When your broker goes bad
What if your losses in this market were due to a financial adviser who didn't play fair? Getting your money back won't be easy, but your odds may be improving.
(Money Magazine) -- Maybe the bear market ended your early-retirement dreams. Or you found out that your parents' nest egg is nearly gone. Or you just didn't think you could lose that much, that quickly. You're angry. Especially if there was a "financial adviser" -- what everybody used to call a broker -- getting paid along the way.
Just how much blame can you lay at that guy's doorstep? You'd have lost money in the past year even with the soundest of advisers. And most ways a broker can leave you poorer are perfectly legal. But there are times when a broker steps out of bounds and he -- actually, his firm -- can be forced to pay up.
Forget about suing the brokerage. Back when you became a customer, you signed an agreement to settle any dispute in private arbitration, a process that investor advocates complain tilts toward the industry.
For now, those are the rules. Your first order of business is to figure out what went wrong with your account. Here you'll learn the difference between a fair gripe and a winnable case, plus how to navigate the arbitration process. Finally, you'll see how the system may be about to change in your favor.
Some of the most common problems with brokers won't merit arbitration. But they may be good reasons to find another adviser. For example:
He keeps putting you in trendy investments that tank. So it turns out that the red-hot emerging-markets mutual fund you bought in 2007 wasn't the magic diversifier that would protect you when U.S. markets fell. And then your broker suggested you move into bonds -- just in time to miss the rebound. The best advisers build long-term financial plans; others are just salesmen. It's easier to pitch what's already performing well. But if bad market calls were illegal, Wall Street would be a ghost town.
Instead of picking the best investments, he picked the ones that paid him (or his firm). Brokers must recommend investments that are suitable for you (more on that in a moment). That doesn't keep them from choosing funds or annuities from "preferred" lists of firms that pay the brokerage extra, or pitching mainly funds run by their own company. Brokerages can get in trouble for not disclosing such potential conflicts, but "disclosure" simply means putting it in writing somewhere.
Fraudulent investments, unauthorized trades, churning (pointless trading to generate fees) -- all that classic sleaze is grounds for arbitration. But relatively few complaints allege such things today. The more common claims:
The investments he sold were unsuitable for you. If you told your broker you didn't mind big risks, no arbitrator is likely to care how much you lost. But what if you said you didn't want to gamble?
Phil Rein claims he told his Stifel Nicolaus adviser just that after he took early retirement in 2000 at 43. Rein had accumulated $750,000 and hoped to live on it. That may have been overly ambitious at his age, but his broker's advice was hardly a realistic plan to preserve capital. He got Rein heavily into tech stocks via managed accounts and a variable annuity. Rein lost more than half his savings.
"I would call the broker about the losses, and he would reassure me each time, saying this was normal," says Rein. He won $220,000 in arbitration in March. Stifel Nicolaus declined to comment.
The broker misrepresented the risks of what he was selling. The firm Morgan Keegan is facing numerous such claims. Bond funds sold by its advisers held risky mortgage-backed securities, but many investors say these were sold to them as conservative funds.
Former pro football player Jerome Woods won a $950,000 award in April. Jo Wright, a church secretary in Indianapolis, won $18,000 after claiming an $11,000 loss. Wright had taken her $20,000 life savings out of a CD and put it into one of the bond funds. Morgan Keegan says it disagrees with these outcomes and is defending itself against the other claims.
If you think your broker has done you wrong, complain to your state regulator (see nasaa.org for a listing) and to FINRA (finra.org), a private agency funded by the securities industry. But the regulators' main role is enforcement, not recouping your losses. For that you'll have to go to arbitration, which is also run by FINRA. What to know going in:
You'll need a lawyer for most claims. Just because you don't go to court doesn't mean the system is easy to navigate. Brokerages will have lawyers on their side. An attorney will usually give you a free consultation -- most get paid only if you win or settle -- but many won't pursue claims under $100,000. If yours is less than that, try a law school legal clinic. (Get info at sec.gov/answers/arbclin.htm.)
If your claim is less than $25,000, there's no hearing, just filings. An attorney can help you draft the papers for about $500 to $1,000, says securities attorney and Baruch College law professor Seth Lipner.
You likely won't be made whole. Your lawyer will take 30% to 40% of what you get, and investors rarely win compensation for legal or other costs. On average, investors who win get back less than half of their claimed loss, according to a study by attorney Dan Solin and the Securities Litigation & Consulting Group. About half of cases settle, often for as little as 25 on the dollar, lawyers say.
The brokerage may have a built-in advantage. If the claim is over $100,000, your case will be heard by three arbitrators agreed to by your lawyer and the brokerage's. At least one must have worked in the securities industry. Linda Fienberg, president of FINRA Dispute Resolution, says this ensures that someone in the room understands the business. Plaintiffs lawyers disagree. "It's like having a doctor on a jury in a medical malpractice suit," says Brian Smiley of the Public Investors Arbitration Bar Association.
In response to criticism, FINRA has launched a pilot program in which some cases can be heard by a panel with no industry arbitrator. Fienberg says they'll study the results.
Meanwhile, the Obama administration has hinted that it doesn't like mandatory arbitration. In June the Treasury Department called on the Securities and Exchange Commission to look at whether investors should have the option of going to court. Being able to threaten a lawsuit could give you extra leverage.
The White House is also talking about doing more to regulate brokers' compensation, as well as holding brokers to a "fiduciary" standard. That means they'd have to put your interests ahead of their own financial incentives. (Certified financial planners are already held to a fiduciary standard through their credentialing organization.)