By DIANA B. HENRIQUES
Published: May 26, 1991
In 1987, after he inherited $50,000 from his mother, Joseph Kallaher, a retired industrial arts teacher, and his wife, Mary, signed up at a local high school for an adult education course on the basics of investing. "We knew we were babes in the woods," he said. "Then, lo and behold, three blocks away is an investment class. And it was taught by Prudential-Bache, and not just the lowest guy on the totem pole, but a vice president."
Mr. Kallaher said he was excited by the instructor, James P. McCormick. "Oh, such a personality and mannerisms," he said. "It almost, in a sense, mesmerized you." Mr. Kallaher kept tidy notes that included dozens of classroom references to specific investments sold by Prudential-Bache, a Wall Street investment firm now called Prudential Securities Inc.
Ultimately, Mr. Kallaher put $82,000, all his savings plus his inheritance, into high-risk investments introduced in class -- and he lost heavily.
His nest egg is worth less than half what it was and much of what remains is frozen in limited partnerships paying little or no interest and impossible to sell.
Six other adult-school students who suffered similar losses have brought suit against Mr. McCormick and Prudential -- and, in what appears to be the first such suit, against the Dade County school district. More complaints are expected, from Mr. Kallaher and other former students who have come forward since the suit was initiated in March.
The case rings with implications for both the financial community and the nation's vast world of adult education. Many investment seminars are taught around the country, and it is widely acknowledged that they are not closely monitored by the school boards that sponsor them. It is also clear that many broker-teachers use the classes to attract new clients, despite state rules that classrooms not be used for personal gain. What is unclear is to what extent these teachers may be recommending inappropriate investments as part of the courses, as Mr. McCormick is accused of doing.
Mr. McCormick and Prudential deny they mishandled the plaintiffs' accounts. Echoing the view of the brokerage industry, they insist Mr. McCormick did nothing wrong by doing business with his adult students outside of class. Such dealings are not uncommon in adult education programs across the nation, said Loren Schechter, Prudential's general counsel, "nor is that a secret from the schools." Whose Rules Apply?
But the case raises serious questions for teachers and administrators of thousands of adult courses: When a broker enters the classroom, whose rules apply?
Should it be those of Wall Street, which acknowledges that the teaching of school-based investment seminars by brokers is common across the country, but which insists the practice is a perfectly legitimate way to attract new clients?
Or should it be those of the broader community, which expects its teachers to avoid using the classroom for personal gain? Under those standards, does a school system bear responsibility if a classroom sales pitch goes awry? What if a teacher deliberately misleads students, teaching them to make risky investments that generate high commissions for the teacher?
Educators are openly alarmed at the notion that schools may be liable for losses that result from a teacher's sales pitch.
Jolt to the Industry
"The implications of this are very serious and very widespread," said William Draves, executive director of the Learning Resources Network in Manhattan, Kan., an international adult education association.
The suit has also come as a jolt to the securities industry. Seminars have been an increasingly popular response in the industry to the public's resistance to cold calls since the crash in 1987. Cold calls were the classic device brokers used to attract new customers. Thomas O'Hara, executive director of the National Association of Investors, said brokers tell him seminars are far and away the most effective way to sign up clients these days.
The best place for such seminars, the industry believes, is a school classroom, because it is less threatening and lends "an implied endorsement" said Craig Hoogstra, director of financial services for the American Association of Retired Persons. Indeed, many securities industry experts said in interviews that they were not aware that it may be an ethical violation in most states for teachers in public schools to use their classrooms to attract clients.
The Complaints - Investors See A Conspiracy
The six Miami plaintiffs, represented by Lee Schillinger, a lawyer in Coral Gables, filed complaints in Dade County Circuit Court in March that Mr. McCormick, in selling investments to students, violated both state law and codes of ethics.
The students also accuse the school system of negligence in failing to supervise what was going on in Mr. McCormick's classes. And they charge that Mr. McCormick conspired with his employer, Prudential, to use the classes to sell risky and unsuitable investments -- behavior that Mr. Schillinger contends constitutes a criminal activity under state anti-racketeering laws.
The plaintiffs are seeking triple damages and nullification of the brokerage contracts they signed.
Mr. McCormick refused to be interviewed. His lawyer, Michael Lozoff, said his client "is the victim of one of the most scurrilous witch hunts I have ever encountered," and added, "This case is a golden opportunity to vindicate him." Mr. Lozoff refused to discuss the plaintiffs' specific accusations and denied his client had done anything improper.
A Prudential spokeswoman, Eleanor Mascheroni, said the firm would vigorously oppose the suits by the students. "We have given their claims a fair and thorough analysis," she said, "and see no basis for their claims." Prudential refused to say how many other brokers, if any, were teaching similar classes.
The school board would not comment. In court papers it denied that it bore any responsibility for the students' losses or that it had any duty to insure that Mr. McCormick was not using the classes to sell his wares.
The Broker - Questions Arise About Background
To members of the public interested in enrolling in adult education, the personal biography that Mr. McCormick presented to his classes at Southwest High School sounded impressive.
The 58-year-old broker told students he had been in the business since 1962, had graduated from the University of Texas and had a master's in business. In letters submitted to the school in July 1982, Richard H. Ross, Mr. McCormick's supervisor at Prudential, said, "Mr. McCormick has had over 12 years' experience in stock brokerage and investment banking," adding that his "initiative, personal integrity and character are of the highest quality."
Neither biography matches information Mr. McCormick provided the National Association of Securities Dealers, the securities industry organization that licenses and regulates brokers. Those records show that he received his broker's license not in 1962 but in 1971 and left the brokerage business four years later. In 1980, he was hired by the Wall Street firm now called Shearson Lehman Brothers and relicensed.
Mr. McCormick did not report a master's degree in his licensing records. He said only that he had enrolled in graduate school for six months, without taking a degree. He said he held a bachelor's degree in business from the University of Texas but in the course of the current dispute, school board investigators found that, too, was false.
Nor did he have an unblemished record. In 1967, Shearson paid $60,000 to settle a case that arose during the two years Mr. McCormick worked for the firm. A customer had complained that Mr. McCormick misled her about investments.
In any case, Mr. McCormick was approved as a part-time instructor in 1982. He advertised in the local paper, describing his classes as "sponsored by the Southwest High School." Roger Cuevas, director of the county adult education program, said, "Everything appeared to be in order and we were not aware there was any problem."
The course soon became one of the adult program's most popular and heavily subscribed.
The Classroom - Hard Lessons On Investing
In class, according to Helen Buckner, a former journalist and one of the students, Mr. McCormick would say that "90 percent of his clients gave him discretion to manage their accounts." She said she allowed him to make all the decisions about her portfolio, which, like Mr. Kallaher's, is now essentially mired in limited partnerships paying no dividends.
Walter Dozier and his wife, Abby, also invested heavily, with disastrous results, in the limited partnerships. They said Mr. McCormick talked about the partnerships frequently without ever mentioning that his commission was several times higher for selling them than for selling bluechip stocks, for example.
The other plaintiffs -- Carolyn M. Wilson and Patricia E. Garrison, both police officers, and Daniel A. Green, a 30-year employee of the Dade County Fire Department -- recount similar experiences. "I went for an education," Ms. Wilson recalled. "Well, I got an education, all right." She said her initiation into finance might have cost her as much as $40,000.
Mr. Kallaher, who said he had found much of the language used in the course over his head, came back for more than a dozen of Mr. McCormick's classes in two years. "The man had all my money," he said. "I wanted him to look out and number me among the loyal students. I felt that might help to keep me in his field of vision."
A Larger Issue - Adult Education Lures Brokers
About 15 million people participate in non-credit adult education programs each year in public schools, community colleges and independent centers across the country, said Mr. Draves of the Learning Resource Network. At least 20,000 courses on business and investing are offered annually, chiefly at public schools and colleges. Among today's hot classes, he added, is "Investing for Children's Education."
John Perkins, president of the National Association of State Securities Administrators, said the Miami case showed that schools -- indeed, all community groups that sponsor financial seminars -- need to be alert for the brokerage industry's efforts to "borrow their credibility." He advised brokers who are approached by students seeking to become clients to refer the students to someone else. "If people are doing the class for the right reason, if they're interested in investor education, then they should not mind making that referral," Mr. Perkins said. "And if they do mind, is that the kind of person you want to have teaching?"
Education administrators argue that such stern standards would drive away potential instructors and drive up course costs. Indeed, Mr. Schillinger, the plaintiffs' lawyer, said the principal of Southwest High School accused him of trying to destroy adult education. "No, ma'am," he said he replied, "I'm trying to save it."
Some adult education programs take a stern line with salespeople who teach classes. At the Boston Center for Adult Education, an independent nonprofit learning center, instructors are forbidden to even pass out business cards. "A business card may be a perfectly legitimate form of identification in a business setting," said Jamie Jaffe, a director at the center, "but it is not appropriate in an educational setting. It is the first step to selling."
Ms. Jaffe said one of her most difficult tasks at the center was to cope with a broker-teacher who had been teaching investment classes for many years. "I had to dismiss him because of continuing complaints about how much he was selling in class," she said. "Other program directors will tell you that this is a common problem, and a common kind of complaint."
But many adult education programs are far less exacting, even where there are clear school policies that prohibit full-time teachers from selling to students, Ms. Jaffe and others said. School officials say they lack resources to monitor what happens in the classroom after hours.
Mr. Hoogstra of the American Association of Retired Persons said brokers who teach and sell at the same time had become commonplace. "If you check in almost every metropolitan area," he said, "you'll find that brokers have found that this is a very cost-effective way of presenting themselves to a lot of people. It beats the heck out of cold-calling."
Virtually every major firm teaches its retail brokers how to conduct community seminars, and there are high-profile brokers who illustrate how successful the practice can be.
Martin W. Bach, a senior vice president with Dean Witter Reynolds in Oakland, Calif., has taught adult-education classes at three local school districts for nearly 25 years, often obtaining new clients from among his students. Mr. Bach is considered controversial in the industry because he advises his students against illiquid, high-fee investments like limited partnerships. He declined to comment on the Miami case.
Registered Representative, a magazine for retail brokers, has published more than a half-dozen articles in the last two years in which other brokers describe how they have cultivated new customers by teaching seminars in schools or community libraries.
The securities industry prohibits its brokers from selling investments unsuitable for clients and misrepresenting their risks or rewards. They are required to be especially careful when selling limited partnerships, generally regarded as best suited for the rich. The possible long-term gain can be high but so can the risk.
Students in Mr. McCormick's class have produced class handouts that describe Prudential's partnerships as good alternatives to bank certificates of deposit, regarded as among the safest forms of savings. But unlike C.D.'s, partnership investments are not insured by the Government, the stream of income can vary without warning and, as the students learned, the investment can be difficult or impossible to redeem.
The risks were not mentioned in the handouts. They were detailed in a prospectus for potential investors. But Mr. Green, the fireman, quoted Mr. McCormick as saying: "You don't need a prospectus. I can tell you anything you need to know."
School's Reaction - Role as Teacher Is Questioned
It was Mr. McCormick's role as teacher rather than broker that bothered the students' lawyer most. Mr. Schillinger, who was chief assistant City Attorney for Miami Beach before entering private practice, said, "Everybody else has been looking at this case from the standpoint of the securities laws -- not from the standpoint of the ethics commission laws."
After the Doziers first complained about the investment classroom in 1989, the matter was referred to Patrick Gray, assistant Dade County school superintendent. Dr. Gray suspended Mr. McCormick pending an investigation. The district concluded in 1990 that Mr. McCormick used the schools for personal gain and barred him from serving as an adult-school teacher, a decision he is still fighting.
Dr. Gray emphasized that the board did not examine Mr. McCormick's handling of his students' assets and had no responsibility for it. Dr. Gray did acknowledge, however, that adult education, "of all the areas of education," is the most vulnerable to problems because the instructors are not certified teachers.
But Mr. Schillinger said he believed that the district clearly had responsibilities to this type of student and was not meeting them.
In February, Prudential said, Mr. McCormick "was permitted to resign." He then was hired by Dean Witter Reynolds, where he worked until recently. When the company was asked by a reporter whether it knew about his background, he resigned from Dean Witter as well.
