Magistrate Judge Elizabeth Laporte of the U.S. District Court for the Northern District of California late on Friday granted a request by the Financial Industry Regulatory Authority to dismiss a lawsuit that Schwab filed against the regulator in February.

Schwab sued FINRA, Wall Street’s industry-funded watchdog, a day after the regulator announced an enforcement case against the San Francisco-based company.

FINRA alleged that Schwab added a new provision to more than 6.8 million customer account agreements in October that would preclude them from starting or joining class-action lawsuits against the brokerage.

The case raised significant investor protection issues, according to lawyers.

Class actions are a common way for small investors to band together in a court case to recover their losses. A win by Schwab would have set the stage for a showdown that could lead other companies to change their arbitration agreements and potentially weaken FINRA’s hold over its own enforcement process, lawyers said.

Schwab also required customers to agree that industry arbitrators would not have the authority to consolidate claims from multiple parties. Such consolidated cases are common, but typically include far fewer claimants than those in class actions. Both types of cases often involve investors with smaller claims, typically under $10,000, according to lawyers.

“It’s a good decision for all investors and customers of Charles Schwab,” said Ryan K. Bakhtiari, president of the Public Investors Arbitration Bar Association, a Norman, Oklahoma-based group of securities arbitration lawyers. “The rules are clear and unequivocal that Schwab did not have the right to prohibit class actions, he said.

Judge Laporte, in a 21-page opinion, agreed with FINRA that Schwab is required to follow its procedures for disciplinary cases. That process ultimately includes a review by a federal court judge.

FINRA, in addition to being Wall Street’s regulator, runs the arbitration forum where customers and brokerage firms typically must resolve legal disputes. FINRA arbitration rules do not allow arbitrators to hear class action cases.

FINRA rules also restrict brokerages from limiting investors’ rights to file court cases in certain situations.

Schwab’s agreement would effectively leave investors in a bind, in which many would not have access to a legal process for recovering their losses, lawyers said.

Schwab had argued, among other things, that it would be “irreparably harmed” by using FINRA’s process, which the company said could take up to four or more years. But delay is not an adequate reason for avoiding FINRA’s process, the court wrote. Schwab did not show it was “entitled to an exception” from FINRA’s process, according to the opinion.

The court’s dismissal of Schwab’s lawsuit against FINRA, however, leaves some questions unresolved while FINRA continues its disciplinary case against the brokerage, said William Jacobson, a professor at Cornell Law School’s Securities Law Clinic in Ithaca, New York.

Schwab must now decide whether to continue using a provision in its customer agreement during those proceedings “that amounts to, in effect, a continued, knowing violation,” he said. It is also unclear what would happen if Schwab tried to enforce the class action waiver agreement in a case against a customer, Jacobson said.

A spokesperson for Schwab was not immediately available for comment. A FINRA spokeswoman declined to comment.

Lawyer Madelaine Eppenstein had taken the morning off from work for a parent-teacher event at her 5-year-old’s elementary school on June 8, 1987, when she was summoned to the principal’s office for an urgent call. Her husband and law partner, Theodore Eppenstein, told her they lost the Supreme Court case he had argued two months before on behalf of a couple trying to sue their stockbroker for fraud.

“I felt like I got punched in the face,” she told me in an interview late last month.

If Eppenstein was punched, the investing public was mauled. The case known as Shearson v. McMahon would wind up locking investors out of U.S. courts any time they tried to sue a broker. A tiny clause in customer agreements turned out to be Wall Street’s magic formula to keep its transgressions out of sight. The agreement that Eugene and Julia McMahon signed said that any dispute between them and their broker at Shearson/American Express Inc. — a trusted fellow parishioner at their church –“shall be settled by arbitration” in a Wall Street forum. Investors since then have either had to agree to similar terms, or forget about having a securities account.

“If you get screwed,” Theodore Eppenstein says, “now you have no place to go.”

Looking for Luxuries

No place to go, that is, if you’re looking for luxuries like publicly filed documents, juries that hear the facts and judges that preside over open proceedings.

The McMahon decision was damaging enough for the impact it had on individual brokerage customers, who tell their stories about fraud, misrepresentation and churning behind closed doors where the public — including reporters — isn’t welcome. Perhaps worse is what happens when a powerful industry gets accustomed to keeping its squabbles quiet: Wrongdoers are inclined to relax, sending ethics to ever-lower lows.

“It means that all sorts of scams against individuals, however large, are very unlikely to come to the attention of the media and the public,” says F. Paul Bland Jr., a senior attorney at the public-interest law firm Public Justice in Washington.

Wall Street may have been first to catch on to the benefits of mandatory arbitration, but Bland worries that the closed-door trials are spreading to industries from retailing to homebuilding. “The silence and secrecy that surrounds arbitration is extremely harmful to the country,” he says.

These days, employers – Manpower Inc. and Nordstrom Inc. among them — require new hires to give up their rights to court before a fresh-faced recruit can check in for orientation. And consumers can forget about opening a Netflix account, signing a mobile-phone contract, or putting a loved one into most big-name nursing homes unless they are willing to give up their rights to go to court. Buying a Starbucks gift card? You are agreeing to mandatory arbitration of any fraud or misrepresentation by the company.

The results can be chilling. After watching his father die from sepsis of the blood caused by infections from 13 bedsores in 2005, David W. Kurth of Burlington, Wisconsin, tried to sue the nursing home whose staff he claimed had left his father’s wounds covered in excrement and urine for days at a time. Though the death of his father would have been shocking enough, Kurth told a Congressional subcommittee in 2008 that the “most shocking” part of his family’s ordeal was this: They wouldn’t be able to sue for the alleged neglect because the deceased man’s wife had signed admissions documents that had a mandatory- arbitration agreement.

“How can anyone in good conscience argue that it should be perfectly legal to trick frail, elderly, infirm senior citizens experiencing the most stressful time in their lives into waiving their legal rights?” Kurth asked.

Free Phones

Conscience, of course, plays no role when companies demand arbitration. But Supreme Court decisions do. In April 2011, the court dealt a new blow to consumers and employees in a caseknown as AT&T Mobility v. Concepcion. AT&T had pitched a deal to woo new mobile-phone customers by offering free phones, but it turned out the freebie came with a $30.22 bill for “taxes.” Vincent and Liza Concepcion tried to bring a class-action lawsuit on behalf of all the other consumers who took AT&T’s deal. But the court said that when the couple signed the customer agreement, they gave up their right not only to sue, but also to a class action even in arbitration.

In the year since the Concepcion decision, lower courts have trashed dozens of cases in which consumers or employees were trying to sue as a group. The National Labor Relations Boardpushed back against the impact the Concepcion decision might have on employment class actions, ruling in January that it’s a violation of federal labor law to make workers give up the right to pursue group claims. That decision probably will be challenged in court.

About 25 percent of U.S. employees are covered by mandatory-arbitration clauses, says Alexander J.S. Colvin, an associate professor of labor relations and conflict resolution at Cornell University. He figures the number will grow as a result of the Concepcion case.

If you are wondering just how bad arbitration can be, the examples are many. When I wrote my book about sexual harassment on Wall Street, “Tales From the Boom-Boom Room,” I was aghast at the things brokerage firms could do that would never be allowed in court. In the weeks before one woman’s arbitration hearing was set to begin, her former employer hired a psychiatrist who questioned about her sex life and her menstrual cycle. She had alleged that a man in the office had followed her into a stock room and grabbed her breasts. Another woman, who said the same man had accosted her, was directed by the consultant-shrink to sit in a chair in the middle of a room and recite the names of all the U.S. presidents — in reverse order.

Both women bailed out and settled, having seen enough of arbitration’s downside before the hearings even started.

Get There Early

In October, a doctor who was fired from her job by a physicians’ group in suburban Philadelphiatold the tale of her arbitration to the Senate Judiciary Committee. Deborah Pierce would have preferred to sue the partnership (17 men, one woman at the time) that fired her, but her employment agreement tied her to arbitration run by the American Health Lawyers Association. One morning, she arrived early to her hearing at a law office in Wayne, Pennsylvania, to see one of her former bosses strolling out of the arbitrator’s office carrying a cup of coffee. That sort of encounter is known as an ex-parte meeting between a judge and a party to a case. It isn’t allowed in court proceedings.

To pay for her case, which included her half of the arbitrator’s $117,042 fee, Pierce took out a home-equity loan that she and her husband are still paying off three years later. Her consolation prize: the arbitrator at one point ordered her adversaries to pay her $1,000 in sanctions for destroying documents and delaying the proceedings. And then, he billed her $2,000 for the time he spent deciding whether he should impose the fine. She lost.

It’s an open secret in legal circles that arbitrators are more worried about alienating the corporations who give them regular business than they are about one-shot plaintiffs. “Arbitrators who ding a major firm know they’re going to be blackballed,” says Timothy J. Dennin, a New York lawyer who represents aggrieved investors.

There are upsides to arbitration, if only the public had a chance to consider it as an alternative to court instead of a mandate. Investors whose losses are too small to be attractive to lawyers, for example, can often navigate securities arbitration more easily than a court case. And arbitration can be faster than court.

“Do some cases fare better in arbitration? Definitely,” says Ryan K. Bakhtiari, the president of the Public Investors Arbitration Bar Association, a group of lawyers who represent investors. He says arbitration should be at the choice of the investor, not mandatory.

Bad Behavior

The more cases we relegate to arbitration, the more we fail to hold companies accountable for bad behavior.

Frank Partnoy, the author of “Infectious Greed: How Deceit and Risk Corrupted the Financial Markets,” says that even if an arbitrator decides a business is guilty of fraud, a company “can write a check and not worry about creating a dangerous precedent.”

That case by the McMahons never got to arbitration after the Supreme Court said the couple couldn’t go to court. Regulatory records for their former broker show they settled for $700,000. Christine Hines, the consumer and civil-justice counsel in Public Citizen’s Congress Watch unit, says groups such as hers would simply have no material to work with if bad products and practices were all relegated to private justice.

“There is no way we, as advocates, would know what’s going on,” she says.

Twenty-five years after the McMahons lost their fight for a public hearing, it’s hard not to conclude that’s precisely what business is counting on.

But thanks, in part, to sharp pressure from some investor advocates, that system has now gone the way of Olympic live-pigeon shooting. A rule change made last year by the Financial Industry Regulatory Authority now gives investors the option of bringing disputes to a three-person jury in which none of the arbiters is a brokerage-industry employee — a move that “goes a long way toward leveling the playing field that was tilted against investors,” says Ryan Bakhtiari, president of the Public Investors Arbitration Bar Association. Indeed, investors are quickly taking advantage of the option: In the time since the new rules took effect, 76 percent of all complainants have chosen to bring their cases to a wholly non-Wall Street panel. And, at least in one test of the new program, investors who selected an all-public panel fared slightly better than those who faced a jury with one industry arbitrator (though the numbers were too small to be statistically significant).

Some arbitration insiders, however, say that while the playing field may be more even now, the odds are still stacked against investors. “It’s putting lipstick on a pig,” says Dan Solin, senior vice president at Index Fund Advisors and coauthor of a report analyzing the results of securities arbitration. For one thing, the process remains administered by Finra, the brokerage industry’s self-regulator. Even with an all-public panel, critics say, investors are not exactly being judged by their peers — while “nonindustry” arbitrators don’t currently work for financial firms, many are retired lawyers and accountants recruited by Finra, says Louis Straney, a securities litigation consultant who wrote a book on the topic. And although win rates are improving, such numbers don’t tell the whole story. Even if an investor wins, says Solin, the average amount recovered has historically been only about 20 percent of the original claim. “Investors are seldom made whole,” adds Straney.

Finra says the recovery figure doesn’t include cases that have been settled (the vast majority) and that the process, including the selection of arbitrators, is unbiased and fair. Be that as it may, advises Solin, if you do bring a dispute against your broker, be sure to hire an experienced arbitration lawyer. The new rule is “definitely a step in the right direction,” he says, “but the odds still favor the house.”

Lincoln Financial Advisors had abruptly terminated Jeffrey Concepcion in August 2008, according to the arbitration filing, and then withheld severance after he refused to agree to a non-competition agreement.

The firm allegedly then published false and misleading information about why he left the firm, saying Concepcion had made a “career change,” according to the arbitration award document. The statement implied that Concepcion had left the industry altogether. Further, Lincoln Financial asserted that Concepcion had been terminated “with cause,” according to the document. A spokeswoman for Lincoln Financial declined to comment.

Concepcion, whose attorney did not return a call seeking comment, is currently a dually registered financial advisor affiliated with LPL Financial, according to FINRA BrokerCheck.

Negative attacks often ensue when advisors leave securities firms. That said, proving defamation, unfair competition and disrupting business relationships can be an uphill battle for reps, says Ryan Bakhtiari, a partner at Aidikoff, Uhl & Bakhtiari, a law firm in Beverly Hills, Calif.

“It seems clear that Mr. Concepcion was able to prove to a panel of arbitrators that the firm’s conduct caused him significant harm,” Bakhtiari says.

Before he was terminated, Concepcion had worked for Lincoln Financial, the planning division of Philadelphia-based Lincoln National, for more than 20 years, according to the arbitration award.

The Pepperdine Law Investor Advocacy Clinic was established in the fall of 2010 through a $250,000 grant from the Financial Industry Regulatory Authority (FINRA). The Clinic’s founding Director, Robert Uhl, an attorney specializing in securities arbitration and litigation, approached the Straus Institute about establishing the Clinic based on a recommendation from his law firm partner, Philip Aidikoff. Thomas Stipanowich, Academic Director of the Straus Institute, William H. Webster, Chair in Dispute Resolution, and professor of law, supported the idea and assisted Uhl and the Clinic’s co-director, Judith Hale Norris, in writing the FINRA grant.

Upon the approval of the grant, Uhl began teaching a securities arbitration course at Pepperdine Law. The first class of 12 students was welcomed in the fall of 2010. Of the 12, five were invited to join the Clinic and begin working on a select number of cases. Students who participate in the Investor Advocacy Clinic are certified with the State Bar so they can represent parties under the direct supervision of an attorney

“We were receiving dozens of calls,” Uhl said. “Many were regarding investments people made with friends. Our focus is on investments made with licensed brokers, so we had to turn down about 95 percent of the calls.”

Uhl noted that each case takes approximately fourteen months to prepare and go to either mediation or an arbitration hearing. The students work closely with Uhl to prepare the witnesses and documents for mediation and arbitration, and to develop negotiation and learing strategies. In addition to preparing the case, the Clinic’s students are required to participate in community outreach projects designed to educate the public about investment fraud.

In the fall of 2011, Uhl welcomed 25 students into his second securities arbitration class. Five additional students were selected from that class to join the Clinic for the coming year.

The Clinic’s first case, Surinder Paul, et al. vs. FSC Securities Corp., et al., included Pepperdine Law’s Meghan Milloy, a certified law student. The case was settled in January, 2012 in mediation. Milloy delivered the opening argument and negotiated the settlement under Uhl’s supervision.

The second case, Susan Jenkins vs. Crowell Weedon & Co., went to arbitration hearing in February, 2012. Pepperdine Law students Matthew Troncali and Lindsey Dodge, both certified law students, worked with Uhl and Norris on the case. Troncali, a member of the Clinic’s first cohort, delivered the opening statement and the direct examination of Susan Jenkins. After four days, the Chairman of the arbitration panel ruled in favor of Jenkins, and awarded 100 percent of the damages requested at the hearing. Pepperdine is the only one of six investor advocacy clinics funded by FINRA to try a case, and the first FINRA clinic to prevail at arbitration.

“I’m very enthusiastic about it,” said Peter Robinson, managing director of the Straus Institute and Associate Professor of Law. “It’s an incredible opportunity for our students. It’s lawyering at its pinnacle. For the students to be coached and prepared and to be a part of presenting peoples’ cases is a perfect law school educational experiences. The fact that we had such a good outcome is a dream come true.”

A third case, Robert Olson vs. Morgan Wilshire, et al., went to a three-day arbitration hearing in March. A decision is pending. Pepperdine certified law students Maxfield Marquardt and Cory O’Yang participated. Marquardt, a member of the Clinic’s first cohort, delivered the opening statement and the direct examination of Robert Olson.

“The Clinic and the underlying Securities Arbitration course that we teach are a triple play win for all concerned,” Uhl said. “Clients receive professional representation at no cost for claims that otherwise would go begging, the students learn practical skills generally not taught in purely academic classes, and I personally satisfy a long held desire to pass on by way of teaching the incredible experiences I have had representing investors for more than 20 years.”

Cogburn, a U.S. district court judge in North Carolina, expressed a deep dislike for the mandatory arbitration system managed by the Financial Industry Regulatory Authority.

He made it clear in a recent decision he thinks brokerages enjoy a clear advantage in the forum. “Arbitration under the Federal Arbitration Act is a process that, although retaining the appearance of constitutionality by involving the courts in confirming an award, does not even attempt to retain the appearance of fairness,” he wrote in the decision.

He also made it clear he dislikes when his authority is questioned. His criticism of Finra arbitration appears to have been set off by what he described in his ruling as an “open challenge” to his court’s powers by a lawyer for Wells Fargo Advisors.

Wells Fargo wanted the court to confirm an arbitration panel’s ruling that a former broker must repay the outstanding balance on his promissory note. According to the decision, the lawyer, Deborah Gale Evans, irked Cogburn by claiming she handles 30 to 40 arbitrations a year and never loses. “I’ve never lost one and I’ve never not gotten attorney’s fees. I always win these cases,” she is quoted as saying during the hearing.

Cogburn’s sarcastic response: “Now there’s a level playing field.”

Cogburn ultimately did confirm the award, finding the promissory-note contract to be legal. Attorneys say it’s extremely difficult for brokers to win such cases, so Evans’ track record on them isn’t too surprising.

But Cogburn seized upon Evans’ statement to question the inherent fairness of Finra’s arbitration system, which requires brokers and customers to bring their disputes with firms to arbitration instead of the courts. And arbitration rulings can only be challenged in court under narrow circumstances.

“Because of its constant and prolific participation in FAA arbitration, the claimant bank enjoys a clear advantage over the individual employee or customer,” Cogburn wrote.

Evans couldn’t immediately be reached for comment.

Ryan K. Bakhtiari, president of the Public Investors Arbitration Bar Association, agrees with Cogburn’s assertion that the odds in arbitration aren’t even.

“I think Wall Street can enjoy an advantage over employees or customers in these cases,” he said. “There’s still a ways to go to level the playing field between customers and employees and Wall Street.”

Bakhtiari believes customers should be able to choose whether they want to go to court or have their claims heard in Finra arbitration.

In the decision, Cogburn explains that in arbitration, a bank will know from experience which arbitrators are more likely to favor it and will choose those people. In contrast, an individual employee or customer has very limited knowledge of the arbitrator, Cogburn notes.

“Couple that with the proposition that the arbiter’s mistakes of facts or law are not reviewable by the courts, and the result is a process in which, as in this case, counsel for the bank can remain undefeated 30 or 40 times a year,” Cogburn adds.

But a Finra official stressed that there were measures in place to ensure fairness during the arbitration process, which she says is a neutral forum.

“The fact that our data show the industry loses roughly half the number of customer claimant arbitration award cases clearly demonstrates that no such ‘repeat player advantage’ exists,” said Linda Fienberg, president of Finra Dispute Resolution.

Jonathan Uretsky, a securities attorney who often represents broker-dealers, said a bank doesn’t necessarily have the upper hand just because it’s in arbitration more often than an employee or customer.

“If you assume both sides hire experienced counsel, and they will, the claimant and respondent will both have lawyers who do this 40 times a year and probably have been doing it for 10 to 20 years,” he said.

Although Cogburn ultimately confirmed Wells Fargo’s award, he vacated the award of attorney’s fees, citing the lack of an itemized list of hours worked and rates claimed.

Thomas B. Lewis, head of the employment litigation group at Stark & Stark in Princeton, N.J., notes that despite Cogburn’s disdain for arbitration, he found the arbitration award enforceable and the legal fees would likely have been enforced if there were proper documentation.

“We have to respect the judge’s opinions on arbitration but I think the uniform view among practitioners is that Finra’s arbitration process is a fair process,” Lewis said.

And counting.

The payments, awarded since 2008 in 59 arbitrations or settlements, represent just part of a continuing legacy of the nation’s financial collapse. At least 39 additional clients with similar claims reached confidential settlements before their arbitrations, conducted through the Financial Industry Regulatory Authority (FINRA), were decided.

The embarrassing total could climb even higher as dozens more cases are set for arbitration through 2013. One California law firm says it represents about 65 clients with claims that total “north of $50 million.” A Florida firm has roughly 25 cases seeking “tens of millions of dollars.”

Burned investors who recovered all or part of their Citigroup losses include the Callaway Golf board chairman, a Florida cable television developer and a New York entrepreneur who earned riches from Internet ventures.

“I had an investment adviser at Citi who was supposed to look out for my best interests, and he never warned me how risky this investment was,” said Alex Zhardanovsky, co-founder of PetFlow.com, an online food and supply delivery service for pets. He lost roughly $350,000.

SEC probe

The Securities and Exchange Commission has been investigating Citigroup’s management and marketing of the investments for nearly four years, according to a copy of a May 2008 request for documents the agency sent to the financial giant.

Citigroup’s SEC filings have disclosed arbitrations and lawsuits over the investments without providing financial details. That information isn’t required to be disclosed because it isn’t material to the firm’s bottom line. USA TODAY compiled the most current total by searching public arbitration awards, examining court filings and interviewing former Citigroup clients and their lawyers. Investors often must pursue arbitration rather than lawsuits if they have disputes with financial brokers.

The review came as Citigroup failed a government stress test in which the Federal Reserve estimated the losses banks could bear in a steep recession. It also comes as the resignation of a Goldman Sachs executive who accused that company of favoring profits over clients has stoked consumer concerns about how Wall Street works.

“Citi acted appropriately at all times in connection with the development, sales and marketing of ASTA/MAT,” the company said. “Our disclosures were accurate and complete and detailed the risks associated with investing in these products. The products were sold only to highly sophisticated, high-net-worth investors ($5 million-plus in investable assets), all of whom signed subscription agreements in which they expressly acknowledged the risks associated with this investment.”

Citigroup spokeswoman Danielle Romero-Apsilos said the company declined to answer questions about arbitrations regarding the funds.

The investments included a series of six fixed-income hedge funds or alternative investment funds known as ASTA or MAT. Part of Citigroup Global Markets, the investments were retail funds marketed to high-net-worth clients with minimum investments ranging from $250,000 to $1 million. They ultimately held billions of dollars in investor money.

Former customers said Citigroup financial advisers told them the funds would generate returns of 6% to 8% on managed investments in municipal bonds. That would produce slightly higher returns than could be attained via investments in the bonds themselves. Ex-clients said marketers told them a hedging strategy would nonetheless keep risk low.

That interested Ronald Beard, a former managing partner of Gibson Dunn & Crutcher, a global law firm with more than 1,000 attorneys. Beard, a California resident who’s now a law firm adviser and Callaway’s board chairman, said he and his family invested $400,000 in MAT/ASTA in 2007 on the recommendation of a longtime adviser at Citigroup’s private banking arm.

They lost almost the entire investment.

“I wasn’t looking for any vast return. It was simply moving from one muni fund to another, and I didn’t really think that much about it,” said Beard, explaining that he relied on his adviser’s advice.

“We felt betrayed, and we were shocked,” he added.

Christopher Puglisi, a commodities and stocks trader from New Jersey, said he, too, invested during 2007 through an account at Citigroup’s Smith Barney division. But only after he was satisfied the money he invested from the sale of his trading business would be safe.

“I certainly wasn’t going to risk losing capital for a 6% to 8% return,” said Puglisi, who lost more than $700,000.

Puglisi, Beard and other MAT/ASTA investors said they were never told the funds were highly leveraged, borrowing roughly $8 for every $1 invested. When the U.S. municipal bond market fell into turmoil in 2008, the Citigroup investments plunged.

A separate group of Citigroup hedge funds sold to top investment clients, called Falcon Strategies, similarly nose-dived on losing mortgage investments in 2007.

Citigroup put a $661 million infusion into MAT/ASTA in a bid to stabilize the funds. But the move still left the investments down as much as 80%. By Sept. 30, 2008, total assets had dropped to about $1.5 billion, a Citigroup SEC filing shows.

Falcon Strategies fell by more than 50% in the fourth quarter of 2007. The following year, its total assets dropped from an estimated $4 billion in March to $1.3 billion in September, a Citigroup SEC filing shows.

“The fund we invested in literally imploded, almost all the way” to zero, Beard said of his family’s MAT stake.

He and other investors were surprised by discoveries after they filed arbitration challenges that accused Citigroup of breach of fiduciary duty, recommending unsuitable investments, fraud and other charges. A sales memo the company disclosed for the proceedings stated that the funds were tailored not for those willing to take on big financial risks but for “larger traditional fixed-income investors who are seeking alternatives” without adding higher risk.

But company e-mails showed that Citigroup’s internal rating of credit risk listed MAT/ASTA as a 5, the highest and most volatile level. Falcon Strategies was right behind, with a 4 rating. Citigroup’s financial advisers said they had not been told that, so they hadn’t been able to relay that information to investment clients and guide them adequately.

“I am stunned at the complete arrogance and misinformation that we have been receiving,” Arestoula Drakatos, a director of Citi Private Bank wrote in a March 11, 2008, e-mail to several superiors. “The most important point is that it is imperative that we do whatever it takes to make our clients whole.”

“Wow. Even the bankers are turning mean,” wrote Sallie Krawcheck, the executive who at the time ran Citigroup’s global wealth management division, which administered the funds.

Weeks later, a presentation Krawcheck prepared for Citigroup’s director board warned of a potential $1.5 billion financial hit for the company if it didn’t move to keep angry investment clients from closing their accounts and financial advisers from departing.

But Krawcheck instead left Citigroup in late 2008 amid a rift with CEO Vikram Pandit. She declined to comment on the hedge funds episode.

Reaz Islam, the portfolio manager who led Citigroup’s management of the doomed investments, told company executives during an internal December 2007 meeting — a session he recorded and later became part of a federal court case — that he was satisfied with the performance of his staff.

“Really,” responded Jonathan Dorfman, one of the executives. “They’ve lost over half a billion dollars of other people’s money. If this were Morgan Stanley or Goldman Sachs, they would have been fired immediately.”

Islam, who left Citigroup in 2008, repeatedly denied any wrongdoing in formal responses filed with many of the arbitration proceedings. Islam did not respond to a written message left in New York and e-mails sent to Bangladesh, where he now works for New York-based LR Global Partners.

Philip Aidikoff, a California attorney whose law firm has won the bulk of the arbitration awards decided against Citigroup, said he advised clients to pursue the actions in part because the firm offered burned investors 22 cents on the dollar.

During arbitration proceedings, Citigroup argued that the angry clients were sophisticated and wealthy investors who had been alerted to the potential risks in legal disclosures included with the fund offerings.

“I used to write some of these things, and I know what’s in them. But I don’t read them,” said Beard. “I expect them (financial advisers) to tell me what’s relevant.”

‘Damaging’ e-mails

Attorneys for Beard and other former Citigroup investors argued that the financial giant misled customers about funds it knew were risky.

“The biggest surprise is the damaging internal e-mails and the extent to which (Citigroup) people committed to writing that these were defective (investment) products,” said Steven Caruso, a New York lawyer whose firm has worked with Aidikoff’s firm on the arbitrations.

After considering the Citigroup records and weighing arguments from both sides, arbitrators repeatedly sided with the angry investors.

Zhardanovsky said he got back nearly 80% of his loss. Beard recovered his entire investment, though a third of the total went to pay his lawyers. Arbitrators awarded Puglisi most of what he lost, but the battle took three years and cost him roughly $300,000 in legal fees and other expenses.

USA TODAY’s review found that the annual arbitration award totals increased as plaintiff lawyers gained access to internal Citigroup records and e-mails about the funds. In 2009, 15 awards or settlements totaled $4.8 million. Last year, 23 awards or settlements totaled $68.8 million.

The 2011 cases included one of the largest FINRA awards, more than $54.1 million in compensatory and punitive damages, plus attorney fees, to a venture capitalist and an intellectual property attorney from Colorado. Citigroup, which lost a federal district court appeal of the award, is now challenging that decision in federal appeals court.

Aidikoff said his law firm is 17-0 in representing households that pursued arbitration over the funds. Describing that winning string, plus 41 settlements, he said, “I’ve never seen the statistics so stark.”

In contrast, FINRA statistics show that among customers who had filed for arbitration against brokers for any financial matter, roughly 52% recovered some monetary damages or non-monetary relief from 2007 through 2012 to date.

Despite the arbitration victories, Puglisi and others question the absence of any government regulatory action against Citigroup. “Until the SEC steps up and holds people accountable, this is never going to stop,” he said.

The SEC declined to comment on its investigation.

“We’ve handed these cases to them on a silver platter,” said Robert Pearce, whose Boca Raton, Fla., law firm has handled many of the winning arbitrations. “I’m somewhat surprised.”

Discount brokerage Charles Schwab and the Financial Industry Regulatory Authority, or Finra, are in the midst of a dispute over that issue—and it could have wide implications for investors.

When investors open brokerage accounts, they’re generally required to agree not to sue the broker. Instead, they have to settle disputes through an arbitration process run by Finra, which is funded by the industry.

Finra, however, doesn’t have an arbitration process for class-action claims—in which a large number of plaintiffs with similar complaints band together—and says its rules prohibit brokerages from making customers agree to class-action waivers.

Despite this, Schwab added a class-action waiver to its customer agreements in September. It cited an April U.S. Supreme Court decision that allowed companies to limit class-action lawsuits with arbitration clauses.

Gilbert Serota, the lawyer representing Schwab in the case, says that indicates that federal law also would override Finra’s rules that Finra says forbid the waivers. A Finra spokeswoman declined to comment.

Last month, Finra began a disciplinary proceeding to penalize Schwab for violating the rules, and in response, Schwab sued Finra in an attempt to get courts to determine that its waiver couldn’t be barred by the regulator.

The two sides are next scheduled to meet in U.S. district court in April.

“If Schwab gets what it wants, it would deprive customers of the opportunity to bring any claims as a class,” says Jill Gross, director of the Investor Rights Clinic at Pace Law School in White Plains, N.Y.

Schwab officials, for their part, say class-action lawsuits benefit lawyers more than customers.

Mr. Serota, Schwab’s lawyer, says the company believes customers are better served bringing their claims individually through arbitration or through Schwab’s internal dispute process. “It’s much more efficient and cost-effective than a class action,” he says.

Schwab has been hit by class-action lawsuits before. Last month, customers filed a class-action suit against Schwab that alleges the company secretly recorded customer phone calls without their consent.

Since last peaking at 7,137 in 2009, the number of new arbitration cases filed with Finra has tapered off. Investors filed about 4,700 cases in 2011, down almost 17% from 2010. In 2011, the arbitration process awarded damages to customers in about 44% of cases, according to Finra.

Most arbitration cases brought to Finra involve damages that run into thousands of dollars, says Ryan Bakhtiari, president of the Public Investors Arbitration Bar Association. When damages are smaller, attorneys often pursue a class-action lawsuit to make it worth their time, he says.

If a broker charged customers too wide a spread on trades, for example, a single customer’s damages might be only a few dollars, but the total damages among all of its customers could run into millions of dollars, Mr. Bakhtiari says.

Without the option to bring a class-action lawsuit, customers and attorneys would be unlikely to pursue small claims. “No one is going to hire a lawyer to litigate a $12 claim,” he says.

Changes in brokerage agreements are rare, which made Schwab’s move surprising to many attorneys in the securities industry, says Ernest Badway, co-head of the securities industry group at Fox Rothschild, a Philadelphia law firm.

“It’s an agreement that’s fairly standard across brokerages and doesn’t change often,” he says.

If Schwab prevails in this case, Mr. Bakhtiari says, other brokerage firms might follow suit in introducing their own waivers, effectively making it impossible for customers to bring class-action suits against brokerages.

“Other brokers are going to be paying close attention to this case,” he says.

Quite the contrary: Reaz Islam, who managed the highly-levered ASTA/MAT municipal bond hedge funds, wouldn’t do anything differently. According to Islam, speaking out for the first time since the hedge funds failed four years ago, no one foresaw the financial collapse.

“I still think about it, given all the facts at that time, if we could have done anything differently,” he wrote to Bloomberg News. “The answer is consistently no.”

“This was a high-volatility, high-return strategy and never a safe and riskless investment as claimed by a few rogue, ambulance-chasing attorneys,” Islam said from his new base in Dhaka, Bangladesh. “I have no regrets and obviously learned a lot from the crisis, notably to expect the unexpected at all times and how people change color in times of crisis.”

“Unfortunately, like many things in life, the strategies no longer worked after the material and sustained change in correlation in early 2008, breaking 15-plus years of strong history of correlation, the key driver of the strategy,” Islam explained. “Every manager in the space had the same fate, with no exception.”

The Financial Industry Regulatory Authority has already ordered Citi to pay ASTA/MAT investors $60 million, and there are 69 claims remaining. Citi did not contact Islam, now a managing partner at LR Global Partners, about the cases.

While Islam says that those now suing “never” had “any complaints prior to the crisis in 2007 and 2008″ and are “engaged in fraud or highly irresponsible,” he admits that he played no role in marketing the funds, the key issue in the complaints. But while his former investors have produced evidence that Citi private bankers did, in fact, minimize risks in the funds, Islam defended the marketing materials, saying, “we talked about every risk in the prospectuses” and that “the marketing materials, including the term sheet risk disclosures, were comprehensive, written in plain English and idiot-proof.”

Unsurprisingly, Citi’s legal adversaries aren’t impressed by Islam’s protestations.

“He should either have his mouth washed out with soap or have someone slap him a couple of times,” Michael Piuze, said. Philip Aidikoff, told Bloomberg, “his arrogance in the face of recorded conversations and broker e-mails is remarkable, but not unexpected.”

Like Islam, Citi has continued to deny wrongdoing.

Investors in the ASTA/MAT municipal bond funds knew how volatile they were, Islam said in interviews and e-mails that broke his four-year silence on the matter. Those claiming otherwise are either “engaged in fraud or highly irresponsible,” said Islam, who left New York-based Citigroup in 2008 and works in Dhaka, Bangladesh.

The funds, now defunct, placed Citigroup at the center of a regulatory probe and a wave of litigation when they crashed four years ago. The Financial Industry Regulatory Authority, or Finra, has ordered the bank to pay at least $60 million to some of the funds’ investors, who said that Citigroup pitched them a safe, more profitable alternative to other fixed-income investments. There are 69 claims remaining, according to Philip Aidikoff, a lawyer for plaintiffs.

“This was a high-volatility, high-return strategy and never a safe and riskless investment as claimed by a few rogue, ambulance-chasing attorneys,” Islam said in an e-mail. “I have no regrets and obviously learned a lot from the crisis, notably to expect the unexpected at all times and how people change color in times of crisis.”

The ASTA/MAT funds attracted Citigroup clients, who were pitched the investment by the lender’s private bankers and financial advisers. Investors included Ronald Beard, chairman of Callaway Golf Co. (ELY), Jerry Murdock, the founder of a $5 billion venture-capital firm and Bruce Spector, a senior adviser to buyout firm Apollo Global Management LLC.

Borrowed Billions

Islam, 45, sought to exploit differences between yields on U.S. government debt and municipal bonds. He borrowed billions of dollars from banks to amplify the bets, according to Citigroup documents filed in U.S. District Court in Denver.

The funds swooned when investors fled the credit markets in 2008 and lenders requested repayment. As a group, the ASTA/MAT funds had raised $1.92 billion from investors, the court documents show. As of Feb. 29, 2008, they held $303 million, an 84 percent decline.

“Unfortunately, like many things in life, the strategies no longer worked after the material and sustained change in correlation in early 2008, breaking 15-plus years of strong history of correlation, the key driver of the strategy,” Islam wrote. “Every manager in the space had the same fate, with no exceptions.”

Biggest Award

Murdock and Gerald Hosier, who live in Aspen, Colorado, won $54.1 million from the bank through a Finra arbitration claim last April, including $17 million in punitive damages, after alleging that Citigroup misled them about the funds’ risk. Their award is the fifth-biggest of its kind, Finra records show.

Citigroup’s defense in the arbitration was that investors knew of the risks and signed agreements saying they understood that the funds could lose money, according to court records. A three-person Finra panel ruled against the bank, and the federal court in Denver dismissed an appeal in December.

The bank intends to appeal the latest decision, according to its annual filing last month. Citigroup’s legal team didn’t contact Islam about the case, he said.

‘Accurate and Complete’

“Citi acted appropriately at all times in connection with the development, sales and marketing of ASTA/MAT,” Danielle Romero-Apsilos, a spokeswoman for the bank, said in an e-mail. “Our disclosures were accurate and complete and detailed the risks associated with investing in these products.”

Islam is now a managing partner with LR Global Partners LP, a New York-based investment firm with operations in Bangladesh, Singapore, Vietnam and Sri Lanka, according to its website. The company manages about $250 million, much of which he oversees in Bangladesh, Islam said.

He said he never marketed the ASTA/MAT funds to investors. That was done by Citigroup’s private bankers, he said. The sales documents they gave to potential investors were clear about the risks, Islam said. He provided Bloomberg News with a marketing brochure for one of the funds that targeted “traditional municipal-bond investors” who were looking for more profit — and more risk.

“We talked about every risk in the prospectus,” Islam said. “The marketing materials, including the term sheet risk disclosures, were comprehensive, written in plain English and idiot-proof.”

‘Traditional’ Investors

Investors disagree. Citigroup pitched the funds as “conservative,” Hosier and Murdock claimed. Internal documents show that Citigroup sought clients who otherwise invested in more conventional fixed-income securities.

“To be clear, our goal is NOT to target hedge-fund clients who are willing to accept an unrestricted risk profile,” Citigroup wrote in one of the documents. Instead, the lender sought “larger traditional fixed-income investors who are seeking alternatives and customized solutions without materially altering their risk characteristics.”

Richard Zinman, an adviser then working for Citigroup, pitched one of the funds in a Jan. 6, 2006, e-mail to Murdock as “a muni substitute” that took “virtually no credit risk,” court documents show. Zinman, now at Credit Suisse Group AG (CSGN), referred questions to David Walker, a spokesman for the Zurich- based bank, who declined to comment.

‘Slap Him’

Michael Piuze, an attorney in Los Angeles, said the ASTA/MAT fund managers took more risks than they said they would. He won $766,000 from Citigroup on a May 2010 Finra claim.

“He should either have his mouth washed out with soap or have someone slap him a couple of times,” Piuze said of Islam.

Piuze won millions of dollars in damages for families of smokers who sued Altria Group Inc. (MO), the maker of Marlboro cigarettes, claiming the firm misrepresented the risk. Spector, the Apollo Global Management adviser and founder of the Private Bank of California, won a Finra claim for $383,000.

Citigroup pitched the investment to Beard, the Callaway chairman, as a standard municipal-bond investment fund that offered “slightly better” returns, he said in a phone interview. Beard, who said his money is now managed by Wells Fargo & Co. (WFC), won a Finra claim for $336,000 in December 2010.

The Securities and Exchange Commission is examining how Citigroup managed and marketed the ASTA/MAT funds, the bank said in its annual filing. Citigroup disclosed the inquiry in August 2008 and is cooperating with regulators, according to the filing. John Nester, an SEC spokesman, declined to comment.

Borrowed Billions

Islam’s funds borrowed billions of dollars to buy both municipal securities and derivatives designed to minimize losses should the bonds decline in value. The funds borrowed eight to nine times the amount gathered from investors, Citigroup documents show, and controlled about $18 billion of assets because of that leverage, Islam said.

The bank pitched the ASTA/MAT funds to clients in its private bank and at the Smith Barney brokerage, according to a Citigroup document that became public in the Hosier case. The minimum investment in each fund was $500,000, according to the document. All of the money in ASTA/MAT came from Citigroup’s clients, said Steven Caruso, a lawyer for Murdock and Hosier.

Murdock founded Insight Venture Partners, a New York-based investment firm that has raised more than $5 billion, according to its website. Former Treasury Secretary Robert Rubin and ex- Goldman Sachs Group Inc. Chairman Stephen Friedman are listed as special limited partners at the firm.

Lemelson’s Attorney

Hosier, a patent attorney, worked for Jerome Lemelson, an inventor who obtained more than 600 patents on ideas from bar- code readers to soft-tipped darts. Lemelson, who died in 1997, and a foundation he started sued hundreds of businesses for infringement. Companies often settled by paying license fees.

The ASTA/MAT funds were popular among such clients because they promised higher returns than what they could get on other fixed-income investments, Islam said. They also were tax-free because they came from owning municipal bonds, the debt securities issued by U.S. cities and counties, he said.

Islam started the funds in 2002. They returned 14 percent on average each year, including tax savings, until early 2007 when he started the MAT Five fund, he said.

“There were never any complaints prior to the crisis in 2007 and 2008,” Islam said.

Concern about the safety of corporate and asset-backed bonds in the second half of 2007 led to declines in municipal debt, too. U.S. Treasuries, a haven for investors, rallied. The moves pushed the yield on municipal bonds to their highest compared with Treasuries since 2003, and the ratio became more volatile, buffeting the ASTA/MAT funds. The MAT Five fund lost 17 percent in the fourth quarter of 2007.

‘Dislocation’

A “dislocation between tax-exempt and taxable yields” caused the loss, according to a report to investors.

Markets worsened in 2008, and Islam’s lenders demanded repayment of the loans he used to leverage his municipal-bond purchases, according to Caruso. One of the banks making a margin call was Citigroup itself, Caruso said. Citigroup subsequently loaned the funds $660 million to keep them solvent, he said.

Funds that raised money last suffered most because they hadn’t been around long enough to collect interest payments from the municipal bonds they held, Caruso said. MAT Five held $19 million on Feb. 29, 2008, after raising $632 million in 2007, court records show.

Citigroup offered MAT Five investors 23 cents on the dollar for their stakes, Caruso said. All of the funds shut down in 2011, he said.

‘Psychological Capital’

“Despite all odds, until the final days we did everything we could to protect the investments but failed, given the speed and magnitude of the dislocation that no one predicted,” said Islam, who said he lost about $2 million, including deferred compensation. “As a percentage of my net worth at that time, I do not believe anyone lost more money in these strategies as I did, not including loss of my psychological capital.”

Islam’s didn’t just suffer from bad luck, investors say. He and his team took more risk and borrowed too much money because of “powerful economic incentives,” Hosier and Murdock claimed. This included a fee structure that delivered 20 percent of all income earned by the funds, shared by Citigroup and the fund managers, once the funds produced returns exceeding 5.5 percent.

Islam left Citigroup in August 2008. He kept his account of the ASTA/MAT collapse to himself until contacted by Bloomberg News. Nothing could have saved the funds in the end, he said.

The fallout for the bank isn’t over. Aidikoff, the plaintiffs’ attorney, said the 69 households with pending Finra cases put more than $125 million into ASTA/MAT.

“The written evidence produced by Citi in these cases tells a different story” than Islam’s characterization of plaintiffs’ lawyers, Aidikoff said. “His arrogance in the face of recorded conversations and broker e-mails is remarkable, but not unexpected.”

In Dhaka, almost 8,000 miles (12,900 kilometers) from Citigroup’s New York headquarters, Islam said he’s trying to move on with his life.

“I still think about, given all the facts at that time, if we could have done anything differently,” Islam wrote in an e- mail. “The answer is consistently NO.”

Imagine, for instance, what jury selection might look like when Fred Wilpon and Saul Katz, the owners of the Mets, take their seats in the courthouse at 500 Pearl Street in Manhattan later this month.

Will the baseball allegiances of prospective jurors be explored? Will lawyers for the owners try to bar fans of the Mets — or welcome them as long as they are not wearing a team jersey and waving a foam finger?

Recent remarks by Wilpon suggested that enthusiasm for his stewardship among the faithful was not a settled question. In a vow to Mets fans that his family will own the team “for a very long time,” he told reporters last week at spring training in Port St. Lucie, Fla., “Whether they’re happy about that right now or not, I don’t know.”

Not many people predicted the $1 billion lawsuit brought against Wilpon and Katz by the court-appointed trustee for the victims of Bernard L. Madoff’s vast fraud would actually produce a public trial. Wilpon and Katz, for their part, seemed convinced that the case would get dismissed well before a trial. Others speculated that the sides would ultimately find a way to settle, and they still have 10 or so days to do so.

But it appears probable that a trial will start March 19 when a federal judge, Jed S. Rakoff, will question prospective jurors to impanel a 6- or 12-person jury.

“Anytime your fate is in the hands of a jury, it’s a big risk,” said Bradley Simon, a former federal prosecutor who is a partner at Simon & Partners. “Jurors are not likely to be that sympathetic to individuals like them who are financially well off and did well with their Madoff investments. “

He added, “It’s overall bad news.”

Lawyers for the team argued unsuccessfully, on constitutional grounds, against a jury trial.

Rakoff, regarded as a brilliant but unpredictable jurist, alone will question the jury pool. He is a Yankees fan and a partial season-ticket holder. So his neutrality is assured and seems unlikely to be affected by his baseball rooting interests. Anyway, the role of the opposing lawyers in shaping the makeup of the jury will be somewhat limited.

Experts suggest that both sides probably already know the sort of jury makeup they want, and that mock trials have likely yielded juror profiles. But neither side will get all it wants.

“The real challenge is to ferret out latent prejudices, so it’s extremely important for lawyers to suggest questions to the judge beyond those the judge would use to elicit obvious biases,” said Mark Zauderer, a partner at Flemming Zulack Williamson Zauderer in Manhattan. Rakoff need not use their questions.

According to several lawyers and a jury consultant, the trustee will want jurors who resent millionaires.

But Wilpon and Katz’s team, they said, probably want less class-conscious people who might be more inclined to feel the trustee’s pursuit of the Mets’ owners was overzealous and unfair. The trustee has accused the owners of ignoring warning signs about Madoff’s operation as they benefitted from steady returns during their many years of investing with him.

“If they get some Wall Street types on the jury, or partners of big law firms, they might feel this is another attack on wealth,” said Annemarie McAvoy , a former federal prosecutor who is a professor at Fordham Law School. “But if they seek sympathy, they have to come off sympathetically.”

Wilpon and Katz’s wealth is likely to be a recurring theme at what the judge has said will be a 10-day trial. They had a lot of it, and invested much of it with Madoff.

Wilpon and Katz, who are brothers-in-law, built their company, Sterling Equities, out of investments in real estate, sports and private equity. They poured $1.6 billion into their Madoff accounts over 23 years.

Their riches, then, could cut two ways. The financial crash and the Occupy Wall Street protest movement have made the rich less sympathetic than ever; some now pejoratively label the wealthy the one percent.

Simon said that jurors’ resentments of wealthy defendants is not always easy to discern.

“People say it won’t influence but they don’t really say it,” he said.

The owners would be fortunate to find a juror who has been betrayed in his life — or at least has a sense of fair play about people whose wealth is well beyond theirs, the experts said.

Philip Aidikoff, a partner in the securities firm Aidikoff, Uhl & Bakhtiari in Los Angeles, said, “Some of our clients are far wealthier than Wilpon and we say, ‘Our client is wealthy beyond belief? So what? Can you lie to them? Give them false information?’ ” He has represented clients defrauded by Madoff.

Although a jury will decide the case, Rakoff can exercise broad influence on the evidence and testimony he allows into the record. He is not shy about voicing his opinions, no more so than in his tartly worded rejections of the Securities and Exchange Commission’s settlements of major bank cases.

In his decision on Monday to clear the path for the trial of the Mets’ owners, he questioned the trustee’s ability to prove that Wilpon and Katz acted in bad faith and described some of the “bombshells” submitted recently by both sides in the case as evidence “proved to be nothing but bombast,” and may not be admissible.

McAvoy said: “I know Judge Rakoff. He’s tough, he’s very good, and he’s very astute. He won’t give much leeway. They have to present the evidence right or it won’t come down.”

All told, about $100 billion from individual and institutional investors remains outstanding in the former $330 billion market, according to SecondMarket, a broker-dealer and secondary market for illiquid assets. Auction-rate securities are debt instruments with interest rates that are meant to be reset periodically at auction.

As the uncertainty has lingered, investors have put off buying homes, expanding businesses or retiring. Others have stood by, their money on the sidelines, as financial markets made a tremendous recovery in the wake of the financial crisis and global recession.

Thomas Martin, president of Americas Watchdog, a private consumer group in Washington, said he has received phone calls from numerous investors still trapped. “Where’s the outrage?” he asked. “Here comes another spring and these poor people don’t know where their money is, what their retirement situation is; they’re forgotten. Where are the regulators?”

Municipalities, nonprofit hospitals, utilities, housing-finance agencies, student-loan finance authorities and universities were among the frequent issuers of auction-rate securities. Among the investors in the securities were corporations, charities and individual investors. Many purchased them on the advice of brokers, who touted them as a safe, liquid alternative to cash.

But in February 2008, the market froze amid the credit crunch. By the fall of 2010, dozens of big banks and brokerages that underwrote the offerings had repurchased billions of dollars of the securities in settlements with regulators. Since then, various brokerages have redeemed some securities in batches and some investors have won their money back via arbitration. But some banks and brokerages fell through the cracks or have been slow to cash out investors.

The situation is fraught for investors. Many of those who can afford attorneys have hired them because they faced a statute of limitations on filing arbitration claims. Others fear they’ll be placed at the end of the line in any redemption process should they speak out. Brokers who hold the securities in their own accounts fear losing their jobs if they discuss the issue.

The exit avenues aren’t appealing. Investors can sell the shares on the secondary market, but that generally means taking a sizeable loss. Investors may file an arbitration claim, and many have. But for those holding securities worth less than $1 million, it’s difficult to justify the costs, which can run to $100,000.

“It’s kind of a black hole now,” Mr. Martin said. “We’ve got retail investors, small-timers, then big commercial investors who are in these things for tens of millions of dollars, and we don’t know what’s happening to them all.”

Ed Dowling, the owner of a clothing maker in New York City, originally had about $2.6 million stuck in the securities and still has $1.175 million stranded, all of which were sold by Oppenheimer, a subsidiary of Oppenheimer Holdings Inc. “I think it’s absolutely foul and disgusting. I think the whole system is either broken or corrupt.”

For two big sellers of the auction-rate securities—Charles Schwab Corp. and E*Trade Financial Corp.—accords were struck to unfreeze investors. While some securities remain outstanding at the firms, the terms of the wind-down have been set.

BlackRock Inc.’s BlackRock Advisors said in May that it’s in negotiations with liquidity providers and will redeem outstanding securities over the next 12 months based on facts and circumstances surrounding each fund if those negotiations are successful. “There is no guarantee that all or a portion of a particular fund’s ARPS will be redeemed,” it said.

But investors who purchased shares from some firms, including Allianz SE ‘s Pacific Investment Management Co. or Oppenheimer, still have no explicit word on when or whether their investments will be redeemed.

Pimco and Nicholas-Applegate Capital Management—since rebranded Allianz Global Investors Capital—had $5.3 billion in auction-rate preferred shares outstanding in March 2008. About 44% of the shares issued by companies’ closed-end funds have since been redeemed. Pimco said it hasn’t made any redemptions since 2009.

Allianz told shareholders in a December letter that it’s evaluating market alternatives. It isn’t possible “to determine if and when a solution will be identified,” Allianz said at the time. Pimco had no further comment.

The issues at play are perhaps most acute at Oppenheimer, one of the largest sellers of auction-rate securities to individuals. It had about $377 million stranded in auction-rate securities as of Dec. 31, according to a regulatory filing by the company. That amount excludes securities owned by qualified institutional buyers and those transferred to the company, purchased by clients or transferred from the company to other securities firms after February 2008, it said.

Oppenheimer stands out among the major brokerages because its settlement with regulators didn’t result in a timely redemption for individual investors, said Todd Higgins, a managing partner at law firm Crosby & Higgins LLP in New York.

Oppenheimer reached settlements with the New York attorney general’s office—then led by current New York Gov. Andrew Cuomo—and the Massachusetts Secretary of the Commonwealth’s office in 2010, and purchased $69.3 million in auction-rate securities from clients. The settlement committed Oppenheimer to a financial review every six months to see if more funds are available buy additional auction-rate securities from holders. The company must report to the attorney general’s office on those reviews.

“That’s the only one that I’m aware of that’s ended up in a repurchase process that has the potential to drag on for many, many years,” said Mr. Higgins, who has represented about a dozen claims against Oppenheimer, five of which are pending.

Oppenheimer said it is purchasing the securities on a periodic basis in accordance with its settlements. The company noted that it is committed to purchase a total of $57.3 million in the securities from clients through 2016 and will pay about $2.5 million as a result of legal settlements with clients. Oppenheimer had no further comment.

Danny Kanner, a spokesman for New York State Attorney General Eric Schneiderman’s office, said, “This office is routinely scrutinizing the expenditures of the firm, which is conducting buybacks periodically throughout the year.”

Steve Cohen, former chief of staff to Mr. Cuomo, said, “The auction-rate-security settlements speak for themselves, putting billions of dollars back into the pockets of victims across the country who were misled into believing they were buying cash equivalent investments”

Investors say they fear Oppenheimer is waiting them out, hoping they will sell at a discount on the secondary market in desperation before any redemption comes their way.

Phillip Aidikoff, a partner in the law firm Aidikoff, Uhl & Bakhtiari, has represented investors in about 50 arbitration cases related to auction-rate securities since the market froze. Most have been resolved through regulatory settlements or settlements with broker-dealers, he said.

The settlement Oppenheimer reached with Mr. Cuomo’s office was “stunningly inept,” Mr. Aidikoff said. “It allows the broker-dealer to do whatever it wants to do.”

But in the U.S., some of the most important information about a broker is off limits to individual investors.

At present, you can do broker background checks through a web-based system run by the Financial Industry Regulatory Authority, the trade group that regulates the securities industry (FINRA), called BrokerCheck.

Or contact your state securities regulator. FINRA’s site contains incomplete records, since it’s self-reported. And while state regulators often have fuller reports, most investors will probably not know that they are available, and those regulators may not always be accessible nor may their reports be user-friendly.

The information gap between state authorities and FINRA has existed for years. FINRA, which has been slowly improving disclosure, is now seeking comments – send emails to pubcom@finra.org – from the public on how to improve the service.

What kind of information is essential? Here’s what you need to know that isn’t being fully disclosed by FINRA:

* Reasons for termination. Say a broker is fired from a firm. BrokerCheck won’t give you the specific reason. If I were considering a broker, I’d want to know if he was fired for churning accounts and fleecing investors.

* Records that date back to time of registration. FINRA records may not have a complete chronological history of brokers. You need a “legacy” file that includes all of the actions against a broker since he obtained his registration.

* Complete court actions. BrokerCheck does not include complete details on everything an investor might want to know about, including disclosure of all felony charges; misdemeanor charges involving investment related business, fraud, wrongful taking of property, bribery, perjury, forgery, and other crimes of property; employment terminations relating to allegations of violations of investment related statutes or fraud or bankruptcy and unsatisfied judgments or lien information, according to John Cronin, a Vermont securities regulator and chair of the committee that works with FINRA for the North American Securities Administrators Association, a regulator’s group. State securities offices should have this background information.

* Expunged Records. Brokers can petition to have customer disputes involving arbitration awards expunged, and after a process is followed, the records can be taken out of the Central Registration Depository, a database at the heart of BrokerCheck. According to Nancy Condon, FINRA spokesperson, the number of expungements soared to 220 last year “due to the large number of post-crash customer claims,” compared to 77 in 2009. Investors should be able to find out why claims were expunged.

State securities regulators have been frustrated over the years in urging FINRA to offer full broker files. Since FINRA is a trade organization funded by the brokerage industry – with oversight by the Securities and Exchange Commission (SEC) – it has a built-in conflict of interest in also regulating it.

This pernicious conflict was not resolved by Dodd-Frank and is unlikely to be addressed as the financial services industry badgers Congress and federal regulators into delaying, watering down or eliminating financial reforms. FINRA is also lobbying for the authority to regulate registered investment advisers.

As a non-governmental, self-regulatory organization, Freedom-of-Information Act requests can’t be used to pry valuable data from FINRA. So you have little chance of getting complete complaint information on the worst brokerage firms and non-published dispute settlements.

Ryan Bakhtiari, a Los Angeles lawyer and president of the Public Investors Arbitration Bar Association, a trade group of attorneys who represent investors, said brokers can often game BrokerCheck by not reporting investor complaints if they determine the matter involves less than $15,000.

“We ought to be telling the public the whole truth about the people in this business,” Bakhtiari told me. Increasingly, he said, brokerage firms that lose large cases in arbitration go to court to have the awards overturned or “vacated.”

Although PIABA doesn’t have statistics on how many awards are challenged outside of the arbitration forum, his firm notoriously handled an $11 million case filed by actor Larry Hagman against Smith Barney/Citigroup, which succeeded in having the arbitration award thrown out in court. The two parties later settled out of court.

Bakhtiari said one of the best moves regulators could make would be to repeal the mandatory arbitration clauses investors are required to sign when they open brokerage accounts. At present, you don’t have direct access to the court system when you have a dispute with a broker and must work directly with the firm or go through FINRA’s difficult and often costly arbitration process. Still, other lawyers argue the proceedings are still less costly and time-consuming than court.

TRANSPARENCY IS ESSENTIAL

Opening up broker records should be a no-brainer for an industry still under fire for the myriad sins of 2008 and missing scams by Bernie Madoff and Allen Stanford. “When registrants understand that their misconduct will be made available to potential investors, there is a strong incentive to avoid violative conduct,” Cronin added.

The SEC is currently studying the option of scrapping mandatory arbitration provision and is developing a rule that would require brokers who give personalized investment advice to become fiduciaries – making them legally responsible for protecting client’s interests first. Both proposals are ideas whose time have come.

In July 2007, Pandit sold Old Lane Partners LP to Citigroup Inc. for $800 million and pocketed $165 million for his stake. Then he took over the bank’s in-house hedge-fund group, now called Citi Capital Advisors, or CCA. He became chief executive officer of the whole company just five months later.

For Pandit, the hedge-fund business was a sprint to riches. For Citigroup, it’s been a slog, Bloomberg Markets magazine reports in its April issue. When Pandit, 55, was promoted in December 2007, CCA managed $59 billion in hedge funds, private- equity pools and real estate. In 2007, it earned net income — from fees charged to clients and gains on its own money — of $672 million.

After the financial crisis, Citigroup closed some funds — it won’t say how many — and investors fled others. As of mid- February, it managed $18.6 billion. The last time Citi told shareholders how CCA performed was the first quarter of 2008, when the unit lost $509 million. Four of Citi’s seven biggest hedge funds have underperformed their indexes since they started, according to investors. Five of the seven lost money in 2011.

Pandit persevered. Since 2008, he has opened or purchased at least six new funds. In the third quarter of 2011, he invested $800 million of the bank’s own money — not cash from investors or clients — into CCA, even as traders from Goldman Sachs Group Inc. and other banks were jumping ship to start their own hedge funds in advance of the Volcker rule.

Volcker Rule

That law, championed by former Federal Reserve Chairman Paul Volcker and made part of the Dodd-Frank Act, says a deposit-taking bank’s proprietary capital can’t account for more than 3 percent of any hedge fund.

In at least four of Citi’s funds, half or more of the assets have come from Citi’s own balance sheet during the past two years, not from investors or clients of its private bank, according to interviews with people familiar with the funds and documents obtained by Bloomberg Markets. That has to change by the time the Volcker rule is fully implemented; it is scheduled to take effect in July and includes a two-year transition period.

So, in February, Pandit capitulated. John Havens, Citigroup’s chief operating officer and the chairman of CCA, told Bloomberg News that the bank planned to sell a “significant” portion of CCA to managers of the group.

Best Talent

The organization will ultimately be independent of Citi, which will help hedge-fund and private-equity managers raise money from outside investors, says Havens, 55, who worked with Pandit when both were executives at Morgan Stanley and co- founded Old Lane with him.

“Clients like independent, alternative asset managers,” Havens says in his office in downtown Manhattan. “You can attract the best talent in the owner-operator model.”

Citi plans on keeping a stake in CCA, although the percentage will drop as assets from outside investors come in and the bank takes its own money out of the funds, Havens says.

“We like the business; that’s why we took the decisions in 2008 to rebuild it,” he says.

The details and timing of the sale aren’t final, including who will run it, Havens says. He declined to say whether Jonathan Dorfman and James O’Brien, CCA’s co-heads, would be part of the deal. Friends of Vikram

Dorfman, 50, and O’Brien, 51, who both worked with Pandit at Morgan Stanley, are confidantes of the Citigroup CEO and of Havens, to whom they report. The leaders of other units, including mergers advice and private banking, answer to James “Jamie” Forese, head of Citi’s securities and banking division, of which CCA is a unit.

The fund managers eligible to be part of the management buyout also have ties to Pandit and Havens. Mukesh Patel, manager of the Event Driven Fund, and two of his assistants came from Old Lane. Kevin Bespolka, manager of the Global Macro Fund, worked for Pandit there too, as did Manu Rana, manager of the Financial Partners Fund.

The decision to sell the hedge and private-equity funds comes at a time when Citigroup is still recovering from its near-death experience four years ago. Citi needed $45 billion from the Troubled Asset Relief Program, $99 billion in loans from the Federal Reserve and $301 billion in government asset guarantees to stay alive. Its stock declined 33 percent in the 12 months ended on Feb. 13.

Asset Sales

Pandit split the bank in 2009, creating a unit called Citi Holdings, where he sequestered securities built from subprime mortgages and other toxic investments. He has offloaded various enterprises and assets, including life insurer Primerica Inc. and Student Loan Corp.

He sold 51 percent of the bank’s Smith Barney brokerage to Morgan Stanley, where he worked for 22 years before starting Old Lane. Morgan Stanley Smith Barney is a joint venture between the two banks.

It makes sense for Citigroup to add its hedge and private- equity funds to the discard pile, says Richard Staite, an analyst at Atlantic Equities LLP in London. The bank should play to its strengths — consumer lending and emerging-markets finance — says Staite, who has an “overweight” rating on Citi shares. “Strategically, they should be able to exit that and focus on lower-risk businesses,” he says.

Jeff Haindl, who runs the hedge-fund business at Zurich- based Falcon Private Bank Ltd., says the banking and fund- management cultures are a bad fit.

Independent Funds

“It’s difficult for banks, for internal and increasingly for political and regulatory reasons, to offer compensation that’s competitive with independent hedge funds,” Haindl says.

That’s why none of the biggest names in the industry — such as Steven A. Cohen of SAC Capital Advisors LP, Ray Dalio of Bridgewater Associates LP and George Soros of Soros Fund Management LLC — are at banks. Like the independents, managers at banks get paid to perform, Haindl says, yet many collect salaries and bonuses, which are less directly tied to their returns.

Investors say Citi’s funds will need stronger performance than they’ve shown in recent years to attract the outside capital Havens is seeking. The worst performer among the seven largest funds last year was the Strategic Credit Fund, which lost 14.2 percent, according to people who were solicited to invest. Credit funds, on average, climbed 1.5 percent in 2011, according to data compiled by Bloomberg. The $200 million fund is run by Fred Hoffman and manages mostly Citi capital.

Lagging

The $400 million Mortgage/Credit Opportunity Fund, managed by Rajesh Kumar, lost 4.2 percent in 2011, including a 10 percent dive in August. The loss is striking because mortgage funds were the best performers among hedge funds, gaining an average of 14.5 percent, according to Bloomberg data.

Kumar’s fund returned 23 percent in 2009 and 26.5 percent in 2010, according to documents obtained by Bloomberg Markets. Betting that mortgages would continue to rise last year, he bought up shares in CreXus Investment Corp., a New York-based firm that invests in commercial mortgage-backed securities.

Kumar also pumped money into Rayonier Inc. and Weyerhaeuser Co., two U.S. timber companies that he bet would benefit from the March 2011 earthquake and tsunami in northern Japan. “As Japan rebuilds its infrastructure over the next few years, it will likely use a higher proportion of wood this time around, as wood offers better protection against earthquakes,” Kumar wrote in a March 2011 report to investors. “While the Japan crisis is a deep tragedy, we believe it offers some long-term opportunity.”

CreXus Falls

The play failed as the European debt crisis roiled credit markets and sent shares of all commodities companies lower. CreXus shares tumbled more than 20 percent in the six months following his report. Rayonier fell 11 percent and Weyerhaeuser declined 37 percent because the Japanese rebuilt more slowly than some investors had predicted, says Joshua Barber, an analyst at Stifel Nicolaus & Co. in Baltimore.

Patel’s $500 million Event Driven Fund is one of Citigroup’s better performers. Although it lost 1.8 percent last year, it has posted an average annual return of 8.5 percent since it was started in July 2008, compared with 2.4 percent for Hedge Fund Research Inc.’s index of funds that invest based on mergers, restructurings and other corporate events. Still, Patel has had trouble raising outside money. As of April 2010, all of the assets in the fund belonged to Citi, according to a CCA marketing brochure.

Franklin Excels

Another standout is the London-based Emerging Markets Special Opportunities Fund, which trades developing-country bonds and is Citigroup’s largest, with $900 million in assets. Run by Mark Franklin, the fund lost just 3.4 percent in 2008, when the average hedge fund tumbled 19 percent, according to Bloomberg data. Since Franklin started the fund in May 2000, it’s jumped 10.4 percent a year, on average, ahead of Hedge Fund Research’s Emerging Markets Index.

Even with underperformance and the inability of some funds to attract outside cash, Havens praises Dorfman and O’Brien’s work.

“I’m a rough judge; I want everything yesterday,” Havens says. “But the team has done a very good job in transforming the business, attracting the talent, building up the infrastructure.”

Dorfman and O’Brien’s efforts to run CCA under Pandit and Havens have been hampered by more than underperforming funds. Burned investors have also plagued the unit, seeking to regain millions of dollars they say CCA managers have squandered. Two investors from Aspen, Colorado — attorney Gerald Hosier and venture capitalist Jerry Murdock Jr. — were awarded $54.1 million in April 2011 by a three-person mediation panel convened by the Financial Industry Regulatory Authority, or Finra.

ASTA/MAT

Hosier and Murdock said they lost $26.9 million in 2008 investing in municipal bond arbitrage hedge funds that Citigroup had marketed as low risk. The funds, called ASTA/MAT, used borrowed money to try to extract high, consistent returns from the muni market.

Citi asked a federal district court judge in Denver to throw out the award, alleging that Hosier and Murdock had signed documents acknowledging that they knew they could sustain losses. Citi filed a trove of documents, and the plaintiffs filed more, including e-mails from Citi sales personnel depicting the funds as higher-yielding, yet safe, alternatives to ordinary fixed-income securities.

In December, Judge Christine Arguello ruled for Hosier and Murdock and affirmed the award, which is among the largest ever for individual investors. More than three dozen other cases have been settled, according to Phil Aidikoff, the Beverly Hills, California, lawyer who represented Hosier and Murdock. There are more than 60 to go.

Taped Meeting

Dorfman and O’Brien joined Citi in late 2007 when Pandit bought their hedge fund, Carlton Hill Global Capital LLC. They took charge of the bank’s fixed-income hedge funds, including the muni arbitrage funds. On Dec. 18, 2007, Dorfman and O’Brien called a meeting with Reaz Islam, manager of the muni funds. Islam recorded the conversation.

Dorfman and O’Brien told Islam that they were going to remove him from his job and have him set up and market a new fund. Islam protested, saying the funds could recover once the debt markets rebounded.

Dorfman became impatient.

“One thing I have a problem with is everybody at this firm tends to say, ‘Well, it was just the market,’” he said. “That’s why the firm’s stock price is half of what it was this summer. I can’t live with that.”

O’Brien and Dorfman pressed Islam to come up with the names of 10 people they could fire to cut costs.

“Tell me now,” O’Brien said. “That’s what I want to see. That’s what I asked you for three weeks ago and again yesterday. I said, ‘Show me the names.’”

‘Nuclear Winter’

Islam pleaded to let the employees stay until they got their bonuses. Dorfman and O’Brien declined to comment on the 2007 conversation.

Three months later, Citi’s private bankers raged against the hedge-fund unit, accusing it of angering wealthy private- bank clients who had invested in the muni funds.

“Respectfully, this is Nuclear Winter!” wrote one, Andrew Basch, to Sallie Krawcheck, who then ran the wealth management unit. “In no uncertain terms did anyone ever infer a risk of this magnitude in any conference calls or live meetings.”

Islam left Citi in August 2008. Contacted in Dhaka, Bangladesh, where he is a managing partner for New York-based LR Global Partners, Islam says Hosier, Murdock and other investors in the muni funds were well aware of the dangers.

‘Idiot Proof’

“We talked about every risk in the prospectus,” he says. “The marketing materials, including the term sheet risk disclosures, were comprehensive, written in plain English and idiot-proof.”

Dorfman and O’Brien tapped Craig Henick, another municipal- bond-fund manager, to take over Islam’s duties, even though he had his own troubles. In 2007, seven Norwegian towns, including Narvik, which lies above the Arctic Circle, lost $90 million investing in securities linked to a highly leveraged muni-bond fund Henick managed, according to a complaint filed in August 2009 in federal district court in Manhattan. Narvik was forced to shut off its street lights after the loss, the complaint says. The case is pending.

The municipal-bond mess didn’t stop Citigroup from adding more hedge funds to its collection. In November 2008, the bank bought Epic Asset Management LLC, a fund run by James Duplessie and Herbert Seif.

O’Connor Roots

Duplessie, now 52, and Seif, 63, met while working for Chicago-based O’Connor & Associates, a so-called quant shop where traders used algorithms to trade futures and options. Seif, a Brooklyn College graduate, joined O’Connor in 1980 and later started trading in distressed debt, a new field. Duplessie joined O’Connor in 1991, according to a Citi biography of him.

Swiss Bank Corp. bought O’Connor in 1992, and the pair ran the SBC Restructuring and Recovery Fund. Union Bank of Switzerland merged with Swiss Bank in 1998 to form UBS AG. After the 1998 Russian debt default and the collapse of hedge fund Long-Term Capital Management LP, UBS cut back on risk. In 1999, Seif and Duplessie shut their fund, according to a person who was at the bank at the time and knew the men.

They got back together in 2002 and started Epic in Fort Lee, New Jersey. Epic returned 31 percent in 2003, its first full year in operation, according to fund records. It then raked in another 23 percent in 2004, 4 percent in 2005 and 25 percent in 2006. By that year, Epic had $140 million under management, according to a presentation on the fund prepared that April.

Imax in Eilat

Epic was just one of Seif’s pursuits in those days, according to a former investor in the fund. He also owned an Imax movie theater in Eilat, Israel, and built a large house in Jerusalem, where he spent as much time as he could, the former investor says. Seif declined to comment.

Epic’s performance faltered in 2007, when the fund dropped 3 percent. Returns deteriorated rapidly in 2008; the fund lost 15 percent in October alone. Nonetheless, in November Citi bought it for an undisclosed sum. It ended the year down 41 percent, according to a fund document.

At Epic, Duplessie and Seif had seldom made themselves available to talk to clients, former investors say, and the situation worsened at Citi, where they run the $240 million Distressed Debt Opportunity Fund. Investors who succeeded in getting Seif on the phone with a question about performance would be told to contact the chief financial officer of CCA.

Still Down

Duplessie and Seif posted better returns after the crisis, gaining 22 percent in 2009 and 19 percent in 2010. That’s not enough to make up for 2008. Investors who were in the fund before then are still down about 19 percent. The distressed-debt fund has returned 5.84 percent a year since it was launched in April 2002 compared with 8.6 percent for the Hedge Fund Research Distressed Index.

Citigroup is now marketing a new fund, called the Middle Market Direct Lending Fund, to be run by Duplessie and Seif, even though Citi’s own cash made up 65 percent of the existing distressed debt fund’s assets as recently as December 2010.

Havens says he set out in 2010 to raise $3 billion from institutional investors to invest in CCA funds, and he has already pulled in $2.6 billion — though he won’t say how much of it has gone to hedge funds as opposed to private equity.

“They’re critically important clients for this company,” he says of the investors.

The question is whether the fund group that was once Vikram Pandit’s personal domain will do better, and attract investor money, when it’s no longer part of Citigroup.

The Financial Industry Regulatory Authority recently took a step toward resolving that issue. In a notice on Tuesday, FINRA invited suggestions from the public on possible improvements to its free online disclosure system, known as BrokerCheck.

Information available through BrokerCheck has been expanded several times in recent years. Individual reports about brokers, for example, now include links to disciplinary action taken against them, which is available in a separate database that FINRA launched in May. Records about brokers who leave the brokerage industry, and who may take on other financial advisory roles, are now available going back 10 years instead of two.

But many investors seek that information too late.

“Very few people read it until after there’s a problem,” said William Jacobson, a professor at Cornell Law School’s Securities Law Clinic in Ithaca, New York.

Even then, the public reports don’t include some information that only securities industry members and regulators can see, such as details about a broker’s firing, he said.

According to a 2009 study FINRA cited in its notice, only 15 percent of respondents said they checked out their adviser’s background with a state or federal regulator. The actual number may be even lower, industry sources said.

FINRA has been wrestling with those concerns. It hired a market consultant to conduct focus groups and surveys about BrokerCheck, according to the notice, in addition to the suggestions it is now soliciting.

“It’s a huge opportunity for FINRA to say ‘here’s the system in place and here’s how we can tweak it going forward,’” said Ryan Bakhtiari, president of the Public Investors Arbitration Bar Association, an organization of lawyers who represent investors in securities arbitration cases.

SYSTEM TWEAKS

While FINRA prepares to consider those proposals for investor outreach, it is finishing several improvements to BrokerCheck required by a U.S. Securities and Exchange Commission staff study.

For example, FINRA is in the process of providing streamlined search results for BrokerCheck and a separate database, the Investment Adviser Public Disclosure, or IAPD, which the public can use to find annual disclosure forms for SEC-registered advisers.

Investors must now conduct separate searches on the two databases for advisers who are registered with both FINRA and the SEC. But they will soon be able to get that information by running one search.

The regulator is also adding educational content, such as definitions to help investors understand certain industry terms, and a feature that will let them search for advisers by entering a ZIP Code. The database is presently set up to search for advisers and brokerages by their individual names. FINRA must complete the changes by July, according to the Dodd-Frank financial reform law, though it expects to put the changes into effect before then.

Some of those efforts, however, could end up buried in FINRA’s presentation of the information it includes on BrokerCheck, said Gerri Leder, president of LederMark Communications, LLC a financial marketing company in Baltimore, Maryland.

Issues that may worry investors the most, such as customer complaints and enforcement proceedings by regulators, are listed near the end of a BrokerCheck report.

“You’ll see a couple of pages about licenses before you get into anything about complaints,” she said.

The point is not lost on FINRA, whose public plea for help asks for suggestions about possible design and content changes for BrokerCheck. Among the items being considered are concise summaries about complaints and regulatory actions against brokers and brokerages.

PUBLIC NOTICE

FINRA will need to make a nationwide effort to get the word out about BrokerCheck, said Leder, but that could be as simple as requiring its member firms to include the BrokerCheck logo on their Websites and statements, she said.

Allowing for-profit companies to use BrokerCheck information for their own Websites and investor services is another possibility. FINRA is also seeking input on possible benefits and disadvantages of those arrangements.

BrightScope, Inc., a San Diego-based consulting firm that rates 401(k) plans, is already making some headway on that front. In April, it launched “BrightScope Advisor Pages,” a free service through which investors can search advisers by assets under management, geographic area and other criteria. BrightScope gathers information from FINRA’s BrokerCheck and the SEC database, according to Mike Alfred, its co-founder and chief executive.

“In order to make data truly open and public, you have to help (investors) see the light,” Alfred said. “There’s no reason the data should be formatted in an antiquated way,” he said.

Comments to FINRA are due by April 6.

The Memphis, Tennessee-based firm filed a court action in New York on Wednesday to overturn the ruling by a Financial Industry Regulatory Authority arbitration panel, which resulted from the agent’s claims that he incurred personal losses from bad bond investments.

W. Kyle Rote Jr., whose company Athletic Resource Management represents star clients such as Denver Broncos quarterback Tim Tebow, was the latest to allege that Morgan Keegan breached its contract by failing to disclose the extent of risk involved in his personal investments.

“It’s just another tactic to delay, stall and temper the enthusiasm for victims of their practices who are achieving restitution,” said Peter Mougey, a lawyer in Pensacola, Florida who represented Rote.

Arbitration awards are typically binding. However, parties can ask courts to overturn them in limited circumstances, such as when arbitrators misapply the law.

Mougey said he expects the court to uphold its decision and plans to ask for a modification to the award to seek the full amount of $954,000 initially sought, of which only half was granted.

Morgan Keegan declined to comment.

While proceedings to vacate arbitration awards are unusual, Morgan Keegan has tried to overturn numerous awards to investors involving a group of money-losing bond funds which have become the subject of state and federal regulatory actions.

For example, Morgan Keegan tried to challenge an award granted to former professional basketball star Horace Grant in September 2009, after the brokerage was ordered by arbitrators to pay $1.5 million to Grant. That case is still pending in a federal appeals court.

Mougey said out of the roughly 1,000 FINRA arbitration cases he has worked on, he could “count on one hand” how many of those that actually went to hearing were appealed.

“Almost every one of those has been a Morgan Keegan case,” he said.

Trying to overturn an award is among Morgan Keegan’s legal rights, but the practice does not “respect the finality of the arbitration decision,” said Ryan Bakhtiari, president of the Public Investors Arbitration Bar Association, an organization of lawyers which represents investors in securities arbitration cases.

The brokerage’s account-opening agreement requires its customers to arbitrate disputes instead of going to court, he said.

“But when it comes to an arbitration decision they don’t like, they’re the first to walk away,” Bakhtiari said. “It’s a pattern of bad behavior.”

In Rote’s case, Morgan Keegan claimed, among other things, that one of the arbitrators on the panel was biased because of his involvement in a prior Morgan Keegan case involving the money-losing bond funds.

Morgan Keegan also argued that the award did not adequately explain how the $400,000 would be divided among the three claimants, which were Rote, his wife, and a trust, of which Rote is a trustee.

The brokerage, which was owned by Regions Financial Corp at the time that many of losses from the bond funds were incurred, is now being purchased by Raymond James Financial Inc .

Rote is a former professional soccer player and son of the NFL New York Giants football star Kyle Rote.

“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.