“We have a fundamental disagreement” with the Financial Industry Regulatory Authority, said chief executive Walt Bettinger during a winter business update for institutional investors and analysts.

The company and its regulator are at odds, he said, over the interpretation of a Supreme Court case concerning class-action lawsuits and whether it takes precedence over FINRA rules.

FINRA, Wall Street’s self-watchdog, filed a complaint against San Francisco-based Schwab on Wednesday accusing the online brokerage of requiring customers to waive their rights to pursue class actions against the firm, a violation of industry rules. Schwab also required customers to agree that industry arbitrators would not have the authority to consolidate claims from multiple parties.

The waiver effectively leaves many smaller investors without a legal process for pursuing their losses, lawyers said. Investors with small claims, say $25,000, join class-action suits to recover their money. Some also file FINRA arbitration claims as part of a small group of investors, which Schwab’s agreement would prohibit. Investors may be hesitant to file an individual claim for a relatively small loss, lawyers said.

Schwab responded to FINRA’s action by filing a federal court action, also on Wednesday, asking the U.S. District Court for the Northern District of California to declare the provisions are enforceable under federal law and recent decisions by the U.S. Supreme Court, according to court documents.

The company, in the wake of FINRA’s action, may be trying to deflect a perception that it is insensitive to small investors.

“We don’t want smaller clients to think they’re under some barrier to being able to file arbitration claims if they feel they have a viable claim,” Bettinger said. “Until we get this resolved, we’re going to reimburse the filing fee for anyone who files a claim.”

His plan did not appease some investor advocates. “It doesn’t really address the underlying problem,” said Jill Gross, director of the Investor Rights Clinic at Pace Law School in New York. “Investors may want the ability to proceed in a different forum and they’re deprived of that ability,” Gross said.

Arbitration filing fees, which are set by FINRA, are determined based on the amount of an investor’s claims. For example, a $975 fee applies to claims over $50,000 and up to $100,000. Bettinger did not discuss details for getting those funds back to investors.

Those fees are just “the tip of the iceberg” in arbitration cases, said Philip Aidikoff, a securities arbitration lawyer at Aidikoff, Uhl & Bakhtiari in Beverly Hills, Calif.

“If I’m an investor, it ends up creating a situation that costs me money,” said Aidikoff, adding that the terms of Bettinger’s offer are not yet clear. Expert witness fees and attorney time are other considerations in the process, according to Aidikoff.

“In my view, Schwab’s position is completely inappropriate, Aidikoff said.

That position, however, has nothing to do with clients, according to Bettinger. “This is an issue between us and our regulator, not between Schwab and our clients,” Bettinger said.

So popular is the program, in fact, that it could ease concerns about industry bias and help quell calls to end mandatory arbitration.

From the start of the all-public program in February 2011 through Jan. 26, more than three-quarters (76%) of investors chose the all-public option, which allows them to strike industry arbitrators from proposed lists of panelists.

That figure was up from a 54% opt-in rate during a 27-month pilot program, according to Finra.

Normally, investor cases are heard by three-person panels that include an “industry” arbitrator who works in or is associated with the financial industry.

SURPRISING POPULARITY

The popularity of the all-public program is a “bit surprising, because the pilot numbers were lower,” said Linda Fienberg, head of Finra’s arbitration program.

Observers said a growing familiarity with the all-public option by plaintiff’s attorneys is driving its widespread use.

The pilot also was limited to customer cases against a select group of firms and applied only to those cases where an individual broker was not named. The permanent program includes all firms, as well as cases against brokers.

“The program has given everyone an option” to use in a larger number of cases, said Ryan Bakhtiari, a partner at Aidikoff Uhl & Bakhtiari, and president of the Public Investors Arbitration Bar Association, which represents plaintiff’s attorneys.

The Securities Industry and Financial Markets Association also supports the program.

“We also think it’s quite important that an industry panelist remains an option for investors,” Kevin Carroll, associate general counsel at the trade group, wrote in an e-mail.

SIFMA was smart to support all-public panels, said David Robbins, a plaintiff’s lawyer and partner at Kaufmann Gildin Robbins & Oppenheim LLP.

The program has eased concerns about industry bias and helped counter the push by the plaintiff’s bar and state regulators to end mandatory arbitration, he said.

“Finra had to respond this way because … they were fearful they would be out of [the arbitration] business,” Mr. Robbins said.

Finra “wanted to assuage customer’s attorneys [about the process] and it’s worked,” he said.

DATA INCONCLUSIVE

“I do believe this [program] has removed the one issue [critics] could use to claim the [Finra arbitration] forum wasn’t as fair as it might be,” Ms. Fienberg said.

Data from the pilot program are inconclusive as to whether investors did better when they opted into the program.

Of 49 pilot program awards issued by all-public panels, investors were awarded damages in 26 of 40 cases, or 65% of the time, according to Finra. Another 23 pilot program awards were issued by panels with one nonpublic arbitrator, and in these instances, investors got relief 13 times, for a 62% win rate.

In nonpilot cases, win rates were lower: In 2009, arbitrators awarded damages to investors in 49% of cases; in 2010, the win rate was 48%.

However, Finra said that the award data are insufficient to draw meaningful conclusions about whether all-public panels tend to favor investors – a conclusion that others share.

“Talk to me in a year” about win rate data, Ms. Fienberg said.

“We’ll have a better idea then” whether customers do better with all-public panels, she said.

The growing use of the all-public option has worried some industry arbitrators, who insist that they can be as tough, if not tougher, on industry malefactors as public panelists.

“I’ve noticed inquiries for me [to sit on panels] have dried up,” said Neal Tourdo, national sales director at Mastrapasqua Asset Management Inc., who serves as an industry arbitrator.

Eliminating industry panelists “is a mistake,” he said.

“Finra doesn’t do a good job of educating [public] arbitrators about investments,” Mr. Tourdo said.

For more technical products, such as derivatives, “the public arbitrators are generally unprepared,” said Joseph Stineman, a partner and chief compliance officer at Fogel Neale Partners LLC, who is also an industry arbitrator.

He added, however, that his own caseload of four potential customer cases is heavier than ever.

Of the 1,431 cases in the permanent program that have ranked panelists, investors have chosen to strike all the industry people in 66% of the cases, according to Finra.

Despite the success of the all-public option, the plaintiff’s bar and state regulators still want an end to mandatory pre-dispute arbitration agreements.

“We think choice is working with the all-public program, and we think choice is the way to go in arbitration” overall, Mr. Bakhtiari said.

If arbitration were made optional, “I think [the industry] would improve the customer protection aspect of it,” such as providing for attorney’s fees and written decisions, said John Cronin, Vermont’s securities director and chairman of the North American Securities Administrators Association Inc.’s broker-dealer section.

The Dodd-Frank reform law gave the Securities and Exchange Commission authority to prohibit mandatory arbitration in brokerage contracts.

The commission hasn’t yet acted on that authority.

CUSTOMERS WINNING

Mr. Robbins doesn’t think that will happen, due in large part to the all-public option.

Customers “are winning” in Finra arbitrations, he said.

“Why kill a system where you can prevail?” Mr. Robbins said.

The SEC doesn’t have a timetable for looking into the arbitration issue, Ms. Fienberg said.

“My best guess … is, they are mightily working to do [other] things with a time requirement first,” she said.

Meanwhile, Republican control of the House and recent Supreme Court decisions make legislation prohibiting mandatory pre-dispute agreements less likely, Ms. Fienberg said.

The often-used argument that the claimant was a sophisticated investor, and thus should have understood the risks of an investment that went bad, was weakened in the 2008 financial crisis, according to experts in securities law. A lot of wealthy and supposedly smart investors suffered losses in the crisis, exposing flaws in that view.

Brokerages use the “sophisticated investor” defense against many clients who file claims that a broker sold them an unsuitable investment or was otherwise negligent. But the arbitration panels that handle investor claims are now less prone to accept it, securities lawyers say.

“The arbitrator perception of ‘sophisticated investor’ has evolved as a result of such a substantial market break,” says Edward Pekarek, a securities law professor at Pace Law School in White Plains, N.Y. “Such opaque and complex products and such questionable sales tactics associated with those products resulted in even the most sophisticated investors–institutions–being sold securities later revealed to be toxic.”

Wealth, investing experience, profession and education are all factors in who is considered a sophisticated investor. The arbitration system doesn’t have a precise definition.

Regulators require that an investor have a certain amount of wealth–$1 million, for example–to be able to purchase certain complicated securities. But “money and sophistication are not synonymous,” says John Lovi, a securities litigator and founding partner of Steptoe & Johnson’s New York office.

He uses reality television star Kim Kardashian as an example: She may have more than enough money to be considered an accredited investor by the Securities and Exchange Commission, but that doesn’t mean she is sophisticated about investing, he notes.

The panels that hear cases in the Financial Industry Regulatory Authority’s arbitration system rarely include explanations with their decisions, making it hard to know exactly how often the sophisticated investor defense succeeds or fails. But Jonathan Uretsky, a securities attorney who often represents broker-dealers, points to Finra data showing that in 2010, about 76% of customer claimant cases resulted, through settlements or awards, in monetary or non-monetary recovery for the investor.

“That’s telling of the fact that broker-dealer defendants are less likely to go ahead and say, ‘this guy was a sophisticated investor,’” he says. “It doesn’t mean we can’t win on it, it means we’re less willing to try.”

Media coverage of large losses by brokerages, such as a $54 million award against Citigroup Inc. (C) last year, makes arbitrators more aware of cases in which the sophisticated investor defense doesn’t work, Uretsky adds.

In that case, an arbitration panel ordered a Citigroup unit to pay a group of investors for losses they incurred in several municipal arbitrage funds, including one that lost about 80% during a period between 2007 and 2008.

One of the law firms which represented those investors, California-based Aidikoff Uhl & Bakhtiari, has represented a total of 17 households in cases related to the Citi funds and has won awards in all of them.

Ryan Bakhtiari, a partner at the firm, says the investors in all of the cases were sophisticated or “qualified,” meaning they had $5 million or more in liquid assets. But the outcomes show that “arbitrators don’t buy the fact that when a brokerage misrepresents an investment, a sophisticated investor should have known more,” he says.

Even traders have won these cases. In late November, an arbitration panel ruled that Citi had to pay more than $750,000 to Christopher Puglisi, a former oil trader at the New York Mercantile Exchange. Citi misrepresented the fund to its broker, who in turn misrepresented it to Puglisi, Bakhtiari says.

Even though Bakhtiari doesn’t bring claims against brokers in these cases, brokers can be held liable.

The bottom line: It doesn’t matter if your client is sophisticated or not, you have the same obligation to make sure your recommendations are suitable, Lovi says.

Brokers are required to research and know a product, he adds, and it is always a good idea to pass along all of that information to the investor.

True then and, all too often, true now – with rare exceptions. One of them was the case of Gerald D. Hosier and Jerry Murdock Jr., who invested millions with Citigroup, lost big – and came back swinging.

Documents related to the case show how Citigroup pushed exotic investments as safe alternatives to humdrum municipal bonds. The paperwork, which was unsealed recently, makes for fascinating, if disheartening reading.

First, some background. Mr. Hosier and Mr. Murdock are the kind of customers everyone in the investment business covets. Which is to say, they’re prosperous. The two were clients of Citigroup’s wealth management business, which, like its counterparts at other investment firms, takes a particular interest in high-net-worth people.

But Mr. Hosier and Mr. Murdock were not happy customers. They accused Citigroup of fraud and breach of fiduciary duty, saying they had been misled about complex, risky investments that Citigroup had held out as safe and sound.

Last April, a securities arbitration panel agreed with them. The men won the largest sum ever awarded to individuals in such a proceeding – a total of $54.1 million. Most of that was compensation for their losses. But some $17 million consisted of punitive damages. An additional $3 million went to cover legal fees.

Given that harsh judgment, something about this case clearly disturbed the arbitrators. But because such proceedings are confidential, outsiders didn’t know the details – until, that is, Citigroup asked a United States district court to overturn the award.

Now almost all of the documents the arbitrators saw have been unsealed. In late December, Judge Christine M. Arguello, in the District of Colorado, ruled against Citigroup and affirmed the award. So what do the documents show? Among other things, that Citigroup itself viewed these investments as risky. On its internal scale of 1 to 5 – 1 being the safest, 5 the riskiest – this stuff was rated 5. The filings also show how Citigroup tried to deflect problems when the investments began to sour.

Danielle Romero-Apsilos, a spokeswoman for Citigroup, said in a statement that the bank acted appropriately in creating and selling the investments, municipal arbitrage portfolios known as ASTA/MAT.

“Our disclosures were accurate and complete and detailed the risks associated with investing in these products,” Ms. Romero-Apsilos said. Clients who bought the instruments “signed subscription agreements in which they expressly acknowledged the risks associated with this investment.”

Only high-net-worth customers could participate, and they had to put up at least $500,000. In cases like this, banks typically argue that such wealthy, sophisticated investors know a gamble when they see one.

This time, that argument failed, and it’s not hard to see why. The lawyer for the investors, Philip M. Aidikoff, of Aidikoff, Uhl & Bakhtiari,  has won numerous cases against Citi involving these strategies and represents investors in scores of others yet to be decided.

Internal sales memos produced in the arbitration describe the ASTA/MAT as ideal for customers seeking alternatives to fixed-income investments.

“Our goal is NOT to target hedge fund clients who are willing to accept an unrestricted risk profile,” one internal document said, “but larger traditional fixed-income investors who are seeking alternatives and customized solutions without materially altering their risk characteristics.”

But internal Citigroup e-mails were far clearer about potential risks. In early 2008, a few days after the investments started plummeting, Sallie Krawcheck, then head of wealth management at Citigroup, sent an e-mail asking for the risk rating of MAT, part of a family of investments know as “alternatives.”

“Alternatives are always in 3-5,” came the response. A rating of 5 was usually reserved for potentially volatile products that carried the risk that clients could lose their entire investment, or more.

Customers might have known what they were getting into if they’d known about that 5 rating. But it was not disclosed to them. Transcripts of conversations between Citigroup management and the portfolio manager handling the investments also point to a disconnect between what investors were told and what Citigroup actually did.

As Citigroup executives prepared for a conference call with brokers whose customers had been burned, the portfolio manager was advised not to talk about his internal guidelines, which differed from the prospectus sent to investors. This document is known as a private placement memorandum.

“You have internal guidelines that are different from what’s in the P.P.M., correct?” one executive asked.

“Yep, we do,” the manager replied.

“Yeah, so we focus on what’s in the docs, rather than, you know … ,” the executive said, trailing off.

When Citigroup realized its strategy had gone toes-up, it tried to contain the damage. It offered to repurchase the instruments at steep discounts to the purchase price. But that was contingent upon customers signing a form promising not to sue the bank.

Perhaps anticipating objections, Citigroup produced a memo for its brokers, titled “Fund Rescue Options,” outlining answers to various questions about the offer. It included commentary that some brokers read as a veiled threat.

One question, for instance, was whether a client’s decision to accept the offer would show up on a broker’s regulatory record, known as a U-5. The answer was no. If a customer did not sign the legal release but pursued an individual complaint, the complaint and any settlement could appear on the U-5, Citi told its brokers.

E-mails from angry brokers who had, knowingly or not, sandbagged their best clients were also among the documents filed with the court.

“I’m sure a great deal of time and energy went into the ASTA/MAT solution,” one broker wrote. “But my clients and I don’t see it as a solution. From our simplistic perspective, the product was defective, management inept, risk controls nonexistent and the effect was ruinous. If one drives their car into another, they are responsible; they have no option but to take responsibility for their actions.”

Come to think of it, that’s kind of a good metaphor for the entire credit meltdown. Except for the taking responsibility part, that is.

*Investors’ losses were tied to risky municipal bond funds

*FINRA panel ruling among largest to individual investors

A U.S. judge on Wednesday denied a request by Citigroup to overturn a $54.1-million arbitration ruling in favor of a group of investors for losses incurred in a series of municipal bond funds which plunged in value between 2007 and 2008.

Judge Christine Arguello in Denver, Colorado, disagreed with Citigroup’s arguments, including the latter’s assertion that a Financial Industry Regulatory Authority arbitration panel disregarded the law in its award, in April, to venture capital investor Jerry Murdock Jr., retired patent attorney Gerald D. Hosier, and Brush Creek Capital.

The $54.1 million securities arbitration award was among the largest that a brokerage firm has had to pay individual investors, according to the Securities Arbitration Commentator Inc., a newsletter in Maplewood, N.J. The investors’ losses were tied to six different leveraged municipal bond arbitrage funds sold by Citigroup Global Markets.

Of the total award, the FINRA panel ruled that Citi must pay nearly $34.1 million in compensatory damages, $17 million in punitive damages, and $3 million in legal fees.

Citigroup sold a series of funds through an entity called MAT Finance LLC. The MAT, or municipal arbitrage trust funds, borrowed at low short-term rates and invested proceeds in longer-term muni bonds. But the strategy was ultimately shown to be flawed and left investors with losses of as much as 80 percent.

Citigroup had argued to the court, after the FINRA panel made its ruling in April, that the investors could not have relied on certain oral statements that the firm made about their purchases, because they had signed agreements which disclosed that they could lose all of their money.

“The court finds (the) argument wholly unpersuasive,” wrote Judge Christine Arguello in an opinion.

Judge Arguello ruled that the FINRA panel wasn’ wrong to award the investors punitive damages and legal fees.

Lawyers for the parties didn’t make any oral arguments before the court, according to Philip M. Aidikoff, a lawyer for Aidikoff, Uhl & Bakhtiari in Beverly Hills, California, who represented the investments.

The court’s full agreement with all of the investors’ arguments was “startling,” he said.

A Citigroup spokeswoman declined to comment.

Financial advisers from both Commonwealth and LPL sold the fund in question, the Laeroc 2005-2006 Income Fund LP, which wants to raise another $12 million to $15 million to pay off – at a steep discount – $49 million of debt.

Laeroc Partners Inc., a real estate investment firm that focuses on property in Los Angeles and other parts of Southern California, in June issued a “cash call” notice to investors who bought the Laeroc 2005-2006 Income Fund.

The fund’s lenders have said that they will foreclose on one of its holdings, the Country Club Plaza shopping center in Sacramento, Calif., by the end of the year if they can’t raise enough money, according to the notice. The Laeroc fund has paid more than $180 million to buy eight properties and owes $105 million in mortgage debt.

It isn’t clear how much of the Laeroc 2005-2006 Income Fund was sold by Commonwealth and LPL brokers. Plaintiff’s attorneys said that they have received a handful of calls from clients who bought the product, but no arbitration complaints have been filed against either Commonwealth or LPL.

REG D DIFFICULTIES

Dozens of small to midsize independent broker-dealers became ensnared in the fallout from Reg D private placements after the Securities and Exchange Commission charged two sponsors, Medical Capital Holdings Inc. and Provident Royalties LLC, with fraud in 2009.

For the most part, leading independent firms such as Commonwealth and LPL sidestepped the toxic products, of which brokers sold $2.7 billion. About half of investors’ principal was wiped out in those two deals, and the legal costs of arbitration claims and settlements have pushed dozens of independent broker-dealers to close or be sold.

Industry executives noted that real estate deals of various stripes, including nontraded real estate investment trusts that raised money and bought properties between 2006 and 2009, are struggling.

A cash call on a private real estate offering clearly is not a good sign, said Philip Aidikoff, a plaintiff’s attorney who has taken information from one LPL client who bought $250,000 of the Laeroc 2005-2006 Income Fund.

“When you see a cash call in a private real estate deal like this, the patient is on life support. It’s a very bad piece of information,” Mr. Aidikoff said.

“I can’t recall when a cash call solved the problem. It only delays the inevitable,” Mr. Aidikoff said.

Laeroc Partners Inc. has at least $650 million in assets and has created 14 funds, according to its website. Founded in Manhattan Beach, Calif., in 1986, at first it was a workout specialist for distressed real estate.

In 1993, the company began offering income and equity funds, according to the website.

Kim Benjamin, president of Laeroc Partners, didn’t return messages left last week seeking comment.

John Rooney, managing principal with Commonwealth, declined to comment, except to confirm that the firm’s advisers sold the fund.

Joseph Kuo, a spokesman for LPL, said that the firm’s reps and clients “have successfully avoided the most difficult product-related issues associated with the financial crisis.”

“The challenges currently faced by the Laeroc fund are driven by market forces resulting from the 2008 credit crisis and the stress to the commercial-real-estate markets from the ensuing recession,” he said, adding that LPL will keep a close watch as Laeroc works to address the issue.

The property that has spurred the cash call is Country Club Plaza, a mall in Sacramento, Calif., that is almost half empty. According to the Sacramento Business Journal, Laeroc defaulted on its $49 million loan in November 2009.

Investors had until July 30 to respond to Laeroc’s cash call. It isn’t known whether the attempt to raise more funds was successful.

If Laeroc’s cash call was a winner, it would create a new ownership structure with three levels of investors, according to the notice.

‘A LIST’ INVESTORS

Clients who pony up more money will go to the front of the line for any payment and become “A preferred” investors. If investors vote to approve the changes to the partnership but give no more money, one-third of their investment gains will be given “B priority” status, meaning that they get paid after the “A preferred” investors.

The remaining two-thirds of their money will be reclassified as a “C unit holder.”

That level is for people who don’t vote to change the fund structure or give it more money. They get paid last, if at all, according to the notice.

Such a structure is typical when restructuring a cash call, industry executives and analysts said.

“Laeroc made its reputation in assisting and restructuring troubled limited partnerships,” said Bryan Mick, a due diligence analyst for private investments. “Now they are the restructuree.”

Investors have a number of questions to answer before deciding to invest further in a fund that has issued a cash call, said Gordon Yale, principal of the Yale Group Inc., a forensic accounting firm. He also serves as a special witness in securities disputes.

“You can’t generalize, but it needs to be evaluated in a very serious way,” Mr. Yale said.

“First, investors must ask, “How much equity will I lose if the property is foreclosed upon versus how much additional equity am I required to put at risk?’ Then ask, “Why is the property cash flow negative, and is it likely to change?’” Mr. Yale said.

Other points of information, such as economic and real estate market conditions and whether they are likely to improve, also are important, he said.

Investors also must know when the leases of current tenants expire and whether they are likely to renew, and whether the physical condition of the property has deteriorated because of deferred maintenance, Mr. Yale said.

“The danger of a capital call is an investor throwing good money after bad,” he said. “If the net-operating income of the property, that is, rental income less direct expenses, exclusive of debt service and investor distributions, is not sufficient to cover mortgage payments, then investors must pay attention to the discussed considerations.”

Financial advisers from both Commonwealth and LPL sold the fund in question, the Laeroc 2005-2006 Income Fund LP, which wants to raise another $12 million to $15 million to pay off – at a steep discount – $49 million of debt.

Laeroc Partners Inc., a real estate investor that focuses on Los Angeles and other parts of Southern California, in June issued a “cash call” notice to investors who bought the Laeroc 2005-2006 Income Fund.

The fund’s lenders have said that they will foreclose by the end of the year on a shopping center in Sacramento, Calif., if the fresh cash isn’t paid, according to the notice. The Laeroc fund has paid more than $180 million to buy eight properties and owes $105 million in mortgage debt.

It isn’t clear how much of the Laeroc 2005-2006 Income Fund Commonwealth and LPL brokers sold. Plaintiff’s attorneys said that they have received a handful of calls from clients who bought the product but haven’t filed arbitration complaints against either Commonwealth or LPL.

Reg D Difficulties

Dozens of small to midsize independent broker-dealers became ensnared in the fallout from Reg D private placements after the Securities and Exchange Commission charged two sponsors, Medical Capital Holdings Inc. and Provident Royalties LLC, with fraud in 2009.

For the most part, leading independent firms such as Commonwealth and LPL sidestepped the toxic products, of which brokers sold $2.7 billion. About half of investors’ principal was wiped out in those two deals, and the steep legal costs associated with client arbitration claims and settlements have pushed dozens of independent broker-dealers to close or be sold.

Industry executives noted that real estate deals of various stripes, including nontraded real estate investment trusts, which raised money and bought properties from 2006 to 2009, are struggling.

But a cash call on a private real estate offering is clearly not a good indication, said Phil Aidikoff, a plaintiff’s attorney based in Los Angeles who has taken information from one LPL client who bought $250,000 of the Laeroc 2005-2006 Income Fund.

“When you see a cash call in a private real estate deal like this, the patient is on life support. It’s a very bad piece of information,” Mr. Aidikoff said.

“I can’t recall when a cash call solved the problem, but only delayed the inevitable. Retail investors can’t throw more money after such deals.”

Laeroc Partners has at least $650 million in assets and has created 14 funds, according to its website. Founded in Manhattan Beach, Calif., in 1986, at first it was a workout specialist for distressed real estate.

In 1993, the company began offering income and equity funds, according to the website.

Kim Benjamin, president of LaeRoc Funds, didn’t return messages seeking comment left Tuesday and Wednesday.

John Rooney, managing principal with Commonwealth, declined to comment, except to confirm that the firm’s advisers sold the fund.

Joseph Kuo, a spokesman for LPL, said that the firm’s reps and clients “have successfully avoided the most difficult product-related issues associated with the financial crisis.”

“The challenges currently faced by the Laeroc fund are driven by market forces resulting from the 2008 credit crisis and the stress to the commercial-real-estate markets from the ensuing recession,” he said, adding that the firm will keep a close watch as Laeroc works to address the issue.

The trustee for the victims of Bernard L. Madoff’s Ponzi scheme has accused the Mets’ owners of ignoring repeated warnings that Madoff might have been up to no good during their years of investing with him. The owners, the trustee has said, were accomplished businessmen who had made fortunes in various fields, and had to have known the returns from their investments with Madoff were suspect.

For their part, the owners, Fred Wilpon and Saul Katz, have sought to draw a vital distinction: yes, they are successful businessmen, but they are not sophisticated Wall Street investors. They had, indeed, hired Madoff for the investing skills that they lacked. There was no way, they have argued, that they had the expertise and experience to have sniffed out Madoff’s fraud.

The high-stakes arguments – the trustee is seeking $1 billion from Wilpon and Katz – are set to be heard, and perhaps decided, by Judge Jed S. Rakoff in United States District Court in Manhattan on Aug. 17.

In a court filing last week, the trustee, Irving H. Picard, laid out, in more detail than before, his strategy for asking the court to evaluate the conduct of Wilpon and Katz. While not abandoning his theory that the team’s owners are more sophisticated than the average investor, Picard argued they should be tested by a somewhat lesser standard: what would a “reasonable person” of “ordinary intelligence” have done when presented with what he calls a “mountain” of warnings about Madoff’s operation?

“At some level, he is trying to line up his arguments with actionable legal theories,” said Joel Seligman, the president of the University of Rochester and an expert on securities law who has not studied the case.

At a minimum, Picard asserts that Wilpon and Katz should have conducted some kind of inquiry into the details and probity of Madoff’s operations. They never did, but instead continued to invest, and to profit, for years.

Picard’s argument appears to result in part from the successful effort by Wilpon and Katz to transfer the trustee’s lawsuit from bankruptcy court to district court – a procedural victory for them.

Wilpon and Katz wanted the change so their dealings with Madoff might be judged under securities law, not the federal bankruptcy code. Seen merely as individual investors, they argued, they were under no special obligation to check out the trustworthiness of Madoff’s investing.

In a 25-page filing, though, Picard’s lawyers cite what they argue is a body of established New York and securities law that holds that ordinary individual investors – and not necessarily sophisticated ones – have real obligations to meaningfully check out warnings or hints of a possible fraud.

In a 2006 case involving a Ponzi scheme, for example, the Court of Appeals for the Second Circuit in New York ruled that the “exercise of ordinary intelligence” must be used by a prudent investor “or he will not be heard to complain that he was induced to enter into the transaction by misrepresentations.”

In a 2004 decision on a securities-fraud case, a district court said, in part, that “when circumstances would suggest to an investor of ordinary intelligence the probability that it has been defrauded, a duty of inquiry arises, and knowledge will be imputed to the investor who does not make such an inquiry.”

Picard’s aggressive and pointed reassessment of the standard the Mets’ owners are to be held to is a “game changer,” said Philip M. Aidikoff, a partner in the securities law firm of Aidikoff, Uhl & Bakhtiari in Los Angeles.

“ ‘Reasonably prudent’ is a lower threshold,” said Aidikoff, who represents clients who were defrauded by Madoff. “What Picard is doing is creating a new framework in terms of how two people should be measured.” He added, “It has that ‘it-makes-sense’ feeling.”

Still, Picard’s assertions about what Wilpon and Katz knew and should have done ultimately have to convince Rakoff, who has shown a willingness to drastically and surprisingly affect the course of major litigation. At a hearing late last month, he appeared sympathetic to the arguments by the team’s owners that Picard was seeking to, in effect, punish them retroactively for failing to uncover a fraud they were not in any way reasonably obliged to uncover.

Karen Wagner, a lawyer for Wilpon and Katz, argued at the hearing that securities laws did not impose a requirement on her clients to investigate Madoff.

At next month’s hearing, the Mets’ lawyers will almost certainly continue to argue that Picard has fabricated or distorted the evidence that is at the heart of the lawsuit: the supposed red flags and warnings that Wilpon and Katz ignored.

“A red flag is a look back, not living in the moment,” Aidikoff said. “They’re issues after the fact when you ask, ‘What did they know and when should they have known it?’ It’s subject to historical revision.”

Rakoff could dismiss the case entirely or rule on certain critical issues, and return all or parts of the lawsuit to United States Bankruptcy Court.

For years, shares of the real estate investment trusts were listed at $11 on client account statements. The firm continued to list the same price after the Financial Industry Regulatory Authority Inc. in 2009 told broker-dealers to adjust prices on the investments more frequently.

Finra also prohibited broker-dealers from using information more than 18 months old to estimate the value of a nontraded REIT.

At the end of May, Finra filed a complaint against David Lerner, alleging that the firm was misleading investors and marketing unsuitable investment products to them.

Finra spokeswoman Nancy Condon declined to comment on the firm’s change in account pricing.

Since 1992, David Lerner has recommended and sold nearly $6.8 billion in Apple REIT shares, according to Finra.

“There have been some questions from investors” about the change of the value of the REITs shown on account statements, said Joseph Pickard, senior vice president and general counsel with David Lerner, which is based in Syosset, N.Y.

When asked if investors are anxious about the change, he said, “I can’t answer that.” Client account statements also show the cost of investment in the Apple REITs, which is either $10.50 or $11 per share.

Mr. Pickard said there was “no particular reason” for the change, but added that the recent “stir and hoopla in other people’s minds” about the REITs’ estimated market value contributed to the firm’s decision to make the change.

The firm is “absolutely” in compliance with Finra rules and regulations when selling the product, Mr. Pickard said.

The account statement change made by the Lerner firm “is causing serious concern for investors,” said Jake Zamansky, a plaintiff’s attorney, who added that his firm, Zamansky & Associates, has spoken with up to 50 David Lerner clients. “People are really looking for clarity here.”

A broker-dealer switching a security’s value to “not priced” isn’t unheard of, but it is far from ordinary, attorneys said. Although some attorneys noted that such a change could be a bad harbinger for any security, another lawyer said that such a price change is a potential step in the right direction.

“The price of $11 per share is most likely a misrepresentation of its true value, which is almost impossible to ascertain and price,” said Phil Aidikoff, a plaintiff’s attorney who has been following the David Lerner case but has no investors with the firm as clients.

“Issues of pricing have been going on for a long time in the securities business,” Mr. Aidikoff said.

Having nontraded REITs listed as “not priced” on client account statements is not “systemic,” said Kevin Hogan, executive director of the Investment Program Association, a trade group that includes nontraded REITs and the broker-dealers that sell them. He added that he had “no idea” whether any other REITs have recently made such a change on client account statements.

Finra’s complaint against David Lerner has renewed concerns among broker-dealers about the sales of illiquid investments such as nontraded REITs and private placements.

PROBLEM FUNDS

A few small nontraded REITs recently have made disclosures revealing problems, or at least the potential for problems, with investments, broker-dealer executives said.

In addition to problems with investments, some smaller REITs may be having a hard time gaining traction with broker-dealers because firms are looking to product sponsors to educate advisers and their clients, said Nicholas Schorsch, CEO of America Realty Capital, which sponsors five nontraded REITs.

Before the credit crisis in 2008, nontraded REITs could be successful simply by showing up, he said. With anxiety running high among investors and broker-dealer executives due to problems with some of the products and the market in general, that way of doing business has changed, Mr. Schorsch said.

“The market is getting more difficult. Just because you get to the table doesn’t mean you get to play,” he said.

The number of nontraded-REIT products has exploded since 2000, practically quadrupling to 45, noted Jeffrey Hanson, CEO of Grubb & Ellis Equity Advisors LLC.

“There’s saturation with all the new entrants, and barriers are very real and high,” he said. New nontraded REITs need to raise $15 million to $20 million a month to work, and many simply can’t reach that level.

“If you can’t get to $20 million, you’re going to have further shutdowns,” he said.

Problems at smaller nontraded REITs – those that have raised less than $50 million – have caught the attention of the SEC and Finra, which are scrutinizing the popular products sold exclusively through independent broker-dealers.

Around the same time that Finra filed its complaint against David Lerner, several nontraded REITs reported real or potential difficulties.

For example, Desert Capital Real Estate Investment Trust Inc. in April filed for bankruptcy protection, and at the end of May, Todd Parriott, its chief executive, resigned.

Also in April, a member of the board and chairman of the compensation committee resigned from Hartman Short Term Income Properties XX Inc., a nontraded REIT. After the resignation of the director, Larry Bouffard, the company’s board authorized the REIT to consider buying pieces of a related REIT, Hartman Short Term Income Properties XIX Inc.

Meanwhile, this month, Bluerock Enhanced Multifamily Trust Inc., which last year pulled its REIT from the market, said that an affiliated broker-dealer, Bluerock Capital Markets LLC, will assume the managing and distribution for its initial public offering.

Sudden changes in a REIT’s board or the broker-dealer that sells the product, or the purchasing of properties by one REIT from another related REIT, are indicators that broker-dealers and registered representatives need to pay careful attention to the investment, industry observers said.

“When we see something like this, it raises eyebrows and we’ll look into it further,” said Jeff Young, senior vice president with First Financial Equity Corp., a broker-dealer with 125 affiliated reps.

Problems with nontraded REITs often occur off the radar, he said.

The firm has selling agreements with both the Hartman XIX and Hartman XX REITs but passed on selling agreements with the Desert Capital and Bluerock REITs.

“Hartman is a good company, and the properties are good properties,” Mr. Young said.

But First Financial Equity has become “very restrictive” with its selling agreements for investments such as nontraded REITs and private placements.

Mr. Young said that the nontraded-REIT industry does have potential conflicts of interest, particularly if a sponsor of the REITs has more than one program.

First Financial Equity has become more restrictive with the products that it sells just as the industry continues to mushroom, he said.

“I don’t have time to talk to all the REIT wholesalers that are knocking on our door,” Mr. Young said.

Executives from the three nontraded-REIT sponsors stressed that the changes were due to market conditions or a normal part of the business.

Finra hasn’t filed actions against broker-dealers related to the sale of those three sponsors’ REITs.

Desert Capital REIT spokeswoman Carrie Cook attributed her firm’s bankruptcy filing to the effect the credit crisis had on real estate in Las Vegas and elsewhere in Nevada.

Allen Hartman said that the changes revealed in April SEC filings by his firm – which owns about $400 million in real estate, mostly in Texas – were a normal part of doing business and were unrelated. He said that he asked Mr. Bouffard, 78, to resign from the board due to his age.

The two REITs bought properties together, and the Hartman XX REIT is buying up the assets of Hartman XIX based on pricing done by an independent third party and approved by the independent board.

R. Ramin Kamfar, owner and chief executive of Bluerock, said that the broker-dealer switch was necessary because the first firm did a poor job selling the product.

The firm’s own wholesalers began selling the fund last week, Mr. Kamfar said.

This legal dust-up involved supposedly conservative municipal bond investments that Smith Barney had peddled to its wealthiest clients. The investments, which were big money-makers for Smith Barney, turned out to be anything but safe for the firm’s clients: various portfolios lost between half and three-quarters of their value during the financial crisis.

Arbitrators rarely, if ever, discuss such cases, and the materials turned over by both sides are kept under wraps. But the outsize award, which included $17 million in punitive damages, is not the only thing that is noteworthy. The arbitrators appeared to reject – resoundingly – three defenses that Wall Street often employs when clients sue:

No. 1: We didn’t blow up your portfolio. The financial crisis did.

No. 2: If you’re wealthy and sophisticated, you should have understood the risks.

And, No. 3, the most common defense of all: The prospectus warned that you could lose your shirt, so don’t come crying to us if you do.

The investors who prevailed here are Gerald D. Hosier, 69, a wildly successful intellectual-property lawyer, and Jerry Murdock Jr., 52, a prosperous venture capitalist. Mr. Hosier and a trust he set up for his adult children received $48 million. Mr. Murdock got about $6 million.

The men, neighbors in Aspen, Colo., suffered $27 million in out-of-pocket losses on their investments. The big clunker was a municipal bond arbitrage strategy that their Smith Barney broker had characterized as safe, according to the men’s complaint. The deal was supposedly designed to eke out more income than a simple portfolio of bonds would generate.

Not only did the men recover all their losses in the award, they also received damages. Mr. Hosier was awarded $15 million in punitive damages and $6.3 million in market-adjusted damages. The arbitrators also awarded $3 million for the men’s legal fees.

Alexander Samuelson, a Citigroup spokesman, said: “We are disappointed with the decision, which we believe is not supported by the facts or law.” He noted that the bank had won a number of arbitrations involving such leveraged municipal bond strategies and said that the bank was considering its legal options in this case.

Mr. Hosier invested in the bank’s municipal arbitrage strategy from 2002 through 2007. Requiring a minimum investment of $500,000, the deals employed the wonders of leverage, borrowing 8 to 10 times the value of the municipal bonds in an underlying portfolio to generate higher income. Calling the strategy conservative and ideal for investors’ safe money, Smith Barney sold the trusts to wealthy investors.

But Smith Barney and its brokers were the prime beneficiaries of the strategy, which generated fees not only on the money that had been borrowed to juice the returns but also through the life of the investment. Clients paid 0.35 percent annually on the portfolios, plus a fee of 20 percent of all income earned by the investors above a 5.5 percent threshold each year.

Smith Barney’s sales representatives kept 40 percent of the total fees paid by their investors, far exceeding what they would have earned selling ordinary municipal bonds. This arrangement encouraged Smith Barney to lever up the portfolios, Mr. Hosier’s lawyers argued, putting the interests of their clients and those of Smith Barney at odds.

Investors who bought these deals agreed to lock up their money for two years and had to pay a substantial fee if they redeemed their holdings during the next three years.

Mr. Hosier was the single biggest buyer of Smith Barney’s municipal arbitrage deals, with $26 million invested over time. But four different portfolios in which he invested raised almost $2 billion from all investors. All of the portfolios performed badly.

“Citigroup mismarketed this product to high-net-worth investors as an alternative to municipal bonds with a slightly higher return,” said Philip M. Aidikoff, a lawyer at Aidikoff, Uhl & Bakhtiari in Beverly Hills, Calif., who represented Mr. Hosier and Mr. Murdock. “Our clients never knowingly agreed to risk a significant loss of principal for a few extra points of interest.”

AS for Citigroup’s three defenses, Mr. Aidikoff, along with the co-counsel Steven B. Caruso, at Maddox, Hargett & Caruso in New York, demonstrated that municipal bonds did not suffer catastrophic losses during the period. This squelched the bank’s argument that the financial crisis did in the strategy.

Regarding their clients’ sophistication and wealth, the lawyers agreed that both men were comfortable taking risks in certain circumstances, but not with the money they had given to the bank. “Citigroup misled their wealthiest clients and then tried to blame them for relying on what they were told,” Mr. Caruso said.

Arguing that the risks were laid out in the prospectus also seems to have run into a stone wall. Mr. Hosier’s lawyers produced seven different notices on the topic published by Finra and its predecessor regulator since 1994, including a notice from 2009 that states: “Providing risk disclosure in a prospectus or product description does not cure otherwise deficient disclosure in sales material, even if such sales material is accompanied or preceded by the prospectus.”

Mr. Hosier’s victory is particularly noteworthy, given the nominal amounts typically extracted by regulators in cases against major banks. The punitive damages awarded to Mr. Hosier, for example, are more than triple the $4.45 million penalty levied against Wachovia Securities by the Securities and Exchange Commission this month in a suit that the S.E.C. settled with the bank. The S.E.C. accused the bank of selling about $10 million of mortgage-related securities to investors at above-market prices and at excessive markups. Wachovia, now part of Wells Fargo, neither admitted nor denied wrongdoing in the settlement.

The arbitrators in Mr. Hosier’s case seemed keen to hold Wall Street accountable. And his win against Citigroup does not appear to be an anomaly. Since April 2010, his lawyer, Mr. Aidikoff, has argued 16 other arbitrations involving the same type of investment. Mr. Aidikoff and the lawyers who assist him have won every one.

In an interview, Mr. Hosier said the experience had opened his eyes to the disturbing ways of Wall Street.

“Instead of the financial world being the lubricant for business, they are out there manufacturing products with no utility whatsoever except for generating fees,” he said. “Somebody’s got to do something about Wall Street. It is destroying the country.”

The ruling by arbitrators at the Financial Industry Regulatory Authority, which oversees US brokerages, includes $17 million in punitive damages, according to a copy of the panel’s decision posted yesterday on the regulator’s website. It’s the third-largest arbitration award by Finra and predecessor NASD since 1988, according to Securities Arbitration Commentator Inc., a Maplewood, N.J., legal publishing and research firm.

“We are disappointed with the decision, which we believe is not supported by the facts or law, and we are reviewing our options,” Danielle Romero-Apsilos, a spokeswoman for Citigroup, said in an e-mailed statement.

The Securities and Exchange Commission has questioned former Citigroup brokers as part of a probe into whether the bank misled investors about risks associated with certain debt funds, people familiar with the matter said last year. Citigroup disclosed the inquiry into the MAT and ASTA funds in August 2008, after the funds tumbled to values ranging from 10 cents to 60 cents on the dollar amid souring credit markets early that year. The two funds had $15 billion in assets and about $2 billion in capital.

Arbitrators didn’t explain the reasoning behind their ruling. They ordered Citigroup to pay $21.7 million to patent attorney Gerald Hosier, $8.5 million to Brush Creek Capital LLC, which is owned by Hosier’s family, and $3.9 million to venture capitalist Jerry Murdock Jr., the ruling shows. The plaintiffs had accused the bank of breaching a fiduciary duty, contract violation, fraud, breaking Finra rules, and supervisory failures.

The bank must also pay the claimants’ $3 million legal fees, according to the ruling.

An arbitration panel of the Financial Industry Regulatory Authority in Denver awarded the investors $34.1 million in compensatory damages and $17 million in punitive damages in an order signed Monday.

Investors Jerry Murdock Jr. and Gerald Hosier filed claims with regulators in June 2009 over their losses in the MAT Finance and ASTA Finance funds launched by Citigroup Global Markets Inc.

The investors’ attorney, Philip Aidikoff, says Citigroup marketed the funds as being of little more risk than municipal bonds, when in fact they were far more risky.

Citigroup said Tuesday it is disappointed with the decision and is reviewing its options.

An arbitration panel of the Financial Industry Regulatory Authority in Denver awarded the investors $34.1 million in compensatory damages and $17 million in punitive damages in an order signed Monday.

Investors Jerry Murdock Jr. and Gerald Hosier filed claims with regulators in June 2009 over their losses in the MAT Finance and ASTA Finance funds launched by Citigroup Global Markets Inc.

The investors’ attorney, Philip Aidikoff, says Citigroup marketed the funds as being of little more risk than municipal bonds, when in fact they were far more risky.

Citigroup said Tuesday it is disappointed with the decision and is reviewing its options.

Three investors, including Brush Creek Capital, filed the claim in 2009, seeking damages related to MAT Five and several other municipal-bond hedge funds. Another investor, intellectual-property lawyer Gerald D. Hosier, is also a managing partner of Brush Creek Capital, a family investment company. The third investor, Jerry Murdock, is managing director and co-founder of Insight Venture Partners, a New York-based private-equity and venture-capital firm.

The MAT funds are in a series run by MAT Finance LLC, a name that refers to municipal arbitrage trusts. The funds, which have been the subject of a Securities and Exchange Commission probe, borrowed at low short-term rates and invested in longer-term bonds that paid higher rates. Three brokers who worked for a Citigroup unit contend the bank misled investors about how risky the funds were.

The $54 million ruling, entered Monday, includes $17 million in punitive damages. Awards of punitive damages are rare, lawyers say. The total includes $3 million in legal fees and $13,000 in costs. Citigroup must also pay interest and $21,600 to cover the entire hearing fee, which the panel typically splits between parties.

Lawyers for the investors weren’t immediately available for comment.

“We are disappointed with the decision which we believe is not supported by the facts or law and we are reviewing our options,” a Citigroup spokeswoman said in a statement.

Three investors — Gerald Hosier, Brush Creek Capital and Jerry Murdock — filed in June 2009, seeking $48.2 million of damages plus other relief related to their losses on three municipal bond arbitrage funds and three ASTA Finance funds sold by Citigroup Global Markets brokers.

The ruling, entered Monday, said Citi must pay nearly $34.1 million in compensatory damages. The panel also ordered the bank to pay $17 million in punitive damages, $3 million in lawyer fees and about $80,000 in other costs for an arbitration process spanning 23 hearing sessions since last October.

“We are disappointed with the decision, which we believe is not supported by the facts or law, and we are reviewing our options,” Citi spokeswoman Danielle Romero-Apsilos said in an emailed statement.

Citigroup sold a series of funds through an entity called MAT Finance LLC; MAT stands for municipal arbitrage trust. These funds borrowed at low short-term rates and invested proceeds in longer-term muni bonds.

The strategy backfired when credit markets broke down in 2007, leaving investors with losses of as much as 80 percent.

These funds, which were marketed as alternatives to municipal bond funds, are the subject of a U.S. Securities and Exchange Commission probe, and have cost Citi dearly across a number of recent rulings.

In February, a Florida panel awarded an investor $6.4 million, which until now was the largest award related to these funds, plaintiff lawyers said.

Craig McCann of Securities Litigation and Consulting Group, a firm that provides expert witness testimony for investor litigation, said Citi customers have so far prevailed in 12 out of 13 Citigroup MAT cases and have recovered $70 million.

Citi’s shares were up a penny at $4.54 in afternoon trade.

There is no guarantee the panel’s decision will be final.

Hosier is an intellectual property lawyer and a managing partner of Brush Creek, a family investment firm. Murdock is a founder of New York investment firm Insight Venture Partners.

ARBITRATION: $54,105,616.

CASE/NUMBER: Gerald D. Hosier, individually, and as trustee of the Gerald D: Hosier, U/A/D 10/4/99; Brush Creek Capital LLC; Jerry Murdock Jr. v. Citigroup Global Markets Inc. / 09-03297.

COURT/DATE: FINRA/ April 18, 2011.

ARBITRATOR:  Malcolm T. Cleland.

ATTORNEYS: Claimant- Philip M. Aidikoff, Ryan K. Bakhtiari (Aidikoff, Uhl & Bakhtiari, Beverly Hills); Steven B. Caruso (Maddox, Hargett & Caruso, PC, New York,  N,Y.).

Respondent- H. Nicholas Berberian, Patrick G. King, Tina L. Winer (Neal, Gerber & Eisenberg LLP, Chicago, IL.).

FACTS: Gerald Hosier, Brush Creek Capital LLC, and Jerry Murdock entered into arbitration with Citigroup Global Markets Inc., regarding multiple investments in various municipal bond hedge funds.

CLAIMANTS CONTENTIONS:  Hosier, Brush Creek, and Murdock alleged breach of fiduciary duty, breach of contract, constructive fraud, unsuitability, failure to supervise, and respondeat superior .

RESPONDENTS CONTENTIONS:  Citigroup denied the allegations, asserting various affirmative defenses.

DAMAGES: The Net Out of Pocket (NOP) loss in this case as presented to the panel was $26,893,945 and the market adjusted damages were $34,058,948.

RESULT: The panel awarded full market adjusted damages plus $17,000,000 in punitives, $3,000,000 in attorney fees, $33,500 in expert witness fees, $13,168,in court reporter costs, and assessed forum fees of $26,100 against respondents .

ARBITRATORS: Malcom T. Cleland, Marc H. Schtul and Patricia M. Vondra.

The ruling by arbitrators at the Financial Industry Regulatory Authority, which oversees U.S. brokerages, includes $17 million in punitive damages, according to a copy of the panel’s decision on Finra’s website. It’s the third-largest arbitration award by Finra and predecessor NASD since 1988, according to Securities Arbitration Commentator Inc., a Maplewood, New Jersey-based legal publishing and research firm.

“We are disappointed with the decision, which we believe is not supported by the facts or law, and we are reviewing our options,” Danielle Romero-Apsilos, a spokeswoman for the New York-based bank, said in an e-mailed statement.

The U.S. Securities and Exchange Commission has questioned former Citigroup brokers as part of a probe into whether the bank misled investors about risks associated with certain debt funds, people familiar with the matter said last year. Citigroup disclosed the inquiry into the MAT and ASTA funds in August 2008, after the funds tumbled to values ranging from 10 cents to 60 cents on the dollar amid souring credit markets early that year.

Arbitrators didn’t explain the reasoning behind their ruling. They ordered Citigroup to pay $21.7 million to patent attorney Gerald Hosier, $8.5 million to Brush Creek Capital LLC, which is owned by Hosier’s family, and $3.9 million to venture capitalist Jerry Murdock Jr., the ruling shows. Among their claims, plaintiffs had accused the bank of breaching a fiduciary duty, contract violation, fraud, breaking Finra rules and supervisory failures.

‘Very Significant Award’

“It’s a very significant award,” said Phil Aidikoff, a partner at Aidikoff, Uhl & Bakhtiari, a Beverly Hills, California-based law firm that helped represent the claimants. “The panels are clearly recognizing that even though all of these customers were wealthy sophisticated people, they’ve been lied to about this particular investment.”

The funds used short-term borrowings to fund purchases of long-term municipal bonds, said Craig McCann of the Securities Litigation & Consulting Group, a Virginia consulting firm, who worked as an expert witness for the plaintiffs.

“It was sold as having just a little bit more risk than an unlevered municipal bond portfolio,” said McCann. “It wasn’t just a little bit more risky, it was a lot more risky.”

Citigroup said in a regulatory filing last month that “several” investors in funds including MAT and ASTA had filed lawsuits and arbitration claims against the bank, and that many of the disputes are already resolved. The SEC is examining the marketing, management and accounting treatment of the funds, the company said, adding that it is fully cooperating.

The bank, run by Chief Executive Officer Vikram Pandit, 54, since December 2007, must also pay the claimants’ $3 million legal fees, according to the ruling.

Those funds – including MAT Two LLC, MAT Three LLC and MAT Five LLC – have been the subject of numerous investor lawsuits and a U.S. Securities and Exchange Commission investigation.

A FINRA panel ruled Citigroup Global Markets must pay compensatory damages of $21.7 million to Hosier, $8.5 million to Brush Creek and $3.9 million to Murdock. The ruling also requires the company to pay $17 million in punitive damages and more than $3 million for the claimants’ attorneys’ fees and other court costs.

“We are disappointed with the decision, which we believe is not supported by the facts or law, and we are reviewing our options,” a Citigroup spokeswoman said in an emailed statement Tuesday.

Attorneys for the claimants did not immediately respond to requests for comment.

The latest award is the largest by far that FINRA has granted in the matter of the MAT funds.

In February, an arbitration panel slapped Citigroup subsidiaries with a $6.4 million judgment in a case brought by Vector Securities LLC Chairman and CEO Theodore Berghorst and funds he controlled.

Berghorst claimed Citigroup said the MAT funds would be closely monitored in accordance with a sophisticated risk management strategy that would minimize risk or losses. Despite assurances the funds were secure and low-risk, the funds in fact lost a significant amount of money, he said.

In December, another award was made to five Tennessee investors who claimed the hedge funds caused them to suffer “catastrophic losses.”

The claimants in that case – Bertram E. Barnett Jr., Robert L. and Kathy C. Cockroft, Allen R. Graber, Bittjal Partners and Robert R. Yarbrough – received $2.4 million.

The claimants in the current matter are represented by Aidikoff, Uhl & Bakhtiari and Maddox Hargett & Caruso PC.

Citigroup is represented by Neal Gerber & Eisenberg LLP.

The case is In the Matter of the Arbitration Between Gerald D. Hosier et al. and Citigroup Global Markets Inc., case number 09-03297, in the Financial Industry Regulatory Authority.

The award by an industry arbitration panel is the largest ever levied against a major Wall Street brokerage in favor of individual investors, according to the Securities Arbitration Commentator Inc., a newsletter in Maplewood, N.J.

As is customary, the arbitration panel, which is under the auspices of the Financial Industry Regulatory Authority, didn’t explain its reasoning for the award. But the penalty was aggressive, including an order for Citi to pay $17 million in punitive damages and $3 million in legal fees, among other expenses.

The payments were awarded to investors Jerry Murdock Jr., 52, a venture capital investor, and Gerald D. Hosier, 69, a retired patent attorney.

Citigroup said in a statement, “We are disappointed with the decision, which we believe is not supported by the facts or law.” It also said it is reviewing its options, which include going to the courts with an appeal.

The award is just the latest problem to spring from Citigroup’s municipal bond funds. The bond funds are also the subject of Securities and Exchange Commission probe, according to people familiar with the matter. The SEC is investigating whether the bank misled investors by failing to disclose the funds’ risks.

With a minimum investment of $500,000, the bond funds aimed to deliver returns a few percentage points higher than municipal bonds by borrowing as much as $7 for every $1 invested, putting the proceeds in municipal bonds and mortgage debt. But they plummeted in value when the mortgage market crumbled starting in mid-2007.

Thomas Stipanowich, a law professor at Pepperdine University law school in Malibu, Calif., called the panel’s action “a significant statement, a bold use of a variety of remedial tools to vindicate the rights of an individual investor.” Citigroup, for example, must pay $21,600 for the entire hearing fee expense, which panels typically split between parties.

Messrs. Hosier and Murdock, who are neighbors in the Aspen, Colo., had the same broker at Citi’s former Smith Barney unit. The broker, Richard Zinman, left the firm shortly after the funds blew up.

Mr. Zinman testified for his former clients during the arbitration hearing in Denver last month that the funds, which were designed for wealthy investors, proved to be more volatile and risky than Citi officials had told its brokers, according to Philip M. Aidikoff, the investors’ lawyer.

Mr. Zinman referred calls to a spokesman for Credit Suisse Group, where he now works. The spokesman declined to comment.

After a storm of protest by Citi brokers, Citi officials offered share buybacks that reduced investors’ losses to about 61%.

The largest previous award to individuals under arbitration procedures, which are mandatory in most Wall Street customer agreements, was a $20.2 million award to a group of individuals against Ameriprise Financial Inc. in 2006 related to the sale of variable annuities and mutual funds.

Big brokerage firms have been ordered to pay out larger sums to corporate investors, such as a $406.6 million award in 2009 against Credit Suisse in favor of STMicroelectronics NV in a case involving losses on auction-rate securities. Credit Suisse is appealing that award.

Mr. Aidikoff estimated that investors have prevailed in three quarters of the roughly 20 claims against the Citigroup funds that arbitration panels have decided. The largest previous award to a Citi bond-fund claimant was for $6.4 million.

Securities regulators have broadened their probes into whether Wall Street sold a complex type of bond without fully disclosing the drawbacks to individual investors.

Known as “reverse convertible notes,” the product pays interest but also is tied to the performance on an underlying stock, so if the stock tumbles, investors can lose big chunks of money.

The Securities and Exchange Commission is investigating whether Wall Street firms that developed the bonds failed to adequately disclose the risks and fees to investors before they bought the notes, according to people familiar with the situation. They also are examining the disclosure of potential conflicts of interest, such as a bank selling a note linked to the stock of a company it is advising. Meanwhile, the securities industry’s self-regulatory organization, the Financial Industry Regulatory Authority, is likely to impose by this summer a large fine against a brokerage firm for improperly selling reverse convertible notes, people familiar with the matter said.

The securities firms being targeted by Finra couldn’t be determined, and it isn’t clear if the SEC’s probe will result in civil charges against underwriters or sellers of the notes. But the investigations are the latest sign that regulators are zeroing in on possible wrongdoing by brokerages amid booming sales of complicated derivatives packaged for mom-and-pop investors.

Last year, sales of retail structured products hit a record $52 billion, up 53% from $34 billion in 2009, according to industry database StructuredRetailProducts.com. Investors have flocked to reverse convertible notes because they generally offer potentially eye-popping returns over a short time period. Instead, some investors suffered steep losses because the stock to which their bonds were pegged tumbled in value.

The SEC’s investigation is being conducted by a special enforcement unit in charge of structured and new products. A spokesman for the SEC and a spokeswoman for Finra declined to comment.

Securities firms churned out reverse convertible notes as a way for investors to outperform skimpy interest rates. The bonds pay a fixed interest rate and guarantee to return the investor’s initial investment after a specified period, unless the linked stock falls below a certain threshold. If that happens, the notes often pay back just a fraction of the original investment.

Keith Styrcula, chairman of the Structured Products Association, a trade group, defends the product. He said most reverse convertible notes work exactly as intended and are “less risky than common stock in most cases.”

The reverse convertible notes are created by a number of Wall Street banks, and sold by most major brokerage firms. The SEC’s investigation includes reverse convertible notes issued last year by J.P. Morgan Chase & Co. and Barclays PLC, according to people familiar with the matter. SEC officials have asked for information on notes that were tied to the performance of shares in recording-device maker TiVo Inc., these people said.

The total return on the TiVo notes was less than $600 per $1,000 invested. TiVo shares plunged after the company lost a court ruling last May in a long-running patent dispute. A TiVo spokeswoman declined to comment. The company had no involvement in creating the notes, a person familiar with the matter said.

The prospectuses for the notes each contained disclosures on risk factors, but didn’t refer to the pending TiVo court ruling. Craig McCann, founder of Securities Litigation & Consulting Group Inc., a Fairfax, Va., consulting firm that offers expert testimony on behalf of investors and regulators, said the ruling “was almost certain to make the difference between profit and significant losses for the investors.”

J.P. Morgan and Barclays declined to comment. Officials of the two banks have told SEC investigators that the reverse convertible notes were put together at the request of wealthy investors who wanted to bet on the patent dispute, according to the people familiar with the matter.

Dr. McCann calculated that the stock prices in 28% of the 1,255 reverse convertible notes issued by Barclays last year fell below the “trigger level” that can result in losses for investors. About 15% of such deals by J.P. Morgan fell below that level, he said.

“Reverse convertible notes are being sold as if they were just another type of bond, and they’re nothing like a bond,” said Philip Aidikoff, a partner at Beverly Hills, Calif., law firm Aidikoff, Uhl & Bakhtiari who has represented investors in arbitration claims against brokerage firms that sold the notes. “People looking for a higher income are being sold these terribly complex, high-cost products that can land them with a stock that’s going through the floor when they don’t even want to be in equities.”

Others point out that the products have proved profitable for many investors. More than 80% of the reverse convertible notes that paid out last year left investors with a profit, according to a review by StructuredRetailProducts.com, and the average total return was about 4.5%. By comparison, the S&P 500 index-which doesn’t have the notes’ built-in protection against some falls in stock values-produced an overall return last year of about 15%.

“Part of the reason reverse convertibles are so popular now is that many investors are having a positive experience with them,” Mr. Styrcula of the structured products trade group said.

Finra last year fined Ferris Baker Watts LLC, now part of Royal Bank of Canada, and H&R Block Financial Advisors, now owned by Ameriprise Financial Services Inc., for inappropriate sales of reverse convertible notes. The firms didn’t admit or deny wrongdoing.

Securities America Inc. scored a huge legal victory this morning when a federal judge in Dallas halted three upcoming Finra arbitration cases against the firm and its brokers over the sale allegedly bogus private placements.

Judge W. Royal Furgeson Jr. of U.S. District Court for the Northern District of Texas instead combined the arbitration hearings with two class actions.

He ordered Securities America, which is owned by Ameriprise Financial Inc., to create a $21 million settlement fund for investors suing the firm in those class actions, which stem from the sale by Securities America brokers of private-placement notes from Medical Capital Holdings Inc. and Provident Royalties LLC

The ruling is significant to Securities America in that it helps to limit the broker-dealer’s liability in the private-placement cases.

In total, Securities America sold about $700 million of Medical Capital notes and $18 million of Provident shares, according to court documents. (Click here for a breakdown of B-D sales of Provident, as well as commissions booked on these sales.)

Mr. Furgeson placed a temporary restraining order on three Financial Industry Regulatory Authority Inc. arbitration claims proceedings against Securities America, which were to start over the next two weeks. The investors were seeking $4.8 million in damages for buying private placements issued by Medical Capital and Provident, both of which the Securities and Exchange Commission charged with fraud in 2009.

“We are pleased that the judge is willing to consider the agreement reached by the parties,” wrote Janine Wertheim, a spokeswoman for Securities America. “We believe this represents good progress as we pursue a resolution to this matter.”

Many plaintiff’s attorneys had dreaded Judge Ferguson’s decision, fearing that the amount of money their clients could receive from a class action settlement would be far less than what they could win in an individual arbitration.

A plaintiff’s attorney representing Securities America investors blasted the decision. “In my opinion, it’s a corrupt settlement,” said Ryan Bakhtiari, a partner at Aidikoff Uhl Bakhtiari. “It strips the rights of the investors to arbitrate claims and have claims heard by arbitration panels. Instead, they could receive a payment of pennies on the dollar” for their claim, he said. He added that his clients will appeal the settlement.

Ms. Wertheim did not respond to a phone call seeking comment about Mr. Bakhtiari’s statement.

Securities America is by the largest independent broker-dealer that sold Medical Capital and Provident notes. It has about 1,900 reps and advisers and generated close to $500 million in fees and commissions last year.

On Dec. 31, a Finra arbitration panel awarded almost $1.2 million in damages and legal fees to a client who sued Securities America and a broker over the sale of Medical Capital private placements. The firm was facing up to 150 Finra arbitration claims over the next 12 to 18 months, lawyers said in January.

Mr. Furgeson’s reasoning in halting the arbitration cases against Securities America is similar to his decision last month to halt arbitration claims against Capital Financial Services Inc., another broker-dealer that was part of a class action involving the sale of the same private placements. In that case, the firm’s pot of money from excess net capital and insurance was extremely limited, about $1.5 million, so arbitration cases against it had to be halted to protect plaintiffs in the class action, Mr. Furgeson argued.

The decision today is similar regarding the claims against Securities America, and the order is a way to protect the pot of potential money available to all investors, not only those who were first in line through securities arbitration.

“If the arbitration were to proceed, it would expend funds for legal defense that would otherwise be made available to class members,” Mr. Furgeson wrote in his order. “Additionally, if the claimants in these arbitrations are fully successful, they could receive a significant portion of the funds available to potential class members under the proposed settlement agreement.”

The judge wrote: “Should the arbitration be temporarily restrained, funds that would otherwise be equitably distributed to members of the potential settlement class would not be depleted.”

About 20,000 investors bought Medical Capital notes through dozens of independent broker-dealers, but it is not known how many have filed arbitrations against those firms.

Mr. Furguson ordered a hearing about the motion for March 3.

The award by a divided securities arbitration panel represented a partial victory for the investors, who included D. Theodore Berghorst, chairman and chief executive of Vector Securities LLC in Deerfield Ill. The group originally asked for $12 million in damages from Citigroup Global Markets Inc. and Citigroup Alternative Investments LLC in 2008 for losses in a series of funds, run by MAT Finance LLC, that lost as much as 80% between 2007 and 2008.

The claimants, which included various trusts and limited-liability companies, alleged civil fraud, misrepresentation and breach of fiduciary duty, among other things, according to a Financial Industry Regulatory Authority securities arbitration panel ruling dated Monday.

Citigroup Global Markets is responsible for paying 75% of the total $6.4 million ruling while Citigroup Alternative Investments must pay the rest, according to the Finra panel ruling. It is among the largest awards involving the MAT Finance funds.

The chairman of the three-person arbitration panel dissented in the ruling without explanation. Dissents are unusual in arbitration cases, say lawyers, and can provide a basis for a claimant for trying to overturn a ruling in court.

As occurs in most securities arbitration awards, the Finra panel didn’t spell out details of the case or the reasoning behind its decision.

Mr. Berghorst and his lawyer didn’t return calls requesting comment.

MAT Finance short for municipal arbitrage trust, is the subject of a Securities and Exchange Commission probe, as reported by The Wall Street Journal in November. The funds were sold to high-net-worth investors through Smith Barney, then Citigroup’s retail brokerage. They borrowed at low short-term rates and invested in longer-term bonds that paid higher rates.

Despite their risks, the funds were marketed as an alternative to municipal-bond portfolios, according to Ryan Bakhtiari, a lawyer for Aidikoff Uhl & Bakhtiari in Beverly Hills, Calif., who has been representing investors in other cases involving the funds.

A Citigroup spokesman said the company is “disappointed with this award and point to the panel Chairman’s dissent.”

Mr. Bakhtiari contended that the dissent isn’t significant. He noted the only arbitrator on the panel who works in the securities industry sided with the investors. “It’s a sure sign that Citi will continue to lose,” he said. “If they can’t persuade the industry, where do they have left to go?”

Previously, in cases with three arbitrators (those involving claims over $100,000), the panels have been made up of two public arbitrators and one “non-public” arbitrator – somebody with a connection to the securities industry. Finra proposed the rule in October after a 27-month pilot program that allowed certain investors the option of having only public arbitrators hear their cases.

Under the new rule, investors can still choose to have a non-public arbitrator on the panel.

“For us, this is really pretty historic,” says Linda Fienberg, president of the Financial Industry Regulatory Authority’s dispute resolution program. “It’s the most historic of the rule changes we have done since I got to Finra in 1996.”

Some, but not all, investor advocates have criticized the arbitration process for being unfair. They note that many investors at least perceive arbitrators as being biased, largely because Finra, which manages the arbitration forum, is sponsored by the brokerage industry.

Finra says it believes giving investors the ability to have an all-public arbitration panel “will increase public confidence in the fairness of our dispute resolution process,” according to a press release announcing the SEC’s approval of the rule.

Fienberg says that “non-public,” or industry-affiliated, arbitrators can include registered individuals or attorneys or accountants who represent the industry. Public arbitrators can be anyone with five years of financial or business experience and can cover such professions as high school teachers, journalists, engineers and doctors.

Investors participating in the pilot program chose the option of all-public arbitrators about 60% of the time. Investors also frequently opted to use a non-public arbitrator, but the ability to choose between the two options improved their perception of the process, Finra says.

Among the 20 awards issued by all-public panels under the pilot program, investors were awarded damages in 13 of 19 cases, or 68%. The parties settled the remaining case.

Of all the cases that were decided by arbitrators in 2010, 47% awarded damages to investors, up from 43% in 2005.

“So far the data show that customers are prevailing more often with an all-public panel, but there just aren’t enough awards to have any significance yet,” says Fienberg.

Only 22% of investor claims were decided by arbitrators last year. About 60% were settled and the rest were withdrawn or resolved in other ways.

Ryan Bakhtiari, who represents investors in arbitration claims and is a partner at Aidikoff, Uhl & Bakhtiari, says the new rule is a big step toward leveling the playing field for investors in securities arbitration.

He likens the inclusion of non-public arbitrators on securities arbitration panels to doctors’ deciding medical malpractice claims.

“Today, customers have a choice,” says Bakhtiari. “It’s a big structural change.”

While Bakhtiari praised Finra for the change, he says that the self-regulatory organization needs to go a step further and tighten the definition of “public arbitrator.” There are “too many industry types that are creeping their way into the public pool,” he says. “There are loopholes that need to be closed.”

There are currently 3,521 public arbitrators and 2,808 non-public arbitrators, according to Finra’s website. Finra added arbitrators across the board in recent years, in part because it anticipated making the option of an all-public panel permanent after the pilot program, says Fienberg.

Finra pays public and non-public arbitrators an honorarium of $200 per hearing session.

Finra also faced a shortage of arbitrators in the South in the wake of hundreds of claims filed against brokers by investors in several Morgan Keegan bond funds.

“We have more than enough arbitrators even if all of the investors were to choose an all-public panel,” says Fienberg.

Results of the pilot program suggest that one potential drawback of having an all-public panel is the arbitrators take longer to decide claims. Pilot program cases with all-public panels took about two months longer to wrap up than the claims decided by panels with one non-public arbitrator (this includes both those cases that were part of the pilot program and those that were not).

Some in the industry are concerned about arbitrators’ level of knowledge.

“My view is that arbitration panels are better informed about the securities industry if there is an industry arbitrator, and having an industry arbitrator doesn’t create any lack of fairness because that person is only one of three arbitrators on a panel and cannot control the outcome,” says Hardy Callcott, partner at Bingham, in an e-mail response to questions.

Industry observers also note the possible connection between the SEC’s speedy approval of Finra’s proposed rule and the Dodd-Frank mandate that the SEC conduct a review of securities arbitration. The law gives the SEC the power to prohibit mandatory pre-dispute arbitration clauses in agreements between brokers and clients. Nearly all broker-dealers currently require their customers to sign a mandatory arbitration clause, meaning those customers must settle disputes through Finra rather than in court.

There is no deadline on the SEC’s review of securities arbitration.

Jill Gross, professor of law at Pace University School of Law, says the SEC review meant Finra could not justify a non-public arbitrator on all three-arbitrator panel cases.

“I predict that the SEC’s Dodd-Frank study of Finra arbitration will now conclude that this latest reform enhances the fairness of the forum,” writes Gross in a law blog post. “As a result, the SEC will refrain from prohibiting mandatory securities arbitration.”

Fienberg says the new rule has been a long-term goal for Finra and has nothing to do with the SEC’s review of securities arbitration.

The new rule applies to all investor cases requiring a three-arbitrator panel in which arbitration lists have not been sent as of Jan. 31.

Five Memphis-based investors filed the claim in 2009, seeking damages related to MAT Five, which is among a series of funds, MAT Finance LLC, short for municipal arbitrage trust. The funds, which are the subject of a Securities and Exchange Commission probe, borrowed at low short-term rates and invested in longer-term bonds that paid higher rates. The Wall Street Journal reported the SEC probe in a story on Nov. 8.

Citigroup Global Markets, Inc. was accused by the investors of misrepresenting the fund’s risk and breaching its fiduciary duty, among other allegations, according to a Finra panel ruling dated Dec. 1. The $2.43 million fully compensates the investors for their out-of-pocket losses and interest they would have received if they invested in a municipal bond portfolio, according to their lawyer, Ryan Bakhtiari, of Aidikoff Uhl & Bakhtiari in Beverly Hills, Calif.

“It’s a very significant award,” he said.

Although bonds are generally less volatile than stocks, the MAT funds eventually borrowed more than $8 for every $1 invested, magnifying the risk from even small changes in the bonds’ value. The funds were typically sold to very high net-worth investors and marketed as an alternative to municipal bond portfolios, according to Bakhtiari.

The investors in the case purchased the funds in February, 2007 through Smith Barney, then Citigroup’s retail brokerage. Smith Barney and Morgan Stanley merged their brokerage operations in 2009.

As occurs in most securities arbitration awards, the Finra panel did not spell out details of the case or the reasoning behind its decision.

A Citigroup spokesman said that Finra panels “have reached inconsistent decisions on these claims, which we continue to believe are meritless.”

The awards, all decided by Financial Industry Authority Inc. arbitration panels in September and October include: Larry “J.R. Ewing” Hagman’s $11.5 million award vs. Citigroup Global Markets Inc.; Morgan Keegan & Co. Inc. losing a $9.2 million decision over its bond funds to 18 investors; and Lincoln Financial Advisors Corp. being handed a $4.4 million loss in a “selling away” case that involved about two dozen investors.

The three awards, totaling $25.1 million, came within 11 days of each other. Some lawyers and observers said they had never seen such a spate of arbitration awards before.

While a number of attorneys and industry observers say the list of huge awards – the Hagman award was one of the ten biggest in Finra arbitration history – is merely coincidence, others note that the timing of the decisions, two years after the financial collapse of 2008, should be expected.

“I’ve been noticing this all year,” said Rick Ryder, president of Securities Arbitration Commentator Inc., which publishes industry newsletters. A headline from an August newsletter read, in part: “It struck us that multimillion-dollar awards in arbitration have been issuing with some frequency.”

“The stakes are higher,” Mr. Ryder said in an interview, noting that an increase of institutions suing brokerage firms over auction rate securities and structured products have also amped up the number of multimillion-dollar claims.

The timing of the large awards was a coincidence, but there was no disputing that the dollar amounts are higher than in the past, said plaintiff’s attorney Ted Eppenstein, a senior partner at Eppenstein and Eppenstein PLLC. “The number of [investor] claims is higher, and the number of awards is higher. I think the process is becoming fairer,” he said, adding that that may lead to “decent awards” for claimants.

And Wall Street and securities firms facing investor lawsuits due to products that imploded will continue to lose, and lose big, attorneys said.

“I can’t remember these kinds of awards arriving at the same time before,” said Philip Aidikoff, Mr. Hagman’s attorney in the arbitration against Citigroup.

Mr. Hagman’s claim stemmed from unspecified securities in accounts he controlled and the purchase of a life insurance policy, according to the arbitration award. “We are disappointed and disagree with the panel’s finding, and are reviewing our options,” said Citigroup spokesman Alexander Samuelson.

Mr. Aidikoff said the biggest danger to broker-dealers potentially losing millions in arbitration stems not from rogue brokers but from investment products that soured or imploded during the downturn. “It’s just beginning on the product side,” he said, noting upcoming cases stemming from broker-dealers’ selling Medical Capital Holdings notes. “In product cases, the more you sell, the bigger the liability.”

Initial arbitration hearings for many of those investor claims against broker-dealers start in November and December, Mr. Aidikoff and other attorneys noted. Dozens, if not hundreds, of clients who bought Medical Capital notes are suing their broker-dealers.

On Oct. 5, Morgan Keegan lost a $9.2 million arbitration decision to lead plaintiff John J. Garrett and 17 other investors over losses in bond funds. Those funds, which have been the target of dozens of past investor complaints, were allegedly unsuitable because they invested in illiquid mortgage-backed loans and collateralized debt obligations.

Investors had asked for $10.5 million in damages. The $9.2 million award was the largest a Finra panel has decided against Morgan Keegan in the bond cases.

“We are certainly disappointed with the panel’s decision in the Garrett case and have filed a motion to vacate this award,” wrote Eric Bran, a Morgan Keegan spokesman in an e-mail to InvestmentNews.

Morgan Keegan has seen favorable results in arbitration, he wrote. “To date, 110 arbitration cases have been heard, with half resulting in outright dismissals of all claims against Morgan Keegan. Claimants in the 110 cases have sought approximately $88 million in compensatory damages and have received $21.7 million in awards.”

A three-person Finra panel ruled Sept. 27 that Lincoln Financial Advisors was “negligent in not preventing” the actions of Scott Gordon, who, while registered with the firm, was raising money from investors for an outside business.

“It’s a matter of corporate policy that we don’t comment” on arbitration decisions, said Eric Samansky, a spokesman for Lincoln.

Brokers have enjoyed having a say in the management of their own justice system ever since then, even getting to stack every three-person jury with an investment professional. So you’ve got to wonder what’s going on when regulators at the Financial Industry Regulatory Authority, whose paychecks come from Wall Street, are all of a sudden recommending something that would benefit investors in Finra’s courts: the option to have a panel that excludes brokerage employees.

You can think of the role of the so-called industry arbitrator the way you might if you sued me for libel and wound up with four very opinionated columnists on your 12-member jury, or one-third of the panel. When investors come to Finra with a claim that they’ve lost $100,000 or more, it’s mandatory to include a panelist from finance. Why would a clear-thinking person in the brokerage industry contemplate giving that up?

It’s a real head-scratcher when you consider that the status quo turns out to be an even better deal for Wall Street than we’d ever known. For the past two years, Finra has run a pilot program with 14 brokerage firms that agreed to give customers the option to ax the industry guy or gal from an arbitration panel.

Decision Record

At the end of two years, 23 cases had made it all the way through to a decision without first reaching a settlement. And guess what? Investors won half of the six cases where there was a finance person on the panel, but they scored in 12 of the 17 cases, or more than 70 percent, when the panel had nobody from Wall Street.

“The whole character of the proceeding changes when it’s an all-public panel,” said Seth Lipner, a Long Island, New York, lawyer who represented customers in two of the pilot cases where investors won decisions from Wall Street-free panels. Arbitrators “are more aggressive in wanting to know about the terrible stuff that happened,” he said.

Nancy Condon, a Finra spokeswoman, said in an e-mail that there are “too few awards to draw statistical conclusions.” Wall Street arbitrators aren’t involved in cases where investors claim to have lost less than $100,000 because a single public arbitrator decides those cases, she said.

Seeking Change

Finra this month will ask the Securities and Exchange Commission for a rule change to give investors the option of having their cases heard by panels without a financial industry representative, thereby making the pilot program permanent. The request reflects the Dr. Jekyll side of Finra’s dual personality as a self-regulator: it sometimes fulfills its charge to protect investors — thus, a pro-investor proposal — but often gets sidelined when the brokers that endow its budget push the agency toward light-touch regulation.

The SEC will seek public comment once it gets Finra’s proposal, and you can expect the usual suspects to weigh in.

Andrew De Souza, a Securities Industry and Financial Markets Association spokesman, said the group would like to see the full Finra proposal before passing judgment, but Sifma in the past has been clear about its soft spot for industry arbitrators.

In 2007, Sifma published a white paper that depicted arbitration as a fair process in which non-Wall Street arbitrators benefited from having a panelist associated with the securities business in part because — hold the guffaws –”they can serve to educate them” about things such as industry customs.

Fairness Concerns

Any benefits from that educational component seem to be going unnoticed by aggrieved investors. When two law professors sought out the opinions of arbitration participants in 2008, four out of 10 investors said they started out with concerns about arbitration before they even filed their dispute; by the time their arbitrations were done, six out of 10 had fairness concerns.

In spite of the obvious advantage Wall Street gets by having one of its own on dispute panels, there are political reasons that industry types might actually support Finra’s proposal: forces that are threatening mandatory arbitration altogether. The Dodd-Frank Act has the SEC looking into whether arbitration contracts are in the public interest; the Arbitration Fairness Act of 2009 had raised questions on the issue even before Dodd-Frank passed.

‘What’s Driving This’

If this pro-investor proposal goes through, the SEC will be better able to justify the preservation of mandatory arbitration, Wall Street’s prized license to stay out of court.

“That’s what’s driving this,” says Ryan Bakhtiari, a California lawyer who won $1.56 million for clients in two pilot cases where no Wall Streeters were on the panel.

Condon notes that the pilot program began in 2008, “before regulatory reform occurred,” and that the point of Finra’s proposal is to give “choice” to investors.

Another choice would be to let customers decide whether they want arbitration at all, opening the courts to injured investors. Don’t hold your breath to see a proposal like that make it to the SEC from Wall Street’s Finra cops.

Last week, Mr. Hagman, 79, got even once again. This time it was against his broker.

A securities arbitration panel awarded Mr. Hagman and his wife Maj, 82, a big victory against Citigroup, which had overseen some of the couple’s investment accounts. The three arbitrators who heard the case ordered Citigroup to pay the Hagmans $1.1 million in compensatory damages – slightly less than the $1.345 million they had requested – as well as $439,000 in legal fees.

But the kicker was the punitive damages award in the case, which accused Citigroup’s brokerage unit, Smith Barney, of fraud, breach of fiduciary duty and failure to supervise the broker overseeing the Hagmans’ funds. The panel ordered Citigroup to pay $10 million to charities chosen by Mr. Hagman.

The award was the largest given to an individual this year, according to the Financial Industry Regulatory Authority, which oversaw the arbitration. The Hagman award was also the only one in which a panel ordered that punitive damages go to charity, Finra said.

Finra has been recording arbitration awards for 21 years, and Mr. Hagman snared the ninth-largest amount ever awarded. A spokesman for Citigroup said that “we are disappointed and disagree with the panel’s finding and we are reviewing our options.”

That suggests that Citigroup – which said in its own defense that it wasn’t responsible for the losses – might seek to overturn the award. But arbitrations are rarely reversed. Moreover, it’s hard to imagine an award destined for charitable organizations being overturned.

So here’s what happened to the Hagmans: In 2005, they moved their account from a registered investment adviser to Lisa Ann Detanna, a broker at what is now Morgan Stanley Smith Barney. (When the couple first invested with Smith Barney, Citigroup still owned it; Citigroup sold a controlling stake in the brokerage to Morgan Stanley in 2009.)

According to documents produced in the Hagmans’ case, Ms. Detanna quickly began upending the couple’s portfolio, taking it from a conservative blend of 25 percent stocks and 75 percent fixed income and cash to the opposite: 75 percent stocks and the rest cash and bonds.

Never mind that when the Hagmans first sat down with Ms. Detanna, they told her they needed income-producing investments that would preserve their principal, according to the documents.

Ms. Detanna also sold Mr. Hagman a $4 million life insurance policy that required onerous annual premium payments of $168,000.

PHILIP M. AIDIKOFF, a lawyer at Aidikoff, Uhl & Bakhtiari in Los Angeles, represented the Hagmans in the case.

“Like most retail customers, Mr. Hagman trusted Morgan Stanley Smith Barney to do what they said they would do,” he said. “He told the broker that he and his wife were conservative and did not need to take any significant risk with the assets they were transferring. This knowledge of the conservative risk tolerance was confirmed over and over to my clients.”

When the market fell, Mr. Hagman’s lawyer argued, the account’s losses were far larger than they would have been had Ms. Detanna maintained the conservative portfolio. And the life insurance policy, which Mr. Hagman did not need and was therefore unsuitable according to his lawyer, generated losses of almost $437,000 when sold. The losses included an exit fee of $168,610, which Citigroup extracted when Mr. Hagman sold the policy.

Mr. Hagman, who recently returned from Europe, where he made personal appearances for “Dallas” fans, said he was surprised by the award but felt it was justified. “I hire people to take care of these things for me,” he said in an interview. “I felt a little bit taken advantage of.”

Documents produced in the case by Morgan Stanley Smith Barney confirmed that the firm had been advised repeatedly of the conservative nature of the Hagmans’ investment preferences. The firm also produced materials indicating that a portfolio mix dominated by equities, as the Hagmans’ portfolio was, does not qualify as conservative.

Nevertheless, Ms. Detanna piled the couple into stocks.

Much back and forth in the case focused on whether Don T. Davis, her manager in a Beverly Hills office, failed to supervise her properly. A broker who generates significant commissions for her firm, Ms. Detanna was named in June by Barron’s as one of the top 100 Women Financial Advisers in America.

A spokeswoman for the firm said that neither Mr. Davis nor Ms. Detanna would comment for this article and noted that the problems occurred when Citigroup controlled Smith Barney.

“The investment activity that was the subject of this arbitration occurred before Morgan Stanley Smith Barney came into existence,” she said.

A look at Ms. Detanna’s full regulatory record, however, shows nine customer complaints in addition to Mr. Hagman’s between 2000 and 2010. Of these 10 complaints, four resulted in awards or settlements, four were dismissed, one was withdrawn and one is pending. Regardless of their disposition, the sheer number of complaints should have raised flags for Ms. Detanna’s manager if he had followed his firm’s compliance rules, Mr. Aidikoff told the arbitrators.

Mr. Davis’s branch office manager compliance handbook, dated June 2006, states that a broker may require special supervision “if he/she has received three or more complaints and/or arbitrations in a rolling 12-month period or two complaints/arbitrations in a rolling six-month period.”

But in testimony during the arbitration, Mr. Davis conceded that he had never placed Ms. Detanna under increased supervision, even though her record indicated four complaints within a 12-month period in 2002 and 2003.

Notices to member firms published by Finra over the years also warned that managers should increase their oversight of brokers who are subjects of numerous complaints. And the number of complaints on Ms. Detanna’s record makes her a rarity in an industry where a tiny fraction of brokers receive even five. Mr. Aidikoff said he had never seen a compliance history as riddled with complaints as that of Ms. Detanna.

Such complaints are recorded in a C.R.D., or central registration depository. The arbitration panel overseeing the Hagman matter rejected Citigroup’s request that the decision in the actor’s case be removed from Ms. Detanna’s regulatory record.

Of course, there’s an obvious reason that some branch managers prefer not to admonish their big producers: They receive a portion of the hefty commissions that star brokers generate. Mr. Davis, the manager charged with overseeing Ms. Detanna, had such an arrangement, Mr. Aidikoff said.

Mr. Hagman said he was not sure which charities he’d designate as recipients of the $10 million award. Because his wife has Alzheimer’s, he said he would earmark some money to those working on a cure. “It’s an opportunity to do some good,” he said.

Mr. Aidikoff said he thought the unusual award reflected the panel’s view that the firm “refused to accept that broker supervision is really at the heart of the retail stock market.

“The message the panel is sending is, ‘You guys have to take your supervisory obligations seriously,’ ” he added. “And the only way to remind them of how important this is, is to hit them over with a punitive damage award.”

Or, as Mr. Hagman used to say in character on “Dallas”: “The world is littered with the bodies of people that tried to stick it to ole J. R. Ewing!”

Over the course of 15 hearing sessions in Los Angeles in August and September, Hagman, 79, and his lawyers told a panel of Financial Industry Regulatory Authority arbitrators how he came to lose $1.35 million while entrusting 20 accounts to a big-producing broker and one-time president of the Beverly Hills, California, Chamber of Commerce.

The broker, Lisa Detanna, put Hagman and his wife, Maj, now 82, into a life insurance policy with annual premiums of $168,000, according to the statement of claim. Until Oct. 8 she was the featured mentor on Morgan Stanley Smith Barney’s Women Financial Advisors Forum blog, which gives tips on pursuing a career as a broker.

In June, she was named to Barron’s “Top 100 Women Financial Advisors,” ranking 98th for overseeing $1.14 billion in assets for clients with a typical net worth of $15 million.

Detanna works in the joint venture of retail brokers run by Morgan Stanley and Citigroup’s Smith Barney. Only Citigroup Inc., not Detanna, was the respondent in the Hagman case. A woman answering the phone in Detanna’s office referred me to Alexander Samuelson, a Citigroup spokesman, who said “we are disappointed and disagree with the panel’s findings, and we are exploring our options.” He wouldn’t comment on the company’s Beverly Hills broker.

Moving Fast

Hagman and his wife, who have been married for 56 years, probably aren’t thinking of their one-time broker as a star today. When they filed their claim for a Finra arbitration in May 2009, they requested the expedited treatment that Finra allows for the elderly or seriously ill. Maj Hagman has Alzheimer’s disease, according to the claim.

The Hagmans told Detanna in 2005 that they needed income producing investments that would protect their principal, according to the claim. By June 2008, their accounts were about 69 percent invested in equities.

Finra arbitration often comes under justifiable fire for being too friendly with the securities industry and too chintzy in handing out awards to mutilated investors, but whatever happened behind the closed doors in this case apparently disturbed the arbitrators. On Oct. 6, the panel approved an award that would give $1.1 million to the Hagmans, $439,354 to their lawyers and $20,387 to reimburse them for witness costs.

Delivering a Doozy

Then this doozy: The arbitrators took the unusual step of ordering Citigroup Global Markets to pay $10 million in punitive damages to the charitable organization of the Hagman’s choice, citing Finra rules that allow punitive damages when there’s been “serious misconduct.” Punitive damages have been awarded in only about 3 percent of Finra arbitrations of claims above $25,000 in the past decade, says Richard Ryder of Securities Arbitration Commentator, which tracks trends in arbitration.

Citigroup asked the arbitrators to expunge references to the Hagman case from the official records that Finra keeps on Detanna. The arbitrators denied that request.

It wasn’t the first time a panel of arbitrators decided to keep an incident in her record open to the public, ignoring requests that it be erased.

In a case decided in October 2005, arbitrators said Morgan Stanley should pay $39,000 in compensatory damages to a complaining customer, and that two of the three brokerage employees named in the dispute would be allowed to have their records expunged. In the case of the third employee, Lisa Detanna, the expungement request was denied.

Desk Assistant

Detanna started her career in 1989 as an assistant on a trading desk at the now-defunct Drexel Burnham Lambert, moving on to jobs at Merrill Lynch, Dabney/Resnick/Imperial, and Morgan Stanley.

Her regulatory records with Finra show two settlements with complaining customers, four complaints that were denied by her employers, a pending customer case that seeks $2.5 million, and the Hagman case.

Separate records that Finra keeps on the outcomes of arbitrations reveal a race, gender, and disability discrimination complaint against Smith Barney, Detanna and one of Detanna’s colleagues in 2003. The arbitrators in that case told Citigroup Global Markets to pay awards to two of the five claimants, and dismissed the claims against Detanna and her colleague.

Alleged Breach

Morgan Stanley sued Detanna in April 2001. In a complaint filed in federal court in Los Angeles, the brokerage accused her of breach of contract after she left the firm for Citigroup. A judge declined Morgan Stanley’s request for a temporary restraining order against Detanna, saying the firm hadn’t shown evidence that she had illegally solicited the company’s clients.

As can only happen in the bizarre world of post-financial- crisis Wall Street, Detanna wound up working for Morgan Stanley again when it combined its retail brokerage business with Citigroup’s Smith Barney unit in June 2009.

When I called seeking a comment from Detanna, her office referred me to Samuelson, the Citigroup spokesman. But Samuelson said he couldn’t speak on behalf of Morgan Stanley brokers, referring me to a Morgan spokeswoman.

The Morgan spokeswoman, Tricia Nestfield, said “the investment activity that was the subject of this arbitration occurred before Morgan Stanley Smith Barney came into existence,” adding that the firm was “reviewing the matter.”

Detanna, the rising star, now is a hot potato.

Detanna, the former President of the Beverly Hills Chamber of Commerce, is the latest Hollywood hotshot to be hit with multi-million dollar claims. Bambi Holzer, another Beverly Hills-based broker, was profiled in a Forbes feature, “Beware of Your Broker,” for racking up similarly costly settlements. Whereas Holzer’s penalties of $11.6mil came as the result of 54 separate claims, however, Detanna has nearly accrued that much in a single case.

The $11.5mil arbitration sum against Detanna includes a whopping $10mil in punitive damages, to be paid to the charities of Hagman’s choice. Punitive damages, according to the Financial Industry Regulatory Authority’s Arbitrator’s Manual, are “not intended to right a wrong but are intended to punish the wrongdoer and to deter future wrongdoing.” Furthermore, the awarding of punitive damages indicate that Detanna engaged in “serious misconduct.”

Hagman’s claim, which was filed in late May of 2009, relates to the mishandling of unspecified securities, as well as the purchase of a life insurance policy, by Detanna and Citigroup. Hagman asserted that Detanna’s advisory group had breached written contracts and fiduciary duty, committed fraud by misrepresentation and omission, failed to supervise and control accounts, and violated laws and NASD/NYSE rules. A second claim against Detanna, with an unspecified claimant, alleges an additional $2.5mil in damages for unsuitable investments and failure to protect against losses.

Beware of your broker indeed.

Larry Hagman, who portrayed the rich fictitious oil baron Ewing in the CBS cult TV show “Dallas,” won an arbitration panel ruling in a securities case against a unit of Citigroup that will earn him $1.1 million and $10 million in punitive damages for charities of his choosing, the Wall Street Journal reported Friday.

The financial services giant also has to pick up $440,000 in legal fees and $20,000 in arbitration costs, according to the report.

In a May 2009 claim, Hagman alleged breach of fiduciary duty and civil fraud, among other things, related to securities held in Citigroup accounts and the purchase of a life insurance policy, the Journal said.

Citgroup told the Journal it disagrees with the ruling and is reviewing its options. Hagman’s lawyer declined comment, the paper said.

The ruling by a Financial Industry Regulatory Authority arbitration panel requires Citigroup to pay $1.1 million in compensatory damages to Hagman, punitive damages of $10 million to charities the actor will choose, and $440,000 in attorney’s fees.

In a May 29 claim, Hagman accused Citigroup of a breach of fiduciary duty, fraud by misrepresentation and omission, and other violations related to “unspecified securities,” and a life insurance policy.

“We are disappointed and disagree with the panel’s finding and we are reviewing our options,” wrote Citigroup spokesman Alexander Samuelson in an emailed statement.

In addition to his Dallas fame, Hagman played the astronaut Major Anthony Nelson on the 1960′s hit I Dream of Jeannie.

A call to Hagman’s attorney, Philip Aidikoff, was not immediately returned.

Mr. Hagman, along with various trusts and IRA accounts titled in his name, filed a claim in May 2009 against Citigroup Global Markets alleging breach of fiduciary duty, civil fraud, misrepresentation and other charges. The case was related to unspecified securities in accounts held with Citigroup and with the purchase of a life-insurance policy, according to the ruling.

As occurs in most securities-arbitration awards, the Financial Industry Regulatory Authority panel didn’t spell out details of the case or of the reasoning behind its decision. However, the $10 million awarded in punitive damages suggests a conclusion of serious wrongdoing.

Finra’s manual for arbitrators, which was cited by the three-person panel, allows punitive damages if a firm engages in “serious misconduct that meets the standard for such an award.” A 1995 U.S. Supreme Court case ratified Finra arbitrators’ authority to order punitive damages.

Mr. Hagman requested $1.3 million in compensatory damages, plus punitive damages, lost-opportunity costs and other relief, according to the ruling. The $11.6 million award includes $1.1 million in compensatory damages, and Citigroup must also pay $440,000 in legal fees and $20,000 in arbitration costs.

Punitive damages are ordered in a very small number of such cases, said William Jacobson, director of the Securities Law Clinic at Cornell Law School. He was unaware of another case in which a panel required the payment of punitive damages to a charity.

“Having them paid for some public purposes is an interesting concept. The panel just could have made the amount payable to the claimant,” he said.

“We are disappointed and disagree with the panel’s finding,” a Citigroup spokesman said in a statement. The company is reviewing its options, he said.

Mr. Hagman is best known for playing J.R. Ewing in the 1980s hit television series “Dallas,” and Major Anthony Nelson in “I Dream of Jeannie,” the 1960s television comedy.

In its ruling, the panel also declined to expunge a reference to the case in a public-disclosure document for Mr. Hagman’s adviser, Lisa A. Detanna, who works in a Beverly Hills, Calif.-based office of Morgan Stanley Smith Barney. Smith Barney-Citigroup’s retail brokerage-and Morgan Stanley merged their brokerage operations in 2009.

The disclosure, which mentions the docket number of Mr. Hagman’s case but not his name, refers to an allegation of mismanagement by “failing to protect…principal and investing in unsuitable securities from 2005 until 2009.” The case involved both listed and over-the-counter stocks, according to the disclosure.

A second arbitration case related to Ms. Detanna, alleging $2.5 million in damages, according to the disclosure report. The report doesn’t include the claimant’s name, but mentions allegations of making unsuitable investments and failing to take steps to reallocate investments to protect against losses.

Ms. Detanna didn’t return a phone call requesting comment. A Citigroup spokesman declined to comment on the disclosures.

Brokerage firms usually request to expunge information about arbitration claims from brokers’ public disclosure records, according to securities lawyers, and arbitration panels only approve the request in extreme cases, such as where there was a fundamental misunderstanding about the facts.

“Expungement is often requested and rarely granted,” said George Brunelle, a securities lawyer for Brunelle & Hadjikow, P.C. in New York who represents brokers.

Arbitration rulings involving celebrity claimants are rare, say lawyers. Many such cases settle before the proceedings end.

Philip Aidikoff, a Los Angeles-based lawyer who represented Mr. Hagman in the case, declined to comment.

The total award includes $10 million in punitive damages that Citi must pay to charities selected by Hagman, $1.1 million in compensatory damages and nearly $440,000 in legal fees.

Hagman, who also played astronaut Anthony Nelson in “I Dream of Jeannie” in the 1960s TV show, had requested $1.35 million in damages. He could not be reached for comment.

Hagman accused Citi in May 2009 of a breach of fiduciary duty and breach of contract, fraud by misrepresentation and omission, failure to supervise and violation of federal and state law, according to the ruling by an arbitration panel of FINRA, a self-regulatory body of the U.S. financial industry.

The allegations stemmed from unspecified securities held in Citi accounts, as well as the purchase of a life insurance policy.

Hagman received the unusually large award after the arbitrators found Citigroup Global Markets “engaged in serious misconduct,” meeting FINRA’s standards for punitive damages, the ruling said.

“We are disappointed and disagree with the panel’s finding and we are reviewing our options,” said Citigroup spokesman Alex Samuelson.

Hagman, who turned 79 last month, continues to appear on TV and in movies, including the 1998 political spoof “Primary Colors.” More recently he has played off his role as a Texas oilman to become a spokesman for a solar energy company.

According to Solar World, Hagman’s California home was the largest residential producer of solar power in the United States.

The total award includes $10 million in punitive damages that Citi must pay to charities selected by Hagman, $1.1 million in compensatory damages and nearly $440,000 in legal fees.

Hagman, who also played astronaut Anthony Nelson in “I Dream of Jeannie” in the 1960′s TV show, had requested $1.35 million in damages.

According to the ruling, Hagman accused Citi in May 2009 of a breach of fiduciary duty and breach of contract, fraud by misrepresentation and omission, failure to supervise and violation of federal and state law.

The allegations stemmed from unspecified securities held in Citi accounts, as well as the purchase of a life insurance policy.

Hagman received the unusually large award after the arbitrators found Citigroup Global Markets “engaged in serious conduct,” meeting FINRA’s standards for punitive damages, the ruling said.

“We are disappointed and disagree with the panel’s finding and we are reviewing our options,” said Citigroup spokesman Alex Samuelson.

Industry arbitration panels are not required to explain their rulings.

The actor Larry Hagman, who played the rapacious oil baron in the 1980s hit series “Dallas,” won $11.6 million in a securities arbitration case against Citigroup, according to a ruling from a Financial Industry Regulatory Authority panel.

The ruling against Citigroup Global Markets, released on Wednesday, includes $1.1 million in compensatory damages for Mr. Hagman and $10 million in punitive damages to be donated to the charities of Mr. Hagman’s choice. Citigroup must also pay about $460,000 in legal fees and other costs.

Mr. Hagman, along with two trusts and two individual retirement accounts in his name, filed the claim in May 2009. He alleged breach of fiduciary duty, breach of contract, fraud by misrepresentation and failure to supervise, among other things, related to unspecified securities held with Citigroup along with the purchase of a life-insurance policy.

The arbitrators did not explain their reasoning behind the award, but the ruling noted that punitive damages are typically awarded only in cases of “serious misconduct.”

Citigroup, for its part, issued a terse statement expressing its unhappiness with the ruling. “We are disappointed and disagree with the panel’s finding, and we are reviewing our options,” the statement said.

Mr. Hagman, 79, also played Major Anthony Nelson in the 1960s sitcom “I Dream of Jeannie,” but he is best known for his role in “Dallas,” which aired from 1978 to 1991. Earlier this year, he reprised his character in television commercials promoting solar energy.

A lawyer for Mr. Hagman did not immediately return a telephone message, and Mr. Hagman’s manager, Gene Yusem, said he did not have an immediate comment to issue on the actor’s behalf.

“He’s getting so many calls,” Mr. Yusem said.

A Financial Industry Regulatory Authority arbitration board ruled that Citigroup must pay $1.1 million in compensatory damages and must donate $10 million of punitive damages to charities of Hagman’s choice, according the ruling. The bank must also pay about $460,000 for Hagman’s attorney fees and other costs.

The arbitration board said it enforces punitive damages under its authority if a company “has engaged in serious misconduct,” according to the ruling. The board didn’t provide a reason for its decision.

“We are disappointed and disagree with the panel’s findings, and we are reviewing our options,” said Alexander Samuelson, a spokesman for New York-based Citigroup. Philip Aidikoff, one of Hagman’s lawyers, didn’t return a call for comment.

The claim, filed in May 2009, related to “unspecified securities” in Hagman’s accounts and the purchase of a life insurance policy. It was against the Smith Barney brokerage, which was held within Citigroup Global Markets before Morgan Stanley purchased a controlling stake in a joint venture with Smith Barney last year.

Hagman has appeared in movies and television shows for more than 50 years, according to the website IMDB.com. He played Anthony Nelson in the TV show “I Dream of Jeannie” and J.R. Ewing in the show “Dallas.”

Arbitrators from the Financial Industry Regulatory Authority found Citi liable in the case and directed the bank to pay Mr Hagman $1.1m in compensatory damages and $439,000 in legal fees.

The panel awarded $10m in punitive damages to the charities of Mr Hagman’s choice.

The award, revealed on Thursday, was one of the largest for Finra arbitrators, and comes as US regulators including the Securities & Exchange Commission seek to shore up public confidence in their willingness to protect investors. Finra is a self-regulatory body of the US financial industry.

A Citi spokesman said: “We are disappointed and disagree with the panel’s finding and we are reviewing our options.”

Mr Hagman alleged that Citi committed fraud and breached its fiduciary duty. The allegations involved unspecified securities he held at the bank and the purchase of a life-insurance policy, the three-person panel wrote this week.

The actor filed his complaint in May 2009, four months after Citi and Morgan Stanley agreed to fold their retail brokerage businesses into a joint venture.

The punitive award was the largest after a $15m settlement in 1999.

A spokesman for Mr Hagman said the actor had no immediate comment on the ruling and was not ready to name the charities that would receive donations.

The arbitrators denied Citi’s request to expunge all references from the case from the records of Mr Hagman’s financial adviser, Lisa Detanna.

According to Finra’s broker database, Ms Detanna works at the Beverly Hills, California, offices of Morgan Stanley Smith Barney.

A Morgan Stanley spokeswoman confirmed that Ms Detanna remained an employee and declined further comment.

The total award includes $10 million in punitive damages that Citi must pay to charities selected by Hagman, $1.1 million in compensatory damages and nearly $440,000 in legal fees.

Hagman, who also played astronaut Anthony Nelson in “I Dream of Jeannie” in the 1960s TV show, had requested $1.35 million in damages. He could not be reached for comment.

Hagman accused Citi in May 2009 of a breach of fiduciary duty and breach of contract, fraud by misrepresentation and omission, failure to supervise and violation of federal and state law, according to the ruling by an arbitration panel of the Financial Industry Regulatory Authority, a self-regulatory body of the U.S. financial industry.

The allegations stemmed from unspecified securities held in Citi accounts, as well as the purchase of a life insurance policy.

Hagman received the unusually large award after the arbitrators found Citigroup Global Markets “engaged in serious misconduct,” meeting FINRA’s standards for punitive damages, the ruling said.

“We are disappointed and disagree with the panel’s finding and we are reviewing our options,” said Citigroup spokesman Alex Samuelson.

Investor lawyers for the past year have been taking UBS to task for selling Lehman Brothers debt with such reassuring names as “100 percent principal-protected notes” that promised robust returns with no risk of loss. These Lehman-issued notes were largely wiped out when the U.S. investment bank went bankrupt in September 2008.

A string of arbitration losses over the past year may soon be followed by a round of state lawsuits, class actions and possibly intervention by the Securities and Exchange Commission and the Financial Industry Regulatory Authority.

“UBS is something of a house on fire right now,” said Jacob Zamansky, a New York lawyer who helped a South Carolina woman win the first Lehman note arbitration case last year. “They’re doing poorly in arbitration. What happens when FINRA and the SEC get involved?”

After Lehman, UBS was the largest seller of Lehman protected notes — zero-coupon Lehman debt linked to an index or a basket of other securities. These so-called structured products offer limited gains with the assurance that investors would get their money back if the linked securities fell.

UBS sold more than $1 billion of these structured notes.

Unfortunately for investors, these notes were ultimately just unsecured Lehman debt. UBS brokers continued to sell these notes to retail investors through 2008 even as Wall Street grew worried about Lehman’s financial strength.

“What we’ve learned is there were serious concerns inside UBS about these things, certainly during the spring of 2008,” said Phil Aidikoff, whose law firm Aidikoff, Uhl & Bakhtiari has represented investors.

FOLLOWED THE RULES

Lawyers representing dozens of cases and a few state officials contend the notes were unsuitable for small investors, who were lulled by the “principal protected” name.

UBS said it was “following all regulatory requirements, well-established sales practices and client disclosure guidelines” when it sold these notes. “Any client losses were the direct result of the unexpected and unprecedented failure of Lehman Brothers.”

So far, it appears arbitrators are siding with investors, who have prevailed in five of six rulings, according to FINRA arbitration documents.

In some cases investors are receiving full restitution — a rarity — and even legal and expert fees. Lawyers said UBS is now settling more of these cases outside of arbitration.

Soon, state and federal groups will join the fray.

The Swiss bank in its latest quarterly financial report warned it is named in class-action suits and “numerous” investor arbitrations, while also receiving inquiries from “state regulators and FINRA.”

New Hampshire led the charge in June 2009 when it became the first state to allege “unfair sales practices” and “recommending unsuitable investments” to more than 40 state residents.

“We believe ‘principal protection’ meant one thing to investors, but something entirely different to UBS,” Kevin Moquin, a New Hampshire attorney, said at the time.

Missouri, which took a lead role pursuing auction rate securities complaints, is one of several states that are also probing UBS and its Lehman note sales, Missouri Securities Commissioner Matt Kitzi said.

“These are complex products that investors are expressing some concern and confusion over,” said Kitzi.

Industry watchdogs have been slower to respond. FINRA in December advised brokers that promotional materials must not overstate the level of protection, though it stopped short of banning use of the term “principal protected.”

SEC staffers last month began examining how banks described risks of structured note offerings and whether “principal protection” was deceptive.

IMPACT

The potential damage to UBS could be significant in terms of both financial burden and reputation.

UBS recorded $900 million in charges related to auction rate securities, long touted as a high-yielding cash equivalent. These securities, of which UBS sold $22 billion, became impossible to sell when markets seized up in 2007.

State regulators two years ago said UBS continued selling these securities even as the bank’s executives privately worried markets were crumbling. UBS, like other banks, was forced to repurchase these securities from investors.

So far arbitrators seem to be taking a stern view of UBS. Notably, one investor received full restitution of $432,000 plus $53,000 in attorney fees.

“This was the panel’s way of telling UBS this was an egregious situation,” said Seth Lipner of Deutsch & Lipner, whose Garden City, New York, firm represented that investor and has filed more than a dozen cases.

Beyond the financial burden, the Lehman notes may put further strain on a brokerage hard hit by a series of market missteps and regulatory run-ins.

UBS suffered $52 billion of losses on ill-timed U.S. subprime markets, the biggest losses by a European bank during the credit crisis. UBS had to be bailed out by Switzerland.

Then there was news that U.S. authorities accused UBS of helping Americans hide assets overseas and avoid taxes, and clients left in droves.

The question is whether the Lehman cases will further strain a brokerage force that lost more than a thousand advisers over the course of a year, driven away by round after round of bad news.

“With UBS, it’s just one thing after another,” said Zamansky. “They’re like the BP of Wall street.”

Rex and Sherese Glendenning, of the Celina area in Texas, originally sought $1.4 million in the case they filed in February 2009, against Raymond James & Associates, a unit of Raymond James Financial Inc. (RJF) and Larry Milton, a broker associated with the firm in Fort Worth, Texas. They alleged breach of fiduciary duty, misrepresentation and civil fraud, among other things, according to a ruling by a Financial Industry Regulatory Authority arbitration panel.

The Finra panel ordered Raymond James and Milton to pay the Glendennings $925,000 in a ruling dated Aug. 20. The Glendennings must then sign the securities over to Raymond James, according to the ruling.

One of the three arbitrators on that panel that heard the case disagreed with the size of the award. “I believe the award to the Glendennings should be $1,400,000 instead of $925,000,” he wrote. Arbitration rulings, however, are generally still effective, as long as two of the three arbitrators agree.

The panel found both Raymond James and Milton liable for the couple’s damages, but didn’t include a reason for the decision–a practice that’s typical of arbitration rulings.

“We’re glad that the panel found Raymond James and Mr. Milton liable, but wish the majority would have agreed with the dissenting arbitrator in terms of the money awarded,” says Howard Klatsky, a Dallas-based lawyer who represented the Glendennings. The couple, he says, opened a Raymond James account to consolidate funds in numerous certificates of deposit. An estate planner suggested the strategy to make their finances easier to manage, he said.

Milton, the broker, purchased the auction rate securities, consisting of sewer revenue bonds, on behalf of the Glendennings in January, 2008, according to Klatsky. The couple never discussed auction rate securities or sewer bonds with the broker and spoke only about their preference to invest their money in CDs, he says.

A Raymond James spokeswoman declined comment. Milton didn’t immediately return a call requesting comment.

The auction rate securities market froze in February, 2008, leaving many investors stuck with illiquid investments that they initially thought were cash-like.

Dissents in which arbitrators object to not awarding investors 100% of the amount they claimed happen “from time to time,” says Philip Aidikoff, a Los Angeles-based attorney who represents investors.

It’s unusual, however, to find a broker liable in an auction rate case, says Aidikoff. His firm typically doesn’t name brokers in auction rate cases, he says, because many didn’t know the full story behind what they were selling, he says. The ruling against Milton could reflect possible actions that were revealed through testimony, he says.

The case marks the second time in slightly more than a month that Raymond James was ordered to buy back auction-rate securities. A Finra arbitration panel on July 19 ordered the firm to buy back $2.5 million in auction-rate securities from a customer who was acting as trustee for a revocable trust.

The clients had accused the New York-based bank’s global markets unit of breaching fiduciary duty and other misconduct tied to their investments in funds known as MAT Five and MAT Three, according to an Aug. 23 Financial Industry Regulatory Authority award. The three-member arbitration panel didn’t explain its reasoning for the ruling.

“The fund was represented by Citigroup to its brokers as a fixed-income alternative,” Ryan Bakhtiari, an attorney for the claimants at law firm Aidikoff, Uhl & Bakhtiari, said in a statement. “In truth, evidence at the hearing demonstrated that MAT was a risky investment.”

The ruling “is inconsistent with other decisions and we are disappointed that these claims were not dismissed,” Citigroup spokesman Alexander Samuelson said

In May, arbitrators dismissed a $1.5 million claim brought by another investor in the funds, according to decisions posted on Finra’s website. In two other rulings that month, arbitrators ordered the company to pay plaintiffs a total of more than $2 million.

This month, an investor arbitration panel awarded a California family $2.1 million, the full amount of its losses on a $3 million investment in a fund sponsored by First Republic Securities Co., formerly owned by Merrill Lynch & Co.

In May and June, three groups of investors in funds sold by Citigroup Inc. won a total of $2.1 million in separate arbitration proceedings. A spokesman for Citigroup, the largest sponsor of such funds, notes that three other investor claims were denied, which “supports our view the investments were appropriately sold.”

The awards are another indication of the protracted and costly cleanup under way on Wall Street in the aftermath of the financial crisis. These messes involve highly leveraged investments, which amplified losses when financial markets turned rocky.

Some of the cases raise a familiar question in many of the continuing investigations of Wall Street before and during the financial crisis: Were disclosures to investors by securities firms adequate?

The funds at issue were constructed by issuing tax-exempt short-term debt to buy longer-term municipal bonds that offered higher tax-exempt yields. The funds offered investors yields higher than municipal bonds by a few percentage points, according to lawyers for the investors. Then they attempted to use derivatives such as interest-rate swaps to hedge against adverse moves in both short- and long-term interest rates.

The Securities and Exchange Commission is examining the issue of whether fund sponsors including Citigroup understated the funds’ risk, according to people familiar with the situation. Federal prosecutors in the Eastern District of New York also are looking at the funds’ disclosures, according to people familiar with that probe. Spokesmen for the SEC and federal prosecutors declined to comment.

A spokesman for First Republic, which was sold by new Merrill owner Bank of America Corp. in a management-led buyout, said: “We strongly disagree with this finding, which is inconsistent with other legal decisions on this matter. We believe proper disclosure was made about the risks and rewards.” First Republic also noted that investors were experienced enough to understand the risks involved.

Still, when First Republic lawyers raised that argument in the arbitration, the hearing panel criticized the “glibness” of the funds’ managers and defense witnesses for their awareness of the fund’s “upsides,” such as higher yield and higher fees, without “any realistic advance recognition [of] any specific risks or patterns of risk.”

In marketing materials prepared for brokers and investors in 2006, Citigroup indicated its funds could invest $8 for every $1 put into the fund by its investors by borrowing the additional $7. The funds could borrow at a short-term rate of 3.3%, with the proceeds invested at the rate of 4.2% paid by long-term bonds. The strategy could boost investor returns to 8.6%, the marketing materials indicated.

Citigroup compared the funds’ risk to other bond “alternatives” such as high-yield or emerging-market bonds. But another page labeled “risk vs. reward” indicated that the strategy was three times as risky as a bond-market index and even riskier than a stock-market index.

Funds using such borrowing tactics controlled roughly $250 billion in municipal bonds by early 2008, according to Matt Fabian, an analyst at Municipal Market Advisors. At their peak, such funds owned roughly 10% of the $2.6 trillion in muni bonds outstanding, and routinely snapped up as much as one-third of all new issues, Mr. Fabian estimates. “They were able to buy bonds at more aggressive levels than anyone else,” he says.

The First Republic fund raised $34 million and acquired about $200 million of bonds, said Cary Lapidus, a San Francisco lawyer whose clients won the $2.1 million award.

One series of Citigroup funds raised $1.9 billion from investors between 2002 and 2007, invested in an estimated $15 billion in bonds and lost between 70% and 97% of their asset value by the end of February 2008, according to company documents. Citigroup stepped in to rescue the funds by investing more than $650 million of its own capital.

Counting quarterly distributions, representative investors had losses of 15% to 72% through March 2009, according to a person familar with the funds.

Bob Selan, a Calabasas, Calif., magazine publisher, invested $1 million in a Citigroup fund in 2006 through a broker at Smith Barney. Mr. Selan said it was presented as “a safe alternative” to bonds.

“The way it was explained to me, they were going to buy triple-A bonds and you were going to get a couple of extra percentage points,” Mr. Selan recalls.

But when the subprime crisis struck the bond markets in February 2008, municipal-bond prices plummeted amid forced sales. Leveraged funds had to post more collateral against the falling market prices of the bonds. Some funds were forced to liquidate.

By mid-2008, Mr. Selan noticed that his fund was down 15%. Eventually, he lost more than 50%. In May, an arbitration panel awarded him $550,504.96 plus interest-enough to make him whole on the investment.

Philip Aidikoff, a lawyer for Mr. Selan, said the firm has more than three dozen clients who had combined losses of more than $100 million in the Citigroup funds. Craig McCann, an expert witness who has testified for investors in a dozen such cases, estimates that Citigroup will have to pay out tens of millions in losses from such claims.

An Alabama state court has denied a request by Morgan Keegan & Co. to fully overturn a securities arbitration award entered in favor of an investor, disagreeing with the company’s arguments that an arbitrator was allegedly biased.

Judge Nicole Gordon Still, a civil division judge in Birmingham, affirmed a $220,000 award in favor of United Prison Ministries International in Verbena, Ala., which distributes free bibles and religious books to prisoners and their families. A Financial Industry Regulatory Authority arbitration panel awarded the sum in July 2009.

The claim was related to a family of bond funds steeped in mortgage-related holdings that suffered sizable losses in 2007 and 2008 when the housing bubble burst.

Morgan Keegan & Co., a unit of Birmingham-based Regions Financial Corp. (RF), filed the court case seeking to appeal the award shortly thereafter, as previously reported by Dow Jones Newswires. The brokerage argued that the panel’s chairwoman, who previously sat on another panel that ruled against Morgan Keegan, should have been recused, according to court documents.

Judge Gordon Still disagreed in a ruling made on Tuesday, saying there was “no specific instance” of the chairwoman “showing bias or prejudice against Morgan Keegan.”

“The mere fact that she has served on arbitration panels of Morgan Keegan, and has ruled against Morgan Keegan in the past, is not enough to establish bias or prejudice,” the judge wrote in an opinion.

Arbitration awards are typically binding. Federal arbitration law gives parties the right to appeal awards only under very limited circumstances, such as when arbitrators clearly ignore established law. Appeals are rarely granted, say lawyers.

The court did, however, agree to overturn a $20,000 award for expert fees that was calculated in error, according to the ruling.

“It’s a good victory,” says Debra Brewer Hayes, a lawyer in Houston, who represented the investor. “It’s very affirming that the judge did the right thing.”

Philip Aidikoff, a securities lawyer in Beverly Hills, Calif., says the arguments of alleged bias are “absurd.”

“It’s not unusual for a person on one panel to be chosen to sit on another panel,” he says, especially in a situation that involves so many investor claims. About 700 claims are pending against Morgan Keegan. “There is a limited number of people in each geographic pool to be selected for arbitration panels,” he says.

A Morgan Keegan spokeswoman says five awards appealed by the company have been decided. Courts have overturned awards in three of those cases, she says.

“Morgan Keegan appealed the case because we believed the panel was biased and that the award was inaccurately computed,” she says. “The court found our submission compelling and reduced the judgment rather than ordering a retrial.”

Mat Three was a leveraged municipal arbitrage hedge fund launched by Citigroup Global Markets, Inc. and sold through Smith Barney, part of Citigroup’s (NYSE: C – News) Global Wealth Management Group in February 2006 and was marketed only to high net worth clients of the firm.  The fund imploded in February 2008 causing catastrophic losses to investors.

“Despite widespread evidence of material omissions, Citigroup elected to employ the “blame the customer” defense which the FINRA panel rejected.  The award is the second significant investor win in a Mat case for clients of our firm in the last 2 weeks,” according to Philip M. Aidikoff.

“The fund was represented by Citigroup to its brokers as a fixed income alternative with the volatility of the Lehman Brothers Aggregate Bond Index,” stated Ryan K. Bakhtiari who added “In truth, evidence at the hearing demonstrated that Mat Three was a risky investment which subjected investors to a 100 percent or more loss of principal.”

The FINRA arbitrators also assessed the cost of the hearing against Citigroup Global Markets, Inc.

BEVERLY HILLS, Calif., May 12, 2010 – A Los Angeles based Financial Industry Regulatory Authority (FINRA) arbitration panel awarded more than $1.7 million to three clients of Aidikoff, Uhl & Bakhtiari and Maddox, Hargett and Caruso, P.C. in connection with their purchases of Mat Five.

Mat Five was a leveraged municipal arbitrage hedge fund launched by Citigroup Global Markets, Inc. and sold through Smith Barney, part of Citigroup’s (NYSE: C – News) Global Wealth Management Group in February 2007.  Mat Five was marketed only to high net worth clients of the firm.  The fund imploded one year later causing catastrophic losses to investors.

Despite widespread evidence of material omissions, Citigroup elected to employ the “blame the customer” defense which the panel rejected.  When confronted with evidence that Citigroup misrepresented Mat’s risk level to their brokers who passed the misleading information on to their clients, a high ranking Citigroup official said that it would be “unwise” for customers of the firm to rely on what their broker told them about a recommended investment.

“This award represents a return of our clients’ losses plus interest and is the first significant investor win in a Mat case,” according to Philip M. Aidikoff.

“The fund was represented by Citigroup to its brokers as a fixed income alternative with the volatility of the Lehman Brothers Aggregate Bond Index and LIBOR,” stated Ryan K. Bakhtiari who added “In truth, evidence at the hearing demonstrated that Mat Five was a risky investment which subjected investors to a 100 percent or more loss of principal.”

“Despite the representations to our clients, the evidence established that Mat Five was 2.5 times more volatile than the S&P 500 and 7.8 times more volatile than a traditional portfolio of municipal bonds.  This was not what our clients were told by their brokers,” according to Steven B. Caruso.

The FINRA arbitrators also assessed the entire cost of the hearing against Citigroup Global Markets, Inc.

The law firms continue to investigate and pursue FINRA arbitrations on behalf of investors who suffered losses in fixed income alternatives, including Mat/ASTA.

LPL Investment Holdings Inc. and Pacific Life Insurance Co. are staring each other down over which firm will have to pony up the potentially millions of dollars in claims stemming from fraud suits against a rogue broker from one of the three independent-contractor firms LPL acquired from Pac Life two years ago.

Veiled references to the quarrel first surfaced this month in official filings.

Last week, in its quarterly earnings report to the Securities and Exchange Commission, LPL said that it was in dispute with an unnamed third-party indemnifier “in connection with various acquisitions.”

Until now, the report said, the “indemnifying party” defended and paid “for certain legal proceedings and claims.”

The LPL report said that it received a written notice Oct. 1 from an unnamed third party saying that “under a certain purchase and sale agreement” the third party “is no longer obligated to indemnify the company for certain claims” under the agreement.

LPL “believes that this assertion is without merit and intends to vigorously dispute it,” the report said.

One source close to Pacific Life, who asked not to be identified, said the unnamed third party was “absolutely” Pacific Life.

Recent changes in LPL’s clearing agreement with the former Pac Life reps could have triggered the dispute, industry observers said.

In 2007, LPL paid around $97 million for the three firms – Mutual Service Corp., Associated Securities Corp. and Waterstone Financial Inc. – which at the time had a combined 2,200 reps and advisers generating $350 million in gross revenue.

Those three broker-dealers maintained clearing platforms of their own, at first with Pershing LLC and then with a combination of Pershing and LPL’s proprietary platform, BranchNet.

That all changed in September, when LPL moved the remaining 1,700 reps and advisers from those three firms off that platform and solely onto its own self-clearing platform.

That shift of brokers on to the LPL platform may have triggered the legal salvo from Pacific Life, industry observers maintained.

The claims that Pacific Life wants to have off its books involve former Associated Securities broker Jeffrey Forrest, who lost an $8.8 million arbitration claim earlier this year.

The attorney for the plaintiffs in that case, Philip Aidikoff, said that over the summer he filed two more claims totaling $10.5 million against Mr. Forrest, who has been barred from the securities business.

Asked last spring about the company’s liability for Mr. Forrest, a company spokesman, Tennyson Oyler, made it very clear that Pac Life was responsible.

“As is customary in transactions of this type, Pacific Life has agreed to indemnify LPL for certain liabilities related to pre-close activities,” he said.

Today, Mr. Oyler did not return a phone call seeking comment.

An LPL spokesman, Joseph Kuo, said, “As a matter of policy we have no comment beyond the disclosure in our” quarterly report. “We have a long-standing and productive relationship with Pacific Life.”

Forrest, who owned WealthWise LLC, and Associated Securities, an El Segundo-based broker-dealer with which his firm had been registered to sell securities, abandoned their appeal of the judgment in federal court, according to Phil Aidikoff, a Beverly Hills attorney representing the group of WealthWise investors.

“I can only tell you that they saw the error of their ways and felt that by appealing further, it wouldn’t accomplish anything,” Aidikoff said.

A Southern California attorney representing Associated Securities did not return a call Monday afternoon. Forrest acknowledged in an e-mail to The Tribune that the investors have been paid.

However, he declined to comment on the appeal, which had been filed with the U.S. Court of Appeals for the Ninth Circuit on April 22 and dismissed Aug. 4. Forrest noted that WealthWise LLC is defunct “and is no longer in the business of rendering investment advice.”

The U.S. Securities and Exchange Commission this spring charged the San Luis Obispo man with fraud and barred him from acting as an investment adviser.

A panel of the Financial Industry Regulatory Authority (an independent regulator of U.S. securities firm) found in March that Forrest, who had been a broker with Associated Securities from 1989 through 2007, had steered clients to the APEX Equity Options Fund, a highly speculative investment worth about $40 million that he touted as providing safety, security and liquidity of investor principal.

Investors – representing about 16 county households – lost millions when the fund collapsed in August 2007. Some of the investors – among them a retired nurse, stay-at-home mom and a quadriplegic man – had invested their savings and in some cases borrowed against the value of their homes.

Three other arbitration cases have settled and clients have received damages, although the amount of damages is unknown because of confidentiality agreements reached as part of the settlements.

Two additional cases have been filed by Aidikoff’s firm related to investors in Arizona and Utah.

The number of arbitration claims filed with the Financial Industry Regulatory Authority has surged in the first seven months of 2009.

Through July, investors filed 4,481 claims, as compared to 4,982 claims during all of last year. That’s a 71% increase in the number of new case filings over the same period in 2008, according to Finra statistics.

Mutual funds were part of more than a thousand of this year’s claims. There were 1,061 arbitration cases involving mutual funds through July. In 2008, there were 930 such claims.

Finra does not break out the exact types of arbitration claims involving mutual funds, says spokesman Herb Perone.

“I think the system is still trying to digest the subprime-related arbitration claims, concentrated very heavily still against Morgan Keegan, Schwab, Oppenheimer and a few others,” says Andrew Stoltmann, a Chicago attorney who represents investors in securities fraud litigation and arbitration. “There are still people just realizing how much money they’ve lost in what were supposed to be conservative bond funds. I think we’re going to see the same surge for the rest of the year.”

Total arbitration claims may reach 9,000 or 10,000 this year, estimates Stoltmann. That would make 2009 a record-setting year. In the last decade, 2004 had the highest number of arbitration claims filed, 8,201.

Claims against mutual funds probably will peak this year and decline in number in 2010, Stoltmann says. About 90 of his current 130 arbitration cases involve mutual funds, specifically bond funds managed by Schwab, Morgan Keegan, Oppenheimer and Evergreen that had severe losses during the downturn, he says.

Meanwhile, the percentage of cases for which customers were awarded damages has increased to 45% thus far in 2009, or 160 cases. Last year, customers were awarded damages in 42% of cases, or 199 cases. The increase this year may be the result of changes to the arbitration process to make it more investor friendly.

In one notable example, an arbitration panel in July awarded an investor $157,498, or 100% of the losses she had suffered in Schwab’s YieldPlus fund, plus expert witness costs of about $16,000, according to Ryan Bahktiari, partner at Aidikoff, Uhl & Bakhtiari, which represented the investor.

The claim was brought against Charles Schwab on the basis of how the fund was marketed to the investor. This is “very unusual” in that arbitration claims are usually brought against the broker that sold the fund, says Bakhtiari.

“This was more of a systemic, institutional problem than a broker-specific problem,” says Bahktiari. The firm has filed more than 100 similar claims against Charles Schwab on behalf of investors all over the country who claim the YieldPlus fund was sold to them as a conservative investment akin to a money market fund, he says.

“I think because of the number of cases that my firm has filed… that Charles Schwab wanted to test us, frankly,” says Bahktiari when asked why Schwab did not settle the case instead of going through the arbitration process.

Schwab did not immediately return a request for comment yesterday.

Like Stoltmann, Scott Silver, managing partner at Coral Springs, Fla.-based Blum & Silver, says he has also seen a number of arbitration claims brought against brokers who sold bond funds. Silver also represents investors in arbitration claims.

The arbitration claims his firm is working on that involve mutual funds fall into two categories, he says. The first are those involving investors who bring claims against brokers for selling proprietary funds, such as the Morgan Keegan funds and the Schwab YieldPlus fund.

The second category of arbitration claims are those in which investors bring claims against brokers for selling them unaffiliated funds. Many of these claims were brought against brokers that sold the Oppenheimer Rochester municipal bond funds, he says.

In addition, almost 180 arbitration claims filed in 2009 involve auction rate securities, down from 299 in 2008. Auction rate securities “are among the main components of the surge in filings,” says Howard Suskin, a partner in Jenner & Block’s litigation department. Suskin has experience as an arbitrator for several self-regulatory organizations, including Finra.

And the sale of leveraged exchange-traded funds has also spurred some arbitration claims, according to Silver. His firm represents investors in five such claims. But since Finra and the Securities and Exchange Commission have said the product is rarely suitable for retail investors, there won’t be a significant increase in claims in the months to come, he says.

A total of 2,454 arbitration claims have been closed this year. About 25% of those claims were decided by arbitrators; 45% of cases were resolved through direct settlement by the parties; 16% were withdrawn; and 5% were settled by mediation. The remaining 9% of arbitration claims were closed by stipulated award, bankruptcy of a critical party or a stayed court action, among other reasons.

There are currently 6,156 Finra-qualified arbitrators, according to Finra’s Perone. This is somewhat fewer than the number Finra had last year because it culled the list over the past few years, eliminating arbitrators who had not completed mandatory training, he says.