Your Broker Blew It. What to Do

Mad as hell at your stockbroker? You're not alone. A record number of investors want to make their brokers pay for their portfolio blowups. Securities arbitrations--the brokerage industry's version of going to court--soared to 3,358 in the first half of the year at the National Association of Securities Dealers (NASD), which oversees 90% of arbitrations. That's a 24% hike over the first half of 2000. Linda Fienberg, who heads NASD arbitrations, figures that by yearend, arbitration filings could reach 7,000, exceeding 1995's record high of 6,058 filings.

You may be tempted to join these disgruntled investors, especially in light of a recent high-profile proceeding involving Merrill Lynch's (MER) star Internet analyst, Henry Blodget. In July, Merrill agreed to pay $400,000 to an investor who claimed to have lost his kids' college savings by following Merrill's advice, including Blodget's buy recommendation on InfoSpace. The arbitration, which was settled between the parties, charged that Merrill failed to disclose a conflict of interest--namely that the firm was representing a company being acquired by InfoSpace.

Arbitrations don't set legal precedents. Nevertheless, arbitrators, securities lawyers, and aggrieved investors are likely to be influenced by the Merrill case. "Where an investor can show he or she relied upon the integrity of analysts' research and the analysts failed to disclose a conflict of interest, the firm could be held responsible," says Jacob Zamansky, the investor's attorney in the case. Says Merrill spokesman Joe Cohen: "We settled to avoid the distraction and expense of further litigation."

Most arbitrations are against brokers, not analysts. What about taking the broker to court? Forget it. You've probably already agreed to go to arbitration in case of a dispute with your broker. It's in the fine print of the documents you signed when you opened your account.

TAKE NOTES. To win your case, you generally need to show that it was your broker--and not you--who made the bad investment decisions. "If you were on the phone with your broker every day, telling him to buy stocks on margin and then you lost money, you have no claim," says David Robbins, an attorney in Manhattan who has written several books on securities arbitration. However, he stresses that brokers have a fiduciary duty to determine a client's aims and risk tolerance and recommend investments and strategies accordingly.

Indeed, arbitration pros say one of the most widespread complaints they're seeing involves brokers exposing clients to unsuitable risks. For instance, Douglas Schulz, who acts as an expert witness for investors in arbitrations, cites cases in which brokers took conservative investors' money out of blue chips in early 2000 to invest heavily in tech and telecom stocks. "Brokers weren't telling their clients that these stocks had stratospheric price-earnings ratios or that portfolios are supposed to be diversified," he says.

You may also have a case against your broker if you can show that he or she didn't fully explain the risks of an investment strategy. You'll increase your odds of winning an arbitration if you've kept good notes detailing your conversations with the broker.

One increasingly common complaint is that brokers encouraged investors to borrow money on margin to buy stocks as a way to magnify profits. Of course, that leverage compounds losses when stocks sink. The 209 arbitrations involving margin complaints filed at the NASD in the first half of 2001 made up just 6% of the total, but the number of such cases are up sharply from prior years. In all of 2000, 284 cases involved margin, and in 1999, only 104.

Another complaint is excessive trading by brokers. Thad Wong, a 32-year-old Chicago real estate executive, alleges his Morgan Stanley Dean Witter (MWD) broker traded so much that his account lost over $1 million between March and October, 2000. In an arbitration claim, Wong says that his broker never held any of the 204 stocks purchased for his account for more than three months and that some issues were held for just a day. Wong says he was so preoccupied with starting a business that he didn't notice the damage until it was too late. A Morgan Stanley spokesman declined to comment on Wong's complaint, except to say the firm warned Wong about "the extremely risky strategy he was pursuing."

Before you file an arbitration complaint, you'll need to figure out how much to ask for in damages. A common mistake is to ask only for losses. You should add on the amount that your portfolio would likely have earned had it been properly invested, such as in bonds if you are retired and need income from your portfolio. It's also a good idea to ask for attorney's fees.

Arbitration isn't something you want to do on your own, especially if your case is complex. Although the process is simpler than going to court, you can't afford a mistake, since decisions can rarely be appealed. What's more, you'll be up against seasoned brokerage firm attorneys. Seventy percent of all arbitrations are settled before the hearing, and an experienced attorney will know how to best negotiate a fair settlement. To hire one who specializes in securities arbitration, contact your state's bar association or the Public Investors Arbitration Bar Assn., a nationwide group of investors' attorneys (table).

Expect to fork over 30% to 40% of any award to your lawyer. Few attorneys will accept contingency cases asking for less than $50,000 in damages. But even with smaller claims, it's prudent to hire a specialized attorney on an hourly basis. Most charge $200 to $350 an hour.

Investors are largely limited to filing arbitrations claims with the NASD or the New York Stock Exchange. If your claim is $25,000 or less, you can forgo a formal hearing and have an arbitrator make a decision based on a written submission. For claims between $25,000 and $50,000, one arbitrator will preside at your hearing. Three arbitrators decide cases above $50,000. If both parties agree, you can also opt for mediation--a process of trying to negotiate a settlement.

SETTLE FOR LESS? Investors recover money in around 55% to 60% of arbitration cases, according to the NASD. Don't expect full reimbursement, however. A common result when arbitrators can't agree about fault is to "split the baby," giving the investor only a portion of the requested amount. Also, you're likely to do better against an established brokerage. A General Accounting Office study found that only half of all investors who won arbitration awards in 1998 got their money, largely because the firms went bust.

Arbitration can be lengthy and frustrating. But doing your homework increases your odds of victory. "You've already had one disaster," says Mark Maddox, an ex-Indiana securities regulator who now represents investors. "Don't compound it by having a bad arbitration experience." By Susan Scherreik

The Good Business Issue
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