "I've tried for 30 years, and I'm still not used to getting up so early." But with heavy volume York can't afford to be sleepy-eyed.

York is the head equity trader at Safeco Asset Management Company in Seattle, a subsidiary of Safeco Corporation. Her three-person desk arrives by 6 a.m. each day, ready for the stock market openings a half hour later.

Since the year began, her desk York, a second trader and an assistant has clocked orders with 89 broker dealers. The desk averages 50 trades each day, and may log up to 90 trades during busy sessions. "This desk has gradually gotten busier, and the firm has grown rapidly because people are still investing in mutual funds," she said.

York takes advantage of many technological tools. Her desk uses Instinet for small orders, AutEx for trade reporting and indications of interest and a Bloomberg terminal for information and quotes.

York is also interested in the heavily-marketed OptiMark trading system. "I'm waiting to see what it's all about. I'm optimistically cautious about OptiMark," York said.

"A lot of new systems stir interest in the beginning, but they're really like new offerings," she added. "They all start out with a lot of excitement, but only a few stick around."

York trades for six portfolio managers handling the ten Safeco Asset Management mutual funds. Two recently topped $1 billion in assets each. The equity desk also trades for the firm's managed accounts.

Safeco Corporation is one of the largest diversified financial corporations in the U.S., with 1997 assets exceeding $29 billion. Based in Seattle, the company's 7,500 employees work in a variety of product areas, including property and casualty insurance, life and health insurance, surety, real-estate investment, commercial credit and asset management.

Safeco Asset Management, established in 1967, is the investment adviser for Safeco's mutual funds, and manages investment portfolios for Safeco Life Insurance Company's variable annuity products and pension accounts for other businesses. Safeco Asset Management has $28 billion in assets under management, $5 billion in equities.

York was hired at Safeco in 1968, after she moved to Seattle with her husband they have since divorced and young son from rustic Oroville. In Oroville, her quiet Washington hometown, she had a much different job working at an apple orchard, packing apples for shipping.

At Safeco, work at first was quite ordinary compared to packing apples. "When I arrived in Seattle, Safeco was just a job," York said. "It certainly wasn't like apple packing."

At Safeco, York first worked in the investment department, learning the business and working wherever she was needed. "I was lucky. I had a lot of fun as I learned the business," York said. "It really got my interest once I started."

In 1985, she was asked to rechannel her enthusiasm and succeed the retiring equity trader. "It was a lot quieter then," York said. "I was able to learn trading while I worked."

Now 13 years later, she is still challenged by her work. She enjoys the different trading needs of each mutual fund, working to find the best place for each trade.

"You talk to such interesting people each day portfolio managers, broker dealers, other traders," York said. "You find different types of people in each fund area you trade in."

When her trading day ends at 1 p.m., she makes the short drive to her home in the Woodenville area outside Seattle, well-before the rush of late-day traffic. She plays with her dogs, works in her yard and takes long walks around nearby Green Lake before the sun sets in the Pacific Northwest.

York plans to retire in 2008, after 40 years of service at Safeco Asset Management. When she started fresh from the packing shed in Oroville, she laughed at the thought of a career in finance. "In 1968, when they told me about retirement plans for 2008, I rolled on the floor," she said. "Now, retiring here is going to be my choice. It makes sense."

When she retires, she'll have more time to enjoy the outdoors with her dogs and her granddaughter. And being a little older too, their youthful energy won't seem so boundless.