Give Me Back My Money - use of arbitration when investment suggestions from stock brokers prove to be bad

Kiplinger's Personal Finance Magazine, Jan, 2001 by Jeffrey R. Kosnett

BROKERS | When you've been done wrong, you can win the ARBITRATION game.

ERWIN ANDERSEN, a self-employed construction engineer, runs his business from his cell phone. So when his handset chirped early on an October morning two years ago, as he worked at a Kmart building site in Chicago, he didn't expect it to be his broker, Jack Lantis of A.G. Edwards, talking options.

Andersen says that Lands persuaded him he could grab a quick $1,600 profit by selling some Dell Computer options he owned. But after the market closed that day, Lantis called back with a "problem." Dell shares had just plunged, and remaining in Andersen's account were other options that obliged him to buy Dell shares at a price above what they now traded for. (The options he sold in the morning had hedged his exposure to this risk.) The effect of the day's events: Andersen faced a margin call of $25,000.

The broker advised Andersen that he could satisfy the margin call by buying back the same Dell options he had sold that morning, plus other Dell options--but now it would cost him more than $27,000. To raise the money, Andersen sold options positions on other stocks that, as luck would have it, would have won big. When the dust settled, Andersen's account was wiped out and he owed A.G. Edwards $3,700.

Andersen later argued in an arbitration claim that the episode cost him $36,000 in actual losses on the Dell options and others he sold to cover shortages in his account, and $89,000 in profits he would have made had he not sold all his option positions because of the Dell disaster. A panel of three arbitrators awarded Andersen $64,000 plus interest and all his legal costs. Although lawyers for A.G. Edwards called Andersen a speculator who knew more about high-risk options trading than he let on, Andersen not only prevailed but won back more than he had lost. You can win, too--if you have a strong case, a good lawyer, complete records, and a strong stomach and patience.

Pressing an arbitration claim isn't cheap. A two-day hearing by a three-member panel of the National Association of Securities Dealers (NASD) cost Andersen $4,500. (If you win, the other side usually pays.) Legal fees and the cost of an expert witness can reach five figures. And even if you win, collecting the money you're awarded can be a problem, especially if your claim isn't against an established firm. Many losers of arbitration cases are missing, defunct or have filed for bankruptcy protection.

Learn the odds

AGGRIEVED investors can beef about the arbitration system, but they're stuck with it. Arbitration is used by the brokerage industry to avoid lawsuits. So in most instances, when you open a new brokerage account, you agree to take any "controversy" to arbitration. Arbitration allows no right of appeal. Punitive damages are rare, and there is no jury to impress. Cases are decided by a three-person panel, one of whose members is involved in the brokerage business. The other two panelists are "public" representatives, such as college professors or retired business people. To get even, you need to grab control of the process and stay on the offensive.

Roughly 6,000 arbitration claims are filed each year, a number that has held steady since 1995, after big increases earlier in the decade. The issues most commonly fought over involve investor claims of breach of fiduciary duty, misrepresentation, negligence, churning and unauthorized trading.

NASD data indicate that investors receive an award in 50% to 60% of the cases decided in arbitration. About 60% are settled before they reach a hearing, so investors recover something in about three-fourths of the arbitrations. But how much? There are no statistics on settled cases, but from 1992 to 1998 NASD arbitrators awarded about half of the amount claimed. Arbitrators rarely award lawyers' fees unless the investor asks. But if you do win and ask to be reimbursed for your legal fees, the odds favor you. In 1998 arbitrators awarded attorneys' fees to 68% of winners who asked for them.

For most investors, whether they are satisfied with the system depends on the outcome of their own case. Alex Philibert, 66, an engineer from Philadelphia, got an NASD panel to award him $43,000 (but not the legal fees he sought) for a back-office mess in which a stock certificate for 741 shares of AT&T belonging to his late father was mailed to the wrong address, lost and never replaced. Philibert says the three arbitrators were "savvy" and "very professional," but he had sought $300,000, including punitive damages, and thinks he could have done better in court. Philibert's attorney, Debra Speyer, says she believes the outcome was fair.

Rami Kichi, 34, a gem trader and importer from Miami, says he caught vibes during his hearing last summer that he might not win his six-figure churning case against a group of brokers from two firms. So he agreed to settle for about one-fourth of his claim. He says one of the brokers still owes him $65,000 of that settlement. His lawyer, Alexander Novak of New York City, says the settlement was reasonable.