The sub-prime lending meltdown could be spreading. It’s one thing for Bear Stearns to have to arrange a $3.2 billion bailout of one of its hedge funds, but, for the brokerage industry, the problem just hit closer to home.

Brookstreet Securities Corporation, an independent broker-dealer in Irvine, Calif., is apparently near death after its bets—on margin—on mortgage backed securities went south. According to published reports, Brookstreet’s capital fell from $16 million last Friday to several million below zero as of this past Wednesday after National Financial Services, the firm’s clearing house, demanded payment for the securities bought on margin. (For more details, read here.)

Executive Vice President Scott Brooks, a 5 percent stakeholder in the Brooks Family Trust, which owns Brookstreet Securities, did not comment on the developments and spokesperson Julie Mains could not be reached for comment, either. However, brokers are apparently already feeling the hurt and looking for safety nets. An attorney who wished not to be identified says a Brookstreet broker contacted him today requesting his services and claiming that Brookstreet is withholding over $100,000 in commissions owed to him, and that the firm is not planning to pay it later either.

Clients are far worse off. Sam Edwards, an attorney with Shepherd, Smith & Edwards in Houston, says he’s received dozens of calls from customers from Florida, New York, Hawaii and other states whose accounts have been liquidated. Edwards says some of them are looking at losses in the $500,000 range (some of them actually, technically, “owe” the money on their accounts now), largely due to “heavy margin bets” in CMOs and CMO derivatives he says, investments institutions may utilize to hedge interest rate moves. “There seems to be a pattern of conduct here, that somebody was pushing brokers to sell these products,” says Edwards, who adds that Brookstreet has “over the years hired many suspect brokers” and that his firm has five to seven open cases (out of 80) involving their brokers.

According to Philip Palaveev, a consultant at Seattle-based Moss Adams, broker/dealers that trade on their own accounts are a rarity. “Most broker/dealers just run the business and support the reps,” says Palaveev, who says less than 0.1 percent of the total revenue from all closely held, independent broker/dealers is from trading on their own accounts. “Certainly, Merrill Lynch and any of the big five have big trading operations.”

Don’t expect many other independent b/ds to go down, though. “It’s very rare for an independent to do this, although many do have an itchy finger, going where they think there is easy money to be made,” Palaveev says.

Of course, Brookstreet isn’t the first firm to take a flier in the sub-prime market. Bear Stearns’ 10-month old hedge fund, the High-Grade Structured Credit Strategies Enhanced Leverage Fund, was down 23 percent for the year as of April, according to reports. Clients have been trying to get out, but Bear Stearns is blocking withdrawals because they fear they will lack the liquidity to pay investors.

Brookstreet is hardly Bear Stearns, but the problem seems to be similar: a lack of oversight. “This is an indictment of the firm, for sure. Every b/d should have an audit committee that intercepts this stuff,” says Bill Singer, securities attorney and columnist for this magazine, who adds that Brookstreet has a “checkered” regulatory history and probably should have been prevented from putting itself and its clients in this position. The SEC did not return calls for comment but, when asked if the NASD was investigating Brookstreet, SEC spokesman Herb Perone said, “The NASD does not comment on investigations of firms it may or may not be investigating.” An anonymous source says the firm is indeed under investigation by both NASD and SEC and may face an action soon regarding its current situation.

But according to Singer, the regulators are due at least a small portion of the blame here. “It’s an indictment of the regulators too. Every recent case brought against members has talked of red flags that supervisors failed to miss. Well, here you have questionable brokerage firm investing its own money in a collapsing subprime market and where are the regulators? SIPC is not supposed to be a safety-net for firms to jump out of 10-story buildings.” (SIPC is the Securities Investor Protection Corporation, which helps to pay back investors who lose cash or securities when brokerage firms go belly up.)