Mary's story
Seventy-four-year-old Mary W. took all she had saved over a fifty-year teaching career and invested it with a friendly local brokerage firm. The firm was small, and therefore could offer her the prompt personalized service she desired. She did receive individualized attention, and much, much more. The stockbroker placed Mary in a stock whose company he happened to consult for. Unfortunately, the friendly broker neglected to disclose this glaring conflict of interest. Of course, the stock was entirely unsuitable for his elderly client. By even the laxest of standards, her stated and written investing objectives were clearly unmet, although she was treated in a very personalized way. The company went under surprisingly quickly, and Mary lost almost all of her life savings. Not surprisingly, the brokerage firm went under shortly thereafter. In a better world, Mary would have been able to bring the stockbroker and the brokerage firm to arbitration and, perhaps, recover some or most of her lost money. Unfortunately, Mary learned that defunct brokerage firms have no assets. She also learned that the stockbroker had no assets, and had hastily left the industry for greener pastures, without even sending her a friendly postcard. Of course, Mary would likely have won in an arbitration against them; few within or outside the industry would have failed to see the obvious breaches of professionalism evident here or to remain unmoved by Mary's plight. Sadly, she would have obtained a judgment suitable for framing, but not much else.

Brokerage firms are going under in record number; how it will affect you.
Recent years have seen brokerage firms going out of business in record numbers, leaving investors bewildered and without recourse. Often, it is only after the firm has gone out of business that investors discovers that they have been victims of fraud. This fraud can include such things as the mismanagement of the account, unauthorized trading, overtrading the account, or breach of fiduciary duty. Many investors think that, even if the firm goes out of business, they will be able to recover from the firm's malpractice insurance policy or from SIPC or the NASD. Indeed, brokerage firms list their SIPC and NASD membership on their letterhead and account statements like a badge of honor.

What does membership in those organizations really mean?
SIPC, or the Securities Investors Protection Corporation, was authorized by an act of Congress. The board of directors of SIPC is chosen by the President of the United States, the Secretary of the Treasury, and the Federal Reserve Board. The purpose of SIPC is to provide protection to investors in the event that a brokerage firm goes out of business. With a reasonably high-powered group of people behind it, you might guess that someone in this organization could help Mary. Well, guess again. SIPC will only protect an investor if the brokerage firm has stolen an investor's stock certificates or money. Then SIPC will replace the stock certificates or refund the stolen funds. However, consider this situation: on Monday, the stockbroker purchases a stock without an investor's authorization. It is worth $20 per share, but on Tuesday it is worth only one dollar. If on Wednesday the brokerage firm goes out of business and a broker steals that stock certificate, SIPC will replace it. Unfortunately, the stock certificate is now worth one dollar and that is all the investor will recover. SIPC will not reimburse the investor for the $19 lost from the unauthorized trade made by the stockbroker. Further, most investors do not realize that SIPC is not a government agency, but a non-profit organization funded by the brokerage firms who are its members.

SIPC is therefore not what Mary needs to recover her life savings. She could turn to the NASD, but the NASD has a limited role as well. "NASD" stands for the National Association of Securities Dealers. Like SIPC, it is not a government agency, but rather an organization made up of brokerage firms. It self-polices the brokerage industry, and is in charge of an arbitration program. The NASD has an enforcement division that can bar a brokerage firm and a stockbroker from the securities industry. This may be done if either fails to pay an arbitration award, for example. However, since bankrupt firms are unable to participate in the securities industry anyway, the NASD really can't affect them by barring them from it. Obviously then, if the firm is in bankruptcy or otherwise out of business, the NASD cannot help the investor.

A government report filed by the General Accounting Office found that in 1998 eighty percent of the investors who won arbitration awards were not paid, or were paid only a percentage of what they were awarded. This report noted that out of the 161 million dollars that arbitrators awarded investors, 129 million dollars were uncollected by these investors. The reason for these uncollected awards was that the brokerage firms had either gone out of business, were in bankruptcy, or were undercapitalized and could not pay the award. These numbers did not include investors who settled their cases prior to an arbitration hearing and were paid by the brokerage firm as part of that settlement.

Most investors sign arbitration agreements when they open brokerage accounts. Arbitration, therefore, is generally the only legal recourse one has against a brokerage firm. When one considers that only fifty percent of investors win NASD arbitrations, and that, out of that fifty percent, the arbitrators award only about fifty percent of the amount requested by the investor, one realizes the situation is not good for the investor. Why are so many NASD arbitration awards uncollectible? It may be because these firms are undercapitalized. It could also be that almost anyone can open up a brokerage firm. The NASD allows anyone to open a brokerage firm with a minimum of $5,000, depending upon the type of brokerage firm being opened. Malpractice insurance is currently set at from $25,000 to $500,000 depending upon the size of the firm, but if a brokerage firm has several claims against it, that amount vaporizes in a heartbeat. Arbitration attorneys have suggested several different solutions to the problems arising when brokerage firms fail to pay arbitration awards. First, it has been suggested that unpaid arbitration awards could be paid by the SIPC fund if Congress changed the SIPC Act; second, that the NASD could establish a separate fund to pay these unpaid awards; third, that the NASD could increase the amount of capital that brokerage firms are required to have in order to open a brokerage firm; and fourth, that the NASD could require additional bonding or insurance to cover malpractice claims.

So what is an investor to do?
Until Congress passes an act which deals with this problem, or the brokerage industry finds a way to protect investors from firms that go out of business, investors have to be extremely careful regarding which brokerage firm they do business with. Remember, if a large brokerage firm defrauds you, and you sue them and win, you will be able to collect the award. With a small or unknown brokerage firm, you do not know if they will have the funds to pay the award. Although currently there is no public information indicating if a brokerage firm has unpaid arbitration awards, an investor can find out if a brokerage firm or a stockbroker has a disciplinary history. An investor can telephone the NASD at (800) 289-9999 or the investor's States Securities Commission to find out about the disciplinary history of the brokerage firm or stockbroker. Also, an investor can perform an online search by going to the NASD website at NASDR.com.