CRASH OF '87: HOW THE SMALL INVESTOR GOT THE SHAFT
(MONEY Magazine) – It was always true, and everybody knew it, that professional investors had advantages that the little guy didn't -- access to better research, prompter execution of orders, lower commissions. But it wasn't until October's stock market crash that the small investor found out how much of a stepchild he is. He got clobbered, not only by plunging stock prices but by a system that discriminates against him. In particular, his broker, to whom he turned for help, proved to be an inconstant ally -- a bull market friend. Government regulators and securities industry officials are now going over the crash site looking for the black box. The North American Securities Administrators Association, or NASAA, an organization of state regulators, has set up a toll-free hotline (800-942-9022) to receive investor complaints about brokers. The brokers held their own postmortem at their annual convention last month in Boca Raton, Fla. Money talked to James C. Meyer, NASAA president and director of the Tennessee Securities Division, about what he has learned so far from the hotline. Money reporters were also on the scene in Boca Raton. What follows is a compendium of Meyer's observations, reports from Boca, horror stories from individual investors, gallows humor off late-night TV and other fragments from the crash.
Money: What kind of complaints are you getting? Meyer: There are many reports of brokers who took their phones off the hook, didn't return calls, were just inattentive to clients.
Ethel Grasso, 70, a Canoga Park, Calif. widow, had about $255,000 in her brokerage account before the crash. Normally, she spoke to her Shearson Lehman Bros. broker, Eric Book, or his assistant at least once a week. ''On Tuesday I called my broker to get advice on whether to sell some of my investments -- that is why I am paying a full-service broker instead of using a discounter,'' she says. ''The office told me he was out of town. I tried to get the branch manager. He hung up on me several times and when he finally called me back, he said my questions would have to wait until my broker got back.'' Grasso says Book did not return her call for a week. ''Then he tried to tell me that what I had lost was no big deal. To me, $45,000 is a big deal.'' A spokesman at Shearson's New York headquarters contends that Grasso was dealt with ''promptly and sympathetically.''
''When E.F. Hutton talks, people say, 'Go to hell.' '' -- Johnny Carson in his Tonight Show monologue on Oct. 20
David Arnold, 49, a Redmond, Wash. wholesale representative for a furniture manufacturer, is an active stock trader. He has accounts with full-service brokers Prudential-Bache and Smith Barney and also with discounter Charles Schwab & Co. Arnold was traveling on business when the market began falling on the morning of Oct. 19. Phoning from High Point, N.C., he reached his Prudential-Bache broker in Bellevue, Wash. without any difficulty and bought put options on the stock of software producer Microsoft Corp. -- a bet on a falling stock price that soon proved profitable. Arnold also made trades that day through his Smith Barney broker. But Arnold was stymied in his attempts to get through to Schwab. He wanted to sell the 400 shares of Sun Microsystems, a maker of computers for scientific and engineering use, that were in his Schwab account. ''I not only called the office where I have my account,'' he recalls. ''I had 800 numbers for Schwab in North Carolina, in the Northwest and two for the main office in San Francisco. I dialed all these steadily and got nothing but busy signals.'' For five days, Arnold tried to reach Schwab whenever he was near a phone. On Friday, while in Minneapolis, he finally got through. After Arnold spent an hour on hold, the Schwab employee who took his call said that problems with the firm's computers made it impossible to sell the stock. By then, Sun had fallen from $39 to $29 a share, and Arnold no longer wished to sell anyway. ''I am a big boy, and I am not crying about some bad days in the market,'' he says. ''But I am very angry that my liquidity was cut off.'' At Schwab headquarters in San Francisco, vice president of communications Hugo Quackenbush responded to Arnold's complaint and others like it: ''We apologize to the people who suffered through this.'' He explained that the volume of calls -- three times as many as on a normal day -- and their length overloaded the firm's telephone system. Quackenbush says plans to install new technology have been speeded up and that added capacity may be in place by mid-1988.
Money: Do people who managed to talk to their broker have grievances? Meyer: Many sellers say the prices they got were much lower than those their brokers quoted when they placed the orders. The firms say that stocks fell so fast, they weren't able to fill orders at quoted prices, but many investors believe trades were delayed.
Worried by the big market drop on the previous Friday, William Porter, 47, a Seattle real estate appraiser, called his broker before the market opened on Black Monday to put in an order to sell his 1,500 shares of Microsoft. Though Microsoft opened at $61.25, Porter's shares were sold several hours later at $45 -- a difference of some $24,000. Porter's discount brokerage firm, Fidelity, says that the delay stemmed from trading problems common that day in the over-the-counter market. The firm sold Porter's holdings, it says, as soon as it could. Porter refuses to accept Fidelity's explanation; he thinks the firm sidetracked his order while others were executed. ''I feel like I was stepped on,'' says Porter.
Money: Did big insitutional investors get their trades executed first? Meyer: Experience tells you that large investors are treated differently -- they have greater access to the markets.
''One of the lessons of Oct. 19 may be that large investors clean up when the market is on the rise, but the small investor gets cleaned out when the market goes into that kind of rapid decline.'' -- Democratic Representative Edward Markey of Massachusetts, chairman of the House subcommittee overseeing the securities industry
The mood at the Security Industry Association's annual three-day convention at the posh Boca Raton Hotel & Club was, frankly, worried. Brokerage executives were worried about the market outlook. Worried about the value of their own investments. And worried about their jobs. Wendy Tishman, a broker who moved to Boca just after the crash, wished she had a job to worry about. ''I called every brokerage firm in this area looking for a position, and most of them just laughed,'' says Tishman. ''They said: 'We're firing people, not hiring.' '' Lisa Benson, a local photographer hired by the SIA to cover the proceedings, says the partying was subdued compared with previous years when ''yachts lined up like sardines along the marina and hotel suites were so jam-packed that people spilled out into the hallways.'' This year, with attendance down to 875 from 1,020 in 1986, neither the official meetings nor the parties afterward were filled to capacity. Tom O'Brien notes that business was slow too at the hotel's poolside cafe where he tends bar. SIA conventioneers tippled and tipped a lot less this year, says O'Brien.
''We firmly believe most individuals should avoid market timing. Few individual investors have the time, resources and temperament to market-time successfully.'' -- from an ad placed in 12 newspapers between Oct. 25 and Nov. 1 by Fidelity Investments, the nation's premier mass marketer of mutual funds, and the group that introduced hourly quotes on sector-fund tote boards in some of its investor centers. Now you tell us.
Money: We understand you are hearing about brokers steering customers into inappropriately risky investments. Meyer: Yes, the worst cases involve options. People who are retired or disabled were urged to invest in options and to use margin accounts, and the crash wiped them out.
Money: How does this happen? Meyer: Let's face it, broker compensation is based on the volume of transactions. If a broker can talk customers into an investment where they will do a lot of trading, the broker makes money.
A retiree in Gulf Shores, Ala. who says he was wiped out by his broker's mismanagement of his account, has asked Money not to use his name. His reason, hard as it may be to believe: he is afraid people will figure out who the broker is, and he wants to protect the man's privacy. When the market crashed, the retiree says: ''I thought I might have lost a little, a couple of thousand at most.'' But on Wednesday, Oct. 21, his broker came to his house. He told the retiree and his wife that they had lost $100,000 and owed the brokerage firm $72,000. ''The guy started to cry,'' he recalls, ''and I felt so sorry for him that I did not realize until the next day that they had sold my stocks and I wouldn't get any more dividends.'' The retiree had a friend look at his most recent brokerage statement, and the friend told him he had been selling naked options -- one of the diciest forms of speculation. The retiree says he never heard anything about options from his broker and that he still doesn't really understand them. With their $7,000 in annual dividends gone, the retiree and his wife will now have to rely mostly on Social Security.
In recent years, according to New York City securities attorney Stuart Goldberg, brokers have increasingly tried to lure older investors into unsuitable investments. ''Firms have converted their offices into casinos and urged the elderly to go wild with options,'' he says. In a brief that Goldberg has filed in a case up for arbitration, he gives a client's description of such a ''casino'' in Florida: ''The office contains a large room with about 50 customer seats set up in front of 'the snake' -- the automatic price board. At the rear of the room, there is a buffet-style table always well stocked with coffee, tea, assorted pastries, sandwiches and hard liquor. Occupying the customer seats are a large number of retired people who find this a nice setting in which to pass the day. Friendly brokers are always willing to tell about the latest pick of one of their customers who is 'a good picker who never lost money.' One of the brokers describes options as 'a good way of making easy money. . .' ''
''I often have students in my ethics course who have worked a couple of years on Wall Street. In class discussions, they tell me: 'In the real world, you get away with what you can.' '' -- Thomas W. Dunfee, who teaches M.B.A. candidates at the University of Pennsylvania's Wharton School, in a speech to the SIA convention
Investors who were unable to reach their brokers during the crash probably think their financial advisers wouldn't have the nerve to call them now. But they would be wrong. At the brokerage industry's convention in Boca, SIA general manager Adrian Banky reported that at some firms management is directing ''virtually every broker to call virtually every account.'' The calls would be aimed at re-establishing the broker-client relationship. But investors may be forgiven for remaining skeptical since Banky also noted that some of the firms are furnishing brokers with ''daily sales ideas.''
''I ran into my stockbroker today. I couldn't help it -- he threw himself in front of my car.'' -- Johnny Carson in his Oct. 20 monologue
BOX: Help RECOURSE FOR THE BURNED INVESTOR
Some good could come of the crash and the special problems it caused small investors: brokerage customers could win the right to sue. Last June, the U.S. Supreme Court ruled that investors are barred from filing such lawsuits if they have signed agreements to submit all disputes to arbitration (Money, July 1987). Most brokerage firms include such clauses in the document you sign when you open an account. The House and Senate are still holding hearings on the crash, and Capitol Hill handicappers believe there is an even chance that a bill will pass reversing the Supreme Court decision. Such a reversal will probably come too late to help those with complaints stemming from the crash. Their only recourse is arbitration, and investors seeking arbitration have already increased by more than 50%. But the deck tends to be stacked against a complainant in such proceedings. He does not, for example, have the same rights to dig out the facts that he would have in court; he sometimes can't force the brokerage firm to produce necessary documents. Worse, panels are not always impartial. So-called public members, who are supposed to have no ties to the industry, sometimes include spouses of industry executives and retired industry officials. Even when they rule for the investor (about half the time), arbitration panels rarely award the full amount of his loss and almost never add punitive damages. The Securities and Exchange Commission has already proposed voluntary reforms to improve investor rights. Yet even under the present rules, arbitration is better than suing in some cases. Going to court, according to securities lawyers, makes sense only when an investor hopes to recover $100,000 or more. To initiate an arbitration proceeding, an aggrieved investor should file a notice with one of three arbitration groups, preferably with the assistance of an attorney. The three groups are the New York Stock Exchange, the National Association of Securities Dealers and the American Arbitration Association. You may or may not have a choice among them, depending on the agreement that you signed. If you do have a choice, Orlando, Fla. attorney Robert Dyer advises choosing the American Arbitration Association. He believes it's the likeliest to assemble an objective panel. The best time to protect yourself, however, is when you are opening a brokerage account. Dyer counsels that you rewrite the arbitration clause in the brokerage agreement to indicate that you have the right to AAA arbitration as well as the right to sue -- and then initial the change. ''If the firm will not accept your account on that basis,'' he advises, ''find one that will.''
BOX: Consumer Comfort Poll HUNKERING DOWN
The bad news emanating from Wall Street did not exactly cheer up consumers. The Money/ABC Consumer Comfort index stood at -14 last month, down from a -4 in early October. Forty-three percent of those polled said they have reduced their spending plans for the months ahead.
The index is derived from the response of 1,000 randomly selected adults to three questions about public and personal finances in telephone polls taken over the five weeks through Dec. 6.
Year ago -11
Index on a scale of -100 to +100