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Bitter Investors Want Brokers To Pay

8/12/2001

Kansas City Star

Barbara Kreimer, 75, had planned for her investments not only to provide for her growing health-care needs but also to leave a tidy sum to support her mentally impaired adult son after she died. So when her health began failing last fall, she considered tapping into her investments. But she was stunned to learn from her broker at Dain Rauscher that her account was depleted.

Even worse, she owed money.

Her broker had ratcheted up the trading in her account, buying high-tech stocks on margin – borrowing against her investments to buy more stock, which carries added risks.

By the time she died in January, she had lost nearly $60,000, said her other son, Kraig Anderson, an elementary teacher from Merriam.

“I was upset and shocked,” he said.

Although his mother had signed a form giving her broker permission to trade on margin, Anderson says the broker did not adequately explain the risks to her.

“My mother didn’t know what was going on,” he said. “She had no idea what a margin account even was.” Dain Rauscher will not discuss the loss. A spokesman acknowledged that the firm offered, without admitting fault, to pay a settlement of $9,000, the amount of interest Anderson’s mother had paid on her account.

Instead, Anderson hired an attorney to press an allegation against the brokerage firm with the National Association of Securities Dealers, an industry self-regulatory group.

He is hardly alone. Thousands of investors burned by the volatile stock market are angry – and they want someone to pay. So they are going after their stockbrokers in record number, claiming fraud, breaches of fiduciary duty and misrepresentation.

Securities industry experts say some investors should take personal responsibility for losing their reason in the bull market frenzy.

“The market going up made a lot of people look like geniuses,” said John Kuddes, a Merrill Lynch director for Kansas and Missouri. “Some people who never experienced a bear market didn’t realize stock can also drop.”

Securities experts acknowledge that mounting investor complaints are tarnishing the industry’s image. NASD officials say claims against brokers jumped 25 percent this year. Complaints involving speculative margin trading in high-tech stocks have more than doubled.

“Our total claims are normally in the range of 5,558 to 5,800,” said Linda Fienberg, president of NASD Dispute Resolution Inc. “We expect this year to have approximately 7,000.”

Diane Nygaard, a Kansas City attorney who represents investors who believe they have been wronged by their brokers, said, “We are overwhelmed by investors who lost money.”

She said most complaints mirrored Anderson’s: Investors say their brokers edged them into high-flying margin accounts unsuited to their conservative objectives, misrepresented the risks and then executed frequent trades to pump up the sales commissions.

“This is just the tip of the iceberg,” said Philip Aidikoff, president-elect of the Public Investors Arbitration Bar Association, in Norman, Okla. “The reason we’re seeing claims now is that the bull market covered a lot of wrongs.”

Feverish trading

Industry experts agree some brokers got caught up in the market exuberance and ignored two important rules.

The first rule requires brokers to recommend only trades that are suitable to a client’s financial situation and risk tolerance. For example, you do not place a pensioner on a modest fixed income into an account that trades aggressively in speculative stocks.

The second rule holds that a broker must “use due diligence” to know his or her client’s needs inside and out.

“‘Fever’ was the word most often used to describe the market until it fell off,” said John Boul, a spokesman for Edward Jones, a brokerage firm based in the St. Louis area. “We tried to avoid being caught up in that.”

Still, Kuddes of Merrill Lynch said, brokers were pressured to perform. “When you get into some of these cases, the broker probably advised one thing and the investor did something else because they wanted to make a quick buck,” he said.

“I don’t think anyone is innocent in this one,” said Charlotte Beyer, founder and chief executive of the Institute for Private Investors, in New York, an investment educational organization.

As some money managers predicted unending riches, some investors turned to high-risk day trading. Others abdicated responsibility for their money to would-be investment gurus.

“They thought they could pick some brilliant money manager,” Beyer said. “But typically, when everyone is rushing to the same brilliant person, that person is going to stumble.”

Even so, investor attorneys insist that too many brokers had free rein to chase the market.

“They didn’t explain to investors that when you trade on margin you can lose more than you actually have,” Aidikoff said.

Indeed, many investors did not even know that when their margin accounts plummeted to nothing, their brokers had a legal right to sell off other securities to meet the margin calls, without having to tell their clients they were doing so.

Blindly following

So, were overconfident investors pushing their luck? Or were they taken advantage of?

Nygaard, the Kansas City investor attorney, contends that it is not hard to trace what went wrong. Investors fill out an initial form disclosing their trading objectives, she said. If a client chooses conservative growth but a subsequent spread sheet shows the broker churned sales on margin, it suggests something is haywire.

Consider Kristin Walden, a Wichita veterinarian’s assistant in her 20s. Her life savings were wrapped up in a $150,000 trust account she had inherited. She said her broker at Morgan Stanley Dean Witter traded in tech stocks on margin until the money was almost all gone this year.

“That was everything I had to retire on,” said Walden, who makes about $7 an hour and has no other savings.

“I’m very angry about it. We trusted him. He’s an expert, like when you go to your doctor.”

She is seeking a private settlement from the brokerage firm, while preparing an arbitration claim. Lawyers for Morgan Stanley declined to discuss the case.

After reviewing similar cases involving small investors who lost huge chunks of savings, the NASD this year began a campaign to educate more investors about risky trades. The NASD also promulgated a new rule for the industry that requires brokers to better explain how trading on margin works.

“Prior to the adoption of this new rule, there was not a specific obligation that margin had to be explained,” said Elisse Walter, chief operating officer of the NASD’s regulatory office. “Some brokers did explain the consequences. But some didn’t.”

Even so, Aidikoff asked, “where were the managers who were supposed to supervise the brokers and protect their investors?

“By the time regulators got involved, the horse wasn’t just out the barn door, the horse had died of old age.”

Arbitrating claims

NASD rules require that complaints against brokers are, for the most part, handled through arbitration.

Rather than being heard by a court jury, an investor’s case is considered by a three-judge NASD panel made up of one member from the securities industry and two members from outside of it.

The investor gives up the right to a trial, but the cases are handled swiftly and decisions are binding except in exceptional circumstances. Some investor lawyers say the NASD-run arbitration process is like having the foxes guard the chicken coop.

NASD officials dispute that. “These are neutral forums,” insists the NASD’s Fienberg. She said, in fact, that investors win more than half the time.

Reforms and changes are now being pressed to reduce the number of investor disputes.

Many brokerage firms are already placing less emphasis on the traditional – and some say outmoded – commission-based approach to selling stocks and are acting more like Registered Investment Advisers, who charge only fees for managing their clients’ portfolios.

In contrast, investment advisers, regulated by the Securities and Exchange Commission, generate larger fees only when their clients’ investments grow in value. Brokers make commissions regardless of whether the stocks they sell to clients make money.

“What the investment adviser sells to the customer is advice,” said David Tittsworth, executive director of the Investment Counsel Association of America, in Washington. “There’s not the ability to take the money and run, to use plain English.”

States are also playing a more of an active role in protecting investors.

Kansas State Securities Commissioner David Brant suspects that many unlicensed financial planners simply set up shop to take advantage of the boom in the stock market.

“Lots of folks hold themselves out as qualified financial planners,” he said. “That doesn’t mean they are.”

Tips for investors

  • Take these common-sense steps to protect yourself:
  • Always be clear about your investment objectives.
  • Be certain your objectives are communicated clearly to your broker.
  • Don’t invest in anything you don’t understand.
  • Diversify your investments and beware of margin trading.
  • Don’t give your broker the right to trade without your approval.
  • Review statements and watch for increased trading activity.
  • Check with the NASD for any disciplinary actions against your broker.

If you suspect problems contact your broker’s branch manager. Helpful investor information can be obtained from the following:

Investment Counsel Association of America, Washington
(202) 293-4222
icaa.org
Kansas Securities Commissioner, Topeka
(800) 232-9580
www.ink.org/public/ksecom
Missouri Securities Division, Jefferson City
(800) 721-7996
mosl.sos.state.mo.us/sos-sec/sossec.html
National Association of Investors Corp., Royal Oak, Mich.
(248) 583-NAIC
www.better-investing.org
National Association of Securities Dealers, Washington
(202) 728-8000
www.nasd.com
U.S. Securities & Exchange Commission, Washington
(800) 732-0330
www.sec.gov
– The Kansas City Star


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